It never stops amazing me that, over the years, each time we have a financial crisis a myriad of investment funds hit our desks purporting to be financial alchemy in that they seem ri
It never stops amazing me that, over the years, each time we have a financial crisis a myriad of investment funds hit our desks purporting to be financial alchemy in that they seem risk free, not correlated to stockmarkets and with a promise of good potential returns.
We?d surely be mad not to invest ? wouldn?t we?
As advisers who are authorised by the UK Financial Services Authority (FSA), Blevins Franks is bound by a code of practice known as ?Treating Customers Fairly? (TCF). As part of our TCF obligations we carry out due diligence on everything that we would consider recommending to our clients.
It?s when you carry out due diligence that you find the reasons not to consider the fund further.
Sometimes it?s difficult to carry out due diligence. For example, we were recently asked to research a forestry investment, which seemed to offer great returns. Following investigation we found the forest was Melina trees in Costa Rica. Not being arborists or able to check out the legal title of trees in Costa Rica we recommended that the client should not invest because there was no way we could put our name to something we couldn?t evaluate properly.
We have also looked into Traded Life Policy funds, also known as Viaticals, which are marketed as offering low risk returns which are not correlated to equities. As an asset class it has been around since the 1990s but over that time has had its fair share of trouble.
As reported by IFAOnline on 24th February 2010:
?The traded life policy investments (TLPI) market has ?significant problems? and is in no way a mainstream option for investors, the FSA [UK Financial Services Authority] head of investments said today.
?TLPIs are ?complex products with a number of inherent risks?, and should only be offered to ?sophisticated investors?, Peter Smith told the 2010 Life Settlement Trade Mission in London today.?
From my perspective we didn?t get past first base with this asset class because many of these funds are established as ?sophisticated? or ?experienced? investor funds. If you are offered one of these funds, it?s worthwhile checking out the fund on the fund manager?s website. You will often find a disclaimer telling you that the fund is for sophisticated or experienced investors only, and that the manager takes no responsibility for anything that may go wrong and if you lose all your money it?s on your own head. In short, they are not meant for investors who are not highly knowledgeable and prepared to take the risk, irrespective of what the brochure says you might get back or alternatively what they say the fund invests in.
The ?sophisticated? or ?experienced? investor fund issue is not just confined to Traded Life Policy funds but to all funds where the manager either chooses not to, or cannot, get their fund authorised by their regulator for retail investors. Typically, a fund cannot receive authorisation for sale to retail investors if the manager wants to invest in illiquid assets, or assets where there is no freely known market price, or if he wants to be able to use derivatives or leverage (borrow money within the fund). In effect all the things that could result in the redemptions being suspended so you cannot get your money out, or making the fund performance more volatile or even unknown.
Other funds that have gone down the ?sophisticated? or ?experienced? fund route include ground rent funds and student accommodation funds – in fact most property funds that invest in actual bricks and mortar rather than shares of property companies.
Which bring me to hedge funds, probably the most high profile of funds not regarded as suitable for retail investors. Hedge funds use a myriad of techniques to try and generate returns. There are two main reasons why hedge funds cannot be authorised for retail investors: their ability to borrow significantly (i.e. leverage) and their ability to borrow assets and then sell them hoping that they will fall in value and they can buy them back at a lower price and return them to their owner plus a fee thus keeping the profit. This is known as ?shorting? or ?going short?.
Not only are hedge funds potentially high risk from an investment perspective but, as we have witnessed from the Madoff saga, the lack of regulation which would otherwise be there with a fund which is appropriately authorised for retail investors was not, resulting in fraud.
This may sound like I am castigating all ?sophisticated? and ?experienced? investors? funds but actually I am not, as many of them are operated in accordance with how they are promoted.
There is a saying in investment circles that ?Risk in itself is not bad unless it?s mispriced, mismanaged or misunderstood?. My view is that ?sophisticated? and ?experienced? investor funds can potentially lead retail investors into misunderstanding the risks they are taking and as such they should seek authorised quality advice to understand the actual risks they are taking by investing.
So, how can you tell if it is a ?sophisticated? or ?experienced? investor fund? If you are considering investing in the fund directly you will probably need to sign a disclaimer where you will have to classify yourself as sophisticated or experienced and acknowledge the risks you are taking. It?s more difficult, however, if you are considering investing through an investment bond or a pension or a platform, because the underlying fund manager might consider the company to be an appropriately experienced investor and not ask the question albeit it?s actually your money. In this case you can usually check out the regulatory status of the underlying fund on the investment manager?s website.
Of course, the safest way to invest is through a quality authorised adviser who recommends fully authorised investment funds which are suitable for retail investors.
By David Franks, Chief Executive, Blevins Franks
18th August 2011
Blevins Franks Financial Management Limited is authorised and regulated by the UK Financial Services Authority only for the conduct of investment and pension business. Blevins Franks Trustees Limited is authorised and regulated by the Malta Financial Services Authority for the administration of trusts and companies. Blevins Franks Tax Limited only gives taxation advice; all of the advisers are fully qualified tax advisers.