Update for the month of March 2025. HOG puts closed out. No major long term changes to the portfolio. A small fixed income position in IHRT 6.375% 2026 was added to the portfolio. My ramblings on “EURATO” and the general state of the markets and the world.
Marketable Securities
The top 5 marketable securities held in the portfolio continue to remain Sabre Inc., Visa, Fairfax Holdings, Kellogg, and the Vestis spin-off. Positions in $23 strike HOG US Put were closed out (March OpEx). A small position for a 2026 dated fixed income security in IHRT US paying a 6.375% coupon was initiated.
Revisiting Options – “It’s Deja Vu All Over Again”
Similar to the previous month, I believe market volatility provides umpteen opportunities to find satisfactorily underpriced put options which may be written in order to generate premiums for the portfolio. Whilst Berkshire has been known to employ a similar approach with Index LEAPs, similar opportunities may be found in individual equities on much shorter dated options. Unlike Berkshire, which requires a high amount of liquidity leading them to dabble in index options or structuring OTC “European Style” option trades, individual investors and smaller funds, especially of the value type may exploit these opportunities for, among others, two specific instances. The first one being generating premiums for the portfolio (as mentioned above), whilst the other would be to generate premiums for the portfolio with a view to potentially initiating a position in the underlying at an acceptable cost basis.
Speaking of which, if yours truly, is piqued by a slice of equity in a marketable business and finds that the options are undervalued at a level which I would be comfortable purchasing, it would behoove me to make use of the opportunity and exploit the market anomaly. Additionally, PMs at pod-based shops, or those who value quarter to quarter performance, may use the facility of writing derivatives against existing, or non-existing positions to book in profits for their quarter.
Assume that we have a stock of company “XYZ” or say “ABC” (one only needs to look at Indian markets to find even longer tickers!) trading at a level which is undervalued with the markets in fear territory. If one has allocated a target position size of say 5% to the specific business, the PM can then go on to adjust his position size (and cost basis) by writing derivatives against this position at a much lower strike price which is languishing in bargain basement territory, potentially leading to two outcomes. In the optimal outcome, yours truly achieves his position size at his target cost basis and the options expire leading to a successful capture of the premiums. The not so optimal outcome would be to have the the option expire ITM leading to an increased position size with a cost basis adjusted to more favorable levels. As with most of such situations (a recent example being VSCO US when trading sub $14 or THO US trading around $65, which is definitely value territory for either businesses), one could close the options positions for a quick profit on the stock price rebound so as to ensure that the quarter’s bonus is accounted for and the wife (and mistresses) happy. (May the two never meet!)
Whilst AQR Capital has put out an interesting paper on option strategies (Rebuffed: A Closer Look at Options Strategies), which makes for interesting reading – it is to be noted that the paper specifically looks at options as an asset class, in that the derivatives are being used as a mandate on average and whether they achieve returns with a favorable risk / reward profile compared to the index.
Clubbing various options strategies as a whole and discussing them in broad-strokes so as to generalize the investments is, in my opinion, missing the forest for the trees (or akin to saying that taken as an average, the “automobiles asset class” is unfit for Formula 1 racing and beating the average speed set by a middle-marker on the grid – aka “the index”). If one wants to achieve a drive at high speeds with grip around the corners, perhaps buying an SUV or a truck might not be the best option, albeit it being an automobile, as compared to a performance vehicle. The counter argument works similarly. Coming back to options, one needs to appreciate the various roles and “mission profiles” that each form of derivatives strategy can be used for, as compared to clubbing all the strategies together.
Tail-Hedging and other strategies oft, on their own, might make for poor investment returns over a year or two, but treated as an asset allocation as a part of a portfolio (say 0.5 – 2% of the portfolio allocation will go to a tail risk based derivatives strategy or a covered call strategy either as a given or as a tactical allocation by the lead PM), these mandates have a propensity to generate outsized returns for the risk and capital outlay compared to the indices. Furthermore, as mentioned above, the individual investor may employ similar strategies on a single name or even create a basket of options. Therefore whilst always being interesting reading, I would opine that investors think deeper, post reading academic research, and find ways to optimize findings to their own investment style. Coming back to our automobiles analogy, using a Formula 1 racehorse on the potholed filled streets of Mumbai is asking for trouble. (One would get around faster via a bullock-cart – which I’ve been led to believe is equally hard to pilot as a race car if not more!)
Coming to the situation of “Overlays” and the oft used phrase of “betting on America / North America”, one only needs to have a look at the SPY Index Put Options with June and December OpEx respectively. Looking at the strike price of between $400 – 420, which is 20% away from current market levels as on April 06th, one gets an average premia of close to 3.40% for the June expiry options. Cashing in on the premium, one may either go on to invest the monies into treasuries, or other strategies. Assuming the average investor puts the premium to use in “BBB” rated bonds (which is the median credit rating of the S&P500 stock), which are yielding 5%, one will expect to earn an annualized 8.4% on the capital outlay, at expiry – thus making for a satisfactory investment. Given that the current yield of risk arbitrage is over 15%, and one selects “safer” deals averaging between 8 – 10%, one may further push the total return generated to nearabout 13.8 – 14% on an annualized basis. (Please head to the excellent dataset at Alpharank for more info on arbitrage yields).
