In 1906 at a country fair in Plymouth, Sir Francis Galton asked 787 villagers to correctly guess the weight of a ‘slaughtered and dressed’ ox. While none of them got the right answer, a near perfect estimate was reached when Galton averaged their guesses. This idea that when faced by uncertainty, the collective thoughts of many may provide greater clarity than the opinion of a single individual is now commonly referred to as ‘wisdom of the crowds’.
Since 1906, numerous other studies have been conducted to give weight to this theory. One study showed a studio audience is more likely to predict the answer to a general knowledge question (91% accuracy) than a friend (65% accuracy). So a good tip there should they ever revive Who Wants to be a Millionaire...
The wisdom of the crowd approach can also, arguably, be applied to making investments. ‘Grey markets’, which allow investors to trade shares in a company ahead of their official IPO opening day, are a great example of this. By looking at the extent to which those trading on these markets are going long or short on a company ahead of their listing, you can often get a good indication of what the price on opening day might be. Effectively you are ending up with an average price based on the collective wisdom of a large number of people.
Grey markets we ran last year on both the Royal Mail and Twitter IPOs were more accurate in predicting prices than bankers and their advisers. On the Twitter IPO, the grey market predicted shares at the end of first day of trading would be worth $44. They actually ended up at $45.06 - incredibly close, particularly when you consider the price set by Twitter and the bankers was $26.
How does this work?
Ahead of the major IPOs there can be a huge amount of noise in the market around potential pricings and valuations. Everyone has an opinion, whether it’s analysts, media, the banks or wider market commentators. But perhaps one of the reasons grey markets are becoming an increasingly popular tool to help estimate pricings is that they rely upon the thoughts and opinions of those who are actually prepared to put their money where their mouth is.
Could it be that a crowd led more by its own financial motivation than emotive opinion or the need to grab attention, can help identify a more accurate price than many pundits, or advisors?
Growth in grey markets
It is no doubt that because awareness of the potential accuracy of grey markets has grown, their use has begun to attract attention. The large number of high-profile IPOs taking place has led to more and people becoming interested in how they can potentially make money out of them as part of their wider wealth management strategy.
With new flotations of well-known brands being announced on an almost daily basis at the moment, this increased interest will keep going. Already this year in the UK retail sector alone the likes of Poundland, Pets at Home and AO.com have all listed and a number of other big names are on the way – the biggest of all being the upcoming listing of Chinese ecommerce company Alibaba, which is expected to beat all records.
And here it’s worth pointing out an additional attraction of grey markets. Recently, we’ve seen a number of companies, including online takeaway service Just Eat, which is due to list at the beginning of April, say that they will exclude retail investors from any offering and only offer shares to institutional investors. This means that even if you know a company well, have a very strong feel for how it might perform, and want to invest, as a retail investor, you can’t. Grey markets, which are open to retail investors, offer a way to get around this exclusion by providing a means to trade shares in the company ahead of official opening day.
Of course, grey market ‘predictions’ aren’t always right and it would be wrong to suggest otherwise. Indeed, the wisdom of the crowd approach itself has been questioned by different experts over the years. What grey markets do show us though, is that they can at least provide another interesting, different perspective to add to the research mix.
And this is an important point. Grey markets are just one source of information. To really get a good feel for how or if you might want to invest in an IPO, the wider the perspective you can get the better. This means doing your research and, like Sir Francis Galton, not relying on a single source.
Shares in China’s biggest ecommerce company and an early 20th century ox may seem to have little in common, but I for one will be watching our next grey market on Alibaba with interest to see this more modern example of wisdom of the crowds in action.
- Brenda Kelly is chief market strategist at IG