Pokfulam Investments has developed a unique investment process based on new research in equity analysis and forecasting. This allows them to reduce costs, increase performance consistency, and gain a competitive advantage. The process is based on doctoral work and has achieved excess returns of up to 20% annually in various markets. Pokfulam plans to expand the process globally over the next 7-10 years. The key aspects of the process are a new way of quantifying capital gain expectations, risk measurement, and understanding the impact of dividends on pricing.
Pokfulam investments:A Model of Equity Market Pricing
1.
2. The Investment Proposition
Pokfulam Investments has developed a unique investment process based on a major advancement in
the way that equities are analysed, managed and forecast. This substantially changes the business
model of funds management, reducing costs, increasing consistency of performance and creating
demonstrable competitive advantage.
The process is based on doctoral work done at Macquarie Graduate School of Management and
applied in practice.
Excess returns in S-E Asia approached 20%pa from 1997-2000, and 6.5%pa for a market neutral fund
in the Australian market from 2009-2012.
A long-only ASX200, absolute return fund is the first step in a process that is expected to extend to S-
E Asia within 2 years, followed by the UK, continental Europe and the US within 7-10 years. Initial
investment is in FUM, with equity allocation in the company on expansion.
3. The Investment Proposition cont’d
The Biggest Changes: Quantification and inclusion of Capital Gain Expectations and
Measurement of Risk.
Risk can’t be measured without a workable model of market pricing (Fama (1965), (1991)): i.e. a
model that explains both a high percentage of variation in, and absolute levels of, market pricing.
Slide 10 shows estimates of the ASX200 Equity Risk Premium based on the model highlighted in
Slide 9.
The Biggest Difference from Convention: Dividends (Slide 11) and their effect on Capital Gain
Expectations in prices.
4. The Investment Proposition cont’d
Industry can be very slow to adopt practical change.
DCF proposed in the 1930’s: not widely adopted until the late‘80s
Modigliani & Miller won Nobel Prize in 1985 for Dividend Irrelevancy, yet 55 years
after publication, not fully accepted (we’ve disproved it).
Campbell & Schiller proved that the DDM doesn’t explain market pricing, yet it is
still used, and implications haven’t been further developed after 28 years.
By investing in a new academic development, there is a potentially long period of competitive
advantage and commercial gain.
5. Current Industry Position
“…there is as yet no general model of price formation in the stock market which explains price levels and distribution of
price changes in terms of the behaviour of more basic economic variables” Fama (1965 )p 99; and
“Market efficiency per se is not testable. It must be tested jointly with some model of equilibrium, an asset-pricing
model.” Fama (1991) pp 1575-6.
There is REAL QUESTIONING of the ability to consistently beat the market by professionals(Barber, Lehavy, McNichols and
Trueman (2001), Crichfield, Dychman and Lakonishok (1978), Diefenbach (1972), Fried and Givoly (1982), Jacob, Lys and Neale
(1999), etc. This is consistent with, and caused by, the absence of an effective model and highlights the problems for the industry.
An analogous comparison can be made between predicting stock market pricing and predicting the weather. Unfortunately, despite
academic study of markets since 1930, we have barely moved beyond the equivalent of “it may be sunny” or “maybe it will be cloudy”.
We should be in a position to do the financial equivalent of predicting max and min temperatures; rain and how much; hail and/or snow;
when a typhoon/cyclone is coming and why; and what specifically is producing these phenomena.
This is what the Pockfulam Investment process achieves in practice.
Why? The most important issue: Stocks are NOT Companies (at least, from a valuation and/or market pricing perspective)
6. There is no Empirical Evidence For ANY
Existing Market Pricing Model
Amazingly, there is almost no published empirical testing of any link between fundamental
pricing models and actual market pricing (stated as required by Fama (1965), (1991) for effective
understanding of markets ).
One known exception in the Australian market is unpublished work by Macquarie Bank which
suggested during 11 years of testing, DCF failed to explain more than 50% of variation in market
prising variability (based on month-end closes for the ASX200), nor absolute price levels: the
equivalent of a house pricing model that explains half of the changes in house prices, but can’t
tell you if the house is worth $500k or $2m.
There is no widely accepted empirical evidence on the relationship between specific fundamental
or quantitative models and either market volatility or absolute pricing levels.
7. The Market Pricing Questions Yet to be
Answered……
Financial assets are worth the Net Present Value of Returns Expected by the market (Malkiel and
Cragg (1970)).
