Too Good to Be True?

If an investment sounds too good to be true, it usually is.  If you don’t understand how the investment or the market in which it exists, that only amplifies things.  Still, neither of those means it’s a bad investment, it only means the following:

1. You probably don’t understand the risk
2. It’s time do some research

I bring this up as we were just pitched by an investment firm which is waist deep in experience and credentials on an investment strategy with:

1. High yield
2. Low risk
3. Non-correlation to the assets in the portfolio
4. Non-correlation to other asset classes

What an investment!  Frankly, I came out of that meeting, and my only concern was the title of this commentary.  So I dug a bit deeper…

1. High Yield – Yes, the yield was nice, but has also come down as other investors took a liking to this asset class
2. Low Risk – Kind of, but it remains unclear if the models used to price these investments are accurate.  Further, the now lower yield enhances this risk (i.e. you aren’t compensated enough for the risk)
3. Non-correlation to other assets in the portfolio – In theory, yes; however, it’s possible these assets all move together if everyone tries to leave the same broad market.  Hard to gage the likelihood of such an event
4. Non-correlation to other asset classes – Yes, until it isn’t.  By this I mean there are instances when this asset class would move with equities, and only at the time when you would need them not to do so

I don’t want to divulge the asset class because we are still doing our due diligence.  I just wanted to give an example that there is always more than meets the eye, and it is critical to dig and dig deep when presented with a possible investment.

However, just because we uncovered some risks doesn’t mean it’s not a good opportunity.  It just means we need to be aware of all of the downsides, weigh those against the possible return, and if it passes our screening process, explain all of this to the client where is fits accordingly.

Past performance is no guarantee of future results.  Diversification does not guarantee a profit or protect against a loss. International investing involves special risks, including, but not limited to, the possibility of substantial volatility due to currency fluctuation and political uncertainties. The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  Nothing in the above writing should be taken as an investment recommendation.