Profiting from Volatility using Leveraged and Inverse ETFs

Global financial markets have been erratic throughout 2019. Market cycles are seen to be sharper and shorter as of late moving on news flow and expectations. With volatility back and investors bracing for a bumpier ride ahead, instruments like leveraged and inverse exchange-traded funds (L&I ETFs) can be used to capitalise on such market conditions.

With the fresh listing of the country’s first L&I ETF on Bursa, local investors now have access to a popular strategy that was until recently only available in more developed markets like the US, Hong Kong or South Korea.

Last November saw the simultaneous listing of 4 L&I ETFs by Affin Hwang AM that would provide investors the opportunity to profit from both bearish and bullish market trends.

The 4 ETFs are the TradePlus NYSE® FANG+™ Daily (2x) Leveraged Tracker, TradePlus NYSE® FANG+™ Daily (-1x) Inverse Tracker, TradePlus HSCEI Daily (2x) Leveraged Tracker, and TradePlus HSCEI Daily (-1x) Inverse Tracker.

Benchmarked against the Hang Seng China Enterprises Index and NYSE® FANG+™ Index respectively, the ETFs will provide investors the option to either gain a (2x) leverage or hold an inverse (-1x) position on the 2 indices.

It would provide investors with the opportunity to either double their investment returns through a Leveraged ETF in up markets, as well as the opportunity to gain returns/hedge against losses by shorting the market through an Inverse ETF in down markets.
All these without the common hassle that comes with derivative trading through warrants/futures such as margining or expiry.

Here’s a breakdown of how investors can employ L&I ETFs as part of their portfolio strategy to potentially profit no matter which direction the market goes.

Tactical Exposure – Trade on Market News/Noise

2019 has been a trading market throughout the year as volatility surges whether stemming from trade tensions, recessionary fears or geopolitical tensions (e.g. Hong Kong riots, Brexit). The smartest strategy is to buckle-up, stay disciplined and invest consistently to ride the market peaks and troughs.

But, for investors looking to unleash their inner-trader and want some tactical exposure, then L&I ETFs are the ammunition to do so. L&I ETFs should be primarily viewed as daily trading tools for investors to express their short-term market views and potentially profit from intraday swings of the index.

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Estate Planning Don’t Postpone the Inevitable

In 2018, Finance Minister YB Lim Guan Eng disclosed in Parliament that unclaimed monies amounting close to RM10billion from various entities had been submitted to the Accountant-General’s Department. Yes, you read that correctly – almost RM10billion in cash sitting idly left unclaimed by Malaysians.

The figure underscores a pertinent issue surrounding the lack of awareness amongst Malaysians on proper estate planning practices as well as apathy and just plain ignorance on the basic steps in wealth & asset distribution.

Tan Ping Ying, CEO of Affin Hwang Trustee Berhad (AHTB) highlights that the actual value of unclaimed assets could be even higher than what was reported. “Unclaimed monies comprising of inactive bank accounts, unclaimed fixed deposits or insurance payouts is just one aspect of unclaimed assets. The value of unclaimed estates such as land, landed or non-landed properties, farms and estates are even more significant,” she states.

That is why investors should pay as much attention to the wealth distribution phase of the financial lifecycle to avoid having their assets trapped in bureaucratic limbo and regulatory red tape which puts their dependants at risk, says Tan.

In the financial lifecycle, investors tend to pay more attention to the wealth accumulation stage when they start to build their assets and later move on to the wealth preservation stage when they approach retirement. However, the wealth distribution component is often ignored because nobody wants to broach the subject on death and inheritance.

“Most people have a tendency to postpone estate planning and shy away from thinking about distribution plans. They would perceive estate planning as a complicated process and will only leave such planning to a later stage,” says Tan.

“But a complete and holistic estate plan encompasses more than just what happens after you pass on. Sufficient awareness should be built around the concept that you should start planning as soon as you have assets to pass down to your loved ones and to provide for yourself during your incapacity which is now, rather than hoping things will work out when the time comes.”

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Global Easing Cycle Close to an End

In the following Maggie Wong, Senior Portfolio Manager of Affin Hwang Asset Management shares her views on where we are in the current interest rate cycle and outlook for Asian credits.

