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| Risk & Reward: New Products |
Macro Machinations
John Ferry
08/01/2005
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While private investors cannot yet participate in these auctions,
they can view the results and see how professional traders expect the economy to
grow or shrink, much like looking at the futures market for short-term interest
rates gives insight into how professional traders believe rates will move in the
future. “This provides up-to-the-minute views on where the market really
believes a number might come out,” Wheatley explains.
TOP VIEW
Economic derivatives let investors bet on specific economic variables, such as
the nonfarm payroll number or GDP. They can be used either to speculate on
specific announcements or as a hedging tool for other investments. While the
major market for economic derivatives is currently limited to professional
traders, there are emerging opportunities for individual investors seeking to
gain exposure to these novel, yet promising, products. |
However, because they
only reflect what the market believes at the moment, economic hedging tools
remain short term and somewhat speculative. “These are not long-term investment
products,” says HedgeStreet cofounder Russell Andersson. “Economic derivatives
by their nature are short term. They are event based. A number comes out and the
market moves.”
Yet, Andersson says, the information they provide does have
long-term value. “So while it may not be a product that you put a large
percentage of into a portfolio, you should be participating in small size
because it’s a cheap, easy and effective way to bring you close to the markets.”
Safer than Houses
As these markets mature, private investors will find
ways to hedge or take exposure to economic variables. Wells Fargo, for
instance, is looking at how it can sell investors structured notes with a payoff
linked to HedgeStreet contracts. Gordy Holterman, San Francisco–based head of
derivatives trading at Wells Fargo, says he would like to see a secondary market
emerge for structured investments linked to economic indicators. “We’re trying
to figure out how we can be a market-maker in economic derivatives,” Holterman
notes. An example would be a contract that pays a positive return if a benchmark
interest rate is above, say 5 percent in three years. “If you’re a business
owner, you care about things like that a lot,” he explains.
Yet, before
Holterman’s vision can become a reality, a liquid primary market must emerge.
HedgeStreet, the closest thing to such a market, is just getting started, and so
far it has no major competitors. “As somebody in the risk management business, I
think there are pretty interesting hedging opportunities that could result if
these markets get liquid, but there’s no doubt that the short-term growth will
probably come from those who want to speculate on different things,” Holterman
says.
Yale’s Shiller has argued that there are numerous long-term
opportunities that may prove just as interesting, and not just to speculators.
He believes financial markets should develop to the extent that individuals can
decide which risks they wish to take and which ones they do not. In The New
Financial Order, Shiller says individuals should manage risk by trading in
financial instruments, for example, that are based on the value of homes in
their area and on economic statistics such as the unemployment rate. Andersson
agrees; his company is developing derivatives contracts that let buyers protect
themselves against house-price falls.
Probably one of the largest risks that
an affluent individual will face is in real estate, Andersson explains. “They
may own properties and are concerned about the value of their properties
falling, or they may be making an evaluation on whether they need to buy more
properties. We will very shortly be rolling out real estate products that enable
people to hedge or speculate on the direction of key property indexes in major
metropolitan areas.”
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