value and opportunity

Last year I had a couple of posts about the (in)famous Greek GDP linker (introduction, valuation approach) a result of the “restructuring” of Greek debt last year.

I concluded that the security is fundamentally worthless and criticised in August 2012 a post by FT’s John Dizzard recommending the linker at 33 cents. In the last few weeks and months, I recognized increasing clicks on my old articles and I even got an Email from a UK based hedge fund manager asking for the prospectus.

So its time to look at the score between me and the FT since I wrote that post:

Holy cow !!! The price of this security tripled since I made fun of the FT. guy, so I would say 3 for the FT, nil for me.

First lesson learned: I was clearly wrong on that one for the time being. If you followed the FTs advise, you made big bucks in only a year. if you have followed my advice you made nothing.

So whenever I see one of my analysis going wrong so horrible, I keep asking myself: Was I wrong or ist the market (price) wrong ?

Let’s go back to the fundamental analysis and see if something has changed to the better in the meantime ?

Well, the Greek stock exchange doubled, but as we know for the analysis, for the GDP linker the only two things that count are: Nominal value of GDP and GDP growth rates. Let’s look at the hardest hurdle which in my opinion is nominal GDP.

Those are the levels of nominal GDP required to get a single cent out of this security:

year	nominal GDP	yoy
2014	210.1
2015	217.9	3.71%
2016	226.4	3.90%
2017	235.7	4.11%
2018	245.5	4.16%
2019	255.9	4.24%
2020	266.47	4.13%
therafter	266.47	0.00%

So again, let’s go to the original Greek statistics website and do a quick update on Greek GDP including 2012:

Year	GDP
2000	136,281
2001	146,428
2002	156,615
2003	172,431
2004	185,266
2005	193,050
2006	208,622
2007	223,160
2008*	233,198
2009*	231,081
2010*	222,151
2011*	208,532
2012*	193,749

So we can clearly see that nominal GDP decreased quite dramatically. For 2013 it doesn’t seem to get much better. If we look at the last quarter, we can see that in Q1, Greek GDP decreased ~ 7% on market prices basis.

So lets just assume that things pick up in the rest of the year and the Greek GDP shrinks only by -5%. That would leave us with a GDP of around 184 bn. Now we can easily calculate what kind of compound annual growth rates (CAGR) Greece needs in order for the GDP linker to “jump” the nominal GDP hurdle:

	Hurdle	Actual	CAGR required
2013		184
2014	210.1		14.2%
2015	217.9		8.82%
2016	226.4		7.16%
2017	235.7		6.39%
2018	245.5		5.94%
2019	255.9		5.65%
2020	266.47		5.43%

This table can be read as follows: In order to hit the GDP hurdle in 2014 (and receive money in 2015), Greek GDP has to rise 14% in 2014. Or: in order to hit the hurdle in 2015 (and get paid in 2016), the Greek GDP has to have a compound growth rate of 8.8% in 2014 and 2015.

Now it is clearly open to discussion how likely that is. I would however argue fundamentally this is more or less impossible because Greek is under a lot of deflationary pressure.

So the fundamental outlook didn’t really improve from last year, but why the hell did the linker trade up so much ?

I have a few explanations:

a) The linker looks optically cheap. It “officially” trades at 1.1% of nominal value, so for many investors that means it trades “for almost nothing”. In the post last year I mentioned, that the quotation is highly misleading. As the maximum cash (undiscounted) you get is around 18% of the stated “nominal”, the linker is in fact trading rather at 1.2/18= 6.7% of nominal, not adjusting for coupons. So still “cheap” but not so cheap as some investors think.

b) Argentinian experience: Argentinian GDP linker have been a very good investment. However part of that was that Argentina could inflate its economy because they have their own currency. Greece can not inflate in EUR, instead they have to deflate salaries, costs etc. This is fundamentally different to Argentina.

c) People are betting on some kind of Greek recovery and use the GDP linker as a levered proxy for a Greek recovery without really understanding it.

Of course, my fundamental analysis could be all wrong and I missed something. However I woudl need to read something fundamentally justified to accept this. If someone knows something about such a piece of research, please let me know !!!

Summary (and implications for value investing):

I was clearly wrong about the future price of the GDP linker last year. However I am still convinced that I am right on the ultimate “value” of this GDP linker which is close to zero. So one could see this as a weakness of the “value investing” approach because I never consider that someone might pay a higher price despite the value of this security being close to zero.

And clearly, as a value investor you rarely share in “speculative gains” but on the other hand, you also avoid many speculative losses if you really stick to your strategy.

This is also one of the biggest mistakes (and one of the hardest parts of the startegy) I see with some value investors: It is really hard to resist the urge to “speculate” at some point in time. Our mind often plays tricks on us that we can recall great trades much easier than bad trades. But i think that mixing in speculations (investments not based on intrinsic value but based on the hope that someone buys it even more expensive) into a value investing strategy might be the biggest “detractor” for a superior long term performance.

For every GDP linker you miss out as a value investor, you also miss out a couple of “bad trades” and in my experience the balance of those missed out trades is negative (or positive for your performance) over the cycle.

There are clearly people who are great “speculators” and got rich with that (Soros & Co), but for every successful speculator, there is a large graveyard of bankrupt losers. Whereas I don’t know that many bankrupt value investors…..