Welcome readers to letter 15 where I will update the Basket Portfolio as of 25th of September 2023. Please subscribe now if you would like to see more about my work.
DISCLAIMER: This article does not recommend buying or selling any financial instrument. Please do your own research. This information is for general purposes only and should not be considered investment advice. I am not a financial advisor and do not offer investment recommendations. Investors should obtain advice based on their own individual circumstances from their own tax, financial, legal, and other advisers about the risks and merits of any transaction before making an investment decision, and only make such decisions on the basis of the investor’s own objectives, experience, and resources.
When deciding upon buying (or selling) a business, I investigate the following aspects:
Categorize the business as a fast grower, slow grower, cyclical business, and everything in between.
Understand the business model really well
Understand the playing field (countries of operation, industry, competitors)
Looking at Profitability, balance sheet health, cash flows
Discover the growth prospects, management quality, and capital allocation
Allocation
Regarding my investments, I am only choosing quality businesses that offer me cash flows now. My biggest position is Kaspi.kz. Cash provides a form of cash flow in the interest rate on my broker account but with substantial inflation that cash position will be worth less and less in the future. Though I may be somewhat biased against cash. 2021 was the first time since I have been walking this earth where inflation (devaluation of currency) crossed the 10% on a year-to-year basis.
Comparing these assets to the ones I mentioned in Letter 12, I sold my stake in Liberty Global while adding a bit to Flow traders. Additionally, I started to add the finnish Fortum Oyj to the Baskets. Both Flow and Fortum have been beaten down since 2022 for different reasons.
Flow Traders Ltd belongs to the group of market makers/liquidity providers on the equity markets. It is a company that quotes both a buy and a sell price in a tradable asset held in inventory, hoping to make a profit on the bid-ask spread. The benefit to the equities market is that they help limit price variation (volatility) by setting a limited trading price range for the assets being traded.
The company describes how they generate net trading income and thus profitability where the two key parameters are trading activity or trading volume on the markets and the bid-ask spreads.1 When there is enough liquidity in an equity (like stocks or ETFs) the bid-ask spread is tight and Flow Traders role is marginal. However, when an equity trades with a wide bid-ask spread Flow Traders starts to generate more income as they serve as the liquidity provider. Wide bid-ask spreads occur in more volatile times.
The Chicago Board Options Exchange's CBOE Volatility Index is a popular measure of the stock market's expectation of volatility based on S&P 500 index options and is often referred to as the fear index. In the past 20 years, several times saw a big spike in expected volatility including October 2008 (Great financial crisis), August 2011 (European sovereign debt crisis), and february 2020 (COVID-19 pandemic). In these situations, lots of trading and moving is happening in the equity markets which causes larger bid-ask spreads and trading volumes.
Back to the present, where both the volatility index and trading volumes have been cooling down from the COVID-19 times and the war in ukraine. Investors are aware that low volatility and low trading volumes will have a negative impact on the results of market makers as the demand for liquidity goes down with it (compare figure 2 & 3). Even so, the big increases in valuation of Flow Traders always occur when least expected. I chose to take a position in Flow Traders because it is less correlated to broad market moevs and makes jumps in uncertain financial times (typically when other equities are tanking).
Concluding remarks
It has been somewhat busier for me in life and I had to prioritize personal matters over writing.
Technically, most of europe is in recession already but you don’t hear too much on the topic in recent weeks.2 One of Warren Buffet’s most famous sayings is "Rule No. 1: Never lose money. Rule No. 2: Never forget Rule No. 1."
For the time being I stick to my conviction on statistical data provided by the 10-year minus 3-month US treasury bonds. It indicates a inverted yield curve that is on its way to the positive. All major recessions (grey areas in figure 4) of the last 40 years came after a yield curve coming back from inversion.
Enjoy your Mid-Autumn Festival today and hope to see you in the next edition where I will discuss TBC bank.
DISCLAIMER: This article does not recommend buying or selling any financial instrument. Please do your own research. This information is for general purposes only and should not be considered investment advice. I am not a financial advisor and do not offer investment recommendations. Investors should obtain advice based on their own individual circumstances from their own tax, financial, legal, and other advisers about the risks and merits of any transaction before making an investment decision, and only make such decisions on the basis of the investor’s own objectives, experience, and resources.
Resources
What Is a Bid-Ask Spread, and How Does It Work in Trading? (investopedia.com)
The Netherlands falls into a technical recession | Snap | ING Think