Forum Archive Index - May 2004

["tennyson@caverock.net.nz" <tennyson@caverock.net.nz>]

Hi Dean,
 
> 
>Do you have any idea why some institutions may be 
>using a higher than realistic premium? ( I did go back
> and checked my interpretations - that it was an actual
>risk premium and not an expected return for the market. 
> I was interpreting it correctly.) 
> 

The risk premium is there as a relative concept, for what reason?    Is 
the risk premium there because returns in NZ are more volatile than 
the US?  The longer time term you consider and the wider number of 
shares you look at, the less volatility becomes an issue.   Certainly 
over the last 5 years the NZ market has been far less volatile than the 
US.

What about the risk of losing a large chunk of your capital?    Dividend 
yield will put a floor under the price of many of the New Zealand 
shares, in a way that is not there for US shares.   So I would argue that 
money in NZ shares is 'safer' than in US shares.  That is not what a 
higher risk premium for NZ implies.

That leaves me with the idea tha the real risk for investors in NZ is that 
NZ companies cannot reinvest their profits to grow the business in a 
way a corporation in the US can, because of the much smaller 
business universe they operate in.   Certainly NZ is geographically 
smaller.   But is that really the restriction to growth that analysts putting 
a risk premium on NZ would have us believe?   I'm not sugggesting 
that NZ can take on the US in a straight head for head commerce 
battle.  But for the investor, a growth in profitability from $2m profit per 
year to $20m per year will theoretically yield the same return, to a 
small shareholder, that a company growing profits from $200m per 
year to $2b per year would.   In other words 'growth' depends on the 
difference in size between where you finish, and where you start - not 
the absolute size of the pie.

I am trying very hard to see why NZ should have a 'risk premium' over 
the US, but frankly I cannot reconcile the basis for any such premium 
existing.

In the NZ vs US market context, I'm not sure I see the distinction 
between 'risk premium' and 'expected return' either.   If the NZ market 
is:
 
1/ not more volatile (leaving aside the deregulation bubble that 
occurred when NZ markets were freed up in the mid to late 1980s) 
2/ less likely to suddenly lose value because eof the underlying 
dividend yields.

THEN
That leaves the main risk for NZ investors being that they will get a 
lower expected return.  If you provide a 'risk premium hurdle' or look for 
a 'higher expected return' from your particular NZ investments,  I say 
this is two ways of saying exactly the same thing.    There is no 
distinction between 'risk premium' and 'expected return hurdle'.

Could I be wrong?   Possibly but I'll need someone who believes that 
NZ deserves a 'risk premium'  to put forward the other side of the 
argument to start to be convinced.  It looks to me like if anything, the 
US market should have a 'risk premium' relative to NZ- not the other 
way around!

SNOOPY




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