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May 30, 2006

So What's New?
by Bob Hoye

Bull markets generate new issues and great bull markets inspire new investment tools. As this one blossoms, it is generating new descriptions as well as growing concern in high places about risk.

On May 6, Fed Governor Susan Schmidt Bies made a speech titled "Financial Innovation and Effective Risk Management", that included the following: "Some of the complex structured finance transactions we have recently seen reflect and incorporate innovations in credit risk transfer mechanisms - credit default swaps and synthetic collateralized debt obligations in particular."

The next paragraph explained that these creations "provide flexibility in tailoring and marketing financial transactions to match the risk appetites of investors".

Getting into a sector that has performed very well is last week's launch of an ETF base upon gold mining stocks, including some "small companies from around the world". The symbol is GDX and it is interesting for two reasons. One is that it is a gold innovation and the second is that it will probably act contra cyclical to the general stock and corporate bond markets.

But in the orthodox side of financial innovation, a report in the May 25 Financial Times is noteworthy: "Led by banks in Germany, Switzerland and Italy, investors have been confronted by a bewildering range of structured products. While some, such as warrants, are familiar, others, such as highly complex synthetics with exotic trademarks, are harder to grasp.

But whatever their characteristics, demand is booming, whether from retail investors seeking guaranteed returns along with some downside capital protection, or institutions looking for more arcane products. The number of monthly new listings on the SWX alone doubled from 700 in the autumn to more than 1,400 in March."

Note the use of the term "bewildering" and compare it to a description of financial innovation made by an exasperated writer in 1720 - the year the infamous South Sea Bubble blew out. "They can ruin men silently, undermine and impoverish, fiddle them out of their money, by the strange, unheard of engines of discount, transfers, tallies, debentures, shares, projects, and the devil and all figures and hard names."

So, to answer the question So What's New? - not much.

Bob Hoye
Institutional Advisors

The opinions in this report are solely those of the author. The information herein was obtained from various sources; however we do not guarantee its accuracy or completeness. This research report is prepared for general circulation and is circulated for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realized. Investors should note that income from such securities, if any, may fluctuate and that each securitys price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not necessarily a guide to future performance.

Neither the information nor any opinion expressed constitutes an offer to buy or sell any securities or options or futures contracts. Foreign currency rates of exchange may adversely affect the value, price or income of any security or related investment mentioned in this report. In addition, investors in securities such as ADRs, whose values are influenced by the currency of the underlying security, effectively assume currency risk.

Moreover, from time to time, members of the Institutional Advisors team may be long or short positions discussed in our publications.

Copyright © 2003-2008 Bob Hoye

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