CFDs

The Financial Ombudsman Service (FOS) in a profound act of ignorance and nannying has called for a ban on investors trading derivatives such as CFDs until they can prove that they are capable of doing so.

”In our experience, the only investors who trade in CFDs successfully are sophisticated traders who watch and manage their investments full-time,” the FOS stated in its review.

Unfortunately, experience is not evidence and the evidence as to who does and does not make money probably paints a vastly different picture. Consider the case of option traders, liquidity for option markets comes from Mum and Dad traders who as a population are net losers. Yet there is no call to  ban options.

This also needs to be viewed in a wider context. Consider the case of managed superannuation funds in Australia. According to ASIC the average 10 year return for all Australian superannuation firms has been between 3.1% to 4.6%. Over the same period the average cash rate – that is the return you could get buying sticking your money in the bank was 5% . This gives you a sense of how pathetic traditional recommended investments are. I actually think that ASICs figures are somewhat misleading because average percentage return is a poor measure of true return and is prone to manipulation as a function of its calculation. A better measure is simply how well did funds do in relation to the benchmark. The answer to that is surprising in terms of the perceived competency of such funds.

A quick back of the envelope calculation shows that some 90% of all funds underperform the market. That is the people who invest in them in the hope not spending their retirement in poverty are in effect net losers due to the opportunity costs they incur and the fees they are charged. Surely, given the societal importance of retirement savings that an investigation into superannuation funds is warranted. Based upon this evidence only non fee charging index based superannuation funds should be allowed – investors would certainly be better off.

The FOS’s investments ombudsman, Alison Maynard, said in an interview: ”We think a certificate from an accountant or an AFSL holder [financial planner] would be an appropriate safeguard.”

How would your accountant know as to whether you have the capacity to trade a given instrument. The financial education of accountants is woeful and in my professional life, I have only ever found one who truly understands what running a trading business is about. The average advice from an accountant consists of invest in managed fund X from which I receive 3% upfront and 0.25% each year. By the way did I mention that fund X has made no net return for the past 5 years.

I would suggest that instead of your accountant providing you with a gold star to say that you can invest in X vehicle that the role should be reversed. Financial advisors and the funds they spruik should provide certificates of competency to investors and these certificates of competency should come with penalty clauses. Such as if, we underperform the market for X period all fees will be waived and you will suffer no financial loss because of our incompetency.

In a fundamental misunderstanding of how markets work CFDs that have been described by the Australian Securities and Investments Commission as ”much riskier than a flutter on the horses or a night at the casino”.”You take a punt, with borrowed money, on whether a share price or market index will go up or down.”

How is this different from margin lending or futures trading where you pay an initial margin to control a large amount of product. In fact, the margin available on many CFD products is less than that offered by bank backed margin lenders.

Ms Maynard said the FOS saw cases because CFD providers only needed to provide ”general advice” about the product and not take into account the personal situation of the investor.”The CFD provider is not in the position of being a financial adviser who has to take personal circumstances into account,

The interesting thing about this is the belief that financial advisors know what they are doing (having been through the licensing regime I can assure you they don’t) And are impartial in their recommendations. This presents an extremely naïve view of how the world works and is simply not a reflection of the financial planning industry which is somehow viewed by the FOS through rose tinted glasses. It is not the job of a CFD provider to work out whether you are an idiot or not. Their role is simply to provide a platform to enable people to express a view and in the expression of that view they or win or lose. That is the economic nature of trading. People make their own decisions and they live or die by those decisions. You cannot legislate against stupidity despite the profound attempts of the nanny state to do so.

Apparently, in the FOS last review there were 54 complaints about derivatives – half of those related to CFDs. I would suggest that given that there are probably several hundred thousand derivative traders in Australia that this is a tiny percentage of individuals. In addition, if someone who knew what they were doing had a look at the results you would probably find that most (if not all) related to cases of operator error. Given that people cannot take responsibility for their own actions then it must be someone else’s fault so they go and find a regulator who is willing to indulge them instead of saying bugger off and grow up. No one forces people to be idiots – they manage to do this all by themselves.

Whilst, I am not one for conspiracy theories each time I have a conversation with a traditional stockbroker the conversation inevitable turns to CFDs and how evil they are. This is actually code for these vehicles are completely rooting my cosy little business, what with the ability they give traders to access in market in the world and use fancy tools such as stop losses. My thoughts are that brokers probably have a hand in lobbying against these products simply because they cannot cope with the competition. The ASX for years ignored CFDs as a passing fad only to realise too late that they presented an extreme form of competition. As usual, the response of the ASX to competition was to bleat, whinge and moan instead of manning up and meeting the competition head on.