Where Has All The Risk Capital Gone?

What does RISK mean? It means the potential for loss. Therefore an investment that is more risky than another is considered to have a higher potential for loss than the other.

However, in the case of financial markets a new dimension is added to risk. The dimension is that of perception. There can be and almost always is a difference between the perceived risk of an investment and its intrinsic risk. In the case of financial markets, risk has almost entirely come to mean the perceived risk of an investment rather than its intrinsic risk.

In fact, the markets have built a heirarchy of perceived risk and movements in the markets are now categorized into risk-on and risk-off movements. At the bottom of the inverted risk pyramid are US treasury bills and bonds and at the top are probably things like emerging market real estate.

The perception of risk is by definition dependent on the perceiver. Therefore anything that is far away and difficult to understand appears risky. Therefore, for a wealthy doctor in Philadelphia, PA, a house in Cherry Hill, NJ appears like a less risky investment than a house in Chennai, India.

Since most of the dominant pools of wealth are in developed countries, emerging markets by definition are perceived as risky investments.

Central bankers around the world (with the exception of India) have been trying to stimulate the risk appetite of markets by keeping liquidity loose and flooding the markets with money. Unfortunately, all the money that they create flows right back to them and to the US treasury without resulting in any sustained improvement in risk appetite.

The divide in availability of capital and liquidity between the haves (the US treasury) and the have-nots (Indian infrastructure and real estate companies) has never been greater in history.

The following article on Indian infrastructure developer Lanco's inability to sell its assets highlights this point http://tinyurl.com/8d4e3pa. The article is only illustrative and I dont want to get into the merits and demerits of Lanco as a company.

In my view, we have reached the cresecendo of fear and risk aversion in the world. Anything that is even remotely risky is shunned. And this risk aversion is taking place at a time when the world has seen the biggest injection of participants into the free market system.

I do not know what will create the tipping point. However, as a contrarian, I do know that the US dollar and US treasuries are grossly overvalued and that risk assets are the cheapest that they have ever been.

In my opinion the risk-reward (no pun intended) is skewed completely in favor of the riskiest (perceived) investments one can find.