Best Semiconductor Gem!

Semiconductor stocks had a superb run in the last fwe years driven by shortage of chips and then the current A.I. craze. The following chart from finchat.io showed that investing in the SOXX ETF would have delivered over 200% return or CAGR of 25%.

Today, we are going to discuss a related idea with potentially more upside given that the stock has corrected more than 45% but the big tailwind story hasn't really changed. But first let's look at the financials:

Simple Financials (Mar 25 estimate)

• Sales: 2.3trn and EBITDA: 700bn
• OP: 600bn and NI: 500bn
• Market Cap: 10trn
• FCF: 450bn and Net Cash: 500bn 

Financial Ratios

• PBR 5.3x and ROE: 26%
• EV/EBITDA: 11.3x
• PER:16.7x
• FCF yield: 5%, Dividend Yield: 1.8% 

Isn't it amazing to be able to buy such a high-octane semiconductor play at such valuations? Hence the tagline that this could be the best semiconductor gem! As an experiment, we shall not reveal the name today. Interested readers could try to guess and go onto substack to find out. But for convenience, let's call this company T. 

1. Fundamentals

The following is the investment thesis for T:

T is the one of the top players in the semiconductor industry with high market share in certain core products. It stands to benefit from the continuous growth of the semiconductor market and is especially geared to capex growth in its home country. At current valuation, investors can enjoy 5% FCF yield and almost 2% dividend with 80% technical upside if market sentiments improve quickly.

The chart below shows that the market is estimated to double from USD500bn to USD1trn by 2030. As one of the top companies in the value chain, T will grow in tandem with the market and current share price correction provides the opportunity to buy cheap and gain good exposure today!

The manufacturing of semiconductors is also highly complex and in various parts of the value chain only the best of the best survived. The number of players have shrunk to just 1-3 in most segments. In actual high end cutting edge production, there is only Intel, Samsung and TSMC and in the field of lithography, there is only one player left - ASML.

Positives

High and growing market share: the production of semiconductors requires many types of equipment which are manufactured by T. It would take up too much space to describe all of them. The following paragraph describes the opportunity well:

T commands a share of more than 80% of the coater/developer market and more than 60% of the thermal processing system market*, but has less than a 30% share of the etch system market and less than 20% of the cleaning system market. Etch systems and cleaning systems are both used in key semiconductor production processes and therefore their markets offer strong growth prospects going forward. 

Increasing dominance in servicing: as the largest player in the field, T also has a huge installed base of past equipment globally and only T can service its own equipment. This has led to the growth of its servicing business (currently 20-30% of revenue) and at the same time strengthen its business moat as customers are unable to switch to competitors while new entrants are also not able to gain market share.

Risks

However, the thesis is not without risk. T has significant exposure to China and stands to lose this portion of its business should the trade and technology war between US and China exacerbate. The mitigating factor is that there is no other provider and China will find a way to still buy from T via different routes not unlike how arms dealer can find ways to sell weapons around embargoes.

The rest of the post can be found on substack.

When to Top Up?

This post serves as a note-to-self to refine the right process to top up names that are already in the portfolio. It deserves a post because of how our monkey evolved brains work with all its biases and blind spots. It also describes why investing is difficult because the initiation of a position is the start of a very long process for value investors. The position could stay in the portfolio for years, an initial bump up makes it difficult to top up later on and a mistake will take years to unwind.

The scenario we are talking about here is usually when we have done an initial analysis on a name, decided it was worth to take the risk and buy an amount. However, things did not pan out the way it should, bad news erupted, shit hits the fan and the stock collapsed, usually c.20%. We need to decide if we should buy, sell or hold. After years of going through some of these scenarios, having gained some experience, I believe the following would be the right process to follow, with the caveats and strategies attached.

