The story of Ali Baba and the forty thieves may not be as popular as it once was, but it may provide some insight into the stock market’s strength and serve as a reminder to maintain a healthy sense of respect for one’s own asset allocation strategy. It also reminds us that there is no easy path to success.
Ali Baba was a woodcutter who discovers the den of thieves in a cave that can only be opened with the words “Open sesame.” He tries to keep the cave a secret but after taking a bag of gold, his greedy brother discovers its riches and ends up being killed by the thieves. Ultimately the thieves trace the stolen booty back to Ali Baba. Several attempts by the thieves to kill him are thwarted by Morgiana, a slave girl, who earns her freedom for her loyalty and wit.
The Big IPO
Unless you missed all of last week’s news cycle, you probably heard about the initial public offering (IPO) of the company Alibaba Group Holding Ltd (symbol BABA). The Chinese company’s stock was priced at $68 per share and quickly rose to $99 before settling Friday closer to $93. The company raised $21.8 billion with the offering. And at its closing price has a market capitalization of over $231 billion, larger than all but 10 of the companies in the S&P 500 Index. Its founder, a Chinese English teacher, Jack Ma, is building an Internet juggernaut for the consumers of China and “the rest of the world.” The company has over 630 million users in mainland China. The company is a little bit like Amazon.com, eBay and Google all rolled into one. Unlike many other recent technology IPOs though, it has both revenue and earnings (although the stock is now trading at something like 29 times those earnings).
We’ve written before about slowing economic growth in China as they manage the transition from being an export driven economy to one based on consumerism. This stock represents an engine of growth for that consumption driven economy. Alibaba is expected to add over 200 million users in the next 12 to 24 months which shows just how fast this transition is taking place.
Why all the hype? There are two reasons. This may be nearly the largest IPO ever and the management team has been on a global road show for months selling the company’s story (the $200 plus million in investment banker fees also had something to do with it I’m sure). As a result everyone in the tech world has been following the story and watching the launch to see if it heralds the next wave of IPOs in technology or the peak. Let’s face it; companies don’t want to go public when the stock market or their sector is weak. When going public you are trying to maximize the proceeds generated for the stock being sold so you want to sell at a time when the market is strong. With the S&P 500 Index making new all-time highs last week, the market couldn’t be stronger.
Cassim’s Curse
Alibaba’s greedy brother provides a lesson for us all. Not content to benefit from his own wealth, he schemed to take more treasure from the thieves cave, and ended up quartered. Often times, investors are interested in pursuing investments in the hottest asset class. The hype surrounding the Alibaba IPO is an example of how a sector gets a boost from a hot new stock. The fact that the stock traded up almost 40% in the first day of trading is an indication that the sector is “hot.” It is difficult not to want to add more capital to that portion of your portfolio that is performing best while ignoring the portion that isn’t performing as well. Of course that is exactly what you are supposed to do and what rebalancing is all about.
As advisors, our job is to use the rebalancing discipline to take from winning positions and add to those positions less well off. If we have confidence in the managers we’ve selected to execute their strategies effectively over the course of a market cycle we should want to take advantage of the strength of one asset class over another. Every client’s rebalancing objective is different. Some have a regimen for rebalancing prescribed by their investment policy statement and some have an opportunistic approach. Whatever the approach may be, it makes sense to do it in a disciplined manner in order to avoid Cassim’s curse.
The other lesson we can take away from the Alibaba IPO is also important. We have discussed the need to include global investments in your portfolio. There is a secular trend around the world wherein developing and emerging markets are beginning to benefit from the information revolution brought on by the advent of Internet infrastructure. This means that consumption for literally billions of people will continue to increase and there will be companies based in those countries and abroad that will be able to find a business plan to succeed in tapping into that consumer strength. This means that our allocation to the global investment opportunity set should reach across asset classes and throughout portfolios. We have identified investment managers that have a global focus. They have investment research and portfolio management teams stationed around the globe and identify investment opportunities in many markets. As the Alibaba IPO suggests, the U.S. is still one of the best markets to invest in that is why they chose to go public here. However, the growing global middle class will create a long-term secular trend supporting global economic growth and investment opportunities.
Morgiana’s Legacy
We can also learn from Alibaba’s loyal slave girl who earned her freedom by being true to herself and her master. As investors, our master is our financial plan. The asset allocation strategy that we’ve identified, hopefully through careful investment and financial planning, is our guide to generating the principal growth and income we hope to achieve in order to meet our financial objectives. Being alert to the risks inherent in investing, one of which is getting greedy when a particular asset class is doing well, is important. Rebalancing to take advantage of the changing fortunes among asset classes is another. Just as Morgiana earned her freedom by being true, we too can accomplish what we set out to with our investment portfolio if we use our stated investment policy as our guide.
I have managed money for many institutional investors over my career. The investment committees of those organizations are made up of individual investors who have different ideas about risk and return. I can think of many times when investment committee members are determined to raise the allocation to stocks as the market moves later in the cycle and appears to be getting more expensive. The investment policy guide should act like the reasoned investor in the room. It is focused on the long-term objectives and guides the committee, like Morgiana’s dagger, singularly to the goal. A disciplined approach to rebalancing is critical to the success of any asset allocation strategy.
