Monthly Archives: May 2014

Shorting the Allied Irish Banks ADR (AIBYY)

Allied Irish Banks (AIB.IR) was nationalized in 2011 by the Irish government and it now owns 99.8% of the outstanding shares while the remaining 0.2% remains in public hands. At the time of the nationalization 25% of these shares were traded in New York as ADRs (AIBYY), and because of this development the depository decided that it would cancel the ADRs. As a result they have started to sell the shares underlying the ADRs on the Irish stock exchange, and when the selling is done the cash will be returned to ADR holders.

Because the depository owned a big part of the outstanding float the sale process is taking some time. They have started selling shares on April 10, 2012 and at the end of 2013 they managed to sell 65% of their shares. Because of this the ADRs now consist mostly of cash instead of Allied Irish Banks equity, but despite this fact they trade as if this is not the case.


A Seeking Alpha article alerted me to this opportunity this weekend, and it’s worth a read to get some more background information. Unfortunately the methodology employed by the author to calculate the value of the ADR, and the time remaining before redemption is seriously flawed because he uses a time-weighted average price to estimate the average selling price instead of a more realistic volume-weighted average price.


We first need to figure out how much shares have been sold. We know what the number was at the end of 2013, but we don’t know how much has been sold so far this year. I will assume that the depository continues to account for the same percentage of the market in 2014 as it did in the previous years. I think this is a good assumption because in these kind of transactions a broker usually gets an instruction to sell everything as fast as possible, but with a threshold based on the average traded volume to prevent a too big market impact.

  • Total trading volume from 10 April, 2012 to 31 December, 2013: 597 million shares
  • Number of outstanding ADRs: 26.5 million (underlying shares: 265 million)
  • Number of shares sold in this period 172 million (3.5 shares remaining per ADR at the end of 2013 => 6.5 * 26.5 million)
  • This means that the depository accounted for 28.88% of daily volume in 2012/2013.
  • Volume in 2014 has been 238 million shares
  • This means that it could have sold another 68.8 million shares
  • This implies that just 0.91 shares are remaining per ADS
  • The volume weighted average price between 10 April 2012 and today is 0.0993
  • The current share price is €0.12
  • The EUR/USD exchange rate is 1.3875

We now know everything that we need to know to value the ADRs: It’s simply the number of shares sold so far times the average price plus the value of the remaining shares. This gives the following result:

(9.09 * 0.0993 + 0.91 * €0.12) * 1.3875 = $1.4032

With the ADR trading at $1.61 it is significantly overvalued, especially considering the fact that there will be a $0.05 fee when the ADR is cancelled. With less than one share per ADR remaining there is also a clear catalyst for this short. At the elevated trading volume that we have witnessed so far in 2014 selling the remaining 24 million shares should take less than two months. A good thing considering that we do need to pay a 5% borrow fee for the privilege of shorting the stock.


Shorting AIBYY seems a relative save way to generate a return that will be uncorrelated with the market in a short period. There is of course uncertainty with regards to the exact value of the assets underlying the ADR and there are also other risks related to shorting such as facing a buy-in notice or just seeing the borrow fee getting increasingly expensive. But at current prices I think you are paid more than plenty to take these risks.


Author is short AIBYY

Some thoughts about (il)liquidity

The biggest common factor that connects the stocks in my portfolio is that they are all (relative) illiquid. If you have two almost identical assets, one liquid and one illiquid, the most attractive asset is obviously the liquid one because illiquidity is a real risk:

  1. You can never be totally certain that you don’t need money on short notice.
  2. An illiquid stock also makes it hard to profit from superior insight. For example: you can’t turn on a dime and exit when you change your mind.

The question of course if how much you want to be paid for illiquidity risk, and how much the market is willing to pay you for that risk. In my opinion you shouldn’t be paid a whole lot to take on illiquidity risk. The main reason is that stocks are only a suitable investment if you have a long-term horizon. But why would you need intraday liquidity if you are holding an asset for a multi-year period? The answer is simple: you don’t! The value of being able to trade out of your position in a few microseconds is negligible when your intention is to hold it for years or even decades.

So if the market is willing to pay you a significant premium for holding an illiquid asset it’s a deal you should take, and there is a lot of academic research that suggests that the illiquidity premium is sizable. The paper “Liquidity as an Investment Style” contains to following table that shows that low liquidity stocks outperform irrespective of size:

Size and Liquidity Quartile Portfolios, 1972–2011

As is visible the difference in performance is huge. Especially when we look at the microcap segment where it is a whopping 14% per annum while taking less risk at the same time (if we accept the standard deviation as a risk measure). I don’t know if I’m able to add alpha to my portfolio. I of course think that I do, but by structuring my portfolio in a such a way that I have exposure to factors that have outperformed in the past I’m hedging my bets. Besides a bet on illiquidity my portfolio is of course also a bet on small-sized firms and value stocks.

And the big question is of course: can we expect that the illiquidity premium persists in the future? I think that it will because of how the financial services industry is structured. Most individual investors don’t really need very liquid assets because they do have a long-term horizon. But they do park their money in ETF’s, mutual funds and hedge funds, and the managers of those funds can’t afford to buy illiquid assets. They never know when their investors want to withdraw, so they always have to plan for the worst.

As an individual investor you don’t face this risk, and because of that illiquid assets are a great match if you want to generate high returns over a long-term horizon. I think that is (or should be) the goal of most investors, but as long as they don’t realize what they are implicitly paying for the liquidity they don’t use they will be at a disadvantage.


Author is long a lot of (relative) illiquid stuff