Posts Tagged ‘Australian Financial Review’

Sports Arbitrage Trading In The News

Australians like most people dream of a comfortable retirement. Each of us, all have a vision of how our retirement will be like. Some of us dreamt of lazing away in the sun by beach. Other dreamt of a ranch in the outback, living in harmony with the surroundings. Whatever our dreams are, we all strive to work hard to make it come true. We save and we invest to build up our “nest” of funds in order that we can reach our ultimate goals during our golden years. To achieve this, we put our hard earned monies into superannuation funds, mutual funds and properties hoping that in the near foreseeable future that we will be able to reap the rewards of our sweats. These are the ways that we know how to realistically achieve what we have dreamed off. We are pragmatic about what we can do and none of us believe in “get rich quick schemes”. Unfortunately the current credit crisis brought about by the collapse of the housing bubble in the US has all but shattered our dreams and hopes.

The credit crisis had come about due to greed and recklessness of supposedly financial experts at Wall Street. Most of us have no inkling what are Collaterised Debt Obligations (CDO’s), Mortgage Backed Securities (MBS’s) until the current credit crunch. The worldwide credit crisis faced by all of us now is proving to be a painful and rude awakening for many of us. Painful because the hard earned money that we have stashed away which were regarded as safe and conservative investments are now diminishing in value by the day.

Those who took the traditional approach of investing in “rock solid” investments like bricks and mortars, are finding themselves faring no better than before. Putting our money into properties has traditionally being the favorite mode of saving for our retirement. However, the crisis faced by the world today have demonstrated that the real estate market in the US also have the ability to affect us here in Australia. Interest rates have spiked and have made it more costly to borrow to fund our purchases. This is in addition to the fact that the banks are also tightening their lending. To make matter worse, spruikers are not making things easier for property investors to discern what a legitimate investment is. The collapse of Fincorp and Australian Capital Reserve (ACR) are all stark remainders of what are in store for us if we are not careful with whom we entrust our hard earned money to. The Australian Securities and Investments Commission (ASIC) tasked with the job of overseeing investors’ interests have fared pretty poorly in their job resulting in thousands of retirees losing their life savings. Their explanation is that ASIC is not responsible for approving any prospectus rather that is the responsibility of the issuer and the advisers. For the thousands of investors who had lost an aggregate of A$1 billion, that explanation brings little comfort.

Apart from properties, unless we struck it rich by chance, Australian generally has one of the following options to adopt for their retirements plans. The easiest is to not do anything and just seek the aged pension. But as our esteem Deputy Prime Minister had said, even she will be hard pressed to survive on the pension that is currently being doled out by the Australian Government. Indeed many of our seniors on the pension system now are living near the poverty line. The alternative is to self fund our retirement with the superannuation funds. Unfortunately, even that now is subjected to events that are happening at the other end of the world. The loss of investors’ confidence in the world’s financial markets had lead to declining shares prices on the Australian Stock Exchange (ASX). This in return have resulted in our superannuation funds returns declining as well. The effects are not just confined to our retirement funds. Local councils like the Wingecarribee Shire council have also lost all their surplus monies in supposingly prime value money market instruments. Even with the much publicised $700 billion dollars bailout plan by the US government, lawyers for the local councils have said it is doubtful that the many local councils which have invested in mortgage backed securities in the US will ever see a single cent returned. What this mean is that many of the schools, clinics or roads that are to be built in the future will never get off the drawing board.

The money market instruments investment have always been the core of any investment portfolio because the fixed interest yield strike a balance between volatility of the shares prices and the returns of low yield treasury bonds. However due to the way the globalised economies interact with each other, all the traditional models of investments are no proving to be really practical. A company stocks was previously valued based on how much dividends that it would return to its shareholders. Today with the advert of computerised trading and newer and creative ways of accounting, shares prices are valued based on their earning forecast. In addition as the financial market become more competitive, market traders are turning to other ways of generating more income. Using complex computer programs based on algorithmic patterns and quantitative analysis like statistical arbitrage, hedge funds are able to squeeze billions of dollars in profits daily with as little as two decimal point price differentials between any two assets. This is why we hear of hedge funds being able to cause the price of shares to fall or rise by their trading. Irrespective of the direction a market is moving, hedge funds with their systems are able to profit because profitability now is not dependent upon the yield of the share but rather on the price differential between two complementary shares.

