Guerrilla capitalism

A revolution is taking place in the nation's living rooms and studies. Peter Koenig reports on the new semi-professional investors

RAY STACEY bears all the marks of a City insider. While average investors have watched their savings shrivel as PEPs and other such products have headed south with the stock market, he has made a small profit since the downturn in July. While fifty- forty- and even thirty-somethings are talking about what they will live on in retirement, he is talking about reform in one of the most esoteric corners of the City - the London Financial Futures and Options Exchange - where experts trade contracts allowing them to speculate on and hedge against future movements in stock and bond markets.

But Mr Stacey is emphatically not a City insider. A 53-year-old Yorkshireman living in Chalfont St Peter, Buckinghamshire, with his wife and two daughters, he is about as far from the Broadgate wine bar scene as you can get. Seven years ago when he retired early as a further education department head, he barely knew a stock from a bond.

"I realised I had to protect my pension," he says, explaining how it is that he now spends days in his study talking to brokers, surrounded by much the same paraphernalia you see on City trading floors.

"I went along to an investment seminar at a local computer shop. The bloke giving the talk, David Linton, explained how, with the technology available, people could now invest from home and still compete against the professionals. I signed up with David's company, Updata Software, which gives me market information on my computer via a feed through my TV aerial. I've sort of grown up as an investor as Updata has grown up as a financial services company."

Mr Stacey and Mr Linton belong to what may be the wildest subterranean capitalist club in the country - call them the ski extreme of investing. This club encompasses investors like Mr Stacey and far-out companies like Updata. But it also encompasses brokers reaching customers through the internet and the computer experts in the back offices of exchanges like Liffe.

"You have farmers, teachers, doctors in Leeds, dentists in Surrey, semi- retired people and lots of younger people in this group," says a Liffe back-office boffin, Nick Bramley. "Almost all these people are self-taught. Five years ago no business school in the country ran a single course on derivatives."

"We do think of ourselves as a club," says Mr Stacey. "We meet. We go to seminars. Sometimes we even invest together."

Mr Stacey's club is modest in size. It consists of perhaps several hundred thousand semi-professional investors nationwide - along with the cutting- edge firms servicing them. The database at Liffe for individual investors interested in UK equity options is 45,000. "But", says Mr Stacey, "I would guess there are a heck of a lot more who buy the odd option."

The revenues generated selling financial services to this club are also modest. Take UK equity options - contracts giving investors from giants like Barclays to minnows like Mr Stacey the right, but not the obligation, to buy or sell shares in British companies at a specified date at a specified price in the future - good if you have a strong feeling about how a share is going to move, or are worried the movement might damage your portfolio.

Liffe trades an average of 15,000 lots of UK equity options a day. But this is only a small part of Liffe's overall business, and the retail side of the UK equity options business amounts to less than 5 per cent of the total.

Still, Mr Stacey attracts interest as a semi-professional investor wherever he goes. "Everyone, from the plumber to my friends, wants advice," he says. Mr Stacey is of interest to politicians, too. The state is rolling back social security. Companies are scaling back occupational pensions. The Government offers tax breaks on PEPs - personal equity plans - and ISAs - individual savings accounts. Anyone who has done the arithmetic, however, knows that even those taking maximum advantage of these breaks is unlikely to save up enough to avoid a serious cut in his standard of living upon retirement.

Mr Stacey offers a way out of this. What he does is take PEPs and ISAs as his platform, then actively manages a portfolio of shares, bonds, and futures and options contracts derived from the primary markets from home.

For all the mystery attached to dealing, Mr Stacey's approach as an investor has been straightforward. He began seven years ago the same way anyone would. After paying Updata Software pounds 1,000 to link its market information system to his computer - so gaining access to up-to-the-minute share prices as well as the capacity to analyse historical price data - he began trading shares.

As he gained sophistication, he moved on to share options - the instruments which cost a fraction of what shares cost, but allow him to take a view on future share price movements. Then he moved on to index options which allowed him to speculate on and hedge against the movement of the UK stock market overall. More recently, Mr Stacey has moved on to futures and options contracts in gilts - UK government bonds - and US Treasury bonds, the instruments the biggest investment houses in the world trade as their meat and potatoes.

