Investments, the unconsidered risks

Many people have made the excellent decision to invest some of their hard earned money into an investment scheme for their future financial security. There is often much discussion about investment risk…be it bonds, equities, property, commodities or alternative investments.

What is not considered and discussed enough by financial advisers or their clients are the STRUCTURAL RISKS of buying into an investment scheme. It is important to ask your adviser about all of the risks to your capital, not just to what can happen to the value through poor investment performance… which will always happen from time to time.

Policyholder protection – in Europe many investment schemes are set up via Insurance Policies; these often have significant tax advantages and offer levels of policyholder protection not provided by banks or investment/brokerage accounts or platforms. The insurance company model means that a life company is required to hold all the assets underlying its clients’ policies at all times plus an additional amount of its own capital for a “solvency margin”. This means that if the Insurance company is put into liquidation then the client assets are ring fenced and the company can pay for all of the costs of transferring the ‘book of business’ to another insurance company or to return 100% of the assets to its policy holders.

The better the jurisdiction in which the life company is based, the stronger the regulation tends to be and the more capital it must have; therefore the less likely it will be become insolvent anyway. In nearly all cases big is beautiful when it come to Insurance Companies.

Credit Rating – when it comes to most financial institutions it is important to understand the solvency of that financial institution, i.e. how likely it is to make its financial obligations. This is often measured via a credit rating from one of the rating agencies. For example S&P ratings are AAA, AA, A, BBB, BB, B, CCC, CC, C and then D where AAA is “extremely strong capacity to meet financial commitments” to D is “defaulting on financial commitments”.. (source

Custody – many life companies and investment “platforms” add another tier of protection by using a ‘third party custodian’ which avoids conflicts of interest and helps segregate your assets from those of the company. Find out who is actually holding your assets and why.

Investment Fund Structure – very careful consideration should also be given to the actual structure of the investment you choose. There are approximately 80 000 Collective Investment Funds in the world and where they are registered and how they are regulated can vary enormously, you must understand the structural risks you take when investing.

Considerations include:

  1. Liquidity – daily priced is best for being able to get money out
  2. Regulatory structure – look for SICAV, UCITS, OEIC etc. this ensures a strong regulatory reporting requirement about all aspects of the funds.
  3. Highly rated – if possible check that the funds you are thinking of buying have been rated by at least one or two independent rating companies (Morningstar, Trustnet, OBSR etc).
  4. Check the fact sheets of the funds carefully for SIF, EIF or QIF – these are Specialized or Experienced or Qualified Investor Funds – they are often sold inside insurance policies but rarely come with the required disclaimer that you, as the investor, must sign confirming that you consider yourself an Experienced or Qualified Investor. Over the last two years many of these types of funds have suspended trading leaving normal ‘retail clients’ who shouldn’t have been allowed to buy them in the first place, stuck in portfolios they cannot access.

If in any doubt check any advice or any of your own investment ideas with a fully regulated adviser or preferably two!! Oh and check the adviser’s regulatory position too!!

This article is for information only and should not be considered as advice.