Investors with favorable margin rates may engage in such strategies without having any monies tied up as well – thereby leading to a form of relatively secure leverage. In the eventuality that the index does not perform as expected and “Uncle Sam” decides to delay economic resurgence, whether a retail or a professional investor, given that one would be purchasing the index, the expected loss, if any, would be minimized given that part of the portfolio would be tracking the index in this eventuality (selecting the right strike price is critical).
Skeptics of this investment school, or traditional value investors may interpret this data as the market currently opining that betting on American equities over the next one year is much safer than an investment in similar dated treasuries, which are currently yielding 3.8% on the secondary markets as compared to the 3.4% yield generated by the LEAPs on the S&P 500.
The research and insightful articles on AQRs website always make for instructional and insightful reading and I always look forward to what Team AQR has to say. However, as with most academic research, caveat emptor!
“In theory, there is no difference between practice and theory. In practice, there is”
– Yogi Berra
March Performance
The cumulative performance of the fund since inception has been 14.73% as compared to the S&P 500 (Benchmark) yielding a total of 1.62%. The portfolio returned -8.12% in March as compared to the index, which returned -5.75% to index investors. It is my expectation that we continue to target a 10% CAGR over the long run for the portfolio by investing in a mix of long term compounders as well as some opportunistic opportunities.
I continue to favor the low touch strategy of buying relatively cheap companies which can be held over a long investment horizon, with an agnostic view towards sectors. If quoted at cheap prices, high tech and new-age companies which are scaling up quickly and are cash flow compounders, are very much on the table.
General Portfolio Update & State of Play
I would assume that professional and enthusiast investors such as me, would be exceptionally pleased with the current state of the markets and hoping for a few more months of corrections. I am already seeing a slate of businesses trade for extremely cheap valuations. As an immigrant to North America who has experienced both, the hearsay of “not betting against America” as a youngster in the salubrious climes of India, as well as living and breathing the North American economy, further corrections in the markets as per me would cause an inflection point in the markets which would spur, among others, outward and global investors to move back to the North American shores leading to reflexivity in the stock prices and businesses on a very small scale – but enough to restart the resurgence in markets. Given the current state of play, It would be remiss of me to not mention two oft quoted remarks by one of my previous mentors in Vancouver: “Investing is hard” and “There’s no substitute for doing the work”. We have to choose our fighter (the wiser ones would likely select both to fight their corner).
Although the MAGA memes continue given the market downturn, I believe President Trump, as a businessman & first citizen, is well placed and smart enough to realize that the markets & valuations are frothy, and with his goals of intending to keep the interest rates relatively steady or lower, his strategy of utilizing tariffs to create more favorable circumstances for American businesses will be extremely beneficial in both – the long run as well as the administrations years moving ahead.
It behooves Wall Street to understand that there is more to life than the markets, and manufacturing market fear or a recession in the short run, thereby causing the prices of oil to drop among other items, might just be the Trump card that the West needs to counter the current stand-off in Ukraine without taking direct action. It is my belief and opinion that we will likely see some sort of peace agreement between Russia and the Ukrainian forces without actual induction of the country (Ukraine) into the NATO alliance.
Given that the Ukrainian military operates legacy Russian equipment and is not a large arms importer from the nation, donating Western equipment to Ukraine as well as President Trump’s rhetoric on the “EURATO” (European NATO members) needing to increase their own defense manufacturing and expenditure, a peace treaty will sit well with all nation states involved. This will allow Russia to maintain its territorial integrity without further expansion of EURATO forces, (which is seen as a provocative and aggressive measure by Russia towards its own land). In addition to the above, this is likely to provide a fillip to the EURATO based military-industrial complex as well as generate recurrent revenue streams in the future through Ukraine and from within. This likely will achieve President Trump’s agenda of getting EURATO to focus on increasing their military capabilities and spending to a degree if not completely as well as boost the local economies.
As far as Russia is concerned, in addition to stopping Ukraine from joining the NATO alliance, it has likely now gotten to know first-hand, the operational capabilities of American and Western military equipment without much attrition of their “fully-trained” troops. To say that Russia would have used this scenario to insert its own “state actors” en-masse into Ukrainian territory, and witness first hand the limitations and capabilities of donated equipment to Ukraine would not be a stretch. What tempers this fact however, is that the tandem benefits to the Western militaries would also be paramount, who now have combat tested systems (in Ukraine) thereby allowing them to re-write and potentially revisit their own SOPs.
“Whoever said that military action is the final form of diplomacy might perhaps need to have a relook at their geopolitical playbook.”
– Unknown
– Sanket Karve
Given the above macro backdrop, I believe that the world is positioning itself for a decent run of prosperity over the next few years. Given that the general elections in most of the free world and economic superpowers has been completed, it is my belief that we unlikely to see any more overt conflicts or stand-offs in “non-conventional” regions. It might benefit investors to keep an eye out on equities belonging to European defense companies as well as budding or established cybersecurity companies, along with a rebound in Euro-based automobile and manufacturing businesses.
Either ways, although I continue to keep an eye out on the general news, state of markets and world affairs, the goal is to find undervalued businesses at attractive prices along with short term commitments offering attractive yields so as to park monies and avoid the short term market volatility.
Feel free to comment or to reach out to me!
Sincerely,
Sanket Karve