Inputs are: Market expected returns, Determinants of those expectations, Interest rates, Risk
premium, Period of inputs being discounted.
Key questions are currently unanswered by either academia or practitioners:
What returns are expected by the market, and how are they determined? Do prices reflect expectations
of capital gains as well as dividends?
What is the risk associated with investing now, and how is that determined? (the use of long-term
averages suggest that pricing is largely irrational),
How far forward is the market looking in setting prices?
Are those expected returns and associated risks valid or not, and if not, what should they be given past
pricing behaviour?
8. The Investment Process
What returns? MUST BE dividends + capital gains. But NO PUBLISHED WORK on capital gain
expectations and pricing. ONLY when expected returns can be fixed can risk be measured
and analysed.
If NPV of Expected Returns cannot explain market behaviour, markets cannot be rational, and must
therefore be unpredictable, leaving the equity industry no raison d’etre.
Assumptions required for quant methods are invalid: efficient markets (Fama (1991)); beta.
We have developed fundamental methods to systematically measure risk pricing by markets at index and
stock levels.
In addition, there are findings on the pricing of dividends not previously identified.
These have allowed us to explain and predict capital gain expectations in price.
These issues combine to let us explain and predict Index pricing in the medium term.
To achieve absolute returns, there must be a basis for both market and stock valuation.
9. ASX200 v Model: ‘92-Present
Market Model line and Actual Market
Pricing has Regression Coefficient of
0.86 (86% explanation).
Modest recovery in EPS growth from
low current levels, plus continued low
interest rates for 2 yrs.
Risk will fall modestly.
Mkt POR will stay at approx. 70%
Valuations will expand further.
Renewed inflation is the primary
threat, but unlikely without substantial
policy change.
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PERx
Model PER Mkt PER
ASX200 PER v Model PER Forecast
10. Risk is Ignored Variable
Measuring risk at a point-in-
time has been considered
effectively impossible.
L-t average excess returns
don’t change: IMPRACTICAL
PI process reflects current
analysis and projections of risk,
returns and pricing.
0%
2%
4%
6%
8%
10%
12%
14%
0%
2%
4%
6%
8%
10%
12%
14%
ASX200 RISK PREMIUMS
CALCULATED V ESTIMATED
Est'd Premium Calc'd Premium
11. Dividends DO Matter
In 1961, Modigliani & Miller
proposed Dividend Irrelevancy
Theorem
PI findings suggest that this is
false, and why.
Data proves it, as does
“conventional wisdom”: stocks
tend to move when POR
changes.
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23.0
30.0%
35.0%
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45.0%
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60.0%
65.0%
70.0%
75.0%
80.0%
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ASX200 POR v P/E
Index POR
Mkt P/E
12. Pricing at Stock Level
Index level results suggest consistent pricing model for markets and stocks.
Similar inputs apply to stocks as well as markets with the exception of market-relative risk factors.
Timing has been added to the process: stocks are selected according to value + price
momentum to maximise returns.
13. Measuring Stock Risk is complex
We use a complex mixture of data on each stock to estimate value over next 12 months and continually
roll that forward. At any point-in-time, we have a 12 month+ view.
Key factors for measuring investment risk of individual stocks indicated by market prices, in descending
order of importance, are:
Business Exposures Historical EPS Growth
Price to Book Forecast Confidence
Return on Equity Debt/Equity
Size Interest Cover
Short Term Market Sentiment EPS Stability
Quality of Earnings Current Ratio
Liquidity Price Volatility
Cash Flow/EPS
14. Findings Apply to Most Global Markets
Australia
Hong Kong, Singapore, Malaysia, Thailand, Indonesia, Philippines
United Kingdom
France, Germany, Netherlands, Italy, Norway, Switzerland, etc.
United States
Exceptions are Japan, South Korea and Taiwan due to non-consolidated accounts
Work still to be done on China and India
17. Invest NOW in a Potential Global Business
Fundamental findings form the basis of a potential global business.
None of the key features of the Process have been identified previously.
Implementation to date has produced strong results in both Asia and Australia.
Publication of results has been avoided to protect intellectual property.
Process enables low-cost/high value-add operation in contrast to convention.
18. Invest NOW in a Potential Global Business
For more information contact
Peter Rice at
peter@pokfulaminvestments.com
+61 451177749