1. Review the new info
2. Redo valuation
3. Write an update 
4. Decide to buy, sell or hold

Review

The first step is obvious. We need to review what happened. This could be an earnings miss, or some bad news at some competitors or some lawsuits etc. The short-term bad news would be the easiest to handle as they would usually provide the opportunity to add because longer term we know things will revert to normal, if the thesis is still intact. 

By and large, we did our homework well when buying initially. So if it is now cheaper, than it should mean we should buy more! But there are some shit that we should look out for: big lawsuits, impairments, potential fraud and solvency issues. These could be negatively gamechanging and we might run the risk of putting good money after bad.

Redo valuation

The next step would then be redoing valuations. This would require doing some assumptions of how much the intrinsic value was impacted and did the share price fall more than it should. This is an art and it could be quite difficult at times to make a good judgement and establish the right valuation when new info is scarce. With lawsuits, impairments and all the big bad stuff, it could really be difficult. If the solvency issue looms big enough, perhaps it would be best to just wait for the next opportunity to get out.

Update

After the above initial analysis, the logical next step would be to write out an update and pencil the thoughts out. This serves to help us crystallize the thinking and of similar importance, for future reference and learning. The update should relook at the thesis, reviews the risk, see if there could be any silver lining and provides the new valuation to see if there is strong basis to top up the position.

The update should also include:

• New information from the 2-3 quarters of recent earnings update
• Information from newswire and the internet, including Youtube and substack
• Alternative sources from interviews with experts (if we can find them via our network)

Decide

Once we have the update in hand, we then need to decide whether we should buy, hold or sell. I will go through the thought process for each of them.

Sell

The decision to sell happens when the thesis is no longer valid. The news was devastating, the intrinsic  value is impaired. This could be fraud, or some mega lawsuit or some big changes. As such, it should not be as difficult because if we have followed the discipline never to put too much into any position, this means that the losses should not be big. 

Percentage wise, it would be big, usually 30-50% type but if we did our risk management well, it could be losing a few thousand dollars or a couple of air tickets for our holidays in today's context. It would make sense to recoup the remaining capital to deploy into better names, with more upside. We can also set a target sell price and wait for the stock to bounce to sell. 

Hold

This would usually be the default decision. It could be because the new data and hence the review was inconclusive. We need more time for more data points to reveal themselves. For example, if the company is involved in some class action lawsuits, the verdict could be months out. It might make sense to wait for that verdict or at least some clearer indication closer to the verdict date. Or it could be simply waiting for the next quarter results. In such cases, we just need another review when there is more data.

Buy

Lastly, the decision to buy more should un-ambiguous. The valuation checks out. There is now more upside than before. What is left is how much more to buy. It would make sense to slowly build the position up to a max size. If we are now at 1% of the portfolio and target to go to 4% then perhaps it could be adding another 1%. Incremental step ups would be my preferred option.

Fear and Greed

Even when everything checked out logically, there will be one final hurdle. Emotions. Fear and Greed. Fear that despite all the analysis, we will make the wrong decision, sell and then it goes up. Or top up only do catch a falling knife. Ouch!

Greed can also come into play, for some reason, we are blinded by some biases and want to buy more despite everything pointing the other direction. At this point, we may need to speak to like-minded investors to help us straighten our thinking, resolve blind spots to make the right decision. 

So that is it!

Hope this lay out a good top up process. As you can see, investing is a full time job. It does not end with one analysis. So much is at play and luck is definitely involved. Sometimes, it is really way simpler to just put everything in T-bills!

Huat Ah!

Update on Reckitt

 This idea was first published on substack.

Consumer staples have always been a feature in the 8% eco-system because the revenues are recurring, the businesses easy-to-understand and generate good cashflows and dividends.

We have discussed Reckitt (RKT) briefly on this blog and more extensively on substack. This post serves as an update with the following framework: review, update, value and decide. The stock has performed terribly since 2020 and while the substack portfolio added at the lows in 2023, we have not seen a strong recovery. The position today is slightly underwater.

Hence, this update today. Let's start with the review of the investment thesis.

