Tuesday, March 3, 2015

Why focus on equities?

You can generate much larger and outsized returns with minimal riskusing arbitrage strategies. There are several arbitrage opportunities available to investors in warrants, Rights, Options, Futures & forwards to name a few. These are typically wonderful opportunities especially if the capital you are running is small. The annualized returns from these can be much larger than buy and hold on good companies. So then why should you even look at at equities?

The downside is that they suck up lots of your time and many a times require some special infrastructure like database subscriptions and technological infrastructure like servers and software. For example statistical arbitrage may generate massive returns at a very low risk – and several money managers use it but the initial investment required in the servers, hardware and software would be in the millions of dollars.

Another downside is that opportunities show up in various places and are not always available. You need to be constantly on the lookout in several nooks and corners. Overall this is a wonderful area of value investing but needs you to do this at scale with large teams.

Even bonds are typically fixed term and to generate large outsized returns you either need to use lots of leverage or repeatedly find opportunities that provide returns much larger than the risk taken. Bonds can also be very illiquid and might need large amounts of capital to trade.

Publicly listed equities (on Dalal Street, wall street, or any other exchanges) provide several advantages over the rest. The capital required for an equities portfolio can be very small and very big. The liquidity of the securities is large and you can generate good returns without the use of leverage. It is the only strategy in which once you have found a continuous compounding company at a good price it can generate wonderful returns for you for decades. This is the reason why Berkshire has been able to hold on to wonderful businesses for years.