Episode Transcript
The Finance Ghost: Welcome to episode 246 of Magic Markets. I can't speak for Moe right now, but I can certainly speak for myself - I'm feeling slightly giddy after spending a day looking at Ferrari's capital markets day and lots of beautiful cars in their investor relations pack. It really is one of those moments where you have to try very, very hard to distinguish between the underlying company and how you feel about the products from the investment decision.
We've covered Ferrari in Magic Markets Premium this week and I checked, thinking of episode 246 - so there are some models in Ferrari's history that have that as part of their model name. Ferrari Dino 246 GT. That was in 1969. I had a classic Alfa from the same year which is like a Ferrari off Temu. Joking. I really loved that car, it was very special.
Anyway, Moe, let me stop geeking out on Italian cars now and we should rather talk about the importance of hedging, which I've got to say for anyone who is currently sitting with Ferrari shares that they've held over say the past week or so, it's a very sore point. They will be wishing that they were hedged because their money has landed in the hedge. It's not pretty.
Mohammed Nalla: Yeah, certainly Ghost, I think there may have been some people that on Thursday thought they were able to buy a Ferrari and then with Friday's correction, then Monday's bounce and then today not looking too great as well at the time of this recording, maybe you can't afford that Ferrari anymore now.
Ghost, there are few things that get me as excited about looking at Ferraris as I know we looked at in Magic Markets Premium. Gold is one of those things. I think it's one of those where I've got to try and separate the emotive tie I've got to gold. We're not talking about gold, we're talking about hedging. But gold will certainly feature simply because I'm as passionate about that as I am about the Ferraris.
Ghost, hedging in markets, do you do it? Should you do it? How do you do it? I think that's really what we're trying to get to in the show. And again, I think it's relevant and timely just given this kind of nervousness you've got in markets. You've got US markets close to record highs, but everyone's talking about tech valuations, how they look overbaked and when they start investing in one another. Some concerns around how sustainable the rally is in tech and then by extension, how sustainable is that rally for the S&P500 and US stocks in general.
I'm going to jump in because I've got a couple of portfolios, I've got a long investing portfolio, then I've got a trading portfolio and I've experimented with a number of ways to actually go out there and put a hedge on when you are concerned around just tactically, can the market see a bit of a correction from where we are right now?
And the first question is why would you do that? And what I'd like to answer there, simply in terms of why you would do that is sometimes, certainly in a long portfolio, you own a lot of companies that you really do like and maybe you think that there is some upside to them, but you're concerned around some downside correction. So you don't want to sell out the share because you don't want to effectively have a tax event on that. You want to keep your exposure, but you want to mitigate some of that downside risk. You can either do that by going and buying some insurance, some optionality, put options on a specific stock, or you could do that on the index as a whole. There are other ways as well where you could look at maybe not going with the options. Options can get quite complex, they can get expensive and sometimes if you don't know what you're doing in the options space, you can end up overpaying for insurance that then expires pretty much at the time when you need it the most.
When you go into hedging, I think it's very important to consider the hedging before you actually need it. It's like buying insurance on your car, on your house, whatever it might be. And you've got to apply that kind of mindset. But before we even go into some of the nitty gritty of which hedges you look at, what you consider, you also have to consider what are you trying to hedge? And I mentioned gold, kind of tongue-in-cheek at the intro. But for me, gold is that hedge around long term currency debasement. Maybe you get some inflation risks coming through there if you've got geopolitical risks. Gold actually ticks the box on a lot of those, but it doesn't necessarily translate as nicely into exposures that you might have in the equity market. And that's where you got to consider things like options or maybe the VIXI, that's a volatility index. There's some ETFs that reference that - we can unpack that in some detail.
But Ghost, I want to actually ask you a direct question before we even go into that. And this is, do you actually look at hedging your portfolio? Do you actually just sell out your positions? What is your approach when you get nervous around where the market is at any point in time?
The Finance Ghost: Yeah, it's such a juicy topic that we're doing this week. The first thing I'm going to say is that the best hedge in the markets is to not need the money for emergencies that you put into the markets. And I think that is - I know that sounds like a cop-out, but it's actually so important because so many people make this mistake, they go and invest money in equities that they don't actually have as genuine spare money. They don't have their proper emergency savings in place, etc. And this is not a personal finance podcast and it's never going to be - we try and do stuff that's a little bit more advanced than that - but I think it's still important to just say that the best hedge possible is to not be in a position where you are not sleeping at night because you need this money and what's going to happen, then you're doing something wrong, you're then not understanding volatility, you're not managing your money correctly, you don't have enough in liquid assets, you don't have enough in resilient assets. So that's the one overarching point then in terms of the approach that I take.
