Break all Term Deposits and Invest in Cheap Shares

[Sauce]

Sauce, sorry for any previous misunderstanding of your point. But look at what you just wrote. How can deciding the percentage of house deposit funds to invest be a 'binary decision'? There are 100 integer choices, starting from 1% and ending with 100% for a start. And the percentage figure you choose will affect both the upside and the downside risk for the same underlying sharemarket investment.

Haha, I knew you would say that. You are steering the debate away from my point to argue semantics. But, for the sake of a bit of banter: For me the initial decision is "yes or no" i.e. Binary. If the answer is "yes", THEN the question becomes how much? (I believe Boolean Logic applies to binary decisions ) And yes, how much is an important question, I agree. You can focus on this if you want, but the banter below is the real discussion.

OK then, which of any equity investments available will provide the best return in two years? If the oil price goes up to $US300 per barrel then one of the best NZX50 investments around is likely to be Contact Energy. Their renewable generation assets have a known fixed operating cost. CEN's profit will be the difference between the marginal cost of generating new baseload power minus the (low) operating costs of their existing baseload renewables generation assets.

OTOH if oil drops to $US50 per barrel all these new geothermal power plants that Contact wants to bring on line are in big trouble. High operating costs will see them mothballed and the holding interest costs will likely destroy Contact's profitability.

So what will the oil price be in two years time: $US50 or $US300? Once you can figure that out whether or not to invest in Contact is a no brainer :-P!

I can say "the market for retirement villages is forecast to grow by X in the next 20 years" or "The price of oil is likely to be higher in the future because we are running out" and those kind of considerations are important when analysing CEN or RYM, as long as they are combined with understanding the business, it's competitive position and its value.

But that is very different than your thesis, which is that there is an offset that somehow protects you if power prices go down, or house prices go down, or retirement village prices get cheaper. The fact is that those reductions in personal expenses are there regardless if you own CEN or RYM or not. There is NO offset to a capital loss from your personal expense reduction, because you will get that benefit regardless of what you invest in. You have just lost that capital.

If you buy CEN you are in effect making a bet that CEN will outperform other investments. I.e. your opportunity cost. End of story.

Of course using the product/service hedging investment philosophy, you do not need a crystal ball. You invest and whatever the result in two years time you will wear it. If power costs are high, so are your dividends from Contact. If power costs are low you take a haircut on your Contact investment but your power bills will be offsettingly low.

Are only Contact shareholders entitled to lower power bills Snoopy?

This reasoning is completely irrational for the reason above. You get the downside benefit regardless of whether you invest in contact or not, so its only the upside that you should be interested in.

I have used power as a conceptually simple example of how product/service hedging investing works. But I hope you can see that I could use exactly the same argument for using the product/service (in this case the product is a property) hedging argument for housing.

Whether you can actually find a listed entity that follows house prices the way that Contact follows power bills is another question. But IMO, conceptually, the product/service hedging strategy regarding property is sound.

SNOOPY

Although it comes with a degree of emotional comfort, your hedging strategy is flawed.

Even if your hedging strategy wasn't flawed, in ENP's case the variables are too complex to find any reliable link between house values and business results/share prices, as you allude to.

However, I very much enjoy the banter Snoopy and as previously mentioned, I always enjoy your generally rational and wise investment views. So no disrespect is desired here, but I simply cannot agree.

Regards,

Sauce

[peat]

my thoughts would be that you shouldnt break term investments to speculate (or get your house faster) because this loss that you take on the break fees means you have to do even better on the risky investment to break even where break even means a risk adjusted reward. Term deposits are there to preserve capital and decrease volatility/risk in the overall portfolio. You should have made some decisions on goals and ways to achieve those goals earlier and not be restrategizing every time the Vix farts. (not that I think this is just a fart - but it may well be)
If you were using the bond market to achieve your goals faster(instead of equities) look how only a few weeks ago you might have gone short on bonds thinking inflation was going to kick in - there were whole page articles in the Herald if i recall correctly, but no - we're not going there just yet.
Goals under five years away shouldnt be steered towards in a volatile investment vehicle.

