HEDGING AGAINST YOUR RISK
The investment world, and specifically the stock market, is full of opportunities and it has been proven time and time again to be the one sure fire way of wealth generation. Many investors however limit their outcome by steering away from equities as they feel the risks are too great. We counter that argument and say that equities provide the perfect foil to risk and by detailing what risks you may face in life you can construct an equity portfolio to protect you against the risk you will incur and still deliver a great investment return. In this month’s Financial View, we look at some of the risks that we all consider and how owning equities can assist.
Inflation
Inflation has famously been equated to being “like a thief in the night”. You don’t see it or hear it coming but every morning you wake up to find that a little bit of your purchasing power has been removed. You can buy less with your hard-earned money.
In South Africa we have a monetary policy where they try limit inflation to 6% year-on-year as measured by the Consumer Price Index. At 6% inflation prices of goods would double every 12 years. A loaf of Albany sliced bread currently costs around R18 per loaf. In 12 years from now, we can expect to be paying R36 for exactly the same loaf or conversely for the same R18 we will only receive half a loaf.
No change in ingredients – but we can only get half. Such is the challenge of inflation.
Fortunately investing in the stock market is one true method of beating inflation. Large corporates are price makers. They have the ability to pass on their increase in costs onto their customers. Take the example with Albany bread. If you are now paying R36 for a loaf of bread it is because they have passed on their increased costs onto you, the consumer. Thus, to protect against inflation invest in companies that benefit from inflation through their position as price makers. If interested Albany is one of the many brands of Tiger Brands, a company listed on the JSE.
Currency Risk
The Rand is certainly a volatile beast. July it was flying and in August it was dying. Over the last decade however there has been a clearer trend and that has been of a weakening Rand. This has got South Africans spooked as we seem to be moving backwards compared to the rest of the world. All of us have heard of some unskilled job in the developed world that pays far more than what we ourselves earn just because of the currency depreciation and the weak Rand.
South Africa has a number of listed companies that benefit from a weak Rand. These are typically companies that have either have operations outside of our borders or alternatively their products are priced in a foreign currency. Often quoted estimates state that around 65% of the entire market capitalisation of the JSE listed companies consist of Rand hedge shares. They benefit from a weak Rand, as the rand depreciates, they earn more.
Consider Naspers & Prosus which combined is the largest company on the JSE. The bulk of their value is derived from their investment in Tencent, a Chinese technology company. Movements in the Rand don’t impact Tencent’s business. Or consider Sasol, certainly a more South African company at heart yet their revenues are based on commodity prices (predominantly oil) priced in US Dollars.
Most investors will notice that as the Rand weakens their income and capital grows.
Loadshedding Risk
We are all gatvol with Eskom. We are all gatvol with the people who run Eskom or who have any influence over it. We are all gatvol with the fact that the lights go out frequently, often on very short notice. This level of “gatvolness” (a word specifically coined for this article) means that both the private sector and household consumers have started to install their own “power stations”, generally in the form of solar powered solutions.
For those that have already done this, it is a huge cost and much of it an unaffordable outlay in one go. But fortunately, almost every single South African bank has stepped in with the provision of funding for your new solar system. The banks fully understand that the money saved on payments to Eskom can quite easily go towards repaying the loan to get solar installed. And one thing that is certain with a bank is that it won’t lend the money to its clients without some benefit to the bank in the form of interest in return. So, if you are worried about load shedding, buy the shares of a South African bank. Locally, we have amongst the best financial regulation in the world and our banks are well capitalised as a result, so when the lights go out you can rather think of the enhanced return that is happening to your share portfolio.
Fuel Price Risk
As previously mentioned, the Rand has not done well for a long time. This combined with increases in the fuel levy and an increase in the price of oil has meant that we sweat every time we go to the fuel station for that tank of petrol or diesel. As one can gather already from this article when investing you can look at which companies benefit from higher fuel prices. We have already mentioned Sasol as a fantastic Rand hedge, but Sasol also is a great hedge against fuel price increases. The price of oil goes up, the Rand weakens, and Sasol protects you by making you wealthier to counter what your gas guzzling vehicle may be removing.
Country / Political Risk
A very hot potato and a very emotional topic of conversation for South Africans but the reality is that many of us have become more pessimistic about the country. As the GDP per capita shrinks, we all feel the effects and are on average each a little poorer each year.
The relaxation of exchange controls that have taken place over the last decade does mean that it is easier to invest offshore. If you think that South Africa is going to lag its emerging market peers well there are many investments offering exposure to China, to India, or to any of the other expanded BRIC nations. If you feel that the developed world is going to better it is easier, and quicker, to buy the S&P500 through your banking apps than it takes Checkers to get the online shopping to your door. Building an offshore portfolio will allow you to use these funds to travel in future and pay with your accumulated foreign currency.
Conclusion
We have always maintained that equities remains the best asset class to invest in. This is because the protection that it provides against risk. Risk can be identifiable and thus understood. We have just used a few simple examples but there are many more that if you can identify the risk, we can help you identify the investment that would help to mitigate that risk. Often a bigger risk is sitting in cash, while inflation reduces your buying power and not taking a chance and investing in equities that gives you a real return which outperforms inflation.
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