“You better cut the pizza in four pieces because I’m not hungry enough to eat six.” —Yogi Berra
While the election dominated the national news, market watchers were also focused on a change to the way that the S&P 500 is constructed. Since 1999, the S&P 500 has been governed by the Global Industry Classification Standard (GICS), a system that essentially slices and dices the market into its component sectors and industries. This past September, GICS was changed for the first time since its creation to elevate “Real Estate” from its status as an Industry Group under the “Financials” heading to a starring role as its own Sector.
Common sense dictates that changing how an investment is “classified” should not change the value of the investment, just as cutting a pizza in four pieces rather than six doesn’t change how much pizza there is. However, as I am fond of saying, common sense is uncommon on Wall Street, and according to an article on REIT.com, the change in GICS is expected to result in “$30 billion to $100 billion in new capital coming into [real estate stocks], as equity funds that have been significantly underweight in real estate look to achieve a market-neutral position.”
That billions of dollars are expected to flow into REITs simply because of how they are “classified” is an excellent illustration of why so few investors are able to outperform the market over time. It should be obvious that the ultimate value of the real estate in question will be a function of the value of the cash flows that the properties can generate over their lifetimes, but billions of dollars are expected to ignore the cash flows, and jump into real estate stocks based on classification alone.
These are the people that I want to compete against in the investing world. They are so afraid of under-performing the market in the short term due to under-owning real estate versus the index that they are willing to completely abandon the most basic principles of valuation. Contrast this approach with our own style of ignoring the indexes while patiently digging through the hidden corners of the markets looking for true anomalies, and you will understand why I am confident in the future of our partnership.
The above post has been excerpted from a recent letter of Laughing Water Capital.
Disclaimer: This document, which is being provided on a confidential basis, shall not constitute an offer to sell or the solicitation of any offer to buy which may only be made at the time a qualified offeree receives a confidential private offering memorandum (“CPOM”) / confidential explanatory memorandum (“CEM”), which contains important information (including investment objective, policies, risk factors, fees, tax implications and relevant qualifications), and only in those jurisdictions where permitted by law. In the case of any inconsistency between the descriptions or terms in this document and the CPOM/CEM, the CPOM/CEM shall control. These securities shall not be offered or sold in any jurisdiction in which such offer, solicitation or sale would be unlawful until the requirements of the laws of such jurisdiction have been satisfied. This document is not intended for public use or distribution. While all the information prepared in this document is believed to be accurate, Laughing Water Capital, LP and LW Capital Management, LLC make no express warranty as to the completeness or accuracy, nor can they accept responsibility for errors appearing in the document. An investment in the fund/partnership is speculative and involves a high degree of risk. Opportunities for withdrawal/redemption and transferability of interests are restricted, so investors may not have access to capital when it is needed. There is no secondary market for the interests and none is expected to develop. The portfolio is under the sole trading authority of the general partner/investment manager. A portion of the trades executed may take place on non-U.S. exchanges. Leverage may be employed in the portfolio, which can make investment performance volatile. The portfolio is concentrated, which leads to increased volatility. An investor should not make an investment, unless it is prepared to lose all or a substantial portion of its investment. The fees and expenses charged in connection with this investment may be higher than the fees and expenses of other investment alternatives and may offset profits. There is no guarantee that the investment objective will be achieved. Moreover, the past performance of the investment team should not be construed as an indicator of future performance. Any projections, market outlooks or estimates in this document are forward-looking statements and are based upon certain assumptions. Other events which were not taken into account may occur and may significantly affect the returns or performance of the fund/partnership. Any projections, outlooks or assumptions should not be construed to be indicative of the actual events which will occur. The enclosed material is confidential and not to be reproduced or redistributed in whole or in part without the prior written consent of LW Capital Management, LLC. The information in this material is only current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Statements concerning financial market trends are based on current market conditions, which will fluctuate. Any statements of opinion constitute only current opinions of Laughing Water Capital LP, which are subject to change and which Laughing Water Capital LP does not undertake to update. Due to, among other things, the volatile nature of the markets, an investment in the fund/partnership may only be suitable for certain investors. Parties should independently investigate any investment strategy or manager, and should consult with qualified investment, legal and tax professionals before making any investment. The fund/partnership is not registered under the investment company act of 1940, as amended, in reliance on an exemption there under. Interests in the fund/partnership have not been registered under the securities act of 1933, as amended, or the securities laws of any state and are being offered and sold in reliance on exemptions from the registration requirements of said act and laws. The S&P 500 and Russell 2000 are indices of US equities. They are included for informational purposes only and may not be representative of the type of investments made by the fund.