My presentation at our client advisory board meeting this week shared the story of our favourite investment scam; ‘favourite’ in the sense that it’s the most outrageous we have seen to date.
We often think of more vulnerable members of our society as those who fall victim to scams, but in truth even plausible investment recommendations can turn out to be investment scams.
In our line of work, we often hear about dodgy investments and scams.
Four years ago, we were approached by a lady called Lisa who needed some advice for her parents.
James and Susan were a couple in their 70s, who had been advised to borrow £750,000 against the value of their home and invest in a single investment fund.
Back in 2007, the couple met with an adviser who suggested they borrow £250,000 with a mortgage against their property and then a further £500,000 for leverage to invest in a traded life policy fund.
The total £750,000 loan was invested in the Corinthian Growth Fund, an unregulated traded life settlement fund run by Cayman Islands based Managing Partners.
James and Susan were an elderly couple, inexperienced when it came to investing, who had been advised to borrow against the value of their £400,000 home (their only real asset) and then borrow again against this money to invest in a very risky investment.
Life settlement funds invest in second-hand US life insurance policies. In principle, the idea is sound; a terminally ill person in need of cash cannot benefit from their life insurance policy because it will only pay out when they die. Therefore, they sell the policy to a life settlement fund.
Thinking about the advice to James and Susan, this was designed to generate an income in retirement.
The intention would have been for the income generated by the investment to exceed the cost of the mortgage and loan, therefore producing a little extra income each month.
In 2011 the Financial Services Authority (as it was then) issued a consumer warning about these funds and placed it’s first-ever ban on marketing a product to retail investors.
The FSA took aim at what it called ‘high-risk, toxic’ traded life policy investments.
This marketing ban caused new money into the funds to dry up and the fund in which James and Susan invested was subsequently suspended over concerns about liquidity. It was later renamed the Traded Policies Fund, remaining open for new investments but closed for redemptions.
The couple’s former financial adviser was part of a network which later went into default. He remains an adviser, now self-employed and part of a firm of Chartered Financial Planners based in Cheshire.
There’s no happy ending to this story. The best we could do for Lisa was to suggest she spoke to a solicitor who could advise her parents on pursuing legal action against the adviser, but also the mortgage companies involved who made, in our opinion, entirely unsuitable loans so this investment could be made.
Here are a few lessons we can learn from James and Susan:
1 – Never borrow money to invest.
This is called leverage and it massively increases the risks involved.
Leverage helps to magnify investment returns when assets go up in value, but it also magnifies losses when the investments go down.
It also only works if you can guarantee keeping up with payments on the cost of debt.
2 – Spreading risk is essential.
If you invest in a single asset type, like James and Susan did, then you’re exposed to systemic risk, an event that can collapse an entire industry or economy.
All investors are exposed to systematic risk, which refers to overall market risk, but you deal with systemic risk through diversification, holding a variety of different mainstream investment types which tend to behave differently; we call this negative correlation.
In the short-term, this negative correlation is harder to find these days, but diversification still works over the longer-term.
3 – If it seems too good to be true, it probably is.
This is the golden rule when it comes to avoiding dodgy investments and scams.
There’s an unbreakable link between risk and reward. If you want the potential for higher rewards, you have to accept higher risks.
Anyone who offers you a miracle solution is at best misguided, at worst trying to scam you.