Unless the ordinary investors have the financial means to develop and maintain such systems, this form of investment is out of our reach. However a former London City stockbroker, Rajeev Shah, illustrated that arbitrage trading is not just limited to the financial market. The same mathematical principles which had provided risk free investments for the hedge funds in the financial markets can be applied to the world of sports betting. Customising a system developed during the 1980s by the investment bank Morgan Stanley and using an algorithmic programmed software called ArbAlarm, sport betting ceases to become gambling as statistical arbitrages has reduces the risk to near zero level. (To know more, read “Sports Arbitrage–How to place riskless bets & create Tax free investments”). On top of that, the Australian Tax office is not able to tax profits derived from Sports Arbitrage. (See Australian Tax ruling TR2004/DR17). With all that is happening around us today, the world is getting smaller and making it harder to insulate ourselves from all the problems in the world. What the current credit crisis had shown is that our traditional view of our financial matters no longer holds true. Unless we start to learn and rethink outside the box and explore all our investment options, we might find ourselves out in the cold through no fault of ours. Today Main Street is paying for the folly of Wall Street and sad to say, even the Wingecarribee Shire council is also helping to pay.

Sports Arbitrage Trading In The News

Today with globalisation, Australians are enjoying a standard of living which is the envy of many nations in the world. The boom in commodities prices has brought our country’s GDP to the level of those major developed countries in Europe. Many of us are also looking forward towards our ‘golden years” when we retire. Our wise investments and careful financial planning are just waiting for us to cash out so we can reap the fruits of our labour. Life couldn’t be better and all the problems in the world seem so far away. Until a few months ago, this was the idyllic vision that most Australians have in their mind. The full impact of what is happening in the US didn’t hit us until we started to see the consequences of the subprime leading crisis on the major economies of the world. Little by little, we are now beginning to feel the ripples of the fallout. Our prudential financial planning for our retirement now seems helpless against the onslaught of bad news that is hitting the news daily.

For those who had planned their retirement around properties investments are finding themselves not insulated from the current credit crisis as well. Property has traditionally being seen as the most stable and fail safe model of investment. The phrase “You can never go wrong with bricks and mortars” is nothing more than a fallacy now. With globalisation, property developers have funded their projects with Real Estate Investment Trust’s (REIT) funds. These funds are in turn obtained from the world’s financial market. With the credit crisis now, many property firms are now finding their sources of funds being cut off leading them to become insolvent. Apart from this, rising cost of funding due to the credit squeeze has resulted in declining demands pushing down the value of homes. To make matter worse, the demise of corporations like ACR, Fincorp and Westpoint demonstrated how easy it is for spruikers to raise money from thousands of unsuspecting victims. The complacency of the Australian Securities and Investments Commission (ASIC) is not helping investors to feel confident in further investment in the Australian real estate market.

Many Australians also use financial planning to amass a portfolio of investments for their retirement purpose. Of course being a welfare state, the State will provide for our pension if we choose not to do anything for our retirement. But most of us are hard working and living near the poverty line doesn’t seem to appeal to most of us as retiring comfortably. Even our Deputy Prime Minister, Ms Gillard, find it hard to survive on the current state pension scheme. This is why many of us choose to self fund our retirement through the superannuation funds so that we will not have to compromise on our standard of living. Unfortunately current events in the world financial markets are also affecting the returns on superannuation funds. Because of the credit squeeze, this has resulted in value of shares dropping by as much as 30 percent since the beginning of the year. As share prices drops, the value of a superannuation funds also drops as the funds are nothing more than just a basket of diversified financial instruments.

The current credit crunch is the result of the world’s financial market being clogged up by risky and questionable assets which many of the financial institutions are stuck with. To remove these toxic assets from the financial market, the US Federal Reserve have seek to buy them up with the enactment of the Emergency Economic Stabilization Act of 2008 or more famously known as the $700 billion Bail Out Plan. Beside from the adverse effects that these toxic assets have on our property value, share prices and the returns of our superannuation funds, monies earmarked for community development have also been depleted as in the case of Wingecarribee Shire council. Long regarded as prime value investments, money market instruments are popular because they represented a good balance between yield and stability as compared to shares and bonds. Even with the bailout plan, lawyers acting for the local councils which had made investments in these mortgage backed securities are doubtful that they will be compensated by the US’s bailout plan.

