The editorial below reflects the views of the editorial contributor only and content may be out of date. This article is sourced from a previous JUNO issue. JUNO’s content comes from sources that it considers accurate, but we do not guarantee that the content is accurate. Charts are visually indicative only. JUNO does not contain financial advice as defined by the Financial Advisers Act 2008. Consult a suitably qualified financial adviser before making investment decisions.
By Chris Smith, CMC Markets
Technology has levelled the playing field for individual traders and investors. It’s now easier to access global markets to diversify your portfolio, says Chris Smith.
Retail traders are no longer bound by location, time zones, or the limitations of costly brokers.
Many individual traders want the freedom to access world markets at any time, and to be able to track and manage their investment portfolios in real time on multiple devices.
The New Zealand market is small, with fewer than 200 listed companies and most activity concentrated in the top 15 stocks, and very few dominant sectors. This offers a narrow scope, so investors wanting to expand must look elsewhere.
Whether you’re trading or investing, having access to international markets is important, especially if you want to tap into the global growth industries and companies we don’t have locally. Many proactive retail investors have gained exposure to phenomenal opportunities over recent years in areas such as fintech, digitisation, electrification, and robotics.
The rise of emerging markets, and capital moving away from old investment favourites in the West, have made more flexible trading access important too.
How to invest globally
Investing in overseas companies is now as easy as investing in New Zealand.
So how can Kiwi investors gain access to international shares? Here are a few options:
Local licensed share brokers and derivative firms offer most international markets.
Some licensed offshore brokers allow New Zealand residents to open accounts.
Local fund managers provide exposure to some international markets through their funds.
The New Zealand stock exchange (NZX) provides some global tradable funds priced in New Zealand dollars.
Those who invest internationally want to diversify and benefit from growth in other economies and protect themselves from a local bias and the lack of global brands here in New Zealand.
Another key benefit of foreign markets is liquidity, and a ready supply of willing buyers and sellers. Liquidity is important, because it helps ensure that you can realise your gains or limit losses when volatility and fear enter the markets.
The drive for derivatives
The emergence of derivatives allows traders to use leverage, which means they can borrow capital to fund an investment.
A derivative is a financial contract, between a seller and a buyer, in which the parties agree to trade an asset at a predetermined date for a set price. The price is derived from the fluctuation in price of one or more underlying assets. Derivatives can be traded over-the-counter (OTC), which allows more customisation to an investor or standardised on an exchange.
Derivatives allow the investor to enter ‘long’ positions on the markets, and purchase and retain an asset on the basis that its value will increase over time. But the investor can also take a ‘short’ view, and sell when something looks overvalued – as we saw in the 2008 global financial crisis, and the 2000 tech crash. This type of flexibility can potentially enhance returns.
Exposure to equities using derivatives has been more common in offshore markets than in New Zealand. Overseas, investors use leverage to increase exposure to some equities within wider portfolios.
Experienced investors and traders use contracts for difference (CFDs), to increase returns and decrease the risk of their investments. A CFD gives them the flexibility to trade both long and short, depending on their views.
But be warned, a CFD does come with much higher risk than physical shares so largely depends on your experience, time available to trade and overall risk profile.
What is a CFD?
A CFD is a derivative that is traded in over-the-counter (OTC) markets or specialised exchanges.
CFDs emerged in the late ’90s within financial institutions, where the trader didn’t own the asset or trade directly on an exchange. Instead, they bought or sold a contract with another broker, with the deal based on the asset price at the time. They then agreed to exchange the difference between profit and loss when the contract was closed.
One of the main advantages of using a CFD to trade is the ability to use leverage with only an initial margin deposit to hold the contract open until closed. This increases the profit and downside potential, and frees up capital for other opportunities.
Margins on equities can start from around 10 per cent, depending on the size of the company and liquidity available. For example, in the case of US-listed Apple shares, an investment of US$20,000 would require a margin deposit of US$2000 to hold that contract open. Profit and loss is then determined on the price movements in the underlying Apple share price.
CFDs compared to physical share ownership
Leverage can be a double-edged sword in the equity markets. If you don’t have sufficient capital, your portfolio can be put at risk by a large movement in a share price. Physical shares carry a lower risk profile as the worst-case movement is $0.
Your broker will charge you to ‘borrow’ capital to ultilise leverage. You’ll incur an overnight financing or daily holding cost which isn’t required for physical outright shares. This cost is less relevant for shares held over shorter periods.
Only larger companies offer leverage and derivative contracts due to importance of liquidity; smaller, micro-cap companies are better suited to physical shares as volume traded is much lower on a daily basis.
Trading commissions are often lower than buying physical shares – a cost to consider if you want to be more active in the market and not just buy and hold positions.
Risk-management tools are more commonly used for trading derivatives than physical shares, because the investment time frames are often shorter. Tools such as stop-loss (setting a price in advance at which to buy or sell), take-profit (locking in a level at which to realise profit) and guaranteed stops (similar to a stop-loss, except your sale price is guaranteed) give you more control over potential risks.
Globally, thousands of listed companies give investors the chance to own a piece of their growth, regardless of country of residence.
Using leverage is an option for experienced investors to increase exposure to global companies, or can be used to help protect a physical share portfolio that may be overvalued and at risk of a decline in value.
Technology will continue to improve Kiwis’ ease of access to the global markets, and trading costs should continue to fall, benefiting the self-directed investor.
Derivatives: A derivative is a financial contract, between a seller and a buyer, in which the parties agree to trade an asset at a predetermined date for a set price. The price is derived from the fluctuation in price of one or more underlying assets. Derivatives can be traded over-the-counter (OTC), which allows more customisation to an investor or standardised on an exchange.
Fintech: A term used to describe emerging financial technology and innovation, particularly in the way transactions are administered.
Margin Deposit: A deposit paid by an investor to a broker, as a guarantee for fulfilling a contract.
Micro Cap: A listed company with a market capitalisation of US$50 million–US$300 million.
Over-The-Counter (OTC): A trading platform that is not a formal exchange. For example, an interbank market between bank dealing rooms, or a dealer network.
Short Selling: The sale of a security that is not owned by the seller, or that the seller has borrowed (from a broker). Short selling is motivated by the belief that a security’s price will decline, enabling it to be bought back at a lower price, to make a profit.