How to avoid Alternative Investment frauds, alwaysPosted on November 25, 2016
Working in investment management in Asia we get asked all the time about investment strategies by our friends. Often the question is these days is about alternative investments since many people are looking for something else besides and in some cases instead of, their stock portfolio. Our advice is in the anti-Nike, “just don’t do it”. Just don’t.
We realize, this simple announcement might need some explaining since the case for an investment that doesn’t follow the stock market can seem like a good idea. We consider alternative investments to be a category of real assets outside the world of funds and direct stocks that was popularized by storied investors such as of the Yale Endowment. Things such as wine, stamps, precious metals, diamonds, forestry plantations, art and collectibles are all alternative in our view.
Our negative advice puts us at odds with quite a few of our friends but we aren’t writing this advice to make friends (or commissions). It also seems to fly in the face of the convincing stories and beautiful pictures and those wonderful graphs that go up towards the horizon, with barely a pause for breathe.
Practically all alternative investments sold by a broker ends in a loss.
Not every investment ends in complete loss of capital its true, But the failure of programs and strategies that we have been
pitched, and avoided, is so regular from what we can see, that your hit rate might be as low as 2 in 10. Yup, that’s an 80% chance of losing money and sometimes the loss is 100% of your money. This makes the stock market look positively low risk. Not that you’ll ever see this risk reflected in the sales material of alternative investment salesmen. Even worse we think that perhaps as many as one third of investment programs are borderline fraudulent if not a complete scam. Sometimes it is difficult to tell the difference between the frauds and merely incompetent, but is that truly a useful distinction?
The only time to buy an alternative investment.
If you know more about something than anyone else you know and could be considered an expert in your area because you have been working or studying your area for years, or even better, a decade, then, maybe, just maybe you are qualified. We don’t mean that you have been drinking a glass or two of wine per night since you were 21 and going to the odd wine dinner. That you once visited Bordeaux on holiday and visited a few wineries. We mean work in the industry selling, growing and producing wine. It is similar to the old poker story. If you can’t tell after the first 5-6 rounds who the dupe is in a game of poker; then the dupe is you. The same goes for alternative investments.
Why are alternative investments so risky?
Once you move outside market traded assets like the stock and bond market, a lot of the protections in place vanish.
- There are no custodian accounts built into the system to protect theft from your asset manager. Think about that for a second – there is nothing stopping your wine broker, loading up a case your valuable wine in the back of his van and selling it and later telling you that it had been “lost or broken”. Of course, that can give him a bad reputation, but by that time, the fraud has happened, and, if done in a small way on enough people, the perpetrator has disappeared somewhere with his illicit gains.
- The valuation methodologies on alternative investments can become divorced from reality, thus meaning you are paying overinflated prices for assets. These methodologies often must be devised because trading happens so rarely (unlike stocks), but they can be abused to pretend you are making gains in your fund when you are not. Often this starts innocently to smooth a bad month, but sooner or later the manager will be relying on this most months to show strong growth and attract assets that the difference might be 20-40%. Independent valuation experts are paid by the manager, so how independent are they truly? We have seen this happen to property funds like student accommodation funds for example, that whilst otherwise solid, ended up with problems unloading their assets that had overinflated prices and thus locked up their client’s assets for years whilst they waited for reality to catch the model.
- There are no protections in place against self-dealing. This is where your helpful broker buys at the market at a lower price and then sells to you for a higher price. For example your wine broker might pick up a case of Chateau Lafite for $10,000 and then sell it to you for $14,000 USD. Would you ever know that your wine broker quietly pocketed $4,000 completely risk free? Later the broker can just say that “demand isn’t that strong right now, so we suggest you hold for another 2 years while we charge you a management fee for crossing our fingers and hoping that the market bails out our poor deal”. Sounds like an awesome deal, right? Protections against this were put in place in securities markets more than 100 years ago, but they don’t exist in these unregulated markets.
- Understand you are betting on future fashions which are unpredictable. We aren’t talking about buying vintage clothes here, but the simple fact that some things go in and out of fashion. Witness the collapse in Bordeaux prices as Chinese investors moved on from buying bottles of wine to buying Burgundy wineries. Who knows what the hot trend in art will be in 10 years? Investing is about buying an asset that can deliver a future income stream, like a company that pays dividends or a property that pays rent. Picking a future hot fashion you need a lot of luck.
- Fear the word ‘guarantee’ and you’ll avoid the worst of the worst. Whenever my partners and I hear the word ‘guarantee’ from an investment provider, we go running immediately. There is no better predictor of investment failure in my opinion, than investment providers who use that word. Look for a good risk on a company that is growing to the future and making money now (think Facebook and not Tesla) and you are likely to do far better than looking for a safe haven that is anything but.
So, our simple rule of thumb is, if you don’t know how to engage in your preferred market without a broker and you don’t know all the right people, the tricks, the history, the strategy and the market players BEFORE the broker turns up. Then you should turn the broker away. If you need entry to the market via a broker (who might also call himself an IFA or financial adviser) because you don’t know enough, then you shouldn’t be playing the game; because the patsy at the poker table is you.
About Caterer Goodman Partners
Caterer Goodman Partners is a Shanghai based wealth management firm established with a clear vision to provide a new level of personalized financial planning services for expatriates in Asia. Our financial advisors provide guidance for our clients in all areas of investment, specialising in managed accounts, money-market funds, retirement planning and alternative investments. At Caterer Goodman Partners, we offer our advice and experience to provide low cost, tax-effective and simple solutions to match our clients' interests.
About Owen Caterer
Since graduation Mr Owen Caterer has worked with the Queensland Premier's Department in Trade Facilitation and then as a financial adviser in Shanghai from 2005 until 2010. He then rose to Senior Adviser, then Business Development manager and then to Chief Investment Officer responsible for portfolios to a value of US$280 million across Asia. Following that Mr Caterer left to found his own firm with a partner in the financial advisory and wealth management area. This focused on developing China and Asia's first fee-based financial advisory (rather than commission-based). This has grown to now have 8 staff and and managing almost US$35 million for clients throughout Asia. This business success was recognized as a finalist in the 2013 ACBA in the Start Up Enterprises category and are one of a small number of foreign managed firms to have a full asset management license in China. Owen has also been active in the community volunteering for the Australian Chamber of Commerce in Shanghai and acting as the Vice-Chair of the Small Business Working Group (2012-2014) and as the Co-Deputy Chair of the Financial Services since 2013 until the present. They have continued to grow their business and havenow been selected as a small group of companies who are platinum members of the Australian chamber of commerce. The achievement they are most proud of is their efforts to reform the financial planning industry in China and push it away from a hard-sales commission driven model to a more ethical management fee and long term customer service model. Owen has a Graduate Diploma of Applied Finance from the Securities Institute of Australia of which he was a member as a Fellow of Finance for many years and also has an undergraduate degree from Griffith University in International Business. Owen's interests are tennis, running and his wife and two children. He speaks fluent Chinese, first arriving in China in 1997.
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