If CFDs are such a great idea, why isn't everyone doing it?

If CFDs are such a great idea, why isn't everyone doing it?
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Go back to Contracts for Difference FAQs Hedge Funds and Fund Managers Up, down, up again. That's the past few months on the Footsie - the UK's main stock market indicator. But experts warn against expecting an index move through 6,000 and into the blue sky beyond. As it hovers around 5,900, it looks like the doom and gloom, that accompanied the sharp falls back in May and June, has been forgotten. But a poll of fund managers by Merrill Lynch shows the mood of most remain gloomy. Nearly half said they expected share prices to be lower, rather than higher, in six months. They cite inflation fears and the sustainability of global economic growth. Most investors think only of rising markets, and cry into their beer when prices fall. But some pop out the champagne - they're the canny ones who know how to make money when markets are falling. In the jargon - they went "short" They no longer have to sell shares and then wait to re-invest. For new European legislation means unit trust managers can make money out of falling, as well as rising, share prices using "contracts for difference" (CFDs). "Going short" is no longer the preserve of a few stock market spivs or the rich elite who have been able to stump up the cash demanded by hedge funds which make money out of falling shares. All that is set to change. Why can retail investors now take advantage of short-selling? New European-wide legislation allows retail funds to use CFDs, which can make money out of falling prices. Can retail investors buy CFDs to go short under their own steam? Individuals can open accounts with firms like IG Index, and sell CFDs. But it's only suitable for those with considerable wealth and experience. Why should fund managers want to go short? It can be hard to find enough undervalued companies to make decent returns. Anthony Bolton, soon-to-be retiring manager of Fidelity Special Situations, the UK's largest unit trust, and expert in spotting undervalued companies, has said his fund has not been able to make money out of falling share prices. CFDs would change that. Are there any managers already doing this? Yes. Mark Lyttelton, who runs Merrill Lynch's UK Absolute Alpha fund, has been using CFDs to do exactly what Mr Bolton is describing - when he believes the market is overvaluing a stock, he has used a CFD to make money when the share price falls. So how does it work? Here's a Merrill Lynch example. Mr Lyttelton says he believes the outlook for advertising is bleak. "The market is underestimating what impact the downturn in consumer spending and the growth of the internet, will have on the traditional advertising market." So to make money, he could sell a CFD, shorting an advertising stock. If he is right, and the share price of that company falls by 10%, then his original investment will rise by 10%. Why do they use CFDs rather than other derivatives? Because they are very transparent - if the share price falls by 10%, then you make exactly 10%, unlike other derivatives. CFDs have another advantage: no stamp duty. So fund managers can also use them to go "long" - the equivalent of buying shares. If retail funds are going to use derivatives - isn't that really risky? Actually, many of the funds who use CFDs are doing so to reduce, rather than increase, risk. CFDs can be used to make the performance of the fund less volatile than the stock market, so returns don't rise and fall so dramatically. If CFDs are such a great idea, why isn't everyone doing it? It is still early days. Fund managers warn using CFDs to "short" a stock takes a different skill set. Mr Lyttelton explains: "When you short a share, an investor is taking a new risk. If you buy £100-worth of shares, expecting the company to rise, but it then falls by 20%, then your exposure is reduced to £80. "If you spend £100 shorting a stock, and the stock rises 20%, your exposure increases to £120. Then you have to decide if you are comfortable having more exposure to that company than you originally wanted."
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If CFDs are such a great idea, why isn't everyone doing it?

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