1. Review thesis

The following is the original thesis:

Reckitt is one of the strongest consumer staples companies in our times with best in class margins for OPM at 20-25% over the last 20 years and has generated consistent growth on the back of strong brands in strong categories. 

Reckitt's portfolio of Power Brands ensures that the stock in defensive in volatile times and compounds nicely over time as it has done. Reckitt's overall geography split has also geared towards developing markets which contribute to 40% of its total revenue. Its strong brands allow its products to establish themselves as premium products, with pricing power but continues to enjoy volume growth. 

While Reckitt has 33% exposure to Europe & ANZ and 27% to US, revenue growth for developed markets had also been stable. The company has generated consistent and strong FCF to the tune of GBP2bn and this should continue and reach GBP3bn in the future.

The thesis has not change much since inception. Reckitt continued to deliver the high margins and cashflows in the recent 1H results. The company grew its emerging markets (EM) business in single digit which was not too different from US and Europe. Its portfolio does have products that are more catered to developed economies such as dishwashing powder and air fresheners. Going forward, growth might have to come from both EM and US/Europe.

Reckitt also continued to manage its cashflow well growing its FCF and returning via dividends and share buyback. Its dividend yield is at a very palatable 4.4% today. Being listed in UK, there is also no withholding tax. Due to the collapse in its share price. FCF yield is close to 7%.

2. Update

The biggest elephant in the room today related to the looming litigation in its infant milk business. Earlier this year, Reckitt and Abbott were sued because its specialized milk formula allegedly caused the deaths of premature babies fed with their products. Verdicts ruled against both companies stated that they failed to warn of the risk of necrotizing enterocolitis (NEC) which has fatality rate of 15-40%. 

Reckitt was ordered to pay USD60m to a mother while Abbott also subsequently lost another case and was order to pay USD495m! There are c.3,000 cases filed against both companies and the legal liabilities could be GBP3-5bn or more for Reckitt. Reckitt has another trial with important dates starting in end Sep 2024 to Mar 2025 which would provide more datapoints. 

3. Valuation

It is worth noting that Reckitt's market cap fell from GBP38bn to GBP31bn today, more than the abovementioned legal liabilities. Although we cannot rule over future revenue impact and more litigation, the share price collapsed have broadly discounted this NEC issue. Let's look at how valuations are:

The table above shows that Reckitt has c.49% upside with IV at GBP67 per share, c.10% lower than the previous GBP70 calculated 18 months ago. However given the litigation is not over, it might be risky to do anything now. 

Peers have largely rerated in the last 18 months with average EV.EBITDA at 17x vs a more reasonable 15x when the last exercise was done. RKT does look exceptional cheap here.

4. Decision 

While there is good margin of safety, it would be prudent to buy more today as litigation could be very detrimental as we had seen with Bayer (share price dropped 50% and never recovered). The 2024 low at GBP40 would be broken should the verdict be unfavorable. If so, Reckitt could fall further to GBP35. This means the risk reward is -c.30% downside (GBP45/35) vs 49% upside (GBP45/67).

As such the decision would be to HOLD for now.

Huat Ah!

Investment Eightfold Path - Part 2

As discussed in the last post, we have simply borrowed the above term from Buddhism to help us think about the eight ways to build wealth. The Noble Eightfold Path is actually super profound and I would urge readers to study it for our own sakes in order to pursue enlightenment someday.

For today, we shall discuss from where we left off in the last post. To recap, we have divided the components of wealth-building as per below and discussed the first four:

1. Active Income
2. Cash, T-bills
3. Pension / CPF
4. Property
5. ETFs
6. Stock Portfolio
7. Top picks for the home run
8. Moonshots

ETFs

Exchange traded funds or ETFs would be the best way for any individual investors to build wealth. The way to do it is also to simply buy regularly. I would suggest every quarter or so, when there is spare cash not needed for daily lifestyle, after paying down mortgage, after investing in T-bills, you would want to put some into risk assets to make more returns, then yes, buy ETFs.