1) On monetary policy outlook, where are we in the interest rate cycle looking ahead?

In the past six months, we saw coordinated efforts by central banks globally to reduce interest rates in response to slowing economic growth. Total interest rate cuts delivered amounted to more than 1000bps by 26 central banks, including US Federal Reserve (Fed), European Central Bank (ECB), Reserve Bank of Australia (RBA) and Bank Indonesia (BI).

Going forward, we believe there is limited room for further monetary policy easing given already low interest rates. Central banks are more inclined to “save some bullets” for future, i.e. in the event whereby a recession materialises, as well as adopting a “wait-and-see” approach to assess impact post recent rate cuts.

In the US, the Fed will likely put rates on hold after a final cut in October (if not December), delivering a total cut of 75bps this easing round. The RBA and Bank of Korea (BoK) have also recently signalled that they have likely approached the end of the current easing cycle.

At the same time, we are also seeing a transition whereby central banks are now passing the baton to governments to prop-up growth (i.e. from monetary easing to fiscal easing). For example, there is increasing pressure on various European governments to launch fiscal stimulus. Other countries which have implemented fiscal stimulus recently include but not limited to France, Netherlands and India.

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Budget 2020 – Job Creation Prime Focus

At the tabling of the budget, Finance Minister YB Lim Guan Eng struck a balanced tone by sticking to the need for fiscal discipline whilst also remaining expansionary.

The budget placed a lot more emphasis on job creation and shifted away from the outright disbursement of large cash handouts and subsidies as seen in prior budgets before.

Among the measures include a Malaysians@Work initiative aimed at creating better employment opportunities for youth and women, as well as reduce dependence on foreign labour.

Malaysians who replace foreign workers will get a monthly wage incentive of RM350/RM500 for two years, depending on the sector. Similarly, employers will get a monthly incentive of up to RM250 a month throughout the same period.

With expectations that 2020 will be another year of a sustained global economic slowdown, the government also focused on the attraction of FDIs and incentives to attract large multi-national corporations (MNCs) to set-up shop in Malaysia.

These include a RM1 billion allocation in investment incentive to attract Fortune 500 companies and global unicorns. The move is intended to create supporting industries that will boost job creation and aid development of the SME segment as an important pillar of the economy.

Technology also received a large allocation of the budget particularly to accelerate the deployment of 5G in the country through a RM50million grant.
There were also initiatives to propel the use of e-wallet via a RM30 seeding incentive to qualified Malaysians aged 18 and above with annual income less than RM100,000 as the economy evolves towards a cashless society.

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How to De-Risk Your Portfolio

As volatility in markets jolt and intraday price swings become more pronounced, many investors are looking at ways to reduce risk in their portfolios. Most investors make the mistake of interpreting ‘de-risking’ as just locking-in gains and cashing out from the market.
But de-risking entails more than just cutting one’s exposure and shifting all their asset allocation to cash. Here are 4 ways investors can lower risk in their portfolios without derailing their long-term plan whilst also staying invested.

1. Hold Some Cash

Cash may be king, but not always and certainly not in excessive amounts in a portfolio. Most investors would automatically flock to cash when faced with higher market volatility or when signs of headwinds appear.

As a safe haven asset class, cash is arguably the safest in its category. But it also offers no real returns or yield and its intrinsic value can be diluted by inflation. Keeping some cash can ensure some form of capital preservation, but the investor also sacrifices yield and could potentially miss out on higher returns when markets rebound.

Holding large amounts of cash also introduces another dilemma when investors plan their eventual entry back into the market. This involves a significant degree of market timing which is near impossible to achieve.

History has shown that investors often never get it right when they attempt to buy at the bottom or sell at the high. In fact it’s usually the other way around because of herding mentality in markets and the presence of algo-traders.

The ideal amount of cash to hold in a portfolio differs from one investor to another. But it typically ranges between 5%-10% depending on the investor’s time horizon and risk profile.

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What Investors Get Wrong About Risk

One of the first steps to investing successfully is to determine your risk profile at the onset before building a portfolio. Investors often do this by answering a series of questionnaire that touches on their attitudes toward risk and also net assets.

