Hot investments just an easy sell?

Three of the major investment trends recently have been hedge funds, capital notes and contributory mortgages.

While there are marked differences between each of these three types of investments, they also share two things in common.

One is they have become popular because of the declining returns, and in many cases, losses suffered by share markets. Likewise low interest rates have sent income investors hunting for higher returns.

But perhaps the more important distinction is that they appear to have been heavily sold to investors by advisers.

Clearly each of these are bonafide investment types and they can play a role in a properly diversified portfolio.

The question that begs answering is how are they being sold? Are they being sold just because they are easy to sell, especially as an alternative to shares, or maybe it's the brokerage available on various products which makes them attractive propositions (to the adviser, as opposed to the investor).

It was pleasing to see the issue raised by the new chairman of the Securities Commission Jane Diplock. (As an aside, Diplock, who is a lawyer from Australia with considerable expertise in securities market regulation, seems to be striking fear into the hearts of some players in the financial services industry. There is a general impression that this lady means business and isn't going to put up with shonky behaviour).

Diplock says the commission is concerned about contributory mortgages for a number of reasons including the way they are being sold. Her contention is that many people who end up putting money into them are not fully aware of the extra risks they are taking on.

After all many contributory mortgages are made to property developments which no one else is prepared to lend on.

The flood of capital notes issues over the past six months has also been an eye-opener. By our estimates more than $1.2 bill has been pumped into notes recently, and the majority of that money has come from the Mom and Pop investors, rather than the institutions.

Capital notes look attractive to the retail sector because they appear to offer some pretty high returns. The reality though is that investors probably aren't getting sufficient return for the extra risk they are taking on, plus they are capping the upside to their investments.

For that reason, and the fact that most of the offerings are junk bonds, or non-investment grade issues, the institutional market has stayed away from the capital note frenzy.

As adviser Norman Stacey points out New Zealand investors are prepared to lend companies money for just 180 basis points more than the Government bond rate, while Americans demand at least 400 or 500 basis points more reward.

While a portion of the money being invested in capital notes is money that is being rolled over from similar offers which have just expired, it appears there is a fair amount which is new money, which in differing circumstances may have been invested elsewhere.

These offers have been attractive to advisers because they are reasonably easy to sell. Let's hope their clients have been given good advice and are aware of the risks that they are taking on.

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