What may appear to be a safe investment could turn out to be the opposite. There is no such thing as a sure thing but, asks Nick Dewhirst, are some investments safer than others?
Crash. And yet another generation of investors discovers to its cost that in their pursuit of a sure thing, they in fact bought something highly risky. This time they discovered that one can not only lose a fortune in bonds, but also be unlucky enough to find the remains of their holdings frozen.
Too many will learn the wrong lesson and decide never again to touch the object of their new-found loathing. Instead they will become suckers for the next sure thing to be dreamed up by the next cohort of snake oil salesmen.
Instead the lesson that investors should learn is that risk and reward are both a function of market conditions. The higher the price, the greater the risk and the lower the reward. Neither is absolutely given as the naive hope, nor are they opposite ends of some risk/reward spectrum.
This is not the first time that experience has been made in bond markets. As a collector of Historische Wertpapiere, I can show you several outstanding examples that I used to decorate the walls of my office while I was a US registered rep in Germany.
• The oldest is an annuity of the South Seas Company, which was expected to replicate the success of the East India Company in 1730, but became the original bubble.
• The next is a receipt for the British Government's 3% Consolidated Annuities at 92.625%, dated 1840, which is still trading but a quarter of a century ago fell as low as a third of that nominal value and a tiny fraction of its real value after allowing for inflation.
• Then there is an Ottoman Empire 3% French Franc certificate issued in 1870, when Turkey's reputation was so high that it could issue bonds which it only promised to pay back a century later, but reneged.
• However the most impressive is the Chinese Government's 5% Reorganisation Loan of 1913, where investors could choose repayment in stirling, marks, francs, roubles or yen, but received nothing after the Revolution.
• Similarly, Germany issued 3% dollar bonds in 1936, and promised to pay them back ten years later, which turned out to be a few months after the Thousand Year Reich collapsed.
All were considered to be the highest quality and safest investments when they were issued, as can be seen by the very low interest rates promised by borrowers with sovereign status. Yet each generation of investors lost fortunes on those bonds.
The interesting question is what is it that leads successive generations of conservative investors to do such foolish things, as repeated now with the latest range of funny money.
Then there was the excuse that information did not flow so freely but that no longer applies nowadays. Two decades ago a book about similar funny money was published that could have been written today. It is still in print and even ranks among the top 500 books currently sold by Amazon and it is probably their best seller on investments. It is Liar's Poker by Michael Lewis.
Therefore there is no excuse for pension fund trustees who now bleat that nobody told them that their pensioners could lose everything on "yield enhancers". Two decades ago, such toxic bonds had already earned the accolade "nuclear waste" on the sell-side.
The explanation is that safety-first investors have an especially strong inclination to trust someone else rather than think investments through for themselves. Among individuals, that is expressed in the purchase of bond funds. Among trustees it is called acting on professional advice.
Equity investors are not immune from this weakness, but they are significantly immunised against it by extensive disclaimers that the value of investments can go down. Forewarned they tend to be better read. To confirm this, just ask individual investors how many read stock reports regularly and how many have ever read a bond prospectus.
Given the choice, what would you prefer – one investment with 100% downside and zero upside potential, or another with the same downside, but infinite upside potential? The case for so-called risky equities is backed by centuries of out-performance over so-called safe bonds, as yet another generation of investors is now learning to its cost.
It is simple – the more money you make, the less you lose. Equities are the only way to make serious money, so they must be the safer investment – providing the price is low, as stated above n
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