Spread the benefits
4 Aug 08
Wall Street, or any other type of investment, is fundamentally a gamble, and financial spread betting makes that explicit. But Anthony Harrington finds that it can have a legitimate place in an investment strategy
by Anthony Harrington
If you handed £200,000 or so of your money to a wealth manager and he or she informed you, as part of the discussion of what might constitute an ideal portfolio, that they planned to pop £30,000 of that money on a solid tip they had had in the fourth race at Cheltenham, you would probably judge them to be a few pence short of a pound. Out-and-out gambling is not what we normally think of as a coherent capital growth strategy.
Yet financial spread betting (FSB) is increasingly becoming normal practice for institutional investors and a growing army of retail customers, which is to say, folk like you and me.
So what is FSB? It is a simple bet on whether the price quoted for a financial instrument is likely to go up or down. The instrument in question could be an equity such as BP’s shares, or a bond, a commodity or a foreign currency pairing (say, dollar-euro) or it could be an index such as the FTSE All-Share, or Wall Street.
A financial spread betting company will cite the sell price and the buy price, usually around 2.5 points either side of what the company calculates the actual market value of the instrument to be at that time. That is the “spread” around the “real” value of the instrument.
If you think the value is likely to go up, you click on the buy button and specify how much per point you want to bet (usually from £1 to £100), and as soon as you confirm you can sit back and watch the numbers change on the screen. If you think the price is going to fall, you choose the sell price.
When you want to stop the trade you click to close the deal and the screen will tell you your profit or loss. It is as simple as that, and in today’s volatile markets, a £20-a-point bet could make or lose you a few thousand pounds while you are off getting a cup of coffee. This is heady stuff.
This point is worth stressing. FSB is by its nature a leveraged game. In other words your base stake is multiplied by the value of the points difference between your buy and sell stake, which might, if the market suddenly soars or plummets, be a number big enough to make your eyes water. As the FSB companies say in their health warnings, you stand to win or lose very much more than your stake.
In each instance, at the moment you place the bet, you will be “out of the money” by at least two points, since the equity’s market value will be sitting between the sell and buy price. That difference constitutes
the spread betting company’s profit on the trade. Once the trade is placed, you are probably in for a roller-coaster ride. If you choose to stay at the screen and watch as the spikes and troughs of the market charts appear, the resulting drama will be powerful enough to keep any adrenalin junkie’s juices flowing.
That is one attraction of spread betting, though it is not a particularly good or sound attraction from the standpoint of a person saving for retirement and knowing that their wealth manager has added this particular tool to his or her toolbox – you really do not want to see a mad glint in their eye… There is at least one other, equally compelling attraction, though: spread betting is free of capital gains tax.
Unlike an investment in ICI shares, say, (a bet by any other name) there is absolutely no CGT at all on spread betting, any more than there is on the £100 you won on Lucky Lad in the 3.30 at Ayr last Friday. To the Treasury, FSB is a bet, is a bet, is a bet.
Actually there are a raft of additional attractions to FSB besides no tax and plenty of thrills. Exploring these brings us to the reasons why FSB is being taken seriously as a wealth management tool.
The FSB provider companies want to make their offering as attractive as possible, and a powerful way of doing this is to provide access to as broad a range of globally traded financial instruments as possible. So FSB gives the punter (sorry, investor) the ability to get exposure to a huge range of markets literally at the click of a mouse. This is quintessentially an on-line, Internet based game, with very powerful tools available on screen, including real time charts of market and instrument prices.
Patrick Latchford, managing director in the UK and Ireland of the global FSB provider CMC Markets, says that devising a sensible strategy for FSB, to fit it into a wealth management portfolio, is all about the usual techniques of understanding the investor’s time horizons and risk appetite.
“There are some very obvious uses for spread betting,” he says. “For example, you can use it to hedge against your long term portfolio equity positions.”
Suppose you think that a favourite stock, say your holdings in RBS or HBoS, are going to be hammered in the short to medium term, but you do not want to sell out of those stocks and then have to pay stamp duty again when you buy back into them later. You can use FSB to offset your short-term loss of value in those stocks without actually transacting in them.
Alternatively, if the whole FTSE is on the slide, downgrading your portfolio, you can capitalise on the slide using FSB as a hedge. “It has to be realised that these instruments are very geared to short-term positions, so the FSB product is geared to short-term horizons,” Latchford says.
In a reversal of the usual position where someone who was close to retirement would be steered to minimum or zero risk products like government gilts, Latchford points out that FSB is a strong product for someone who only has a few years to try to amass a sufficient retirement fund.
Any sensible strategy needs risk management, and the key to risk management with FSBs lies both in the choice and duration of the bet you make, and in the built-in risk management controls offered by the system. These are basically the ability to place automated “stops” on your bet which ensure that you will not lose more than your agreed loss level for each bet.
For example, Tradindex.com, which offers an excellent, instantly available “virtual player” mode where you can trial FSB at no risk with a dummy £20,000, has a minimum stop level of between 20 and 30 points (i.e. £3,000 on a £100-a-point bet). This limits the risk.
Ben Jefferys, Global Products Manager at Saxo Bank, which specialises in or contracts for difference (CfDs), a kindred product to FSBs, points out that Saxo offers a “trailing stop”. This means that if you had a 20 point stop, for example, and the financial instrument you were betting on rose 50 points, the 20 point stop would rise with you. Trailing stops therefore protect gains in a rising market and are a very nice option.
However, some providrs, including CMC, do not offer them.
CfDs are ways of speculating on share price movements without having to buy the shares. Like spread bets they are a leveraged product and the cost is typically 10 per cent to 15 per cent of the underlying value of the equity.
Since you are not buying the share, you do not pay stamp duty, but unlike FSBs, CfDs are not regarded as bets and attract CGT.
Latchford says that CMC built its global business on CfDs but that where it has introduced spread betting, this is now investors’ preference. “In the UK our CfD business is about 10 per cent of the volume of our spread betting business,” he says.
Well, with that tax advantage going for it, and with not too much practical difference between the two products, who would opt for CfDs when they could jump straight in to FSB, tax free? n
Anthony Harrington is a freelance business journalist..