Outperforming the Market: An important investor offers four key lessons.

• Author: Ochoa-Brillembourg, Hilda

An important investor offers four key lessons.

Hilda Ochoa-Brillembourg is the lead founder and chairman of Strategic Investment Group and co-founder of Emerging Markets Management. She served as the Chief Investment Officer at the Pension Investment Division at the World Bank from 1976 to 1987.

Price Is Not Value

1. The value of an asset to any particular investor may be lower or higher than the price (or fair value) of the asset in the marketplace, depending on the correlation of that asset to the investor's legacy (existing) portfolio and needs. This is true even if the investor agrees with market forecasts. Many portfolios contain legacy assets or structures (and reflect client needs) that cannot be easily or cost-effectively changed. Financial theory is insufficient to understand the relationship between market prices and investors' utility curves, which lead to different "fair values" (multiple equilibrium pricing) for the same asset depending on the investor. Assets have a market price available to all buyers but have a different relative value to different buyers. Part I of Delivering Alpha offers a shortcut formula I have found useful to begin identifying assets that fit your legacy portfolio better than other assets.

   There is a brilliant moral assessment of flawed characters we encounter in life in Oscar Wilde's swipe at people who know "the price of everything and the value of nothing." In investing as in life, theory may teach you how the market sets the price of assets, but it will not fully tell you whether that price equals the value of that asset when added to your existing portfolio. In the world of efficient-market believers, this first lesson is probably the most controversial of my findings and possibly the most relevant. The difference between market value and value to an investor might help explain the gap between multiple equilibriums in efficient and inefficient markets--those conditions where different investors are willing to pay different prices for similar assets at the same time.

   The value of an investment to a particular buyer will be determined by the market price, the expected return and risks, and the correlation of that marginal investment to your legacy portfolio. Few institutional portfolios start with cash. And even if one does, once you have built an optimal portfolio structure from cash, you have a legacy portfolio to contend with. Every new asset added to the legacy portfolio may have a different value...