MarketViews

With the Steinhoff directors recently taking out futures to the value of R489million over the company’s shares, the effects of this and the evidence of greater derivative speculation must be considered. The Steinhoff directors gamble joins the ranks of a growing number of directors that have opted for buying into these geared financial products over buying the underlying equity.

I won’t go into all the details of the differences between buying shares as opposed to buying futures, but the point that I find most pertinent is the fact that futures are geared. Unlike shares where you can only lose the amount of money that you have invested, with futures you can lose more than your initial investment.

Furthermore, futures are mark-to-market which means that at the end of each day money is either flowing into your account…or out of it. Short-term cashflows in the form of margins can cripple you if the market turns against your one-way bet and (in the words of Keynes) “…the market can be wrong longer than you will be solvent”.

So, no matter what philosophy is thrown around, futures have a short-term element embedded in their very nature: your solvency.

Although it may show a great regard for the (short-term) prospects of a company when its insiders opt for futures buying over just buying the equity, I question what the long-term effects of this will be on both the market and the underlying company.

Firstly, because futures are geared, it means that if the market crashes then the directors could potentially become bankrupt. According to section 218 of the Companies Act, a person is disqualified from being a director (save under authority of the court) if they are an unrehabitated insolvent…which a bad bet on futures can do to a person.

So, say you are a shareholder of Steinhoff and the market crashes, Steinhoff drops by 50% in one day…and this movement then makes the directors that went long on it bankrupt due to their futures gearing. Not only are your shares in Steinhoff now worth 50% less, but you now have shares in a company whose directors are disqualified from being its directors. Lacking a management team, it will no doubt crash even further, adding woe to woe.

Secondly, bearing this in mind, I’m pretty sure that the directors will follow Steinhoff’s share price extremely closely. This will detract from their focus on managing the company to managing their own investments, i.e. costing shareholders money.

Finally, although I like insider buying I don’t like the cowboy-like buying of futures by insiders. Given that this trend carries on gaining popularity with directors and eventually becomes the norm just before a large market crash, we could be sitting with an entire stock exchange with directorless companies.

In closing I must add that I dread the day I see a director shorting his own share; I only hope that this doesn’t happen to any of the shares in my portfolio…

Regards,
Keith McLachlan