[Sauce]

Sound advice Peat.

[Snoopy]

Your thesis: which is that there is an offset that somehow protects you if power prices go down, or house prices go down, or retirement village prices get cheaper. The fact is that those reductions in personal expenses are there regardless if you own CEN or RYM or not. There is NO offset to a capital loss from your personal expense reduction, because you will get that benefit regardless of what you invest in. You have just lost that capital.

Sauce, hedging is used as a technique to moderate potential losses and potential gains under conditions of market uncertainty. After the event, when the market has spoken, it is very easy to make any prior hedging look silly.

Your presentation of 'my thesis' is only partial and muddled. A product/service hedge in the electricity market from a consumer perspective will protect you if the price of electricity goes up and will punish you if the price of electricity goes down. But if you knew which way the market would go, there would be no point in making a hedge in the first place.

Your statement that if the share price of (CEN in this case) goes down you have lost capital is true, but meaningless in this discussion. Taking out a hedge implicitly means that you do not know whether the share price of CEN will go up or down until after the event.

SNOOPY

[Snoopy]

Are only Contact shareholders entitled to lower power bills Snoopy?

No, and thanks for raising this issue which I meant to tackle myself.

If you believe in 'power hedging' at the retail customer level, then you should buy shares in either Trustpower or Contact because these are the only options available.

If you are a Meridian customer, perhaps you would be warmer and fuzzier holding Meridian shares. But since Meridian at the time of writing is 100% owned by the government you can't own Meridian shares. So you would buy Trustpower or Contact as the next best available expense tracking vehicles.

Taking the argument further, I tend to clock up a few domestic and international air miles during the year. To best track my expenses, I should own Air New Zealand shares. But IMO, the whole airline industry is a lousy business model from an investor perspective. So instead I own Sky City Enertainment shares as a proxy for my 'leisure spend', even though I haven't set foot inside a casino in this country for around ten years! That may sound crazy. But in my assessment owning the best business in the general sector that you spend in makes sense.

Take the best business you can find in the general sector you are spending in is my philosophy. It doesn't have to be an exact match.

This reasoning is completely irrational for the reason above. You get the downside benefit regardless of whether you invest in contact or not, so its only the upside that you should be interested in.

If you can't see that if you have a series of bills to pay coming up that they are always subject to both upside and downside risks, then I think you are missing the point.

SNOOPY

[Snoopy]

In ENP's case the variables are too complex to find any reliable link between house values and business results/share prices, as you allude to.

Ideally you would want a listed vehicle that rents out houses. I know that retirement villages are not pure renting in the traditional sense. But I would argue that with Ryman you are buying into a 'rental company plus'. The plus factors include a generallly lower turnover rate of tenants, tenants less likely to soil their nests, and tenants that you don't have to give 'the bond' back to in the end. The Plus of course also includes all of the captive healthcare and associated services that Ryman offers to the inmates.

If I was 'hedging on housing' and there was a pure house owning entity on the NZX it is very unlikely that I would buy it. Not with Ryman sitting there as an alternative housing sector investment, even though RYM is not as good a match. RYM has the better business model, which is what it is all about in the end.

SNOOPY

[Sauce]

Sauce, hedging is used as a technique to moderate potential losses and potential gains under conditions of market uncertainty. After the event, when the market has spoken, it is very easy to make any prior hedging look silly.

Your statement that if the share price of (CEN in this case) goes down you have lost capital is true, but meaningless in this discussion. Taking out a hedge implicitly means that you do not know whether the share price of CEN will go up or down until after the event.

SNOOPY

You are confusing my point again, every consumer benefits if power prices go down, even if they are not in the share market. So owning CEN provides an investor with absolutely NO downside hedge to start with. Unlike what you suggest here:

Of course using the product/service hedging investment philosophy, you do not need a crystal ball. You invest and whatever the result in two years time you will wear it. If power costs are high, so are your dividends from Contact. If power costs are low you take a haircut on your Contact investment but your power bills will be offsettingly low.

