How to identify high yield investment opportunities?

Investment

oi-Sunil

By Sunil Fernandes

Updated: Monday, December 30, 2013, 12:41 [IST]

"Two qualities are indispensable: first, an intellect that, even in the darkest hour, retains some glimmerings of the inner light which leads to truth; and second, the courage to follow this faint light wherever it may lead." - Carl von Clausewitz

Readers may be wondering in what context, the above quote from Carl von Calusewitz, a revered military strategist has been used. Well, the quote has enough relevance in the financial world especially amongst investors trying for identification of high yield investment opportunities in the stock market. Intellect is something which is necessary for achieving what Warren Buffet has to advice- "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price." In essence this is what all investors intend to do but only a few achieve.

Second level of thinking for identification of high yield investment opportunities

Second level thinking as spoken by Howard Marks, involves an unconventional, intuitive and adaptive approach for identification of high yield investment opportunities. It is about asking questions. Questions about the individual's expectations, and how such expectations vary from the other investors; Whether, the probability of a fair outcome is greater in the case of the individual, or is it better for the others.

Thinking and contemplating what others are thinking at some point, and aiming to out-think them to discover a bargain for identification of high yield investment opportunities is a relentless quest for the smart investor.

Second-level thinking is about having a perspective about other people's perspectives and constantly probing by asking why, how and what. It is a truism that not all investors are successful in identification of high yield investment opportunities simply because the market is made up of individual investors. Such an attempt would tantamount to conjuring up a situation where a dog tries to catch hold of its own tail. Second-level thinking is thus about doing things differently by pursuing qualitatively better thought process.

Introspection for identification of high yield investment opportunities

Introspection by the investor will help in assessing biases and influences which have an impact on attitudes. Humans have a cause and effect relationship with one another and therefore what holds true for one may not hold for the other. There is no set pattern or logical conclusion to everything, investment is an art and it is governed by its own idiosyncrasy.
Howard Marks Matrix for identification of high yield investment opportunities
Dwelling on the subject of second-level thinking, Howard Marks uses a matrix to illustrate how it can influence decisions:

Howard Marks 2 by 2 Matrix	Conventional Behavior	Unconventional Behavior
Favorable outcomes	Average good results	Above-average results
Unfavorable outcomes	Average bad results	Below-average results

To achieve better results than what the average investor, it is necessary to move beyond consensus. Whether the investor is up-to the task will have to be decided by him only.

Understanding the efficiency of the market for identification of high yield investment opportunities

It is assumed that all investors have equal opportunities as far as gathering market information is concerned. It is also assumed that all investors will behave in a rational manner under given market conditions. The reality however differs, and that is why market inefficiencies occur. Ideal conditions do not exist many of the time, due to a variety of reasons. This has a lot to do with the financial behavior of everyone involved.

Ideal Situation for identification of high yield investment opportunities
The fund manager may think in a different manner or follow a style which is in variation with that of the consensus. Similarly the various classes of investors would be driven by their own understandings and biases. It is under such circumstances that identification of high yield investment opportunities evolve.

The intelligentsia involved in creating the market makes it operate on efficient lines most of the time. Still, there exist situations when the functioning may not be at their efficient best. Such inefficiencies may crop up with certain classes of assets or with the market in its entirety. That is the ideal situation for identification of high yield investment opportunities.

Example of identification of high yield investment opportunities

The concept of market efficiency or inefficiency can be explained through an example. The weather forecast states that the weather is going to be clear and sunny for the next few days. However, the clouds which exist in the market signify that the possibility of rain exist. An intelligent investor looking for identification of high yield investment opportunities will go by his own observation and assessment. He would wisely take protection against the rain while the consensus would be affected by the rain. Even though it is highly unlikely that the meteorological department would make mistakes consistently, it is a possibility once in a while and the smart citizen will be alive to such a possibility thus taking advantage or precaution for or against it as the case may be.

Specific Questions to ask for identification of high yield investment opportunities

Understanding market in/efficiency is of prime importance for an investor to be successful in identification of high yield investment opportunities. Some financial experts feel that the investor looking for identification of high yield investment opportunities should ponder over a few questions before making a judgment or decision regarding the existence of a bargain:
1. Why should a bargain exist despite the presence of thousands of investors who stand ready and willing to bid up the price of anything that is too cheap?
2. If the return appears so generous in proportion to risk, might you be overlooking some hidden risk?
3. Why would the seller of the asset be willing to part with it at a price from which you will receive an excessive return?
4. Do you really know more about the asset than the seller does?

Conclusion

To sum up, it may be stated that many good bargains exist at any point due to the fact that a section of investors do not behave in the manner which is considered to be most prudent under the circumstances. Market knowledge and the ability to gather relevant information and using such information intelligence for analysis is perhaps the pivot on which success for identification of high yield investment opportunities hinges. Among other things investors would do well to read and increase their market exposure to gain major success in identification of high yield investment opportunities. Warren Buffet's advice would be prophetic in this regard- "It's better to hang out with people better than you. Pick out associates whose behavior is better than yours and you'll drift in that direction."

The author is Ramalingam K, an MBA (Finance) and Certified Financial Planner. He is the Director and Chief Financial Planner of Holistic Investment Planners (www.holisticinvestment.in) a firm that offers Financial Planning and Wealth Management. He can be reached at [email protected]