It is always best to start with the S&P500, the largest, most liquidity and most well-known ETF which has generated adequate returns since capitalism began.

Stock Portfolio

Investment professionals do not like to buy ETFs. It is their job to beat the index, i.e. by generating more return than the index. So to buy ETF is to admit that they cannot do their job. Warren Buffett certainly won’t buy the S&P500. So, if Warren can do it, so can I. That’s the thinking. But it’s flawed.

I think the way to do this is actually to have two buckets of capital. One to buy ETFs, the other to create your own stock portfolio to try to beat whatever index you want to beat. I would say 99.9% of all investors should not try this.

It is a lot of work. You need to study a lot of companies better than ChatGPT and the next generation of Generative A.I. and you need monitor these companies closely. Frankly, with all our commitments in life, who has time to do this?

Unless you are really interested, really committed and have that spare resource, time and energy and you think you can beat Generative A.I. to it. Then go for it.

Otherwise, just buy the S&P500 or some other broad base ETF.

Top Picks

Once in a blue moon, we see something that makes a lot of sense. This could be an opportunity of a lifetime where there is a huge valuation arbitrage opportunity. We have done the work, we know the risk reward and it makes sense to make an outsize bet on something.

For readers following this substack, it could be Warner Bros Discovery (WBD). I have studied this stock for years. My model shows more than 100% upside. It could even be more. Some time in the past, Warner Bros was the arch nemesis of Disney. If Disney is worth hundreds of billions, today isn’t WBD way too small at c.USD18bn? If I am wrong, the downside seemed limited, but if I am correct, then all the work done should warrant a bigger bet, to make a difference to the portfolio.

The other relatable example would be Nvidia. Many shrewd investors have identified the name a few years ago. It didn’t even have to be an outsized position. If you had just a bit of Nvidia, would you have made a lot of money today. In Singapore’s context, the name was right under our noses - DBS. Singapore banks had gone up 10x if you have held it since 2003, just 20 odd years ago. DBS’ market cap is SGD100bn today.

Of course, hindsight is 20/20.

Moonshots

We are calling the last section Moonshots but it should be thought of an all-encompassing catch-all to cover every possible remote scenario so that our wealth can be preserved and enhanced. Let’s talk about alternative assets first.

For the rest of the post, please visit 8percentpa.substack.com

Investment Eightfold Path - Part 1

This post is also on 8percentpa.substack.com 

In Buddhism, the Noble Eightfold Path refers to the following:

• Right Understanding
• Right Intent
• Right Speech
• Right Action
• Right Livelihood
• Right Effort
• Right Mindfulness
• Right Concentration

It is is a core and profound teaching providing a practical guide to living. Today we are just borrowing the term to use it for our purpose. The analogy ends with the number (eight) and perhaps how we should have important foundations (i.e. Right Understanding and Intent) before we progress. For those interested and want to learn more about the Noble Eightfold Path, please ask ChatGPT :)

For our investment journey, I have thought long and hard about what would be the several important components of our balance sheets (assets) or types of investments to build wealth over time, in the Singaporean context. The following is what I have come up with, based on my own experience, which I will go through point-by-point in this post and another follow-up post.

1. Active Income
2. Cash, T-bills
3. Pension / CPF
4. Property
5. ETFs
6. Stock portfolio
7. Top picks for the home run
8. Speculative investments / Private equity / Gold / Others

Active Income

Years ago, Robert Kiyosaki wrote a so-called seminal book named Rich Dad, Poor Dad. He introduced the concept of passive income. His message was that we should all aspire to generate passive income, through investment, property etc. Then we didn’t have to work etc etc. It was a big myth. Looking back, I think the book did the world a dis-service. We all have to work. That’s the way it is.