That is not a hedge. Lower power bills might make you feel better, but that is an illusion. If I buy a non-power related stock that triples in value in the next three years, and power prices plunge, I get triple my money, plus lower power prices. If I buy CEN and power prices plunge, I get a capital loss and lower power prices. Can you explain how the person who has purchased CEN has gained any relative benefit from the lower power prices i.e. how is the downside hedged ?

Since I would have received the lower power bills regardless of my CEN investment it is irrational to factor that in as some kind of "win".

Buying CEN is simply a bet that the investment will be a good one. It does give NOT give you a natural hedge against falling power prices. It simply exposes you to the risk of falling power prices, with the prospect of gain if power prices rise. So, I will say it again, an investor should only be interested in the upside potential of CEN relative to other potential investments.

The only rational decision making process, is to buy the best investment you possibly can, whether that business is linked to your personal consumer costs or not is completely immaterial. It makes no difference. But, potentially, making a bet on higher power prices in the future might have some merit.

Regards,

Sauce

[Snoopy]

Every consumer benefits if power prices go down, even if they are not in the share market. So owning CEN provides an investor with absolutely NO downside hedge to start with.

Sauce, let me try explaining again. Consider four different customer scenarios.

1/ Contact customer (not a shareholder) gets a rise in their power unit price.
2/ Contact customer (not a shareholder) gets a cut in their power unit price.
3/ Contact customer and shareholder gets a rise in their power unit price.
4/ Contact customer and shareholder gets a cut in their power unit price.

We assume that consumer power price cuts result in a loss of earnings to the company Contact Energy.

Q1/ The power price goes down to the consumer. Is the consumer in scenario 2/ or scenario 4/ better off?
A1/ The best off is customer 2, the non shareholder.

Q2/ The power price goes up to the consumer. Is the consumer in scenario 1/ or scenario 3/ worse off?
A2/ The worst of customer is customer 1, the non shareholder.

The non shareholder is both best off (if the power price is reduced to them) and worst off (if the power price is increased to them). But this is irrelevent to the topic under discussion because this customer is not hedged.

A shareholder customer is not 'downside hedged' or 'upside hedged'. They are just 'hedged'. Whatever happens to the power price they will be less affected than the unhedged customer when exposed to the same market forces. That does not mean they will automatically be better off if they are hedged, as you seem to think I claimed.

SNOOPY

[Sauce]

If I was 'hedging on housing' and there was a pure house owning entity on the NZX it is very unlikely that I would buy it. Not with Ryman sitting there as an alternative housing sector investment, even though RYM is not as good a match. RYM has the better business model, which is what it is all about in the end.
SNOOPY

Finally a hint of rationalism!

By exactly the same reasoning, if ENP finds an investment that he believes has a much higher probability of returning more than RYM in two years, but had no housing market link at all. He would be wisest to choose that over RYM, as it will give him the greatest odds of achieving his goal, regardless of what house prices do.

Regards,

Sauce

[Sauce]

A shareholder customer is not 'downside hedged' or 'upside hedged'. They are just 'hedged'. Whatever happens to the power price they will be less affected than the unhedged customer when exposed to the same market forces. That does not mean they will automatically be better off if they are hedged, as you seem to think I claimed.

Snoopy, a hedge is a position intended to offset potential losses. Since a long position in CEN provides no offset to lower power prices, relative to investing in something else. You are EXPOSED to power prices, not HEDGED to them. If you buy a short and long position you are hedged because you make a gain on the downside that OFFSETS your loss.

The ultimate issue here is one of opportunity cost. If you invest in CEN you are making a bet that it will do well. If you can find an investment that is more likely to do better than CEN then that is what you should do. Your personal power bills are irrelevant.