bulletin 37

managed funds - hedging = insurance

A conversation with a "financial strategist" who is able to supply information that, as usual, is not available in the public domain. It occurred mid-2008 as the market collapsed.

Generally speaking :- markets constantly rise. Each year there will usually be two serious frights when the markets will go down. These shocks present a three day window of opportunity to buy stocks. The stocks push the futures up.

note - shocks and frights tend to occur march and october - funnily enough when daylight saving starts and ends

For 12 years I was a consultant to a "financial planner" who managed $30 million on behalf of clients in Super Funds. The clients would ring up and ask him to "buy". These instructions would be executed immediately without thought. Invariably they occurred at the tops of moves when institutions had pushed the market up to sell call options, and prior to the coming push down to then sell put options. I discussed this with him on a number of occasions. Without success. It was fruitless.

This discussion should be read in context with the article on "my trading methods" on selling on the short side and why its so difficult.

Questions in black. Responses in blue.


From: The Strategist To: iconoclast

Date: Monday, 18 August 2008

Please see my responses in blue. Let me know if you need any more information.


This question has arisen out of questions posed in the facilities bulletin

With a new (negative) paradigm operating in the markets some interesting characteristics have shown themselves

(a) Most of the "investment forums" have either gone quiet or gone dead over the past 9 months. A characteristic of these forums was people looking for better and smarter ways to "buy" ie stock-picking. But now we are in a down-move there is no discussion. Which is telling me everyone (and I mean everyone) is stuck. There is no discussion on how best to manage the downturn. What strategies to use etc etc.

By and large the vast majority of retail investors are long only. The AFR investor section might push CFDs as hard as they like but in reality only a small set of investors use CFDs, Options and Futures. Also CFDs, Options and Futures tends to attract technical TA traders and they are a very small part of the market. Most people are buy and hold or speculators in "topics" they study like gold stocks or oil

(b) As you are aware for about 12 years (until a year ago) I had been consulting to a "financial planner".

(c) 6 years ago I offered to conduct seminars for his clients on derivatives as part of a program to educate his clients as to the timing of investments and how prop-traders shunt the market around. The intention wasn't to persuade them to trade derivatives, but to understand how, why, and when they are used. ie you dont want to be "buying" investments in the week prior to "options expiry week" and so on. No dice. He didnt want his clients thinking for themselves.

Maybe but I suspect it was a lack of interest in his client base. I'm a fully qualified ASX registered derivatives adviser and it is like pulling hens teeth to get people interested. Even at my firm no one was interested in me writing a daily warrant newsletter. At other big firms I know blokes that have had the same problem. CFDs, Options and Futures are mainly (in the retail space) confined to the online traders - very very little real volume and value done in the retail advisory space. Institutional is different. The irony is many brokers are ASX Level 1 (buy option accredited) but they never get to use it because no one is interested. Most clients are investors so anything other than a share is too difficult - even instalment warrants are a very hard sell.

(d) Last year, as we went into melt-down mode I asked if he had any strategy to use futures as an insurance mechanism to protect his clients investments. Again, no dice. He didnt want a futures broker knowing who his clients were. Didnt even want to discuss it. About now, all his clients are down at least 20%. He is a buy and hold advocate.

Insurance costs money. I couldn't get any of my peers interested in put buying seminars or such like after the August fall in 2007. I have been doing a lot of behavioral finance study this year and I think that in the end clients understand the market is a long term investment that can provide good double digit returns, but to get that you have to accept the market can fall. So given that acceptance they don't then want to have to make bets on it falling because (a) they have to pay (b) they might get the timing wrong and (c) its counter intuitive - they don't back horses to lose at the races (though you can now with Betfair) hence they don't want to back stocks to lose. This is further reinforced by the continuous press attacks on short selling hedge funds. Going short is seen as evil - that we should only ever be long. It is in the mindset to buy and hold. Everybody knows someone who invested $100,000 15 years ago and now it is worth over $2 million by just leaving it in the market. The destination is more important for many investors rather than the journey (ie the interim volatility)

The Question

In your experience how does one manage a super fund ?

In general long only - with a cash/stock mix. In rising markets it's easy. Pick the best.

In falling markets - does everyone freeze and hope for the best. ?

