AN INVESTMENT manager's most important service objective is to try and help clients not lose money through ill-structured, over-rated, dubious investment opportunities which have either been presented to them by brokers or promoters, or they are considering investing in after seeing advertisements.
There are four principles that should always be borne in mind. These are:
1. Security of capital: Is your initial capital safe?
2. Quality income: Will you receive regular dividends or interest?
3. Predetermined exit: When can you exit the investment?
4. Capital growth: Will your initial capital have grown at exit stage?
Let’s briefly examine why these principles are important.
1. No one likes to lose money, and checking that the nature and structure of the investment is sound means that you have reasonable protection of capital, although the other principles may be flawed. Make sure you can prove a claim.
For example, consider the comparison of rights between a shareholder and a debenture-holder in a scheme: the former is more at risk than the latter due to the fact that a debenture is a loan instrument, usually bearing terms of repayment and providing for default.
This type of investor has a claim or a right to repayment in advance of ordinary shareholders.
2. When we refer to quality of income, we also refer to the source of that income – knowing that the income you are receiving is not sourced from other people’s capital (à la Ponzi schemes) is a critical factor in establishing the answers to points 2 and 4.
You will also be able to get a sense of whether that income is sustainable, will have growth (income growth), or if it’s at risk in any way.
3. Knowing when and how you can redeem your capital and accrued interest (if any) is critical – this is not a part of any investment agreement that you should ignore.
It indicates the end of your relationship with the other party, and an obligation by that party to return your funds, not to find reasons why they should continue to make use of them.
4. The 4th point is just one of logic – you never intended participating in the investment without seeing your capital grow.
However, we would suggest that it ranks after the former three points in importance; for example, if your capital is relatively secure, you have enjoyed a regular income, and you can get your capital out at a particular future date, then you have not failed in your objectives in any way - your money has worked for you.Evergreen fundamentals
The principles are based on the following fundamentals:
* The existence of risk – accept the fact that there will always be risk in investments, but is that risk in line with your tolerance?
* Pricing – there’s no point in entering an investment at a level which has no opportunity for growth, but definite prospects for depreciation. Examine pricing thoroughly;
* Transaction structure – for this, you will virtually need to take a forensic view of the structure; if it is complex, either avoid it completely, or examine the reasons for the complexity.
Most complex investment opportunities could fit into the category of a ‘scheme’. Keep your investment choices in line with the beauty of simplicity;
* Comparable investments – before finalising your choice, compare your current offering to other classes of choice. Do the key principles exist to the same degree across all opportunities?
* Research and analysis – there is no simpler way of putting this – DO THE RESEARCH!
Information = knowledge = choice;
* Personal choices – the reason why there are myriad investment opportunities is not necessarily only because there are myriad promoters, but also because people like choices.
It gives us a sense of comfort and ownership, as well as a feeling of freedom and independence. Personal choices may reach as far as ethics, corporate social responsibility, culture, religion, association, industries, and such like that either instil comfort or discomfort with the opportunity – these are only indicators of our own values, not indicators of performance;
* Identifying and providing for downside – don’t always see the world through rose-coloured glasses; recognise the potential for loss or downside and you will not be disappointed. In contrast, you will have more appreciation of income and capital growth when it comes your way;
*The majority of people invest for one or more of the following reasons:
- Improved lifestyle;
- Protection of capital;
- Financial freedom;
- Independence; and
- Family legacy.
In the words of 'BCCB', a gracious elderly mentor of mine, remember that you have the ‘benefit of choice’ and to ‘count your blessings’.
is an investment manager at Merkurius Capital Solutions. Views expressed are his own.