It wasn't that long ago that an investor wanting to know a price-to-earnings ratio for a stock had to call their broker. Possessing this information was a big part of the value proposition for brokerage companies and for professional traders, it gave them a huge informational advantage over retail investors.
The Internet democratized market data and erased these benefits for the industry. With everybody having the same information, the easy money for professional traders became much harder to come by.
Many pros deserted the equity markets in favour of derivatives. The higher volatility and speed of futures and options markets puts a premium on trading acumen and a degree of constant focus that allows them to immediately react to market news.
Most of the traders I know from social media – carefully filtered over time for knowledge and success (and temperament) – now buy and sell assets with symbols most investors have never heard of. 'ES', for instance, is the S&P 500 Emini contract that trades like water, and 'CL' is the West Texas Intermediate crude contract.
Derivatives markets also allow an extreme level of complexity. Traders and hedge fund managers will design strategies that simply aren't accessible to most investors, and this now forms the 'competitive advantage' professional investors attempt to exploit.
Here's an example of a typical derivatives trade. Citi interest rate strategist Jabaz Mathai believes the Canadian dollar is currently overvalued, primarily because he does not believe the Bank of Canada can raise interest rates as fast as the market expects. To take advantage of this, Mr. Mathay could have suggested an immediately intelligible trade idea like shorting Canadian government bonds in a U.S. dollar account. Instead, he recommends shorting 'BAM9' , a futures contract tracking domestic bankers' acceptance rates that expires in June of 2019, and using the proceeds to buy 'EDM9', a Eurodollar contract which follows the Fed Funds futures rate, which expires in the same month.
We can only speculate on the effects of this complexity on the portfolios of individual investors. I described my belief this week that futures trading was significantly affecting oil prices. It's also entirely possible that historically low rates of equity market volatility are caused by active professional investors abandoning conventional equity markets.
One thing that is clear is that the asset management industry, thanks to poor performance, information transparency and low fee investing options, is struggling to market a business proposition to investors. After having moved into derivatives to differentiate themselves, let's hope they don't blow up the market in the attempt.
-- Scott Barlow is The Globe's in-house market strategist
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What's up in the days ahead
In Wednesday's Globe Investor, John Heinzl looks at high-yielding stocks that are now on sale, while John Reese outlines some stock picks for the value investor. Later this week, Brian Milner has a reality check on the high-flying pot stock sector.
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Compiled by David Leeder and Darcy Keith