We sometimes come across opportunities where market prices of securities are temporarily dislocated from where they have been recently or where we think they should be trading.
Opportunistic transactions, for us, stem from market actions that are driven by rules, regulations or market structure and customs. While human emotions of fear, greed, apathy, disgust, anxiety etc. can lead to assets becoming irrationally cheap or expensive, these situations normally take a long time to develop up to the point where our fund can implement a transaction to benefit from the opportunity.
In contrast, opportunistic transactions develop from immediate and short-term news flow (like the invasion of Ukraine by Russia), or the actions of a transition broker in a small cap stock in the 3 days before a quarter end, where the transactions are executed without regard – in fact, with complete disregard – for the underlying asset or the value.
A recent example of an opportunistic position: Richemont
Chart: Richemont share price on the JSE
The fund had been short Richemont since the last quarter of 2021. Our assessment was that it had become too expensive, even though it was still one of the cheaper global luxury brands.
In the days following the Russian invasion of Ukraine a general global panic selling of equities ensued, so we closed out our short position at a decent profit – and at a price which suggested to us that the share was not expensive any more. By that time it had rapidly moved to the cheap end of the spectrum, whilst other luxury brands like Hermes and LVMH had not really budged.
A few weeks later, Richemont published their annual results and we were fairly impressed with the achievements of the company. They even announced a special dividend! Despite this, the market was spooked and obviously upset. The share sold off 12% in the space of a few minutes. We struggled to find any reason for the sell-off, except perhaps a few grumpy remarks by the chairman during that morning’s analyst presentation.
We took a position in Richemont shares on that same day for the fund.
We chose to express our view through selling some out-the-money put options, which were trading at a high premium due to the ‘volatility’ or the uncertainty in the recent share price. In essence we were selling really expensive insurance to someone that was very eager to buy protection against significant further falls in the Richemont share price, so we earned a high premium. Our position was that, should the price fall much further, we would become happy owners, at a sizable position in the fund, of Richemont shares at a price we could not have dreamt of a few months ago.
In the case that the price reversed (which it promptly did), we have earned our investors some insurance premium – in cash!
Taking advantage of opportunities
Our experience in markets provides us with the understanding of the practical impact that regulatory constraints, rules and customs have on fund managers, investors and brokers – which lead to finding these opportunities. As we fully understand and appreciate that we might be completely wrong in our assessments of these situations, we implement them in small positions and only as and when they arise. Opportunistic trades will therefore always be a small part of the portfolio, but as a strategy it has contributed significantly to the fund’s performance over time.