Friday, April 25, 2008

Protection against NZ investment fund losses

NZ investors can eliminate risks connected to volatile market exposure; it just takes a little bit of ingenuity. The following idea applies to holders of financing company shares and “buy & hold” funds like the various Kiwi-Saver pools (and those two frozen ING funds).

Main risks from naked market exposure

The existing investment vehicles available in NZ hold positions in American debt and stocks off the NZSX and ASX (New Zealand Stock Exchange and Australian Securities Exchange). They all correlate highly with American economic conditions. As history has asserted, financial systems experience indistinct but nevertheless apparent cycles, a potential downturn imposes heavy losses indirectly for these NZ investments.

The next wave of housing loan defaults will occur in California, as ARM rates reset, failure of American lenders will follow, then Wall Street, and etc. Sooner or later the detrimental impact will cause mentioned NZ funds to crash. This will lead to “round 2” of market free falling, except this time it could become worse than that of last July as pessimism among institutional traders escalate. When it hits, some investors could lose everything.

The fact that some NZ financing companies (or funds at ING) have frozen withdrawals presently suggests they are aware of the coming storm, and want to try bullying the investors into taking losses instead of themselves. (Public investors should voice the outrage in this, but that is for another article).

Protection, insurance against said risk

Downside bets against the shaky, high risk, American borrowers and credit market participants provides a crude, but logical method to hedge against failure of investment funds in NZ. Taking short positions against these counterparties who sold the debts to NZ financing firms basically takes out the possibility of losing everything, because now the investor becomes protected, or hedged.

What you could do is demand for a detailed list of all invested vehicles from the existing investment manager, this would allow for precise hedging. As a client, investor, risk taker for them, you have the right to this information. I would suggest you contact the security commission if the firm holding your money tries anything “funny”.

Potential Scenarios

Say you have $1,000 invested in a NZ financing company and you do not want to risk losing it all, you decide to take a $1,000 worth of short positions in a basket of investment banks and mortgage brokers such as Merrill Lynch (ticker symbol: MER), Countrywide Financial (CFC), and others with respect to your NZ investments. The following possibilities could result.

1. One of the American firms becomes bankrupt. You take large losses in NZ investments, and make huge gains on the short American positions. It cushions the loss dramatically, and allows for potentially profitable result.

2. The US Federal Reserve saves American firms from going belly-up, but nevertheless, they lose value due to unprecedented credit issues. You get your returns from the NZ credit investments on maturity, and make additional profit off the short positions in America.

3. The market stays sideways until your NZ credit funds mature. You make your returns off them, and break even on the short positions.

4. The whole credit-crunch thing blows over, however unlikely it seems, and the market rallies once more. You make large profit in the NZ/ASX stock market funds, and finally able to withdraw from the financing companies, but take a loss in the short American positions. This will result in break-even, or a small loss.

The bottom line remains, the above scheme takes out the possibility of you losing everything from these extremely high risk investment funds in NZ. All said and done, your hard earned money deserves better management than these passive, inept or intentionally deceptive business entities.

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