Yes, even the old lady clients just say "oh well, it (the market) will come back"

fund managers constantly re-balance and protect their portfolios with derivatives

The large fund managers protect their investments with the use of derivatives - Futures and Options - (we know they do - because you told us they do in bulletin 13) what does the little SMSF guy do. What does the SMSF advisor do. Why cant I find anything on the web about small superannuation fund asset protection. ie Buying insurance. I have heard several sad stories of people with good sized SMSF's who have taken some pretty big hits. I dont understand the silence. While everyone is willing to pick one-anothers brains for buying strategies, there is a cone of silence on how to manage a down turn.

There is total silence because there is no real action or interest in the SMSF defensive space. AXA and Perpetual have CPPI type products but they lock you in for 5 years and often go to cash early and then leave you there so you miss the bounce back. In some of these CPPI products you need a 9% return to break even. Often these products are only marketed in June (for the prepaid tax deduction) which might coincide with a point where the market is rising so no one is interested.

Even at the bigger brokers very very few are actively promoting option/future defensive type strategies. They are too hard to sell to retail investors. They don't want to pay for something that can lose 100% (like a put) It is easier to sell a diversified portfolio (cash, some OS stocks, maybe some ETFs) but throw in a derivative and the word alone causes heart palpitations.

Out of 1,000s of clients we have I don't reckon I could have got 50 people to a seminar on portfolio protection via options. Its the same at other brokers

Going to a retail broker has been a huge eye opener for me. I move smoothly through CFDs, Options and Futures and I'm not really into technical analysis. But the reality is these products seem to only attract the TA boys - these guys generally have no real risk management and get more and more esoteric in their strategies (RSI, Bollinger, Dow, Fib etc) to the point where you can't see the price bars for the indicators. Most of clients we had who are into this have blown up in the last 4 months. No risk control, no real strategy, just a lot of colour to hide the fact they had nothing

The last year particularly has highlighted to me the lack of sophistication in the retail investor's mindset and frankly its broken me (and I've just made partner at the firm !). I'm at a fork in the road - either start a fund and deal only with sophisticated clients or just play with my own money. Either way - I've got a good strategy for enhanced indexed (easy to sell as a fund - lots more interest in the market for this type of fund, can leverage off my derivate skills) or universal portfolios (have a look in Google) - very quant - have just knocked back a chance to do a PhD on them - sick of study

About 5 years ago I did a small article on "buying" (or selling) insurance at   www.iconoclast.com.au#insurance
As an active trader yourself you will understand this. What's the overall picture ? Your thoughts ?

Final thoughts - retail clients won't sell a winning position because (a) it might go higher or (b) I have to pay tax. They will only sell if about 20 newsletters and heaps of research says - that stock has gone as far as it should. We had guys take huge hits on Allco - clients just wouldn't get out! I've spoken to brokers in private client advisory at other places and it's the same everywhere. Very hard to get clients interested in any derivate products and the clients that are tend to be the more TA type "investor" and they are really just DIY clients, who open online accounts and do it all themselves.

The future. Many brokers are getting into financial planning - so they can scoop up the client's assets into a wrap and make a trail income regardless of market conditions - its all BS and a ripoff. The handful of genuine alpha generating guys are doing it a bit rough at the moment but their clients are very loyal 'cos these guys will deliver the next batch of stocks that will go - these guys are a stratosphere ahead of the rest - they have small client bases (450) and stick to genuine stock picking.

Whenever you see those advertisements for derivative brokers in efinancialcareers.com they are always on Institutional Trading desks because that's where all the options/futures action really is.

I've spoke


The Superannuation Industry is now a $1 trillion megalith. Few people understand the difference between the three entities, (a) Super Fund, (b) Trustees, and (c) Fund Managers. The Fund Managers (the slow bombers) and the Prime-Brokers (the nimble jet fighters) are the two antagonists in this game. The trading rooms at MF Global are the more nimble day traders trading the gaps between the two groups.

While all this was going on I was talking to a guy who trades the SPI and is nervous taking a $200 hit while he has a $1 million SMSF which lost $500k. He was losing $1000's a day and he wasn't the slightest bit concerned. I kept asking him, if he can't sell his fund holding why not sell some futures for protection. Cant - too nervous.

In March this year as an experiment I did a paper on superannuation and funds investment from the perspective of a derivatives trader and posted it on the website. Care was given to ensure it was properly indexed by the search engines. The one interesting charactersitic is there have been exactly two hits on the page by searchers looking for details. One of those was by one of the large accounting firms. The lack of interest or understanding is amazing.   financial advisors