COMMENTARY: Outperforming stock indices? We have the leverage, says portfolio manager

Published by: 27.09.2023 09:39:22

Investment instruments that follow the development of stock market indices and thus reduce the risks associated with individual titles are becoming more and more widespread. But it is possible to aim even higher, says Erik Kmet, managing director of the K&L Rock Group investment group. With his fund, he wants to get to an annual return of 15 percent or more.

 

Erik Kmet has been active on the capital and financial markets for over ten years and his K&L Rock Group currently has assets of over CZK 420 million. Earlier this year, the group launched the K&L Rock Drawdown Hedge Fund.

 

"The fund aims to outperform the average stock market performance of 10.7 per cent. This is through leverage, which is set at a maximum of two-and-a-half times," says Kmet.

 

How do you perceive the current situation on the stock markets, do you feel any nervousness after the growth eight months of this year?

 

Our view of the markets is simple. Whatever happens in them, we should be able to generate some results. When the central banks started to raise interest rates, it was obvious that a tougher time was coming. This year, Western stock markets have been rising quite nicely. Last year, however, they were in decline, with the S&P 500 losing 19.6 per cent over the course of the year.

 

I wondered how to take advantage of this cyclical trend. Historical data shows that deep declines come from time to time in the stock market. Over the past 18 years, the year-to-year decline in the S&P 500 from its highest level to its lowest, which is known in financial English as a drawdown, has averaged about 17 percent. However, all drawdowns in the past have always been matched and eventually overcome.

 

 

However, the most famous US index has not yet reached the last record high set at the end of 2021.

 

Not yet, but it is very likely that the historical high will be surpassed. We believe in long-term growth in the economy, in real estate, in the markets, which is historically documented. It's all about creating a strategy where the risk is as low as possible. Investors have the choice of a range of investment instruments that replicate the major equity indices.

 

But we wanted to create a fund that delivers something extra. And there's no other way to do that than by using leverage, i.e. borrowed money. I abandoned stock-picking, i.e. picking specific stocks, about two years ago. By betting on specific stocks, it is statistically very difficult to beat the appreciation that an index composed of an entire portfolio of stocks delivers. I'd rather spend my time trading than studying analysis and news in detail to pick the right stock title and bet on its long-term appreciation.

 

So how did you use leverage to fine-tune the strategy of the new fund, which is called the K&L Rock Drawdown Hedge Fund? 

 

We started trading at the beginning of this year, so far only with our own money. The fund's goal is to outperform the stock market average, which is 10.7 percent. This is through leverage, which is set at a maximum of two and a half times. But with higher volatility, we'll have less.

 

In risk - or in drawdowns - we want to be at or below the index drawdown. But the added value comes from the leverage mentioned above, precisely when the index rises. We trade on a daily basis and invest in equity derivatives such as futures, ETFs, indices or options. With the fund, we target an annual return of 15 percent or more.

 

The fund is designed for qualified investors. What kind of investment horizon do they have to take into account?

 

The distribution will be through investment certificates, which are securities that are eligible for a three-year time test for income tax exemption when sold. The investment horizon is set at four years. We want to launch the fund to investors in the near future, and by next year we would like to have $20 million, or about CZK 450 million, in the fund.

 

 

In our first fund, we have linked real estate with trading, which will continue to operate. The new fund is already leaving real estate aside and focusing only on trading. We also want to restructure the whole K&L Rock in this direction, separating the trading part more from real estate. It should also be much more transparent for investors. In the autumn, we will also open a new bond issue of CZK 300 million, which, like the previous one, will be for our development projects.

 

You started your first development project in Světlá nad Sázavou. How far along are you and how are you managing to sell the apartments in times of expensive mortgages?

 

We are on schedule, the rough construction of our apartment building Rezidence Na Bradle 1 should be completed by the end of the year. Over the winter, the interiors and mains will be done. We would prefer to hand it over to our clients "under the tree" at Christmas 2024, but it will be more likely during the following spring. Interest is gradually increasing as the building grows.

 

People are spending every penny and the banks are not meeting them well. We are seeing that people still want to own their own home, they are just wondering whether to get in now. It would certainly be a better decision if they knew that the monthly payment would be CZK 15,000, not CZK 25,000. Just like the stock markets, property prices will rise in the long term. People may overpay a little at the beginning because of the expensive mortgage, but they will be able to find that initial increased payment in the increase in the price of the property, for example. We expect that by the end of the year most of the flats could be sold.

 

And you have other projects in the pipeline?

 

We bought a 12,000 m2 plot of land next door. About 100 apartments should be built in three apartment buildings. It's in the very beginning, in the project phase. It must be said that we have good relations with the town of Světlá nad Sázavou, so we want to continue there. All the permitting processes in the town are going smoothly and predictably.

 

Depending on the market development, we will build in two or three phases. We could start construction sometime in early 2025. And we are gradually starting one project in the Ústí region, specifically in Chomutov, where we have bought a 10,000 m2 plot. There are now warehouses there, but there is residential development around it. We want to build apartments there, possibly with some commercial space. We have the advantage that we are not a big corporation. We can build it with a small number of people, cheaper, in locations where the sales prices from the big developers would not meet local demand.

 

Are your clients more investors or people who buy apartments for their own living?

 

It makes sense for young people who will stay locally and not go elsewhere. In general, the trend among them is to move to big cities. But a large proportion of them will eventually come to realise that even a small town has something to offer. For example, there is more local food available, often cheaper services. Over time, the population will move back to these cities. Of course, it will also depend on job opportunities. But if companies see that people are staying in small towns, they will follow.

 

What are your plans for the future?

 

We are looking at the possibility of investing in the energy sector, for example. And in the long term, we're thinking about expanding into the biggest financial worlds, we'd like to go into countries with the dollar, the US. It's kind of a longer-term vision, New York is a financial mecca and you can seek much larger deposits there. Of course, we need to have results in the Czech Republic behind us first, without them there is no point in going abroad.

 

 

We are also very attracted to Southeast Asia, for example Singapore. But it is always necessary to get to know the local environment thoroughly; investors around the world react differently to new investment products. We also built our new fund with the market situation in mind, it helped that we already know the local market well, we are in close and frequent contact with our investors. We invite them to sports matches, for example, and regularly talk to them about how they think about their investments.

 

You come from Slovakia. Isn't that the direction you want to go?

 

We are not going to the neighbouring countries yet. I think the Czech Republic is better for investment. Although Czech investors are more conservative, much more balanced, I find them easier to work with. Most of the time they already know more about investments, they are more prepared for them. Slovaks are often very impulsive, they often pump all their money into an investment that may not be suitable for them. And, of course, this may be related to their more open nature.

 

Original article: https://finmag.penize.cz/penize/445152-prekonat-akciove-indexy-mame-na-to-paku-rika-portfolio-manazer