In craps the best bet on the table (other than Odds) is Don’t Pass. The house edge is just a teensy bit narrower there than on the Pass Line. But no one really bets that way. And when people do, they are quiet about it, because they are betting for everyone else at the table to lose. That’s not the way you endear yourself to a bunch of degenerates at the casino. Betting Don’t Pass is also called betting “dark side.”
Personally, I have no interest in betting dark side in craps. The edge is pretty small to have to endure swarthy drunks shooting you sideways glances all night. But when it comes to investing I am plenty interested in opportunities to bet dark side.
In fact, sometimes I play a mental little game with myself called: What’s A Seemingly Obvious Trend Or Theme I Can Get On The Other Side Of?
For example right now everyone in the US is whining about how there are no cheap stocks. You know where stocks are cheap?
Russia.
In Russia you’ve got stuff on single digit earnings multiples paying 6% dividend yields. And it’s not even distressed stuff for the most part. Research Affiliates has got a phenomenal little asset allocation tool you can use for free. See those two red dots on the upper right in the double-digit return zone? That’s Russian and Turkish equities. (In case you are wondering, US large cap equity plots at about 40 bps of annualized real return)
Yeah. I know. Everyone hates Russia. You can probably rattle off at least five reasons why Russia is an absolute no-go off the top of your head. But I will happily bet dark side on Russian equity. I won’t bet the farm, but I’ll take meaningful exposure. The reason is I am getting paid pretty well to take Russian equity risk.
Risk assets are a pretty crappy deal here in the US. (40 bps real per year over the next decade, remember?) Here everyone’s convinced themselves stocks don’t go down anymore so they are willing to pay up. I guess some day that will be put to the test. We’ll see.
In the meantime, what other trends can we get on the other side of?
ESG might create opportunities. If you haven’t heard of ESG it stands for Environmental, Social and Governance. Big asset managers have become obsessed with ESG because it’s an opportunity to gather assets from millennials and women at a time when index funds and quants are hoovering up all the flows.
This is literally what the big asset managers tell allocators in presentations now: “millenials and women are going to inherit all the assets and they want to be invested in line with their values. Here are all our ESG products. Also here is marketing collateral to help you have ‘the ESG talk’ with your clients.”
So where do we go from here?
Well, for starters I am thinking a trillion dollars rotates into stuff that screens well on ESG. If this persists long enough and to a significant enough degree the stuff that doesn’t screen well on ESG is going to get hammered. With any luck it will get kicked out of indices and analysts will drop coverage and the bid-offer spreads will blow out.
Like Russian equities, the oil companies and the natural gas companies and the miners and the basic chemical companies and the capital intensive heavy manufacturers will trade on single digit earnings multiples with 6% dividend yields. All because they don’t score well on the asset gatherers’ screens.
So yeah, I think I’ll bet dark side when it comes to ESG, too.
For the record, I don’t have anything against ESG in principle. I am actually a big fan of an extreme form of ESG, called impact investing, where you allocate capital with low return hurdles (like 0% real) to achieve a specific social objective. Maybe to fund development in a low income community in your city. Micro-lending is an example of this, and I think it’s a better model than philanthropy in many cases. But that’s a topic for another day.
This post is about how people’s emotional reactions to the securities they own create bargains. Here betting dark side is betting on something kind of icky. “Ick” is an emotional reaction. When people react emotionally to stuff, it has the potential to get mispriced. “Ick” is a feeling that encourages indiscriminate selling.
That’s where the Don’t Pass bet comes back into play. It’s one of the better bets in the casino, and it’s massively underutilized. Why?
Because it makes people feel icky.