Tuesday, August 21, 2007

How New Exotic Investment Products Misled Retail Investors

Last Tuesday's Wall Street Journal carried an article detailing the many exotic financial investment opportunity's available to the average retail investor in today's market environment.

Between ETFs covering many asset classes, mutual funds implying "market neutral" performance, and vehicles allowing relatively easy entry into foreign currency, foreign market funds, and commodities investment/trading, today's retail investor can enter the realm of complex financial instruments, electronically, totally unaided.

According to the Journal story, this is bringing the sort of results you'd expect- margin calls, losses and bewildered retail investors.

What seems to be happening is that uneducated retail investors are entering financial markets which are largely dominated by sophisticated institutional traders and investors. In such environments, it's almost a given that any sort of turbulence, as we have been experiencing of late, will leave the retail investors holding the losses. Typically being late to market gains, and late exiting declining positions.

Then there is the damage done by implying to retail investors that they, too, can construct effective asset hedges. The same non-performing hedged positions which have caused so much financial loss among leveraged institutional investors and traders is, of course, also causing losses among less-leveraged retail investors.

This brings to mind the opposing forces of financial innovation and regulatory vetting of individuals and institutions as qualified to invest in various instruments.

Basically, it's another version of the old liberal versus conservative viewpoints,

'Should we protect people from themselves?'

Liberals would tend to say "yes," while conservatives would tend to say "no."

I'm not sure we can ever really protect retail investors from foolish behavior. Going back to the go-go equity markets of the 1960s, or the Bonneville Power Authority bond defaults of the 1980s, it doesn't take much in the way of financial opportunities to allow average retail investors to lose their money via bad management.

What astounds me, though, now, is how a retail investor can so nearly replicate, albeit at higher costs, the sorts of financial investment and trading strategies which many sophisticated institutional traders and investors also employ. It's a frightening realization.

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