The possibility of success with my master plan – to grow R100 000 to R1 million over the next two years, by investing in a few neglected shares and others that offer recovery potential – looks extremely slim.
After doing a lot of reading and number crunching it looks like the best I can hope for is that the little portfolio will grow to R241 000.
That in itself is a very optimistic goal. Every share in the portfolio must basically more than double to reach the rather disappointing figure. In addition, the calculations exclude brokerage and other costs.
|Comair||R2.69||8 000||R21 520||R7||R56 000|
|Sasol||R286.73||100||R28 673||R800||R80 000|
|Sasfin||R27.30||900||R24 570||R50||R45 000|
|Astral||R166.58||150||R24 987||R400||R60 000|
|R99 750||R241 000|
Source: Own calculations
A few of the shares are also quite risky propositions as indicated by their low standing in the market. The basic assumption of strong recovery from big problems is equally risky, thus demanding a high return.
My solution to get even higher returns from the risky portfolio is to increase the risk even further by supercharging performance with massive gearing by ignoring the stock market and rather getting exposure to the shares with derivatives.
A few alternatives are available, with single stock futures (SSF) contracts and contracts for difference (CFDs) the two more commonly traded and very liquid alternatives. They are similar in the aspect that an investor can get exposure to a share by putting down a deposit of only around 15% of the value of the ‘shareholding’.
Instead of investing around R21 000 to buy 8 000 Comair shares at R2.69 each, an investor can put down the R21 000 as margin on a CFD or SSF trade and acquire a much larger position. The margin requirement for larger companies is 15% of the share price, while brokers require a margin of 17.5% in the case of smaller companies such as Comair.
An investor can thus buy exposure to 45 000 Comair shares to the value of more than R121 000 with a margin of around R21 000. An increase of 20% in the share price to R3.22 would push the value of the 45 000 shares to nearly R145 000, boosting the return from 20% on the R21 000 investment to nearly 600%.
Unfortunately, the opposite is also true. If the share falls by 20%, an investor does not lose 20% of their investment, but everything. In fact, their loss would be greater than the R21 000 they invested.
It is with good reason that Warren Buffett, credited as the world’s most successful investor, called derivatives the “weapons of mass destruction” of the financial world.
Brokers that make a market and offer platforms to investors and speculators to trade SSF and CFDs also warn their clients about the high risks inherent in trading derivative instruments. They all have similar examples to the one above to show the effect of gearing on profits and losses.
PSG Wealth, the online stockbroking arm of the PSG Group, warns its clients that while trading CFDs can be very profitable, it involves significant risks. “You can lose more money than you started with,” it states on its website.
The reason why losses can exceed the initial margin is that the investor is gaining exposure to the full value of the underlying shares. If Comair falls by 40% (in the case of buying 45 000 Comair shares), my total loss will be more than R48 000, exceeding the initial deposit of R21 000.
Investors are liable for these losses as they effectively ‘own’ all the shares. They would also receive all the dividends paid on the total number of shares in the transaction.
“CFDs require a high-risk appetite, time to watch the markets and expert knowledge on markets and trading,” continues PSG. “You should not trade CFDs if you do not have this knowledge or are an inexperienced trader.”
‘High risk of losing money rapidly’
Another popular market maker to offer trade in CFDs, IG Markets, says CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. It warns clients and prospective clients on its website that 75% of retail investor accounts lose money when trading CFDs on its platform.
This figure gets updated from time to time and has occasionally reflected a higher percentage.
“You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money,” says IG.
Other brokers warn clients to trade only with money they can afford to lose.
In addition, CFDs are not regulated by the JSE, despite a lot of JSE brokers facilitating trade. The buying and selling of CFDs are over-the-counter transactions between the investor and the broker, who acts as principal in the transactions and as market-maker. Most brokers would hedge the CFD positions by buying and selling the underlying shares on the JSE.
Dangerous, yet appealing
The message is that derivatives are dangerous instruments, but the appeal for boosting performance in my portfolio remains. After all, a supercharger worked well for Mad Max back in 1979.
There are different ways to handle risk.
- Firstly, I am willing to accept the risk of further declines in the prices of the selected shares, as it looks like further downside is limited.
- Secondly, the four shares offer a bit of diversification over different sectors. These shares will be affected by different factors, and will hopefully not decline all at once.
It might help a bit to reduce risk, even if the portfolio is by far not optimally diversified with perfect negative correlation, as taught in investment management courses at university or calculated by highly-paid risk analysts working for portfolio managers.
The best defence against the dreaded margin call is not to push the leverage to its maximum. Putting down a margin of 35% to 40% of the value of the portfolio would give enough leverage to enhance returns, but leave ample leeway for temporary adverse movements in the share prices.
This level of gearing would increase the exposure to the shares from the initial R100 000 to R310 000.
|Comair||R2.69||40 000||R107 600||R37 660||R7||R280 000|
|Sasol||R286.73||400||R114 692||R40 142||R800||R320 000|
|Sasfin||R27.30||2 000||R54 600||R19 110||R50||R100 000|
|Astral||R166.58||200||R33 316||R11 661||R400||R80 000|
|R310 208||R108 573||R780 000|
Source: Own calculations
Eventually, the portfolio ended up looking a lot different from the initial idea of investing an equal amount in each of the four shares on the JSE. Bigger exposures were taken in Comair and Sasol, unfortunately at the expense of Sasfin and Astral.
In my view, Comair offers good recovery potential with lower risk, while Sasol can benefit from rand weakness and the attention of global investors. And buying 378 Sasol shares seemed to make little sense.
The end result after another two days of working is still not close to the promised R1 million, but there is still hope of making it to the finish line.
The last step of the two-year plan is to reinvest the returns.