Today I would turn the concept on its head. Passive income can never surpass active income. Take your work seriously. If you don’t like your job, quit and do something else. The active income is the basis of building wealth. Importantly, save up so that you have cash, a big retirement nest egg or pension and property (#2, 3, 4 below).

At a certain point in life, you may acquire the capabilities to not work for someone else. You have achieved the pinnacle in your career and it’s time to slow down. You will still need active income. This is where things get interesting.

The interplay between cash, investments, property can support your transition to do something else. Hopefully this still generates active income which can become supplementary to your investment income which can sustain your lifestyle.

Cash, T-bills

Next we have cash and T-bills, we cannot live without cash in the modern world. While it has no meaning in the animal kingdom, or if you own a farm which can sustain yourself, it is essential for most people today. There are real-world examples of people running out of money and then starving to death. As such, it is important to always have cash. The rule of thumb is 12-18 months worth of liquid cash in case shit happens.

Related to cash is my favourite investment today, which is the first post on my substack. Some of the cash should be invested in T-bills. Singapore 6 month T-bills continue to give 3.4%pa and US ones are even higher. It comes back after six months (effectively you only get 1.7% for 6 months). Honestly, there is no need to do any other investment for most people. Just put all the spare cash (minus what you need for the next 6 months) into T-bills. If you want to remember the one thing from my last 2-3 years of writing, this is it. Buy T-bills. Read this post.

Pension / CPF

In Singapore, almost every worker needs to contribute to the national pension fund which is called CPF. For young readers (ie in your 20s), this is more a pain because you think what is rightfully yours is being locked away. But as you age, the payout day gets closer, then things become really, really relevant.

If you have made the right decisions, you stand to take out a lot at age 55. It could be hundreds of thousands of dollars. Alas, CPF is being used to fund property (the next topic), children’s education and what not. So a significant number of Singaporean cannot hit what is known as the minimum sum which is about SGD200,000. So there was a big backlash that the Singapore Government has cheated us, locked away all these monies. We never see them. We die and it only gets passed on to future generations.

To me it’s a case of mis-concept and not getting all the right information. It is complicated, but it’s all out there. While people called CPF a scam, on the flipside, a guy name Loo Cheng Chuan started the 1M65 movement that utilized the compounding of CPF and grew his money to >SGD1,000,000. Originally, he believed he would get a payout of SGD1,000,000 when he turns 65 (hence 1M65). But he way surpassed his own calculations. He now has way more and he is only in his 50s.

So, think hard about the decisions you need to make with CPF. It can be literally life-changing. Aspire to be like Loo Cheng Chuan.

Property

I have have written one important post about property. In sunny Singapore, we are fortunate to have great leaders who had the foresight to devise a national strategy which allowed 80-90% of Singaporeans to own their homes. So I would presume most readers here would own your own homes.

Your first home is very precious. Don’t trade it.

The second property onwards is then investment. Property provides leverage for individual investors and usually generate positive returns over time. But you could also lose a lot of money if you are not careful. Strive to pay down mortgage fast, then the real investment game begins.

The abovementioned are more like bread and butter of our financials in this lifetime. Please make sure they are secured before you think about anything else. In the next post, we shall discuss the risky stuff. Stay tuned!

TO BE CONTINUED...

Charts #51: Olympics

Found a good chart on the usual Visual Capitalist site, one of the most powerful visualization of data and statistics platform around.

Will we see a day it costs USD100bn to host the Olympics? That would just be a matter of time. Inflation should most certainly take care of that. We will also see the first 10 trillion dollar company, the first trillionaire, the economies would be measured in quadrillions!

Thoughts #35: Private vs Public Investments

Investment ideas can come from everywhere but it is important to understand that public and private investments are as different as apples and oranges. Investment ideas from personal connections, private companies and structured schemes come to us. It is very tempting to put money to work thinking that we are getting good risk reward. But we must be very discerning.

