Are you sophisticated?

As Warren Buffet once said, “When you combine ignorance and leverage, you get some pretty interesting results”. 

Leverage is a common enough term in the UK, but whilst leverage in the UK housing market may be ‘de rigueur’ for most home buyers, when it comes to leveraged investing in the stock markets, we take more caution about who such products are appropriate for.

But how do you know if they are appropriate for you?

Well you will be glad to know that the regulators are equally as keen on this question, and in the case of leveraged investment products, they tend to fall into broad categories corresponding to investor suitability often referred to as “advanced”, “experienced” or “sophisticated’.

But what do these terms really mean, and how do you know if you are one of them?

Every investor is unique, with their own set of circumstances, financial status, background and technical abilities, but the essence of such phrases is to try and articulate the level of knowledge and experience required to invest in such a product.

Perhaps unhelpfully, there are no formal definitions of such categories. Indeed ESMA, the European regulator, acknowledges that there are different practices used by firms to assess clients’ knowledge and competence, but under ESMA rules, some types of complex investments require stockbrokers to ask customers additional questions before they can invest in them to ensure that the product is appropriate for them and that they fully understand how the investment works.

If you are looking to trade a leveraged ETP for the first time, your stockbroker will take you through their own individual appropriateness test before allowing you to trade, and whilst there is no single standardised test applied across the industry, there have been various studies such as those by the UKSPA*, that have identified some key attributes that would imply an investor may have the level of knowledge required to invest in a particular product.

In the case of “advanced” or ”sophisticated”, UKSPA defined this as representing the smallest section of the UK retail  market, representing individuals with a high level of knowledge and experience of financial products and a good ability to understand complex financial products. Individuals within this classification were likely to have a number (but not necessarily all) of the following attributes: 

  • A large number of varied investment holdings (including higher-risk and complex investments) 
  • Frequent trading activity 
  • Financial industry experience 
  • Strong interest / knowledge in financial markets 
  • High level of education 
  • High level of investable assets.

But broker tests and broad classifications aside, what is most important to remember is that we are all individuals, with our own unique set of circumstances and abilities, and we must not forget the basic rule that, as with all investments, you have to make sure you have fully understood what it is you are investing in, and importantly understand the range of investment outcomes and the risks or circumstances in which these may not be achieved. 

It sounds obvious, but it’s not uncommon for investors to sometimes gloss over the details, speed read the brochure or ignore the various education materials provided to them, and they do this at their peril.

In the case of leveraged ETPs, this means understanding key aspects of a product such as the underlying asset it tracks, the level of leverage and the currency, as well as understanding any features embedded in the product such as daily re-striking or any air-bag protection features that may exist.  

Leveraged ETPs,  which trade just like a share, are products that offer opportunities to potentially enhance your investment returns, hedge your portfolio and take profits even when markets fall (even in your ISA). 

So if you don’t know much about these types of products, you could do worse than visit educational sections of sites such as Societe Generale https://etp.societegenerale.co.uk/short-leverage-etps-education/ to help you decide whether you too may want to join the ETP journey....


Post by: Zak de Mariveles, Head of UK Exchange Traded Products


*UK Structured Product Association

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Risk Warning: Short & Long Leveraged ETPs are suitable for sophisticated retail investors. Both gains and losses will be accelerated in comparison to a direct investment in the underlying asset.
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