Hedge Your Bets

Key Capital Private, Investment Note - Issue #36

Hedge Your Bets

Around 2000, Enron, the once-dominant energy trading company that later collapsed in scandal, ran a TV ad pitching an unusual hedge: tradable weather risk. In it, a nervous executive blames weak results on unpredictable weather.  After the obvious statements “you can’t predict the weather” and “there’s nothing you can do about it”, the skit cuts to a shooting-range gag where a cardboard cutout of his head gets blasted off. It ends with a simple instruction: ask why.

Enron’s financial results in the late 1990s and early 2000s were impacted by weather, specifically warmer-than-average winters, which reduced demand for heating, causing utility revenues to fall below budget. But weather derivatives offered a solution to this problem - contracts paying out when temperatures stayed above certain thresholds, directly offsetting the revenue hit from warm weather.

If Enron needed this protection, so did countless other weather-exposed businesses, and so they positioned themselves as the market-maker. It was one of the first attempts to create a standardised market for hedging specific, measurable events.

Enron’s collapse slowed appetite for anything that sounded like “Enron-style innovation”, but the underlying idea of hedging specific risks did not disappear. What did stall was the development of more precise hedges. Despite decades of financial innovation, investors still lean heavily on broad proxies like gold, bonds, and certain currencies rather than instruments that directly hedge the risk in question.

Haven Hunting

In practice, the risk most investors are trying to hedge is not weather, but portfolio-level drawdowns. The menu of “safe haven” assets they use as hedges is short. Top of the pile are easily tradable assets like gold, the US dollar, and US government bonds, along with the Swiss franc, German government bonds and the Japanese yen. Historically, every investor knows these can typically be relied on to increase in price in the event of a market shock. But this relies on traditional correlations between assets continuing to hold. 

Recent market shocks have thrown the protection qualities of these assets into question. When Covid-19 struck, what caught investors off-guard was not stocks falling, but US government bonds falling too.

Last April, when Trump introduced his tariffs, US Treasuries and the US dollar fell, even while stocks sold off. And again, this week, US government bonds failed to provide the protection investors expect during risk-off episodes. AXA CEO Thomas Buberl put it that:

“there is no safe haven any more today because you can blow up anywhere… the only safe haven is diversification.”

Shiny Happy People

Gold has long been the default trade for investors during periods of market stress. But the scale of the recent gold rally doesn’t look like a typical ‘help me sleep at night hedge’.

Gold has accelerated far in excess of the relatively modest drawdowns and volatility seen in broader markets. The headlines would suggest it’s functioning as a de-dollarisation play, a tariff-war haven, and a bet on monetary debasement. Those are legitimate reasons to own gold, but all this overlooks the likely biggest driver behind gold’s latest price action: the irresistible appeal of a line on a chart continuing to move higher.

The result is something that resembles more of a momentum trade than a store of value. All we have to do is look at the price moves over the past few months, possibly based on events that are yet to materialise.

During the global financial crisis, gold initially fell alongside risk assets before later entering a sustained rally as the crisis deepened. The bulk of its gains came after genuine financial stress had materialised - not the anticipation of it.

A model developed from the World Gold Council suggests that over 80 per cent of gold’s recent gains can be explained by “risk and uncertainty” or “residual” factors, which could be translated as, they have no idea.

Hedge at the Casino

Unlike the safe haven assets mentioned so far, which depend on historical relationships holding during stress, prediction markets like Polymarket and Kalshi (which we wrote about previously in investment note #22) offer a solution to the problem – hedging the event itself by trading binary, yes/no outcomes.

Take for example an investor or institution looking to hedge their portfolio against next month’s unemployment rate exceeding 4.3%. Ordinarily they would express this view indirectly by deciding on stocks or assets to express that outcome on, determine how those prices might move in a given time, and choosing when to enter or exit those positions.

On prediction platforms, the same investor could look up “Unemployment in March” and purchase a “yes” contract for “above 4.3%.” That trade would resolve shortly after the release of the jobs report.

What may prove even more valuable to financial institutions is the information embedded in these contracts: a real-time probability feed that institutions can use to inform positioning elsewhere. This is perhaps the reason why prediction markets are increasingly being piped into mainstream workflows via platforms such as Robinhood, Tradeweb and Bloomberg.

It’s too early to tell the trajectory of prediction markets. The wisdom of the crowd only works when you have a crowd, and many economic and political contracts are thinly traded.  Long-term success will also depend on regulatory clarity and transparency, particularly if these platforms are to become trusted tools for institutional hedging.

So far, regulators in the US have taken a light-touch approach to the sector, even as they emphasise their authority to police manipulation. Meanwhile, the blockchain infrastructure underpinning some platforms means trades can be traced to individual wallets, giving regulators and other market participants an unusual degree of visibility into activity.

Ode to Why

In another Enron ad titled “Ode to Why,” a voice explained to the viewer that “why” was a “sharp and abrupt word, which can bring years of conventional assumptions to a jarring halt,” a philosophy that coincided with the company’s push into its short-lived internet commodities platform where users could take positions on highly specific market exposures.

Many of these event-linked positions are still difficult or impossible to replicate with traditional instruments today. Newer formats like prediction markets point to a similar idea. Maybe they offer a solution to the recent breakdown in safe haven options, and maybe we are seeing the early stages of something genuinely transformative, but history reminds us how easily innovation can overshoot.

Key Capital Annual Outlook Event:

Please find attached a pdf of the slides, a couple of topic specific video edits and also the full video link.

Video 1 - 8 minute edit. LINK: AI CapEx Spending and AI Financing

Video 2 – Full presentation. LINK: Full Outlook 2026 Presentation

PDF LINK: Outlook 2026 Slides

Key Capital & Schroders Event Video:

Key Capital and Schroders recently hosted an event on the Key Capital Balanced Multi Strategy (BMS) Fund.

• BMS Overview: Ian Kilcullen, Managing Director of Key Capital Private, gives an overview of the BMS Fund and how it differs from traditional multi asset funds. - 14 minutes.

• Panel Discussion: A discussion with Rishi Sivakumar, BMS Fund Manager at Schroders, and David Rees, Head of Global Economics at Schroders, on the diversification illusion at the core of most multi-asset funds and how the BMS Fund seeks to address this for Irish private clients. - 14 minutes.