Personal and private investments cannot be compared to what is publicly listed or backed by a reputable government (e.g. US or Singapore) or large institutions. For example, we see a private investment which shows 20% annual return on paper. We cannot say that this is better than buying DBS, which can only generate 10% annual return (of which 4% is dividend).

There are a few important reasons:

• DBS is the largest bank in Singapore and the 25th largest bank in the world. There is very low probability it would actually go bust.
• DBS is publicly listed and its accounts are audited by top accounting firms. It means the numbers are real. The cash on the balance sheet is real.
• DBS is liquid, you can sell any time and take the money out if you need it.

In contrast, for a startup setup by your friend, or even and big private investment led by a Temasek linked company in which you have an angle to participte, none of the above matters. The considerations becomes:

• Can I trust the person executing the investment. What if he calls it a day at his startup or at Temasek, move on to do something else? What happens to the money committed?
• Who audited the numbers? Can I trust the cash was used the way it was intended?
• How long is this amount locked up for? What if I need the money some time in the future.

The answers are complex. For the first question, would almost certainly be dunno. Even if you have 100% trust, shit happens. What if the friend gets hit by a bus. Or the lawyer who did the work ran away with the money? With DBS stock, such risks are all averted.

So in order to make a good decision, we need to apply the right discount, we probably have to calculate the expected return here. So for DBS stock, the expected return is the same as the above because the probability that DBS will go bust is near zero and we can take the money out any time i.e. expected return is 10%pa.

But for the private investment, if the probability of default is not zero. For a Temasek led private investment, it could be 30% default probability. For your friend's startup, it could be 70%. So using those no.s, the expected returns drop to 14%pa and 6%pa respectively. Then we need to think about the liquidity needs. If it is locked for 10 years, then I cannot put like 10-20% of the portfolio or something big, like six figures. Who knows when I need that money?

Hyflux

Case in point, Hyflux. It was publicly listed. Strong links to Singapore government and Singapore Inc. Yet, it went bust. Thousands of convertible bondholders lost their shirts. Equityholders know their risks, we buy equity knowing it might go zero but we get the enjoy the upside, if any. But bondholders have no upside. We bought thinking we can enjoy 6%. Yet, it went to zero. So even listed entities are not foolproof. Shouldn't we ask more questions?

 

Full post on 8percentpa.substack.com

Huat Ah!

Market review: 2024-2025

2023 came and past. There was no recession, the Russian-Ukraine war continued and more conflict happened in other parts of the world. Israel-Hamas. We may have Trump as the most powerful man on the planet facing off three dictators: Putin, Xi and Kim. How fun.

Meanwhile stock markets continue to make new highs (except China). The Nikkei broke past its peak of 39,000, last achieved in 1989. This was the year Taylor Swift, the first billionaire singer who helped Singapore gain more hatred from our neighbours, was born. At 35, her age is also slightly higher than the median and average age of all the humans on planet Earth. 

My point, is that it's been a while since Japan was on investors' mind and just when Nikkei tried to come back, India took centre-stage limelight again with Modi promising more and the India stock market hit all time high as well. Yeah, the world is crazy.

So what should we expect for the rest of 2024 and 2025?

I believe what goes up must come down. Valuations are stretched but not crazy. The last time Nikkei hit 39,000, it was trading at 60x PE. Today it's 16x. The PE for the US market is expensive but not at its most expensive when we look at its history, as exemplified by the famous Case-Shiller PE ratio chart below.

Case Shiller PE 50 Year Chart

The last bubble was with the Nasdaq and it is worth examining at that as well. The Nasdaq was trading at >100x PE back in 2000. While it has way surpassed that peak of c.5,000 at >17,000 today, the PE ratio is c.30x. So, just looking at PE valuations, we can always argue, things are not super crazy. But every bubble is different. It can go way higher and break the previous PE record high. 

