We are presently building up conflicts within the asset price frame:
Conflicts between asset values and GDP flows and their growth rates;
Between asset prices and return expectations;
Between human capital values and the distribution of those values and their impact on the overall wealth equation with respect to future consumption risks as well as asset pricing via increased asset focus of flows due to distribution dynamics;
Within portfolio structure and relative to the liquidity and capital security dynamics of liability streams.
All of this tied to the relationship between frame transitions, emergent properties and structural imbalances and unconventional monetary policy focused overly on asset price support.
I can see that IIROC have put some real work into this and have largely done as much as they can given the constraints they are operating under: they cannot rule against leveraged investment or unilaterally move outside of a transaction remuneration regime; this is the main securities regulator’s job, if not a government level responsibility.
Here are some other links (FAIR, SIPA, Ken Kivenko) and other miscellaneous leverage references. Please note that not all links relate to views that I would support: many are intended to show some of the dubious aspects of the promotion of leverage, so be warned.
I have had a response from FAIR Canada to one of my posts on leverage and note an excerpt from that response and links to a number of their documents below:
“Leverage continues to be a growing problem in our view. In our letter to the CSA, we thought it was important to point out the linkages between the financial institutions lending the money to pursue these strategies (B2B Trust being a prime example, but not the only one by any means) and the advisors who seek to gain through increased assets under management and/or greater embedded commissions and how this interaction buts consumers at risk:”
Leverage strategies using high cost retail investment products expose investors to significant risks, especially at fair to high market valuations. Even very low cost strategies are exposed to significant risk as the market and economic cycle matures strongly suggesting that leverage is more strategic than a long term asset allocation play.
For the retail investor, leveraged investment with high cost investment products is a bit like surfing on the edge of a razor blade: you either have an exhilarating ride of a lifetime or you end up crashing with all the ugly consequences.
What we should be aware of are that costs and timing are important, and so is the sophistication of the strategy, though neither are really given due consideration at the retail level. As it is, recommending high cost, long term, leveraged strategies is like placing those investors on fast sledges at the top of mountains with no ability to break or manoeuvre.
Importantly the ups and downs of the leveraged strategy are not symmetrical with the returns of the market so you can effectively bin the vast majority of risk disclosure.
I am not talking about the obvious “commission incentive” here for advisors. No, I am talking about the laissez fair attitude (almost a belief in a divine right) towards the risks of inappropriate leverage and the easy assumption, including the apparent complicity of regulators, that a mere insufficient disclosure of risks using unrealistic assumptions (if any) is enough to provide due warning to/inform a client when the accompanying sales practises are ignored by regulators.
How on earth are investors meant to be able to assess the risks and returns on borrowing to invest strategies when they are not provided with the hard data on which to assess the risks of their decision and when everything they read suggests only the unsophisticated are unable to appreciate the incredible benefits of leverage?
A good article from David Baines of the Vancouver Sun (hat tip Ken Kivenko) about how lightly a mutual fund salesman got off from his regulators for what appeared to be inappropriate and excessive use of leverage in his clients’ accounts.
Significant and inappropriate leverage violates one of the key objectives of portfolio construction planning and management for individuals with financial demands on a portfolio – this objective is to minimise the risks to the ability of assets to meet these needs over time. Adding substantial leverage to a portfolio that is needed to meet financial needs increases the uncertainty of income and capital security.
I was passed along a link to web page that provided an advertisement to “advisors” to consider the use of leverage, which actually led to a number of other links that provided more insight and documentation on the leverage implementation process in Canada. The communication I am talking about said the following:
Studies show that for the right investor borrowing to invest can be a sound strategy. It certainly isn’t for everyone, but for knowledgeable investors in good financial health with long time horizons, taking on investment debt may be advantageous for a number of reasons. Recognizing this, and to make borrowing as convenient as possible, xxxxxx now offers investment and RRSP loans for xxxxx funds at preferred rates from xxxx Bank.
I was pleased to see the heading on the Financial Post article, “What is Wrong with Leveraging”, but upon reading found that the article did not provide an argument against leverage. It was an argument against people using their investments to pay the interest costs of the exercise, rather than against leverage per se.