Globalisation has brought a new world order which had benefits us in terms of trade and development. But with increased interaction between all the trading nations of the world, there is also an increased dependency with each other. This had the effect of intensifying risks into areas which were previously impervious to external influences. The traditional models of investment are proving to be outdated as the current credit crisis has shown us. For example, the value of a company stock used to be determined by the yield of its dividend. Today this is no longer the case. With technological advances, shares prices are being determined in ways we had never imagined. With increasing competitions and decreasing margins brought about by globalisation, market traders are seeking alternative avenues for increasing their revenue. One of these ways is to take advantage of inherent market inefficiencies. With the use of complex computer programs and statistical arbitrage, market traders are making billions daily just by trading based on price differentials of two or more complementary assets. It doesn’t matter how small these differential are or which way the market is moving. Their systems virtually eliminated their risk level. With the kind of volume which these market trader deals in, it is not surprising that they can create “market sentiments”.

For many of us, we can only dream about systems like these as the development of these sorts of systems requires heavy capital investments costing millions of dollars. In addition, these systems also require heavy maintenances. On the other hand, a former London city stockbroker, Rajeev Shah, illustrated that using a customised algorithmic program called the ArbAlarm, based on the system developed by the investment bank Morgan Stanley during the 1980s, the same mathematical principles is applicable in the Sport Arbitrage world. (To gain more insight, read: “Sports Arbitrage–How to place riskless bets & create Tax free investments”). For many of us, this is as close as we can get to having a taste of how hedge funds made their monies using complex algorithmic systems. The current credit crunch for many of us is proving to be a rude awakening experience. For those soon to retire, diminishing values of the retirement nest is causing endless sleepless nights as we worry about our options. Perhaps, we should seriously consider and study what other options that we have to secure our retirement that is impartial to influences from the global financial market regardless of how unorthodox the option maybe.

As President Bush signed the bailout plan into law, the majority of the Americans are now watching closely the effects of the bill on the financial market. Most of those on main street are afraid to spend as they are unsure whether the bailout plan will work or not. The bailout plan calls for the acquisitions of toxic assets held in the books of ailing financial institutions. The goal is to help unlock the credit squeeze which is gripping the global economy. Under the Emergency Economic Stabilization Act of 2008, the Treasury Department is allocated $250 billion to buy up the mortgages and CDOs. If this amount is inadequate, at the President’s discretion, another hundred billion can be made available. A final $350 billion is also provided for subjected to the US Congress scrutiny.

The entire dominos effect began with the demise of the Lehman Brothers followed by the bailout of American Insurance Group (AIG) by the US Government. From there onwards, for the 3 weeks prior to the passing of the bailout plan, the world’s financial markets had been on a roller coaster ride. The effects were felt globally as stock markets all over world nosedived. Many had hoped for that the bailout plan will provide for a calming effect on the market. However since a week had passed, in a climate of mistrust, Banks are still holding on tight to their cash worried which is the next bank that will collapse. This has prompted shares prices to continue falling, slowly wiping out the values of retirement funds resulting in even less consumer spending. In fact the US president has asked Americans to brace themselves as he warned that the bailout plan will take time to be effective.

Already analysts are warning that more banks are likely to fail by next year. The question on many peoples mind now is how many of these banks will fail and also the manner with which these banks will be disposed off. The reason for this anxiety is due to the dwindling deposits of the Federal Deposit Insurance Corp (FDIC). Under the bailout plan, the liability of the FDIC is increased from $100,000 to $250,000 per account. It follows as to whether there are enough funds to meet the obligations of the FDIC. Granted that the bailout plan will save some financial institutions from insolvencies, a substantial numbers of banks will still face failures as the deteriorating assets which they hold are not covered by the bailout plan. For example, constructions loans are not covered in the list of assets which the Federal Government will take off from the books of ailing banks.

With the turmoil in the financial markets, despite being covered by the FDIC, many depositors are wondering whether their savings are secured. With the failure of Washington Mutual several weeks prior to the enactment of the Emergency Economic Stabilization Act of 2008, this has not aided in boosting confidence in the minds of depositors. The current trend is a flight of money to quality institutions. The problem is that no one really knows which banks are on a strong footing when banks like Washington Mutual, are not even immune to failure.

Although Australia is on the opposite end of the globe, the fallout from the US has not left Australian banks unscathed. Earlier during the year, the National Australian Bank (NAB) was forced to write down 90 percent of its holdings on American CDOs to the tune of A$1 billion. The write down had forced the NAB to cancel its £550 million bond sales by 70 percent as investors shy away from investing in the NAB bonds. In addition analysts are predicting that the NAB will need to further write down an additional A$500 million to A$1billion to cover its losses in the US mortgage investments. Even the Wingecarribee Shire council is not spared from the fallout of the US credit crisis. Like many of the charities and churches in Australia, the council had purchased millions of dollars worth of these toxic assets as investments. A lawyer acting for the council commented that it is unlikely that the bailout plan will benefit the Wingecarribee Shire council.