This could be generative A.I. sucking in even more money which means the Magnificent Seven (Nvidia, Alphabet/Google, Meta / Facebook, Tesla, Amazon, Microsoft and Apple), the GRANOLAS in Europe (GSK, Roche, ASML, Nestle, Novartis, Novo Nordisk, Loreal, LVMH, AstraZeneca, SAP and Sanofi) and the Seven Samurais (Tokyo Electron, Mitsubishi Corp, Toyota, Nintendo, Fast Retailing, Sony and MUFG) continue to go up. While the rest of the market stagnates.

Or things can just collapse should the weakest link break. It could be another Silicon Valley Bank, it could be China, or Tesla. The risks are not being highlighted today but with interest rates this high, by right, investors should be favoring stocks with lower PE or higher earnings yield. Yet, we are seeing the opposite.

As fundamental investors, we always have to be mindful of valuations. I would advocate we look at the specific companies closely and make sure valuations are cheap. We should also keep comparing earnings yield to T bills. If we can get 3-5% on T bills, we must think hard about buying stocks at less than 3% earnings yield or 33x PE. Singapore 6 month T bills are still giving 3.7% and US ones are even higher at 4-5%.

US T bills from Google

As to fundamental analysis, I believe A.I. will change the game. It is still unclear how. One scenario might be that retail investors might be better served, since we can simply ask chatGPT to do the analysis in the near future. Or it might also be the case that no one beats the market anymore. So we just buy the index which is generating return by A.I. investing for us.

Before that future happens though, we have Substack today (mine is 8percentpa.substack.com). I believe Substack is becoming an important growing eco-system for independent writers who could write as well as professional analysts perhaps with the help of chatGPT. Their analysis are in-depth, informative and much better than Youtube videos (e.g. Roaring Kitty). The following would be a list of posts on both new names and names that I follow.

Just a few posts from other Substacks:

https://eaglepointcapital.substack.com/p/verisign-a-capital-light-compounder

https://buybackcapital.substack.com/p/the-issue-no-4-vrsn

https://hightechinvesting.substack.com/p/warner-bros-discovery-stock-catching

https://pricepoint.substack.com/p/price-point-040-lets-take-a-look

https://theartofhittingbombs.substack.com/p/company-deep-dive-no-5-adobe

https://cloud.substack.com/p/the-5-ways-ai-will-transform-creativity

Huat Ah!

Thoughts #34: A.I. vs Human Portfolio Manager

Portfolio Management has never been easy. 80% of portfolio managers cannot beat the benchmark. Would it be the case that this becomes 99-100%? There could be a few scenarios:

1. A.I. beats everyone -> all portfolio managers cannot beat the benchmark

2. A.I. plus the best portfolio managers beats everyone, including A.I. These hybrid A.I. + best human portfolio managers make up the best 1%.

3. A.I. competes with A.I. and only the best A.I. beats everything else. 

The chart below shows humans don't really stand a chance...

Huat Ah!

Please support us on 8percentpa.substack.com too!

QYLP: Global X Nasdaq 100 Covered Call ETF

Covered call ETFs are relatively new and literature on the internet provide little insights on how such an asset is good for investors. Hence, this post hopes to add knowledge to whoever is interested. First we need to cover the following sub-topics to understand this idea better. 

1. What is a covered call ETF?
2. Why buy on the London Stock Exchange or LSE?
3. What is the thesis?
4. What are the risks?

First up, a covered call is an option which allows the seller to sell a stock which he or she owns, usually at a higher fixed price vs today some time in the future. This allows the seller to receive a premium from the buyer. Call options give the buyer the right to buy a stock at a certain price (i.e. the seller has the obligation to sell at that same price)

There is also something known as a naked call, when the seller doesn’t own the stock. But that is a topic for another day. Today, let’s discuss the thinking for the buyer and seller of call options:

The call option buyer thinks it is good bargain to buy a stock at a certain higher price but doesn’t want to pay up for it. So he wants to only buy the right (i.e. the call option) which is much cheaper. In a way, call options provide stock buyers leverage. He is bullish on the stock.

