Macroeconomics
Asset Tangibility, Macroeconomic Risks and the Diversification Discount
April 3, 2014
Topics - Macroeconomics Trading
Working paper
Some research (e.g., Lang and Stulz (1994) and Berger and Ofek (1995)) has concluded that conglomerates tend to trade at a discount relative to a comparable group of companies focused on single lines of business. It is believed, that this is because investors prefer to diversify within their portfolios, which gives them the flexibility to add or reduce their exposure to particular segments of the economy, rather than to invest in a diversified company that cannot quickly or easily dispose of underperforming assets.
However, the so-called diversification discount associated with conglomerates is not static. The authors’ review of the data shows that the discount decreases during recessions and credit crunches. They assert this is because single-segment firms — particularly young and fast growing firms, which tend to have low asset tangibility — experience a larger decrease in value compared to conglomerates.
This paper concludes that this is because recessions and credit shocks tighten the collateral constraint of low tangibility firms more than they do for conglomerates, which tend to have high asset tangibility. A tightening of the collateral constraint forces firms to reduce leverage, which in turn leads to lower profits, lower investment and more costly external financing.
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This material is not research and should not be treated as research. This paper does not represent valuation judgments with respect to any financial instrument, issuer, security or sector that may be described or referenced herein and does not represent a formal or official view of AQR. The views expressed reflect the current views as of the date hereof and neither the author nor AQR undertakes to advise you of any changes in the views expressed herein.
The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Charts and graphs provided herein are for illustrative purposes only. The information in this presentation has been developed internally and/or obtained from sources believed to be reliable; however, neither AQR nor the author guarantees the accuracy, adequacy or completeness of such information. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. There can be no assurance that an investment strategy will be successful. Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially, and should not be relied upon as such. Diversification does not eliminate the risk of experiencing investment losses.
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