Lumen’s investment approach is value-based as we strongly believe value trumps any other investment style over the investment cycle, particularly in inefficient markets (e.g. emerging, irrational markets). Our objective is to identify value with a margin of safety large enough to make the capacity to methodologically and accurately forecast the future totally futile.
A Global Valuation Compass
Globalization, financial innovation and ever-expanding global liquidity mass have brought about a structural upward shift in correlation across regions, countries, sectors and asset classes and hence a structural upward shift in volatility and systemic risk. In our view, this high correlation and volatility, which could stay with us for a while, dislocates the market, generates massive value distortions and therefore plenty of opportunities, provided one has a way to measure value.
Lumen believes a successful, value-based investment strategies must integrate traditional bottom-up analyses with an objective, quantitatively defined Global Value Framework.
Global Valuation Framework: Starting with Risk
- The price and (current) value of an investment is simply the sum of future cash flows discounted back to present value by its cost of capital, or its IRR.
- Thus the value of any long term investment – bond, equity, private or public – can be screened, ranked and valued by calculating the IRR implied by the market price.
- We start from the riskiest component of investable capital, i.e. common equities, in that in our view risk should be measured from the highest (equity) to the lowest (cash) capital component.
- We calculate the cost of common equities by reverse-engineering the current market level and extracting the internal rate of return for equities across regions, countries and sectors. We then “roll down” this risk curve across the global capital structure, and measure the IRR for high yields, high grades, sovereigns, and risk free rates (or cash).
- The merit of this approach is an unbiased and comparable ranking of investments across regions, countries, sectors and asset classes – without the pitfalls of using a false risk-free rate, an arbitrary risk premium or, worse yet, unstable multiples metrics.