We've been in the bull market of all bull markets, right, so obviously that is important context. But when I've sold stocks in the last couple of years, I've almost always regretted it. And that's because we've been in this massive bull market, that's the main reason, most of them have just kept going up, even beyond where I think they can go up. I've kind of gotten to a place with my own portfolio where I, generally speaking, with only a few exceptions, I own stuff that I'm happy to own long term as opposed to just trying to play a specific level to the next.
It comes down to your personal strategy here. If you are more actively trading, and I know you've certainly done a little bit more of that than me, then I guess it does get to a point where you look at this and say, well, I have a certain objective or I had a certain target price, do you sell that and then lock in that tax event or do you rather hedge it out? And it's going to depend very much on where you are. But I will say this, with where the tech names are at the moment, I am starting to feel a little bit concerned that I'm going to be sitting in six months kicking myself because I didn't actually sell out at this generational high. The problem is, by the time Larry Ellison is done with the Oracle Investor Day in Vegas that's coming up, I might also be sitting there in six months kicking myself saying, look how much hype there still is in this thing.
So my unorthodox approach - just for a change - is I'm actually waiting for that Oracle Investor Day and I want to see what happens with the market. And if it's just this absolute pump around AI, I think the market reaction is going to tell you a lot. It's either going to do more, in which case then this thing has still got some gas in it, or it's going to start to say, yeah, yeah, we've heard this, and it kind of sits sideways, in which case I'm at the point of saying alright, I think it's time to either hedge this out or take profits, or maybe the market will be horribly disappointed. But I somehow doubt it. Because if there's one thing we learned when we covered Oracle recently, Larry Ellison and crew are not shy to pump up the AI story.
If that does happen, Moe, then there's an ETF that I want to look at. I'm not sure if you're familiar with it, actually. The SQQQ, the three times levered inverse ETF on the NASDAQ 100. Have you actually seen that before?
Mohammed Nalla: Ghost, that's too rich even for my taste, right? SQQQ is a directional play there and it's leveraged. What are you talking about?
The Finance Ghost: You go and find me hedging tools that aren't leveraged, other than your shiny gold, obviously. Basically the way it works is if you look at the long-term performance of that, then your money has gone to zero because obviously over the very long-term the NASDAQ has gone literally to the moon. I mean, that's the reality. So clearly that doesn't work. If you buy the SQQQ, you are negatively correlated to the NASDAQ-100 – it’s the inverse, literally. You have a long position, but it behaves as though you are short the NASDAQ-100. In fact, it behaves as though you are three times short the NASDAQ-100. You have to be very careful.
So what does that mean? It means you are short roughly 9% Nvidia, 8.8% Microsoft, 7.3% Apple, 5.5% Amazon. You're even short Costco, that's about 2.5% of the NASDAQ-100. So you are short all of the big dogs. Now you're either doing this because you think the top is in and you are very brave and you want to make some money so that you can afford that Ferrari, or you are sitting with a big long position on this stuff, which I think is more common, and now you just want to hedge it out. So you basically say, well, you know, I'm sitting with X amount there, I can get that levered exposure basically. You have to put down a lot less money than you might be sitting on.
That's the benefit of leverage and you're going to win on one and lose on the other. You're basically acknowledging you're going to sit tight here. And what you can do, for example, is you go into something like that, the market tanks, you sell out on the SQQQ, lock in the profit and you can reinvest it further down in those long positions. That's obviously the dream trade. It doesn't always work out like that - it rarely works out like that!
But you've got to be very careful here because if you actually go and look at the SQQQ website, they've actually got some really good resources there on hedging your positions. And the one thing they point out, be very careful holding for a longer period, not just because it's the Nasdaq, but also because if the thing you are hedging is compounding its growth over time, your inverse position is compounding its losses. So it's becoming a worse hedge, every single time the thing it's hedging is going up, which is actually really interesting. You might not necessarily think about that.
So yeah, it's just - I'm kind of just throwing it on the radar there. This is definitely not a suggestion to go buy this thing, it's super high risk, etc. etc. But for those looking for a way to maybe hedge out some of their tech exposure, this is an interesting one. Because it's an ETF, you'll find it in your normal broking account as a US dollar-based ETF, you're taking a long position, but it's short exposure. And that's very interesting.
Mohammed Nalla: I think that's quite interesting. I haven't traded it, I haven't even looked at it. I'm familiar with it, but I haven't traded it. I guess the reason for that is that when I get really nervous of the market, I've experimented with shorting index futures, which is effectively the same thing, right? It's still the S&P, I get to choose my leverage so it doesn't have to be three times. I can choose what that leverage looks like. Usually you get pretty decent leverage on futures positions, but again, you've got to be trading in certain sizes and again it's an index future. Or they get micro futures as well. So you can scale that down for those that are trading slightly smaller.
The Finance Ghost: Your losses there are not limited, are they? Your losses there are unlimited.