The answers would then ultimately serve as a guide to asset allocation and set the risk-return parameters in a portfolio. Hence, it is a crucial step that investors need to get right at the beginning to avoid a risk mismatch in a portfolio.

But the concept of risk can be tricky terrain for investors to manoeuvre especially when psychological biases and market volatility comes into play.

Among the most common misconception that investors have is the level of risk that they are prepared to accept and actually able to take.

 

Understanding your Risk Profile

According to Investopedia, a risk profile is an evaluation of an individual’s willingness and ability to take risks. There are two parts to the equation here, i.e. willingness and ability to take risks. Investors often get confused between the two.

Risk tolerance is the amount of risk/degree of volatility in one’s portfolio that the investor is willing to accept or able to stomach mentally. This often varies with individuals and their own psychological makeup that forms their attitude towards risk and how they view the risk-return trade off. Adrenaline junkies and high-stake speculators comes to mind and are likely wired differently from the rest of us.  As such one’s risk tolerance is commonly inbuilt, though one can be coached to gradually learn to take risks.

Whereas, risk capacity measures the amount of risk/degree of volatility in a portfolio that the investor is actually able to take without unduly jeopardising one’s financial security.  Different factors like age, having a steady income and liquidity requirements are some of the determinants that affect the investor’s ability to take risks.

To illustrate these two terms, consider a retiree in his 60s who no longer has a stable income and relies on his hard-earned savings to sustain his current lifestyle. Despite modest appearances, the retiree is a punter who enjoys taking risks and is able to tolerate large swings in his portfolio to get higher returns.

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Affin Hwang AM Investment Forum 2019: Geopolitical Flare-Ups Key Market Risk

Geopolitics will continue to be a fixture of markets for time to come as increasing polarisation and fractures appear in bilateral ties leading to more volatility in turbulent times. “We are entering an unprecedented period of geopolitical risk that investors have to price-in when making decisions in their portfolio,” Teng Chee Wai, Managing Director of Affin Hwang AM said at the company’s annual investment forum held at MITEC, Kuala Lumpur on the 20th July, Saturday.

Teng contends that there is a possibility of US President Donald Trump winning a second term in the White House due to a lack of strong candidates from the Democrats and also Trump’s own ability to rile up political support by tapping into populist sentiment.

“The reality is that investors may have to live with Trump for the next 4 to 5 years if he wins election next year. His penchant for Twitter diplomacy has the ability to influence market behaviour and also introduce policy uncertainty unlike anything we have tread before. Will he be a better president or continue to be reckless if he wins? Nobody knows the answer,” adds Teng.

Unresolved US-China trade tensions which has stretched into a year-long trade war is another key risk that could roil risk-assets. Markets enjoyed a temporary reprieve since Trump and Chinese President Xi Jinping reached a trade truce in June at the G-20 summit in Japan, where both sides agreed to hold off from imposing any new tariffs and resume negotiations. However, the apparent lull in the trade war could easily turn the other way, according to Teng.

“Trade talks between US and China are not going to be easy with many structural barriers at hand. And knowing Trump’s volatile nature, he could just as easily upend negotiations and decide to impose tariffs again. Or he may decide to be best friends (sic) once more with China. This makes investing in this environment very difficult,” said Teng.

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Looking Beyond the Yield Curve

If you’re a keen market observer, you would have read about the yield curve inverting which sent chills down the spine of investors globally. Financial and business news outlets were in a frenzy to point out that a key financial indicator was flashing warning signals that a recession is looming ahead.

Benchmark gauges surrendered gains back in March due to recessionary fears when the spread between the 3-month and 10-year Treasury note went negative for the first time this year since a decade ago. A pallid economic picture painted by the US Federal Reserve which downgraded its economic outlook and tilted its policy stance towards a more dovish approach also added to concerns.

But how accurate is the yield curve as a dark omen for markets that an imminent economic slump is coming for us all? Here is what you need to know about the yield curve and what bond markets are trying to tell investors.

Yield Curve Inversion, Explained…
Logically, people would demand higher interest rates for longer-term loans because the risk is higher over longer time horizons. Think about your fixed deposits (FD), where the longer your FD placement is with a bank, the higher your rate of return. So, a normal yield curve would have an upward slope indicating higher yields for longer-dated maturities.