The New World Order brought about by the globalisation of the world’s economy has resulted in many positive benefits like ever increasing trading among the various nations of the world. Corporations are also able to raise funds easily on worldwide capital markets with lower cost. The unfortunate consequences of a globalised economy are that risks are also amplified even to areas seemingly unrelated to the global economy. Today, because of the world dependencies on the US economy, even its domestic problems have the cascading effects on a local council like Wingecarribee Shire council. Today, investing is no longer a simple and clear cut matter as Money Market Instruments are packed and repackaged so many times that no one know what their real risk levels are despite of their triple “A” rating.

In addition, globalisation has also revolutionised the way Share prices are being determined on the stock market. A company shares used to be determined by the amount of dividends that it paid out to shareholders. Today shares prices bears no relation to its intrinsic value but rather to its earning potential based on forecast. With a little bit of creative accounting like what the previous management of the demised Enron did, a company is able to show earning potential much higher than it actually is able to earn. Secondly, with increased competitions among the market traders, trading margins are becoming increasingly lower. To compensate for the decline in margins, market traders are now resorting to alternative ways to generate revenues. One way which the market traders have gone about doing this is by taking advantage of inherent market inefficiencies. Using a system pioneered by Morgan Stanley’s Desk Trading Operations during the 1980s, market traders are able to use statistical arbitrage to profit for temporary mispricings of assets to gain profits from as low as two decimal points. With computers programmed with algorithmic blueprints, market traders are able to isolate these “mispricings” within a fraction of a second and capitalise on them before the market readjust itself. By the sheer volume of shares traded, hedge funds are able to move the prices of shares which they deal in thus creating the market sentiments.

Due to large volume of shares traded by hedge funds to capitalise these mispricings of assets, they are able to profit by the billions daily. Their profit taking abilities are not curtailed by the direction of the market movements. Regardless of whether the market is moving up or down, hedge funds are able to profit from their trading. Statistical arbitrage is able to remove the element of risk from the equation. Because these computerised systems requires substantial amounts of money to develop and to maintain, these systems are beyond the reach of the ordinary investors.

Nevertheless, Rajeev Shah, former London city stockbroker, pointed out those situations of arbitrages is not just limited to the financial market. In the world of Sports betting, the same mathematical principles of statistical arbitrage can be applied to betting. With an algorithmic computer program called the ArbAlarm, placing bets cease to become gambling but rather as hedging because statistical arbitrage reduces the element of risk to zero. (To know more, read “Sports Arbitrage–How to place riskless bets & create Tax free investments”). Furthermore, the profits from Sports Arbitrage are not subjected to tax. (See  Australian Tax ruling TR2004/DR17).

Although this is  an unorthodox method of investing one’s funds, in comparisons, the traditional model of investments based on shares, bonds and money market instruments are no longer fail safe to fund one’s retirement plans. Of late, returns on superannuation funds are declining with many resorting to the aged pension instead. In additions, brick and mortar are also no longer reliable as place to park one’s money. The collapse of ACR, Fincorp all seek to show that the real estate market is also subjected to manipulations by unscrupulous developers. With the current situation, perhaps it really time that we think outside the box to seek an alternative way to fund our retirement without it being at risk to factors beyond our control. 

The Global stock markets instead of responding favorably to news of the enactment of the Emergency Economic Stabilization Act of 2008 in the US have instead been declining. In addition, the credit crisis has now taken root in Europe as European nations scrambled to put into place their own bailout plans to save their own domestic banks. Forbis NV, the largest retail bank in Belgium, was recapitalised with an infusion of €11.2 billion orchestrated by a tripartite efforts of Belgium, Luxembourg and the Netherlands. Ireland in a unilateral move, declared that the Irish Government will guarantee all debts and deposits of its 6 largest banks. Although the move was initially denounced by fellow EU countries, fearing a flight of deposits to Ireland, the measure was later adopted by the Greeks. The latest EU nation to adopt such a measure was Germany which virtually acts as a guarantor for all its saving deposits in the retail banking sector worth €560 billion, a quarter of its GDP. This is in addition to the €50 billion rescue package for the Hypo Real Estate AG, one of Germany largest property lender.

