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12 May 2024

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Investment 101 and the greatest risk in investing

I have been trying to correct some basic investment misunderstandings, apparently with little success. Here are three lessons in Investment 101.

Three incorrect assertions

Some people interpret:

1. Shorting Tesla as being against the amazing Elon Musk, against Green, against innovation.

Lesson 1: A great firm with a great leaders and great products - so long as these are understood by the market and priced in - will deliver a fair return only. To drive great returns, the firm must surprise the market with even more amazing products. Empirically, storied firms tend to be priced for perfection. The market expects the impossible and the forward returns tend to be poor. It's not because the company becomes bad but because the current price has baked in unreasonable growth and profitability assumptions.

2. Underweighting US as anti-American values, betting against US ingenuity, disapproving all that is wonderful about US and its contribution to global prosperity.

Lesson 2: While prices may not be rational, they do reflect consensus. If your views and information are similar to consensus, that's not a bad thing. It just means you read similar information and analysis as other market participants and then your views cannot be predictive of better future returns. For example, we can agree that the US economy is wonderful and that China has a lot of issues. That this is obvious means prices reflect this consensus. Indeed US valuation has been 50% more expensive than China. China's equity performance relative to the US will not be determined by the consensus that China isn't a democracy with checks and balances. It will be determined by whether the US proves to be infallible and China remains as bad and incompetent as headlines have sold it.

3. Diversifying into China as supporting the CCP, favoring autocracy as a political system, ignoring obvious risks posed by China's political agenda, ignorant of China's slowing down.

Lesson 3: Investment risk is not related to an investor's familiarity or comfort with an asset. A tech executive investing in a tech stock doesn't make that stock less risky to him. American's home country bias doesn't make US stocks less risky to US investors. Familiarity and comfort tend to cause people to underestimate the true risk. That overconfidence is far riskier. Having access to Bloomberg, to broker research and CNN doesn't make your portfolios safer. It makes you overconfident and liable to ignore the unknown unknowns. It makes you confuse priced common knowledge as if they are unique insights that give you an edge in forecasting stock prices.

Is your view already a consensus and priced in?

Despite the best efforts of almost every investment book, many investors, including those that manage money professionally, continue to confuse a good company or country with a good investment.

So what is the greatest risk in investing? It is in not understanding that your fears and insights are common and already priced in, or already over-priced.

 

Jason Hsu is Founder and CIO at Rayliant Global Advisors and Portfolio Manager of Rayliant ETFs. Republished with permission from the author’s LinkedIn newsletter, The Bridge.

 

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