The age-old debate between active and passive investing hinges on the efficient market hypothesis (EMH); this is where asset prices reflect all information and consistent outperformance on a risk-adjusted basis (alpha) is not possible. This is then split into 3 main forms of EMH
1. Lack of analyst coverage
Companies which are less well-covered by stock analysts could be mispriced in the market as a result of the lack of public and private information flowing through to the market price. The lack of analyst interest could stem from the low trading volume, implying a lower amount of trading commissions can be earned from transactions in the stock. Even as such companies release information, there may be insufficient market participants and fund flows to correctly price the stock.
2. Lack of liquidity
The gradual shift towards passive investing could also lead to a bifurcation between index-linked/ETF-tracked stocks and smaller, less-liquid stocks that fall through the cracks. Such small-mid cap stocks could potentially be mispriced as a result of the low liquidity. The reason for this exception is also quite similar to the one above where the lack of liquidity prevents the stock from finding an 'equilibrium'/correct market price.
3. Imperfect flow of information
For developing market economies where disclosure standards are less stringent compared to the US, the ability to extract alpha from equity investments highly depends on the amount of research and work put in by the fund manager. An example could be channel checks, where the fund manager speaks directly to the management of companies they invest in and also their industry peers. On the SGX, one example would be Eagle Hospitality Trust, which did not disclose certain interested party transactions as a result of the lack of such requirements.
MAS and SGX were aware of such issues plaguing small-mid cap firms and hence launched the Grant for Equity Markets Singapore (GEMS) to help enhance coverage of small-mid cap stocks as well as to help defray some of the listing costs. It was hoped that more research coverage would lead to greater awareness about certain stocks and in turn lead to greater trading liquidity and hence a more efficient market.
For investors, the inefficiencies could imply that there are opportunities for alpha generation, especially for smaller and less liquid stocks. However, due to the nature of such stocks, there may also be less information available publicly hence a high level of due diligence is required before taking the plunge. As the saying goes, high risk high return.
Some stocks I am keeping track of are: Uni-Asia, Centurion, BRC, HRNet, PropNex, Fuyu
- Weak form - This suggests that stock prices reflect past pricing data and that technical analysis cannot be used to generate consistent risk-adjusted outperformance. On the other hand, fundamental analysis could be used to find under or overvalued stocks.
- Semi-strong form - This suggests that all public information is reflected in a stock's price and neither technical nor fundamental analysis can be used to achieve alpha. Private information can be used to generate alpha.
- Strong form - This suggests that all information (public and private) is reflected in a stock's current price and there is no way to achieve returns greater than the market return.
1. Lack of analyst coverage
Companies which are less well-covered by stock analysts could be mispriced in the market as a result of the lack of public and private information flowing through to the market price. The lack of analyst interest could stem from the low trading volume, implying a lower amount of trading commissions can be earned from transactions in the stock. Even as such companies release information, there may be insufficient market participants and fund flows to correctly price the stock.
2. Lack of liquidity
The gradual shift towards passive investing could also lead to a bifurcation between index-linked/ETF-tracked stocks and smaller, less-liquid stocks that fall through the cracks. Such small-mid cap stocks could potentially be mispriced as a result of the low liquidity. The reason for this exception is also quite similar to the one above where the lack of liquidity prevents the stock from finding an 'equilibrium'/correct market price.
3. Imperfect flow of information
For developing market economies where disclosure standards are less stringent compared to the US, the ability to extract alpha from equity investments highly depends on the amount of research and work put in by the fund manager. An example could be channel checks, where the fund manager speaks directly to the management of companies they invest in and also their industry peers. On the SGX, one example would be Eagle Hospitality Trust, which did not disclose certain interested party transactions as a result of the lack of such requirements.
MAS and SGX were aware of such issues plaguing small-mid cap firms and hence launched the Grant for Equity Markets Singapore (GEMS) to help enhance coverage of small-mid cap stocks as well as to help defray some of the listing costs. It was hoped that more research coverage would lead to greater awareness about certain stocks and in turn lead to greater trading liquidity and hence a more efficient market.
For investors, the inefficiencies could imply that there are opportunities for alpha generation, especially for smaller and less liquid stocks. However, due to the nature of such stocks, there may also be less information available publicly hence a high level of due diligence is required before taking the plunge. As the saying goes, high risk high return.
Some stocks I am keeping track of are: Uni-Asia, Centurion, BRC, HRNet, PropNex, Fuyu
