27th May 2009
Too Complex? Don’t Invest
Here's an idea: take out a 100 per cent loan and invest that money – maybe in a basket of emerging market share indices, soft commodities or a concentrated portfolio of three or four stocks. Then lock the money in for a set period – say seven years.
At the end of the term, if the portfolio's value has risen you’ll get a potentially huge windfall – and how about having that paid out in blue-chip Australian shares? You can always sell them or have the manager arrange their sale for you.
You'll be charged quite a lot of interest on the loan along the way and fees will be fairly high too. But you are a cautious investor and what attracted you to these exotic products were two magic words: 'capital protection'.
You don’t want to lose your initial investment. You want to sleep easily at night.
The investment manager promises to protect your principal using complex derivatives. You'll still get your money back at the end even if the portfolio has lost value. There are conditions: so read about those in the fine print.
Apparently, thousands of investors who put their money into complicated financial products that use structures not too dissimilar to the one described above did not get it – at least they didn’t understand what could go wrong.
Essentially, 'structured products' are highly complex investments and the term 'protected lending' may give a false sense of security.
These products are costly, the fees may not be explicitly stated and capital protection is not failsafe either. The products often have special clauses that limit the conditions under which the protection will apply. These can be easy to miss.
Many investors have since been shocked and dismayed at the way the investments behaved when the credit crisis and subsequent sharemarket crash hit.
They found themselves locked into sinking investments and required to pay high fixed fees on them. They also found the protection illusory in some cases.
Initial payments of 3 per cent to advisors are not uncommon, plus there may be ongoing trails paid on the product and any associated loans.
Moreover the underlying guarantee is also only as good as the issuer that provides it. The financial failure of product providers such as Lehman Brothers, Bears Sterns and Rubicon forced people who put money into these companies' structured products to exit early, at often a large loss.
Importantly many Investors forget the fine print which states those who leave a product before maturity will not qualify for capital protection. Significant break costs can also be involved, which often outweigh any benefit of withdrawing early and investing elsewhere.
Investors should remember that if it sounds too good to be true, it probably is. In a recent article, Stewart Partners chairman and financial advisor Nigel Stewart says structured products are too expensive. He says investors are better off putting their money into more conservative asset classes rather than paying for capital protection.
Residential property: Sexy again!
After being badly burned at the share markets, investors are now turning to Australia's residential properties to make up for their losses according to an expert. Andrew Donnelly, chief executive of global investment firm Whiterock Capital Partners said investors are now looking for tangible assets like residential properties and away from exotic products such as collateralised debt obligations or the like.
"Australian residential properties are becoming increasingly attractive for institutions seeking long-term, low-risk cash flows," said Donnelly. "We have been inundated by global funds and institutions wanting access to Australian residential property assets. Investment firms across Asia, Europe and the US are under pressure to diversify their investment portfolios and residential property is the safe port in this financial storm."
Donnelly said speculators generally consider residential property to be boring. "It is not a sexy story, but these days, boring is beautiful. Capital preservation is imperative and high returns come second. Residential has become more popular as it retains its value," he said. He pointed out that residential property is the highest performing asset class over the last 20 years returning nearly 12% in the 20 years to September 2008, closely followed by shares which returned just over 11% over the same period.
"We still see a market that is extremely stable, especially when you look at the comparative falls in the US and UK. The fundamental case for residential property investment remains strong. The rental market has the lowest vacancy rates in over 20 years and capital appreciation, resulting from the demand-supply imbalance in the market, is attractive to investors," said Donnelly.