Investors are currently still holding to a wait and see attitude as to the trickle down effect of the US $700 billion bail plan. US Treasury bonds yields have remain extremely low due to the flight to quality from the stock market. Investors are avoiding the corporate bonds market as they are wary of what could be a Warren Buffett’s “time bomb” hidden within those investments. The loss of confidence in the financial system has resulted in investors avoiding anything that is remotely deemed risky. Even though the bailout plan seeks to unlock the credit squeeze in the financial markets, banks are still unwilling to lend and if they do lend, the lending comes at a premium. The bailout plan protracted journey to become law has also resulted in the market having doubts about the effectiveness of the plan.

Many analysts agree that what was initially regarded as a domestic problem of the US has now mushroom into a global crisis affecting Europe and ultimately Asia as well. The situation now faced by the Europeans echo that of 1971 when the US abandoned the dollar’s link to the Gold standard. Currently all eyes are on the European Central Bank (ECB) to see if it will cut its interest rate. The reason is that with the establishment of the Economic Monetary Union (EMU), EU nations no longer have the powers to lower interest rates nor devalue their currencies. To give the ECB supranational control of monetary polices, all these powers were surrendered to the ECB.

Thus today individual EU nations, no longer having these powers, are resorting to protectionist methods to insulate themselves from the fallout. The irony of the whole situation is that, the EMU was established to enable the global economies move away from its dependencies on the US dollar. Instead of diversifying risks, globalisation has instead intensified risks even to seemingly immune areas. With the scale of interaction in the global economies, this has resulted increased interaction between Europe and US, making the European nations more exposed to any situation in the US.

Analysts are warning that as the contagion spreads across the globe, Australia could be in for a rougher ride than the Americans. This is because despite a boom in the commodities market, Australia has been running a budget deficit. Household debts are at 177 percent of GDP, one of the highest in the world. Since late last year, the shares prices on the Australian Stock Exchange (ASX) had declined by as much as one third. Mining shares have also been declining. If the slide in the commodities sector continues, Australia will indeed be facing a crisis worse than the US with no means to pay for its imports and no means to borrow in the current credit crunch.

Today, the economies of the world are intertwined together in ways that we cannot imagine. Globalisation has intensified risks in even in areas which we once thought were safe. The traditional model of investing used to be based on three main asset class; stocks, bonds and money market instruments each with its own level of risks and with the money market instruments being the most stable relatively from fluctuations and inflation. Today with a proliferation of exotic financial instruments like CDO’s and MBS rated triple “A” by rating agencies, nothing can be taken for granted at face value anymore. Investing in the financial market has become as dangerous as sticking one;s hand into a nest of cobras and hoping not to get bitten. Shares prices used to be based on the dividends that it pays out but today this has all changed. Movements in shares prices are dictated by its earnings potential and market sentiments instead which are subjected to manipulative creative accounting as in the Enron’s Scandal.

The one thing which has not changed with globalisation is the inefficiencies of the market. With computerisation, trading on the stock markets are done using computer programmed with algorithmic patterns designed to execute trading orders even before human traders are aware of the changes in market conditions. Combined with the use of statistical arbitrages, algorithmic trading has changed the landscape of the financial market dramatically. This is the main reason why hedge funds outperform the other funds on the financial market. Quantitative analysis like statistical arbitrages isolates the price inefficiencies of assets allowing removal of risks while algorithmic trading takes out the emotional aspects of trading removing what Alan Greenspan termed as “irrational exuberance”. The downward side to this investment strategy is that it requires volume trading and a lot of capital as the price differentials are calculated up to two decimal points.

However situation for arbitrages also exist in other markets and not just the financial markets. As former London City stockbroker Rajeev Shah pointed out, conditions for arbitrage can also be found in the world of Sports Arbitrage. Using computer programs like the ArbAlarm, one can capitalise on price differentials just like the financial markets. (To gain more insight, read “Sports Arbitrage–How to place riskless bets & create Tax free investments”).The main difference between this market and the financial market is the transparency which exist in the world of Sport Arbitrage. Mutual funds used to be the simplest and easiest way to invest in as an investment vehicle for retirement. The problem is that with globalisation and increased competitions, this no longer holds true. As demonstrated by the current financial crisis, many investors are caught with their pants down as they have no idea what they are investing in. What presumably was triple “A” class investments turns out to be nothing more than a proliferation of “toxic assets”. With the current economic climate, perhaps it is time to rethink outside the box and look beyond traditional models of investments for one’s retirement. An article published in the Financial Times called “Cherished myths have fallen victim to economic reality” explains why and how times are changing beyond our comprehension. Either way, it should be “Main Street” and not “Wall Street” who should reap the benefits. Instead today, “Main Street” is just bearing the losses of Wall Street’s greed and recklessness.