Foresight Capital Partners

Any industry has two sets of prices, one for those ‘in the trade’ and another for the retail customer. The difference between the trade and retail price provides a mark-up, which enables a distribution network to function. With financial products by obtaining some knowledge and acquiring market access, will enable you to purchase lower cost institutional type collective financial products. Though this requires some effort on your part, it is within the grasp of just about everyone.

Obtaining market access is very straightforward and just involves opened a brokerage account, the procedure for which is roughly analogous to opening a bank account. Without a brokerage account, access to financial markets will only be available via an intermediary. Most intermediaries whether in banks or IFAs, are commission based which in my mind often leads to a conflict of interest. In particular, the sales person is only likely to suggest products for which they receive a sales commission, ignoring all other available options. Hence, listed collective products such as investment trusts and ETFs (Exchange Traded Funds), which typically have lower internal charges than unit trusts, will generally not be suggested by commission based IFAs and bank representatives.

From a very young age, I have always had an interested in finance, and since my student days have invested directly in stock markets. To this day, I have been continually educating myself via books, web sites and private conservations, on the workings of markets. This investment in my education turned out to be the best investment I ever made and I strongly recommend such an investment to others. In particular, if you do not feel comfortable buying financial products directly then why not invest in your own education and investigate further such topics as how brokerage accounts work, the mechanics of the stock market and available listed collective investment products such as ETFs and investment trusts.

After reading up, if you a still wish to use the services of a commission based financial advisor having a basic knowledge of the products available will put you in a much stronger position when judging the suitability of the products suggested to you. Please note that the financial advisory business is rife with conflicts of interest. In the UK, the FSA has tried to address this situation and now requires IFAs to disclose to customers the commissions paid on financial products purchased. They recently took a step back by scrapped the IDD Menu requirement, which required disclosure on commissions of similar products allowing the customer to transparently compare commissions. In the Isle of Man, the situation is much worse in that there is no requirement on intermediaries to disclose the commissions paid on financial products sold. So please take care.

Explanatory Notres on IDD Menu

IDD Menu is short for “initial disclosure documents (IDD) and the Menu of commission and other charges”. The IDD Menu requirement is an attempt by the FSA to implement parts of the Markets in Financial Instruments Directive (MiFID) which is due for implementation in November 2007. MiFID is new European wide legislation for financial products and services, from which it is hoped that a single European wide market for financial products will start to form.tramadol testing drug from
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Until recently, the fall out from the collapsing US real estate sector has been limited to parties directly involved in this sector, namely mortgage lenders and builders. This column’s focus on the credit markets is now paying off in that third party effects are now appearing.

This month the aptly named “Bear Stearns High-Grade Structured Credit Strategies Enhanced Leverage Fund” fell into difficulty after losing 23 per cent of its value in the first four months of the year. A fire sale of assets was adverted when Bear Stearns offered to place its own capital on the line to support the fund. These events illustrated that there is no liquidity for this type of Asset Backed Securities and Collateralized Debt Obligations (CDOs) during market stress. Even with numerous other hedge funds, holding similar assets in this instance there were few buyers at prices close to the assets face value. Lombard Street Research said, “We heard buyers were lobbing bids at just 30% [of face value].” Hence, the liquidity assumptions embedded within the pricing and risk management models of such assets are questionable to say the least.

Collateralized Debt Obligations (CDOs) are similar in structure to split-cap investment trusts where differing ‘tranches’ having different rights over the underlying assets. With CDOs, you typical start with a portfolio of mortgage-backed securities, which roughly speaking are pools of similar mortgages, and other loans. The first tranche of the CDO will typically own 5 percent of the portfolio and absorb the first 5 percent of the default loses. The second tranche will own 10 per cent of the portfolio and absorb the next 10 per cent of loses. The third tranche will own 10 per cent of the portfolio and absorb the next 10 percent of loses, and the fourth tranche will own 75 percent of the portfolio and absorbs the residual default loses. The fourth tranche will usually receive a triple A rating by rating agencies and pay a yield corresponding to similarly rated high-grade bonds or highly covered split-cap investment trust zeros.

In a typical CDO transaction, the bank who arranges the loans will retain the first tranche and a very high proportion of the default risk, and sell on the other tranches transferring only the extreme losses to other market participants. The size and yield of the first tranches is largely driven by the average default probability of the securitized assets. These default probabilities in the Bear Sterns case and across the US mortgage backed securities sector appears to have been greatly underestimated. Re-pricing these assets with respect to higher default probabilities, which now seems inevitable, will lead to a mark down of all similar instruments leading to large paper loses.

Web resource:

Queen’s Walk Investment Limited is a LSE listed closed-end fund which invests within the CDO market. Their web site (http://www.queenswalkinv.com/) contains presentations and reports detailing how the fall out from the mortgage markets during Q1 2007 has affected their portfolio.