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January 4, 2017

Indexers Are Running Amok…

So, this should be pretty easy to sort out. Crawford & Co has two classes of stock, A and B. The A shares pay a dividend that is 2 cents a quarter higher than the B shares. There are differences in voting rights, but as there’s a control shareholder, those are irrelevant. Therefore, a simple analysis says that the A shares ought to trade at a moderate premium to the B shares to account for the nearly 1% higher annual dividend yield. NOPE!! The B shares are in the Russell 2000 index and the B shares now trade at roughly a 35% premium to the A shares.

Now, I’m not here to pass judgement on the investment merits of Crawford and the A or B shares. I have done no analysis on the company and have no opinion on if it is a good investment or not. However, I know that the A shares are better than the B shares as you get a higher dividend and there is no logical reason for the B shares to trade at a huge premium except that the Russell 2000 index has to keep buying them as more money is allocated to the index.

Two years ago, I noted how index funds and ETFs were warping asset valuations and creating opportunities for those who were willing to seek them out. This trend has only accelerated since then and has grown from something of a curiosity in certain asset classes into a true bubble that is doomed to eventually pop. There are now hordes of overvalued assets that have no justification for their overvaluation, except that index funds have to own them. Like all bubbles, this one too will burst.

In the interim, there will be huge opportunities created by how index funds misallocate capital. As I said earlier, I know nothing about Crawford, but if I wanted to own it, I sure as hell wouldn’t be buying the B shares when compared to the A shares. Additionally, I feel pretty confident in saying that at some point in my career, the A shares will trade at a premium to the B shares—as they deserve to. At the same time, I wouldn’t be betting that this spread collapses any time soon either. Shorting indexing has been a widow-maker for many in the hedge fund industry—it’s hard to fight against fund flows. In finance, when a trend gets in motion and the marketers start pushing it (indexing and ETFs today) you can expect it to go further than is logically possible, but the hangover will be pretty epic. Along the way, there will be a lot of money made by better understanding the flaws in these indexes and front running them—much as I front-ran the marketing department back in March.

As a final note, I’d like to share a chart with you from Passport Capital showing the median total returns of markets graduating to the MSCI EM since 1994. If you can’t beat the indexers, you might as well make money off of them by getting there first.

There will be more posts on this topic as it is a fertile place for opportunities.


Disclosure: No positions In CRD/A or CRD/B

Categories: Comments On Events
Positions Mentioned: none

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