A yield curve inverts when yields for longer-dated maturities fall below shorter-dated maturities. As mentioned earlier, the yield for the 10-year Treasury note dipped below the 3-month yield back in March’19 which is a rare occurrence in markets. This means that an investor is now getting paid more to hold shorter-dated maturities.

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Overcoming the Herd Instinct in Markets

Ever walked into a mall and saw heaps of people gathered into lines that stretch as far as the eye could see? You have no idea what’s going on, but for some inextricable reason you feel compelled to join the back of the line too and patiently await for this mysterious artefact to reveal itself. Hopefully something or someone turns up?

If you did, you just succumbed to the lure of the herd and fallen into perhaps one of the most common investor behavioural biases. Most daily examples of herding behaviour can be completely innocuous whether you’re strolling through your neighbourhood mall or adopting the latest trends. But as seen throughout history, extreme instances of herding in markets can significantly distort prices, lead to asset bubbles and even cause recessions.

From Tulipmania that gripped 17th century Netherlands, the dotcom bubble in the early 2000s as well as the subprime mortgage crisis during the 2008-GFC, history has shown that investors are willing to suspend disbelief when market euphoria swells to reach delirious highs. This is prevalent especially during bullish market conditions and when there is abundant liquidity in the system.

Go with the Flow? Not Really…

As social creatures, people have a sense of safety in numbers. There is just a collective reassurance that comes with conforming to the wisdom of the crowd especially when navigating the treacherous peaks and slopes of markets.

But if you take a closer look at just who is behind the trading desk, you may realise that that there isn’t anyone after all. The underlying reality of investing in stock markets today is that most trading are done by machine and algo traders who profit from short-term fluctuation in prices and ignore fundamental analysis. According to reports, 80% of daily moves in the US stock market are machine-led. In 2017, the global algorithmic trading market was valued at US$ 9,297.24 million and is projected to exhibit compound annual growth rate (CAGR) of 10.1% over the forecast period (2018 – 2026).

Behind each market plunge is a digital herd of trading bots programmed to buy and sell based on pre-determined formulas and models. This ignites a ‘flash crash’ like that seen in 2010 when the Dow Jones Index lost close to 1,000 points in mere minutes. The S&P 500, Dow Jones industrial average and Nasdaq collectively lost $1 trillion. But in 36 minutes, the rout was all over and markets rapidly recouped back its losses.

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Malaysia Baru, Where Art Thou?

It has been one year since the watershed 14th general elections (GE14), when the Pakatan Harapan (PH) government unexpectedly trumped Barisan Nasional (BN) 6 decade rule to wrest control of Putrajaya.  However, market reaction has not been kind with the benchmark KLCI plunging close to 12% since May 2018 as euphoria dissipates over lack of policy clarity and sluggish growth, making us the only regional market to be in the red this year. 

 One year on, where is Malaysia Baru headed? Is the local market really that short of zest to be considered ‘boring’?  In the following interview, Gan Eng Peng, Director of Equities Strategy & Advisory, Affin Hwang Asset Management offers some perspective and if the market has bottomed out.

Questions

  1. As we approach the one-year anniversary of PH government coming into power, what’s your assessment of the market so far and speed of reforms?

Malaysia is the only decent size market globally to be down this year.  We did not benefit from the liquidity driven risk-on rally.  Even Thailand, which had an inconclusive election has fared better than Malaysia.

It is fair to point that the speed and effectiveness of reforms has been lacking.   There has been a lot of own goals, flip-flops and policy risk coursing through corporate Malaysia.  Wholesale changes of top corporate personalities would grind down decision making.  To be clear, Malaysia is economically healthy – it’s just the animal spirits that has been taken down.  The velocity of money has slowed.  People are not driven to invest even though there is tremendous wealth on the side-lines.

  1. Are markets just too impatient or are there other external factors ailing the market?

Last year there were various external factors weighing down on markets, so we could hide behind these issues and said we were suffering together. But the performance this year has ended this debate of whether it is a global issue overhang or domestic underperformance.  It is clearly domestic underperformance.

Markets are always impatient.  It is a real-time measure of the performance and prospect of the country via its listed corporate.

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