Morningstar's head of equity research Peter Warnes says retail investors would be mad to use margin loans or geared investment products to "time the market", as the corporate watchdog reports a spike in the number of retail investors trying to capitalise on coronavirus-induced volatility.

While Warnes sees the benefits of using simple index-tracking ETFs as part of a well-balanced portfolio, he says using highly complex products as part of a short-term trading strategy is highly risky, even for experienced investors, and could lead to heavy losses.

"You've always got to have some exposure to growth, even in retirement, and ETFs with a growth bias allow investors to diversify beyond the Australian market into tech and biotech companies we don't have here," he says.

"But you've got to understand what you're buying.

"If you're overlaying gearing into products, the risk is twice as high as what it would normally be; and if you've picked the market going the wrong way, you're in for a wild ride."

Warnes' warning comes as an ASIC investigation reveals a sharp increase in the number of new retail investors—up by a factor of 3.4 times—as well as a spike in the number of reactivated dormant accounts.

Trading frequency has soared as has the number of different securities traded per day; conversely, the duration for holding the securities has plunged. The regulator says this indicates an increase in short-term and "day-trading” activity.

However, ASIC says only a few investors pursuing quick windfalls were successful.
"Retail investors chasing quick profits by playing the market over the short-term have traditionally performed poorly—in good times and bad—even in relatively stable, less volatile market conditions," the regulator says.

"[Between 24 February and 3 April], for more than two thirds of the days on which retail investors were net buyers, their share prices declined the following day.

"On days where retail investors were net sellers, their share prices more likely increased the next day."

Increase in new and reactivated accounts

Dormant is defined as accounts that have not traded during the preceding six months.


Source: ASIC

In particular, the regulator is concerned about the jump in retail investors trading in complex, often high-risk investment products. These include highly geared exchange-traded products, but also contracts for difference (CFDs).

"Geared ETPs should not be traded by investors who do not have appetite for this risk or understand the complexity," the regulator says. "We saw trading volumes for one geared ETP increase by 16 times the normal volume to become the second most traded ETP."

Gearing magnifies the risk of these ETPs by increasing profits from favourable market movements but also increasing losses from unfavourable market movements. Typically, these products either borrow additional funds or utilise derivatives to achieve magnified exposures to the relevant index.

Warnes says he uses geared products as part of his own portfolio as an insurance policy. "If my conviction is that the market will go down, these products help me limit the downside," he says. Although he is quick to point out that he is an experienced investor.

"The risk is just too high for most people."

ASIC declined to nominate specific products. However, trading trends from retail broker SelfWealth show the BetaShares Australian Equities Strong Bear Hedge Fund (ASX: BBOZ) was the most traded among its clients in April. The BetaShares’ Geared Australian Equity Fund (hedge fund) (ASX: GEAR) and BBUS US Equities Strong Bear Fund (BBUS) also featured among the top traded.

Similar data was provided by online portfolio management company Sharesight for March.

Commenting on the rise of GEAR, which offers positively geared exposure to gains in the index, SelfWealth said: "This ETF previously had yet to feature among the most-popular buys, but last month it soared into third place among the most-traded stocks within the community.

"Selling volume in the ETF also spiked to nearly match it, which suggests that many people utilising leveraged ETFs like this are actively trading them rather than holding them as long-term positions."

Morningstar analysts do not cover any of above-mentioned products. However, they have warned against committing to leveraged/inverse funds in the past.

"Stocks have increased in value over long periods of time, and bear markets tend to be relatively brief in historical terms," Morningstar analysts say.

"Using a bear-market fund effectively requires that you be able to predict when the market is going to head south, and few, if any, investors have shown any ability to do this consistently.

In general, Warnes says retail investors shouldn't get into gearing at all.

"If you're a retail investor, the companies you're investing in already have gearing," he says.
"Yes, there are companies there that have no net debt but can count them on your left hand."

"The banks for example are highly geared structures, so if you go and get a margin loan, you're doubling up on gearing.

"The stock market is already a risky vehicle. If you want to have a punt, go to Randwick."