New Zealand investors can remove the risks associated with exposure to the volatile market; it just takes a little ingenuity. The following idea applies to holders of shares in financial companies and “buy-and-hold” funds like the various Kiwi-Saver funds (and those two ING frozen funds).
Main risks of exposure to the naked market
Existing investment vehicles available in NZ hold positions in US debt and equities outside of the NZSX and ASX (New Zealand Stock Exchange and Australian Stock Exchange). All of them are highly correlated with US economic conditions. As history has stated, financial systems experience indistinct but nonetheless apparent cycles, a potential recession indirectly imposing heavy losses on these New Zealand investments.
The next wave of home loan defaults will occur in California, as ARM rates reset, the bankruptcy of US lenders will follow, then Wall Street, etc. Sooner or later, the detrimental impact will send the aforementioned New Zealand funds crashing. This will lead to “round 2” of market freefall, except this time it could be worse than last July as pessimism mounts among institutional traders. When it arrives, some investors could lose everything.
The fact that some New Zealand finance companies (or funds in ING) have frozen withdrawals at present suggests they are aware of the coming storm and wants to try to intimidate investors into taking losses instead of themselves. (Public investors should be outraged by this, but that’s for another article.)
Protection, insurance against said risk
Short bets against unstable and high-risk US borrowers and credit market participants provide a crude but logical method of guarding against mutual fund failure in New Zealand. Going short against these counterparties who sold the debts to the New Zealand financial firms basically eliminates the possibility of losing everything, because now the investor is protected or covered.
What you could do is require a detailed list of all invested vehicles from the existing investment manager, this would allow for accurate hedging. As a client, investor, risk taker for them, you have a right to this information. I suggest you contact the safety commission if the company that has your money tries something “fun”.
potential scenarios
Say you have $1,000 invested in a New Zealand finance company and don’t want to risk losing it all, you decide to take $1,000 in short positions in a basket of investment banks and mortgage brokers like Merrill Lynch (ticker symbol: MER), Countrywide Financial (CFC) and others in respect of their investments in New Zealand. The following possibilities could result.
1. One of the US companies goes bankrupt. He takes big losses on the New Zealand investments and makes big profits on the American short positions. It cushions the loss dramatically and allows you to obtain potentially profitable results.
2. The US Federal Reserve prevents American companies from going bankrupt, but nonetheless losing value due to unprecedented credit problems. It earns its returns from New Zealand investment credits at maturity and makes extra profit of short positions in America.
3. The market remains sideways until your New Zealand credit funds mature. You earn your returns from them and break even on the short positions.
4. The whole credit crunch thing fades, improbable as it may seem, and the market goes back up. He makes big profits on NZ/ASX stock market funds and is eventually able to withdraw from finance companies, but suffers a loss on US shorts. This will result in a breakeven or a small loss.
The bottom line remains, the above scheme eliminates the possibility of you losing all of these extremely high risk investment funds in New Zealand. All said and done, your hard earned money deserves better management than these passive, inept or intentionally deceptive business entities.