The call option seller (i.e. us) is obliged to sell at this higher price, but in return, receives a premium. He doesn’t want to sell the stock now but at a certain higher price, he is okay to sell. On top of that, he receives a premium and is therefore even happier. In a way, the seller is bearish but not bearish enough to sell today.

Covered call ETFs

Now that we have covered covered calls. We can go on to how it works for an ETF. So extrapolating form the above, the Nasdaq 100 covered call ETF will own the 100 Nasdaq stocks but sell covered calls on them. In the US, this goes by the ticker QYLD and in UK, the author would be buying QYLP which is part of the group of ETFs listed in 2022 with the same manager Global X but this particular ticker is denominated in pounds. The reasons shall be discussed in the next section. 

This ETF essentially owns names of the Nasdaq and sells covered calls on them to generate returns. The list of names, which are publicized regularly and differs in weightage vs the index, are as follows:

The US listed entity has a much longer history and we can see from the below that the track record is not far from the index return assuming that all proceeds are reinvested. Since inception (which was 2013), the ETF has returned 7.4% while the index returned 8.3%.

Yes the ETF return is actually lower than the index, so shouldn't we buy the index? This too shall be discussed below in the thesis section. For now, let's call that covered call provides premium to the owner and is less volatile than the index. Covered call ETFs generate very high dividend and this particular one, QYLP has provided 11-12% dividend since inception (which was 2022 on the London Stock Exchange).

This is a good segue to go into the next section.

Why the London Stock Exchange (LSE)?

The reason is that UK has no withholding tax. So the 11-12% goes directly into investors' pockets. If we have bought the US listed one, 30% would be taken away by taxes which makes it less interesting. The author has chosen the GBP denominated one because of future currency needs but most investors should just use USD, which is the default currency and that means less complications.

The dividends come monthly and has been very beneficial for many retirees. Some people have invested in covered call ETFs for decades and benefit from the monthly income. Notable ones include DIVO and JEPI which interested readers can also dig into from the link below.

https://moneyguynow.com/best-covered-call-etfs/

Thesis and Risks

Okay, let's discuss the main topic. Thesis and risks. Why buy such a complicated instrument when we can buy the index. The answer is that in other times other than 2024, you should probably buy the index. Index buying has been proven to be the easiest way to compound returns and dollar cost averaging into index buying will create good wealth over time. The index of choice will be the S&P500 which has returned c.11%pa over the last 10 years and more than 10%pa over the last century.

So why bother with covered call ETF on the Nasdaq? 

Here's why:

1. We don't want to miss out on the tech and Gen AI bubble.
2. The regular income is good.
3. Covered call ETFs will outperform if the market is flat or if it goes down.

There is real upside risk that we are at in the middle of yet another tech bubble which is driven by the Magnificent Seven, Generative AI and perhaps cryptocurrency (again!). Yes these names have rallied a lot but it seemed that we are not in the final legs of any huge bubble. It could go up a lot more from here and we stand to miss all the upside from here.

If you owned Nvidia when it was below $100 and has rode the stock up, then good for you and perhaps this idea is not for you. But for most of us, this might be a good way to participate without taking on all the risk. The covered call ETF owns the underlying names and will go up as long as the index goes up. It also provides regular income. However, it will underperform the index over the long run due to higher expenses, 

This brings us to the second point which is the monthly dividend. Covered call ETFs provide regular income which is very attractive for people who require this. As mentioned, for QYLP listed on LSE, this is 11-12%pa which is very significant. 

The last point is simply a reiteration that we are hedging ourselves should this bubble scenario not play out. If Nasdaq collapses, then we are saved by the dividends and should outperform, at which point, we should then actually buy the index like QQQ or SOXX. 

Let's talk about the risks!

The full post is on 8percentpa.substack.com

References:

https://globalxetfs.eu/funds/qyld/

https://www.globalxetfs.com/funds/qyld/