Press / Media | Cadiz News
Roped to the cliff
14 May 2010
Jittery investors won't get much comfort from Cadiz Asset Management's Francois Finlay's view on the equity market. It may go higher, but then again it could be in for a big fall, he says.
Yet the outcome is academic for Finlay, manager of Cadiz's Equity Ladder Fund (ELF), which is housed in the domestic targeted absolute and real return sector. ELF is a conventional equity fund in all but one key respect: its portfolio is always protected against a major market fall.
Protection is provided through put options written by major banks and traded on the JSE, says Finlay. A put option provides its owner with the right to sell up to a specified number of shares on which the option is written to the writer at a specified price (strike price) at any time during the life of the option.
As a simple example, if a fund holds 1 000 Sasol shares trading at R300/ share, the manager can protect against a fall in the share price by buying a put option with a strike price of R300. If STEADY CLIMB Based to 100 2007 2008 2009 2010 SOURCE: I-NET BRIDGE Sasol falls to, say, R200/share, the option writer would be obliged to buy the shares at R300 and the portfolio would suffer no loss.
Protection stood ELF in good stead during the period of market turmoil that began in May 2007 and ended in March 2009, with the average general equity fund having shed almost 40% in value. ELF investors were left virtually unscathed; the fund's unit price ended the 21-month period a mere 2% lower.
Protection does not mean forgoing the benefit of a rising market. In the Sasol example, should the share price rise to, say, R400, the portfolio would enjoy a R100 000 profit, less the cost of the option. ELF investors found themselves in this position when the equity market began its recovery in March 2009. At its best in April 2010 it was up almost 60%. During this period ELF's price rose 56% and the average general equity fund's price 46%. Taken over the three years to the end of April 2010, ELF's total return of 65% placed it in a class of its own.
Its nearest rival in any sector was PSG's Tanzanite Flexible Fund in the all assets flexible sector, which delivered a 35% total return.
Finlay explains that he is intent on protecting ELF not from minor falls in the market but from major declines. The focus is thus on out-of-the-money put options, where the strike price is below a share's price when bought.
He says that if the market were to fall by 25% and then move sideways for six months, ELF's unit price would end 5% down. ELF's portfolio is heavily slanted towards the top 40 shares, of which seven account for about 60% of equity exposure. The reason, says Finlay, is that options are limited to top-40 shares. An element of smaller-cap shares with potential to provide added performance is included.
One of these is Super Group, headed by Peter Mountford, to which ELF has a 2,8% exposure, ranking it as the lOth-largest holding in its portfolio, which has total assets of about Rl,5bn. "We see significant value in Super Group," says Cadiz analyst Kurt Benn. His confidence in the transport and logistics group, which stood on the brink of bankruptcy in 2008, follows its restructuring and recapitalisation.
On the market as a whole, Finlay is far from optimistic. While not calling a top to the equity market, he stresses that risk outweighs potential reward. Against the background of uncertainty created by Greece's economic meltdown, ELF's hedged approach offers considerable comfort.
