Too Good to be True: Three Investors Who Learned It the Hard Way

It’s not our goal to make empty promises, neither do we claim to be the best. Some might even consider us a bit old-fashioned.

Our strength and value lie in the thorough research done on the stocks we decide to invest in. Each decision is backed by thoughtful review and careful consideration. As a result, we’re confident our risk level is much lower than most risk profiles the larger banks claim. Our assets are liquid, and exchange-traded. It’s not our practice to leverage, nor to employ ‘trendy’ financial derivatives. We also don’t mind moving into cash sometimes.

You may have met investors who enjoy declaring their ability to spot a good deal. The lucky ones who ‘discovered’ a new way to invest, or found the holy grail of investing.

“I found a way to arbitrage the market. It’s a sure win.”

“The business is backed by the government and I know the industry. There is no way it can fail.”

“The founder and I are friends. He is giving me a special buy-in into his company in preparation for IPO later in the year.”

Sound familiar? As Warren Buffet once said, “Only when the tide goes out do you discover who’s been swimming naked.” As it seems, the tide is going out.

John’s Story: The hidden risks in foreign exchange

Just last week, ‘John’, a friend of our investor, showed us his portfolio at a private bank. He was informed by his RM that there was a margin call and he needed some advice.

Looking at his latest bank statement, he told us that when he first started his account a few years ago, he was recommended to buy a Universal Life Insurance. The sum assured is USD 10 million and his premium was approximately USD 3.5 million. However, he only needed to pay USD 1 million in cash.

The bank will lend him the balance to pay for his premium so that he can free up his other cash for investments. He thought it was a great deal: USD 1 million for coverage worth USD 10 million!

Hence, he was able to borrow from the bank USD 2.5 million, as he was further recommended to buy a portfolio of bonds and mutual funds.

Along the way, as USD interest rates rose, John’s borrowing interest rate went above 3%. Naturally, he was displeased with the higher interest rate. Seizing an opportunity, his RM recommended him to convert his USD loan to CHF (Swiss Francs) and JPY (Japanese Yen) loans where the interest rates are around just 1%.

Here’s the catch many don’t realise. If you switch from a USD loan into a CHF or JPY one, you are exposed to foreign exchange rate risks. Further to that, his RM introduced him to FX derivatives, so that not only can John hedge his exposure, he has the potential to make more gains.

Admittedly, John became a FX addict, happy to make some small gains at first and thinking that currencies are liquid, low risk with low volatility instruments. After making a few good guesses with his RM, he felt indomitable.

As you probably guessed, in the past two weeks, in March 2020, when the USD strengthened against his web of the countless structured products in his hands, the bank asked for more cash. Now, he is at a loss.

John’s story reminded me of another famous Warren Buffet quote. To paraphrase, that investing is really not the same as Olympic diving, where the more difficult the stunt, the bigger the payoff.

In fact, in investing, the payoffs are just as high if you jump in from the side of the pool and execute it cleanly (metaphorically, of course).

Paul’s Story: Bond index funds in volatile times

Just at the end of last year, we also met another prospect, ‘Paul’, who we were hoping to get to invest into our fund. Paul was a client of an insurance agent friend and was a successful businessman who recently sold off his business for a large sum of money.

Throughout the conversation, Paul kept repeating how risk averse he is and that he only invests if there is a guaranteed return. He is a big believer in bonds, especially those from government-backed companies.

Paul has invested in a famous global income bond fund that has delivered in excess of 10% p.a. for the last two years. Upon further query, we realised that in addition to the half a million he invested into the fund, the bank has loaned him an additional USD 1 million, amounting to a total of USD 1.5 million into that fund. I wonder how his portfolio is doing these days.

Peter’s Story: The almost-IPO

Another story is about our own investor, ‘Peter’, who invested in a Singapore company that was about to IPO in 2011. Peter claimed that because he and the founder used to go to karaoke pubs together, they were like buddies. And because they were buddies, he was offered a part of the company as a sign of friendship.

When the founder roped in an ex-Goldman Sachs guy to prepare for IPO, Peter was sold to part with a large sum of his savings. He was told that once they IPO, his return will range from 5 to 10 times his capital.

The only difference? The IPO never materialised. And Peter never got back a cent of his money.

As these stories attest, the promises – and the related dangers – come in all shapes but there are common elements as well. Which is why it’s always prudent to understand your own risk profile. Besides analysing the risk-reward reality and conducting due diligence before any investment, ask yourself: Can I take the volatility? Can I afford to invest? Finally, do I need to invest?

And remember, if it’s too good to be true, it probably is.

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