Mohammed Nalla: Yeah, your losses are pretty much unlimited. I mean on any short position, if you're going short the index, the index can go literally to the moon. And so your losses are effectively unlimited. And remember, you're layering leverage on top of that, so be very careful.
The Finance Ghost: Except SQQQ, that's the one thing Moe. So if you are long an ETF, you can't lose more than you put in.
Mohammed Nalla: You'll go to zero.
The Finance Ghost: You can go to zero.
Mohammed Nalla: That's a very important distinction. But it also ties into the next point I want to raise. I've mentioned options and it's why I've experimented with options as well is because sometimes I'm nervous. I'm not outright bearish enough to say I want to be short the market, but I want some insurance. And in those instances, I will go and buy an option either on the index or on specific names. Now the important thing to note about options is that options have expiry dates, so you've got to be very sensitive to how long are you buying that option for, when is the option expiring. You also have something called a strike price. For example, that's “you will be protected from this level and below” but if it's above that, effectively your option is worthless. And so just pay attention because there's a bit of an asymmetry and I look at options like an insurance premium. You’re effectively buying - if you're buying a put option, you're paying an insurance premium and sometimes that's going to work out for you, sometimes that's not going to work out for you and it effectively goes to zero. So I would have used options as I guess the proxy for the SQQQ in that context in that I wouldn't lose more money than I've actually paid for the option at the end of the day. But bear in mind there's an element of leverage that comes through.
Now, Ghost, I want to actually land on something that I've been experimenting with very recently and that is an ETF as well with the ticker $VIXY and this is something that's linked to the VIX. Now the VIX is effectively the volatility index. We know when markets sell off, volatility generally tends to spike. There are lots of other complexities that come when you're looking at trading volatility. And the one I want to raise here is whilst you don't have the same kind of risks as an index future or with SQQQ, for example, you can go to zero, technically with a VIXI you could go to zero as well if volatility goes all the way down, that's a technicality.
But the important thing with the VIXI is that you actually have roll risk. Remember I mentioned options actually expire. So when the options that are underlying this portfolio reach the expiry, the ETF effectively then rolls that into the next contract date. And so that actually gives you a bit of a bleed, similar to what you saw in SQQQ where you've got the compounding, that's a slightly different dynamic - with VIXI you've actually got roll risk that eats you over time. And so I would use this very much as a short-term tool, I've just put some in the portfolio right now because I'm just concerned with the uncertainty in markets. In fact, I put it in before we had the spike in volatility from Friday, then Monday wasn't so good. Now we're actually seeing it spike a little bit again now. But these are just different ways of contextualising how you want to hedge what you're actually hedging. But bear in mind, you get very different payoff profiles on all of these.
And then Ghost, I want to actually land on a completely different point here. And we've mentioned gold, but other things we haven't mentioned is that you've mentioned how you've got to have a cash buffer. And I don't see that as a personal finance kind of perspective. I see that as an asset allocation perspective because remember, asset managers that manage multiple asset classes, including bonds, including cash, they also have the flexibility to move that around within certain bands. And so when you're managing your own portfolio, don't neglect looking at asset classes as a holding. Cash is actually a holding. You might actually choose to sell out some of your equities and then just hold that in your cash buffer to make sure you sleep easy at night. You may choose to actually go and buy bonds because you think interest rates are coming down and bonds might actually outperform equities on a risk adjusted basis.
There are lots of ways to actually hedge yourself out there, whether that's asset allocation, whether that's just managing your exposure, whether that's a sophisticated tool like SQQQ or VIXI, whatever that might be. And then lastly, don't negate looking at alternative asset classes because again, I know you don't like this Ghost, a lot of people look at physical property and other hard assets, whether that's private equity, private credit. You've got to consider the full spectrum of assets that are actually out there when you are crafting your own asset allocation. There's a lot more to the world than just going out there and buying S&P, Nvidia, whatever that might be Ghost.
The Finance Ghost: Yeah, describing buy-to-let investments as a hard asset is probably very accurate. I think that anyone who's tried to manage a flat will agree with you, Moe, that it is a hard asset. Just kidding. Obviously it's not the context in which you're using the word hard, but it applies nonetheless. And the other thing, Moe, that makes this all really complex, obviously, especially for those of us still living in rand town, is you've got to think about - it's not just whether or not these international stocks are overpriced, but what are they doing in terms of their rand/dollar exchange impacts, what does it look like in rand?
And that makes life a lot more complicated. Interestingly, if we go all the way back to, I think our first ever Magic Markets show, which was now quite some time ago, we did it on the rand if I recall correctly. And one of the things we talked about was the need to split out the decision on the currency from the decision on the underlying assets. I'm looking at the moment - it's not quite perfect hedging per se, but I'm kind of sitting there saying okay, I haven't deployed money into equities in a while because I think they have been frothy. So I'm just letting my winners run and I'm not putting more in and I've been instead just building up this nice buffer earning - you get good interest rates in South Africa - yes, at the moment I would have been better off if I had just kept putting into the market, obviously. But what I'm looking at as well is the rand just keeps getting stronger. Now it's impossible to know where that ends with the dollar obviously, but down in the low seventeens is starting to look kind of interesting to potentially take some money out into dollars and then be there for, if there's a big correction, to actually buy it.
