The financial market is believed to be highly efficient. With the internet ushering in a well-connected world, and the knowledge of millions of investors helping to price financial assets, it is hard to find a mispriced situation in the market that can persist for a long time. However, the market is a man-made thing and like most man-made objects, it is not perfect. There are still some instances whereby a security can be mispriced relative to very similar securities for a very long time due to structural issues. Here are a few of them. 1. Trading…
The financial market is believed to be highly efficient. With the internet ushering in a well-connected world, and the knowledge of millions of investors helping to price financial assets, it is hard to find a mispriced situation in the market that can persist for a long time.
However, the market is a man-made thing and like most man-made objects, it is not perfect. There are still some instances whereby a security can be mispriced relative to very similar securities for a very long time due to structural issues.
Here are a few of them.
1. Trading Restrictions
Some markets tend to have certain trading restrictions imposed on them. The share market in Shanghai, China, for instance, is only open to domestic investors and some other qualified foreign investors.
With buying and selling unable to be done smoothly in Shanghai by foreign investors, a mispricing between the shares of dual-listed companies in Shanghai and other foreign shores (say Hong Kong or Singapore where there are no nationality- or geography-based trading restrictions) will likely persist for a very long time – perhaps indefinitely until Shanghai’s trading restrictions are removed.
2. General neglect
If a company is dual-listed in its home market and in Singapore for instance, there might be a chance that investors might neglect the company’s secondary-listing here, thus causing a persistent mispricing between the two.
One such example is that of Total Access Communication (SGX: B2W), more commonly known as DTAC, the second largest telecommunications company in Thailand. The company recently announced that it will be delisting from Singapore in September this year. This is because there is little investor interest in the company’s shares listed in Singapore when the company is also listed in its home country of Thailand.
This has resulted in a slightly lower valuation for the company in Singapore (for instance, the company has a trailing price/earnings ratio of 24.3 and 24.6 in Singapore and Thailand, respectively). A delisting in this case might be beneficial for DTAC as it has to incur additional costs in maintaining a listing status in two separate exchanges.
3. Cost of arbitrage is too high
Although mispricing between two similar companies may exist, if the cost of arbitrage between the two is too high, there might be no way to bring the two share prices in line.
Let’s consider the two pairs of companies: Haw Par Corporation (SGX: H02)and United Overseas Bank (SGX: U11); and Keppel Telecommunications & Transportation (SGX: K11)and M1 (SGX: B2F). In each pair, the two companies within are related (either through having similar holdings or through one owning a large chunk of the other), but one is often mispriced relative to the other.
In a theoretically perfect world, to exploit the pricing difference, an investor might pick a pair and go long on one company within the pairing while shorting the other (when you go long, you’re betting on a rise in prices; when you go short, you’re betting on a fall in prices).
Unfortunately, the restrictions on short-selling and the costs involved would make such arbitrage opportunities almost impossible for investors. Thus, that layer of friction in trading would sort of lock into place a relative mispricing between the companies in each pair.
There’s a silver lining in all these. As long term investors, we should not worry too much about such market inefficiencies. In the long run, these relative mispricing would likely not matter much in the grand scheme of things.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.