Investors search for a lifeline as their portfolios sink

By Liam Egan

A near complete lack of understanding of derivatives is resulting in some individual wholesale investors unnecessarily losing large proportions of their equities portfolios, according to Compound Capital principal John Woodrow.

His opinion is based on a growing number of potential high-net-worth and family offices seeking help from the Sydney boutique wholesale asset manager with distressed portfolios in the wake of the credit crisis.

He said “almost 100 per cent” of these potential clients of the boutique, which manages more than $200 million in individual mandates, have no derivatives in their portfolio.

“They are almost without exception long-only investors, and some of them don’t even understand that they can hedge their portfolios for protection using derivatives.

“It’s incredible that these clients insure their home, car and boat, and yet have no form of ‘insurance’ against capital loss on their portfolios, which, for wholesale investors, is generally worth more.”

Over the past eight months, Woodrow said Compound has experienced “a significant increase in investors coming to see us after their portfolios have already plunged in value simply through their ignorance of derivatives”.

“Some of these investors spent 20 to 25 years building their portfolios and have lost up to 40 per cent of their value as a result of the market falling over the past eight months.

“Invariably, they have been lulled into a false sense of security by the strength of the market over the past 11 years to manage their own portfolios in a long-only strategy.”

He emphasised, however, that the same market volatility had “driven up the cost of protection by up to 350 per cent on prior levels in the space of eight or nine months”.

“However, we independently source prices and structures from the broader market, which results in lower costs to these wholesale clients.”

Compound, which also includes a hedge fund and trading arm, is able to provide this service because its “unique fee structure is aligned to clients’ investment performance”, Woodrow said.

Working on the premise that “our clients should make money before we do”, he said, the fee is “averaged over a nominated term and paid at the end of each term, which is very different to the current industry standard”.

“Therefore, if the term is five years and in the first year the portfolio makes a 25 per cent gain and in the second year it loses all [of] the gain, then there is a net zero return, and there is no performance fee charged on a per year basis.”