Suss investments before buying

2012-08-11 12:33

It is imperative to be wary of the risk you may be taking on your returns when investing, write Maya Fisher-French and Liziwe Ndalana


The recent Relative Value Arbitrage Fund (RVAF) scandal in Western Cape that led to the suicide shooting of Julian Williams by his associate, Herman Pretorius, is estimated to have lost investors about R1.8 billion.

While investors and advisers who recommended the fund throw up their hands and say “how could we have
known”, the simple investment rule is: when returns promised are too good to be true – they usually are.

Paul Roelfse from the Financial Planning Institute says: “If the product sounds too good to be true, it usually is. One common characteristic of a scam is guaranteed high returns, for example, guaranteeing 30% returns – this should ring an alarm as it is not realistic.”

When an investment promises any return above cash, the first question you need to ask is: what is it invested in?

Interest on cash is considered a “risk-free” return which suggests any return above that is taking some risk in order to achieve that return.

You need to understand exactly what that risk is and what it means to your investment.

Investing in equities carries risk and your investment could fall in the short-term, but for a longer-term investor, the risks are lessened.

However, if an adviser recommends returns well above stock-market returns then you really need to be asking questions.

In the case of RVAF returns, in excess of 20% were being promised while the market was averaging about 10%.

What investment could be offering a return higher than shares listed on the JSE and what additional risk is being taken in order to achieve those returns?

If the answer is complicated and doesn’t make sense, it is best to walk away. Most scams are Ponzi schemes, where the returns are paid by new investors into the fund rather than actual returns on investments.

It is only once the fund cannot find new investors that the fraud is discovered.

What is a Ponzis scheme?
A Ponzi scheme is a fraudulent investment operation that pays returns to its investors from their own money or the money paid by subsequent investors, rather than from profit earned by the individual or organisation running the operation.

The Ponzi scheme usually entices new investors by offering higher returns than others in the form of short-term returns that are either abnormally high or unusually consistent.

Perpetuation of the high returns requires an ever-increasing flow of money from new investors to
keep the scheme going. – Wikipedia

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