Is this the time to cut loose the investment herd?
Peter Foster
National Post
It is ironic that Canada's nanny mentality regarding stock market trading is being dismantled when the average investor appears like nothing so much as a baby with a handgun.
But investors are not babies. And that people should be allowed to make their own mistakes is a central tenet of free marketeers; to believe that there is a regulatory alternative is illusory. People only learn from their own mistakes. Within the market system, however, financial markets are particularly vulnerable to herd mentality. Never has the herd thundered more loudly. The value of TSE trading so far this year, at $3.9-billion daily, is close to twice the daily average for 1999, which was itself a record. This surge is increasingly being driven by smaller investors who regard mutual funds as insufficiently hands-on, not to mention underperforming and no fun.
The system is bursting at the seams, and investor frustration at glitches is proportional both to the frenetic desire to trade and to increasing volatility. On Tuesday, a hardware failure caused the TSE to open more than an hour late, then close again for a period in the afternoon. In fact, the TSE seems to have coped remarkably well with this year's record volumes. The bigger recent problem lies not with the TSE but with investors' difficulties in getting through to discount brokerages, whose ability to process orders has been swamped. This is not so much a technical problem -- although Internet link-ups can be agonizingly slow -- but one of having enough qualified staff to vet orders for "suitability" under so-called know-your-client rules.
Under current regulations, all trades have to be vetted by a qualified individual to make sure they meet the investors' own criteria, as outlined in a form that has to be completed when a trading account is opened. The flood of trades has led to a shortage of bodies qualified to see whether investors remember what they wrote down.
This week, representatives of Canada's investment dealers have been huddled with securities regulators in an attempt to ease the situation. A working group of the Investment Dealers Association has recommended that suitability obligations should be waived for unsolicited trades. Regulators are also considering whether to reduce the required training period for those who vet trades from 90 days to 30 days. Finally, they are considering whether to allow companies with both full-service and discount arms to have full-service personnel help out on the discount side, which is now forbidden.
This creditable desire to ensure the speedy fulfillment of orders has, however, to be seen against "suitability" in a larger context, namely: Is the herd about to gallop off a cliff?
The notion of investors specifying their investment objectives and risk tolerance on a piece of paper is one of those great-sounding ideas that ultimately doesn't make much sense. It is grounded in the desire to protect investors, but from whom? If an investor ticks the "ultra-conservative" box, and is then guided into bet-the-farm trades, he presumably has some subsequent recourse against the broker, but only after he has lost his money. However, the market is currently filled with people who ticked the "bet-the-farm" box. Who is somebody with 30 days' training -- even a relatively post-doctoral period of 90 days -- to say that anybody is doing anything crazy when analysts claim that Warren Buffett knows diddly, and P/E ratios are passe?
It has been suggested that investors need less advice now because they have access to so much information over the Web, including financial filings and analysts' reports. But only a tiny minority of people are able to draw meaningful conclusions from fundamental analysis. The market is being driven by a flood of unsophisticated investors who are receiving advice from Auntie Pearl, cousin Mahedi, or the guy in the body shop. The rule relaxation now in the works means investors are being given the right to make their own mistakes when the number of mistakes being made is likely huge.
The TSE is due to have a spiffy new system installed by September to replace the creaking CATS trading engine that has been around since 1977. But an awful lot could happen between now and then. In particular, what happens if the bubble should suddenly burst? The flood of sell orders could eclipse anything seen on the upside, and suddenly people might realize the advantages of paying a little more for full-service broking. One of them is that you can get through on the telephone to somebody who can not merely execute a trade, but who realizes that good investment advice consists of much more than asking: Do you remember this form you filled in? |