"I went defensive on 24 June," he says. His technical analysis told him share prices had peaked. Technical analysis, he explains, is a fancy term for predicting future share prices by studying the pattern of previous share prices.

Going defensive, Mr Stacey left the shares in his PEPs untouched. Their value dropped in line with the drop in the stock market. At the same time, however, he bought put options on the FT-SE 100 index, giving him the right to sell the options at a price higher than the price he believed the market would show in August. He was right and so made a profit selling the options back to the market.

Indeed, Mr Stacey earned enough on his option play to significantly supplement his teacher's pension this autumn while covering the fall in his PEPs portfolio.

Making judgements like this in his study - with his daughter doing her homework at the next table in the afternoons - Mr Stacey is too busy to think much beyond his next trade. Professionals selling financial services to him and other semi-professional investors, however, see a revolution in the making.

Trevor Neil, an associate director at brokers Union CAL, is an amateur historian of this revolution. In the 1960s and 1970s, Mr Neil says, private investors put their savings in the market the traditional way - via their broker.

"This made sense," Mr Neil says. "The City was a club and you had to belong to know what was going on."

In the1980s, however, deregulation and globalisation destroyed the club and gave retail investing an international scope. "Today there are fewer tips," Mr Neil says, "and there is less research you cannot do as well yourself if you put in the time. Individuals often know as much as the professionals and they can use the new technology to act on their information."

This revolution remains in its early stages. A decade ago, Updata Software's David Linton was an engineering student at King's College, London. Since he was Australian he did not qualify for a grant. To pay his way, he taught himself how to invest.

"What I needed was prices and software that allowed me to analyse data," he says. "The only thing available at that point was a Reuters screen, which cost in the vicinity of pounds 10,000 a year."

Mr Linton's Updata now has 20 employees. He is discussing joint ventures with similarly minded entrepreneurs across the Continent.

Over the past 15 years, meanwhile, more and more financial market exchanges have moved away from floor trading systems like Liffe, where men in brightly coloured jackets semaphore each other with abstruse hand signals. In their place have come computerised trading systems. Buyers and sellers post prices on screens. Bargains are matched by machines not men.

Liffe is the latest example of this evolution. Established at the dawn of the derivatives explosion in the 1980s, it quickly became the premier European derivatives market. Gradually, however, competing Euro- pean financial centres have caught up.

The continental exchanges are usually screen-based trading systems. Screens attract customers who like firm prices publicly posted. They like the savings on dealing costs. The openness of screen-based trading has attracted smart money from Chicago - the world centre of futures and options dealing - into the derivative exchanges in Amsterdam and Stockholm particularly, according to Union CAL's Mr Neil.

In February Liffe's arch-rival in the battle of European exchanges, the Deutsche Terminborse, or DTB, claimed a majority of business in trading bund futures - futures in German government bonds. Since then, virtually the whole bund derivatives market has moved to Frankfurt. There is an empty space at Liffe where the bund pit used to be. The DTB beat Liffe because its trading system was computerised, so DTB's victory served as a warning. If Liffe did not scrap its floor trading system, it ran the risk of losing out in other derivative contracts.

Liffe is now shifting to computerised trading. As a first step, on 30 November, Liffe begins trading UK equity options on screen. The system underpinning this service is called Connect. Liffe says Connect will be easier to link to the back- office systems of Europe's brokers.

Seizing on this opportunity, the City broker, Union CAL, hopes to square the circle of the revolution begun by individuals like Mr Stacey and firms like Updata.

Union CAL is already servicing a small number of customers via the internet. Indeed, on a small scale, it has been doing so for 18 months. "We get hits from places like Latvia, where there is interest in investing, but very little information," says Mr Neil.

Union CAL makes its research available free on the internet. It is currently linking its internet operation with Liffe's Connect system.

On 5 September, 150 semi-professional investors congregated at the Balmoral Hotel on Princes Street in Edinburgh for a conference sponsored by Liffe. The exchange wanted to tell them they could buy and sell UK equity options on-line, as of 30 November.

At this conference, Union CAL's Mr Neil asked participants how many were on the internet. "Three-quarters raised their hands," he says.

He asked how many had dealt through the internet. "Three raised their hands," he says.

He asked how many expected to be dealing through the net within a year. "All 150 raised their hands," he says.