Because what inevitably happens with the big risk-off trade and this is the big frustration, the market has a heart attack, something goes wrong, risk-off trade happens, inevitably the Rand gets clapped. Deservedly or not, it's just a reality. And if you're sitting there in those cheap JSE mid-caps thinking oh, this is exactly where I should be for when growth stocks fall over, I've got bad news about what happens to those stocks when risk-off happens and this is why I generally don't own them, because it feels like you lose on the way up because everyone else does better than you do and then when they do badly, you also get klapped anyway. So it's like you just don't win. You just get your head stuck in the toilet at school that day no matter what happens to you. It's a very hard way to make money.
Mohammed Nalla: Try and not get your head stuck in the toilet Ghost, that's terrible. Can't get that picture out of my head.
The Finance Ghost: It's not ideal. Look, no one does that by their own choice, Moe, I think is the point.
Mohammed Nalla: I think you've landed on probably a very nice point to wrap the show up on and we've discussed the rand - you're right. I think it was our first show was on the rand. As a South African investor, that is really essential to your overall decision-making tree because generally South African investors consider that they are under diversified when it comes to global exposure. Maybe that's changed. I know there's a proliferation of investment options that give you exposure to the US markets and again a lot of that's now ended up in these highly valued tech names. But separating the currency decision from the asset decision is absolutely vital. And I like to stress this because I mentioned earlier, you've got to buy your insurance on the market before you actually need it. You've got to buy it before the sell-off happens. Because when the sell-off happens, the insurance becomes a lot more expensive. Now it's the same behaviour that you see on the rand exchange rate. It tends to be so countercyclical. When the rand is strengthening, everyone sits on their hands. They think yes, this is going to go a lot stronger. And so they typically tend to under allocate when the rand is strong. And then after the rand blows out, that's when they all rush - they rush for the doors, they go and buy their dollars usually at a less favourable rate. I think a good solid discipline in terms of either run cost averaging this over time, is decide what you want your offshore versus your local asset split to look like and then slowly over time - don't do it all in one month necessarily - but over time just gently allocate even if it's to your cash balance internationally, leave the powder dry if you're not yet comfortable deploying that to asset markets, whether that's equities or bonds, whatever it might be. I think that's really a very important discipline to actually stand behind and it is firmly entrenched in what we're trying to discuss here with regards to hedges. As a South African you do tend to have to hedge against currency debasement. South Africa has done well. You've got a responsible SARB. The tighter interest rates - I know that irritates a lot of our listeners, but arguably that's also behind why the rand has actually held up pretty well. It's a very strong yield seeking destination, the carry trade certainly underpinning that, foreigners have been big buyers of South African government bonds certainly at the long end. I'm not going to go down that, that's probably a topic for another day. But bear in mind this all goes hand in glove.
Stick to a discipline. Consider what your hedges are out there. It could be commodities, it could be gold, it could just be buying foreign currencies whether that's the euro or the dollar. You're hedging against the South African rand. Look at what you're hedging against and then pick those hedges responsibly and then apply a firm discipline behind that. I think that's the last message I want to land the show on Ghost.
The Finance Ghost: Yeah, I'm happy with that, Moe. I think we can leave it there and we'll keep track of how the market is doing out there. As always, keen to hear from our listeners. What do you do in your portfolio? Have you looked at something like SQQQ before? Do you use other methods? Do you put your money under the mattress? Do you buy gold? Do you simply hope for the best? What is your hedging strategy?
Mohammed Nalla: Or do you buy three blue Lamborghinis? I know that's a cheeky reference at the moment.
The Finance Ghost: There we go - that's a, sho yeah, different kind of strategy, that one, Moe. I don't know if that has anything to do with hedging, gotta tell you. We'll leave it there. Thank you for listening to Magic Markets this week. And Moe and I will be back next week where we won’t talk about blue Lamborghinis, hey Moe?
Mohammed Nalla: Hit us up on social media. It's @MagicMarketsPod, @FinanceGhos, @MohammedNalla. Even if it's a tongue-in-cheek comment about blue Lamborghinis or red Ferraris, go check out our Ferrari report on Magic Markets Premium, only R99 a month. Go and check that out.
We hope you've enjoyed this. Until next week, same time, same place. Thanks and cheers.
The Finance Ghost: Ciao.
This podcast is for informational purposes only and is not financial or investment advice. Please speak to your personal financial advisor.
