The platform offers investors a chance to hedge against losses in a depressed market.
Current down market is testing the faith of many. The Nairobi Securities Exchange (NSE) 20 Share Index has lost some 700 points (an equivalent of 19 per cent) year-to-date and this far negotiation for a price floor appear unresolved. Lower closes have begotten lower closes.
As a result, there’s more parking on the sidelines, more “let’s wait and see” and less bargain-hunting just yet.
For most, it’s not the easiest thing to watch. Share markets bleeding for profit. It is stuff that trips even the most patient ones. But this is the silver lining — in the future, investors will be able to hedge against such adverse moves via index futures, stock options and short-selling. But for your information, while we await this brave new world, not everyone is welcome.
For short selling, in particular, the Capital Markets (Securities Lending, borrowing and short-selling) regulations, 2017 bars the average investor from participating. But all is not lost. Retailers can still directly control their shorting decisions via a different vehicle — Inverse Exchange Traded Funds (ETFs).
Just a quick definition, an inverse ETF, also known as a short ETF or bear ETF, is structured to return the exact opposite performance of a particular index or benchmark.
In other words, buying an inverse ETFs gives a result similar to short selling the stocks in the index.
This means on a day when the NSE 20 Share Index falls five per cent, the inverse ETF should rise by the same percentage.
Conversely, if the benchmark index rises by five per cent, the inverse ETF is expected to rise by five per cent.
That done, here are a few reasons why I think this product will be suitable for the retail investors.
One, it shields them from any “fail to deliver” issues.
Two, it requires none of them to be regulated person (short selling is restricted to regulated persons mainly pension funds, insurance companies, investment funds, exchange-traded funds and commercial banks).
Three, investors are not a party to the lending agreements.
Four, there’s no requirement to provide the 100 per cent collateral cover needed for the short sale.
And fifth the retail investor is shielded from any margin calls.
Having said that, inverse ETFs are not perfect. The need to rebalance daily means compounding works against buy and hold investors.
In other words, when the index rallies say for three straight months (with returns compounding daily), the inverse ETF losses would require even bigger re-bounds just to break even.
This implies that holding an NSE-20 Share Inverse ETF from January to date may not necessarily produce exactly a 20 per cent gain as the ETF would still be regaining ground lost in last year’s 30 per cent rally. What’s the point? This product is most suitable for “short-term” trades and would only be an extended buy when there is a strong directional trend ala 2015-2016.
In summary, these securities offer the closest distance to direct short-selling in a regular market. More importantly, if they do become a reality, investors will have the chance, albeit risky, to hedge against market losses.
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Note: The results are not exact but very close to the actual.
