Extraordinary opportunities in Europe

Very occasionally, forced selling can be a source of incredibly high risk-adjusted returns for the switched-on, canny buyer.

For the Australian investor focused on larger blue chips, bargain opportunities caused by forced selling have been all too rare outside a few months in late 2008. That's the way it is in the good times.

But it won't always be that way. And when the next real downturn/panic/recession hits our shores, the diligent buyer might be able to find the sort of mispriced bargains one never finds in the boom times. It's one reason why investors should prepare - both psychologically and financially - to embrace, rather than fear, market downturns.

I was hoping to copy a segment of the latest quarterly letter from famed investor Daniel Loeb's hedge fund Third Point here. But damned if I can work out how to copy from a PDF. So here's a link to the whole Third Point quarterly review.

In particular, I'd recommend reading about the opportunity Third Point scooped up in Unicredit, one of Italy's largest banks. Late last year, the bank needed to raise €7.5bn to meet its 9% equity requirement under the Basel III.

Demand for a rights issue among existing shareholders was weak (the economy isn't great in Italy and confidence is worse, in case you hadn't heard), and the offering had to be repriced at a huge 60% discount to attract enough outside investor interest, more than doubling the bank's shares on issue because of the raising. This all happened around Christmas in very thin markets, when any selling pressure would have a magnified effect.

Furthermore, the unwanted rights traded cheaper than they should have against the already depressed ordinary share price. Buying unwanted rights, Third Point was able to buy stock in Unicredit at a price that valued the whole bank at approximately one-quarter of book value.

According to Loeb, the bank's stake in other listed entities in Russia and Turkey alone justified that valuation, and the European banking business was thrown in for free.

Sanity returned, and Third Point sold out – doubling its money in less than one month.

Panic selling can be a source of extraordinary opportunity. But make no mistake, the sort of panic that creates opportunities like this feel like investment hell at the time (just ask the Italian investors who didn't participate in the rights issue).

Only those who are prepared will have the foresight to recognise it as investment heaven, and capitalise accordingly. Hopefully, Third Point's experience can help us with our own preparations.