Investment Road Test: Macquarie Prime CFDs

PORTFOLIO POINT: The Macquarie Prime product offers investors a CFD package worth investigating.

As we sail into the holiday season with hopes of another positive year for the Australian stockmarket in 2010, weary investors should ask themselves just how they would weather another 12 months of resurgent volatility.

With some stocks gaining more than 50% in the past 12 months, it’s easy to ignore the risks of riding the market. Some brokers such as Macquarie and Citigroup are predicting total ASX returns of 20% next year (15% growth and 5% income), while others are predicting a wilder ride with market gyrations returning.

Either way, next year will be all about taking a more active approach to the risk management of your portfolio. CFDs can provide you with a few tools to assist with that process.

Macquarie has grounded its CFD solution in a one-stop broking and leverage account, called Macquarie Prime, which provides flexibility and convenience to support the efficient use of CFDs.

CFDs, contracts for difference, are a sort of futures contract morphed into a share-trading tool that allows investors to take normal long positions or to go short. Instead of paying the full price of the share, the CFD allows the investor to start with an initial margin deposit; in this case the initial deposit is 5%.

As the value of the position rises and falls, the investor’s margin may be increased or decreased. For example, if you use a CFD to buy exposure to a share, you would pay an initial margin of 5% of the prevailing share price.

If the share price rises then you can take profit by closing out that position, or you can take delivery of the shares by paying the initial price that you locked in at the start of the CFD transaction. On the other hand, if you buy a CFD to gain share exposure and the share price subsequently falls, you will be required to increase the initial margin deposit, a process it calls “marking to market”.

The beauty of Macquarie Prime is that it wraps up all of the functionality to trade CFDs in one account. For example, you can override the need for a cash deposit by establishing a line of credit within the Prime account. If you do so, then any mark to market drawdowns are applied against that credit facility; and any collateral inflows are used to offset the debit position. Dividends can be retained within the Prime account and used to cover interest liabilities. This means that, in practice, Macquarie Prime offers exactly the level of flexibility facilitating a rapid response to margin calls.

Macquarie Prime allows for short selling, either collateralised by cash or by existing shares. This means that if the market or specific share prices start to fall significantly, investors can profit by selling stocks that either they don’t own, or they can “monetise” their existing holdings by using them as collateral. Full details of specific strategies you can employ are displayed on the Macquarie Prime website.

To reduce the risk entailed in the highly leveraged world of CFDs, Macquarie Prime also allows for implementation of guaranteed stop loss (GSL) positions. GSLs are a feature of most CFD providers and allow for exactly that: at the time buying or shorting shares using a CFD you can select how much capital you are prepared to lose.

In practice this means that if you short sell a stock using a cash collateralised CFD and the price subsequently rises, you can limit how much you lose; and if you buy exposure to a stock that subsequently falls, then you can similarly limit your loss. Given the rapid fluctuations in mark to market values that will be experienced in highly volatile markets, the GSL is a vital feature of Macquarie Prime.

Brokerage costs of as low as 0.06% of prevailing share prices, gearing costs of 6.75% pa, CMT rates of 3.95% and instant access to market for orders are some of the “nut and bolt” benefits of Macquarie Prime.

The FAQ (or Frequently Asked Questions) section is excellent with full detail regarding every key feature and risk. For investors who tend toward the higher turnover of active traders, or even for long term “buy and hold” investors looking to tinker at the edges of their portfolio, CFDs and the Macquarie Prime facility offer significant benefits worth investigating.

The score: 4 stars
1.0 Ease of understanding/transparency
1.0 Fees
0.5 Performance/durability/volatility/relevance of underlying asset
0.5 Regulatory profile/risks
1.0 Innovation

Tony Rumble is the founder of the ASX-listed products course LPAC Online, a provider of investment training to financial services professionals.