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You are here: Home / CPF Are You Ready? / How to avoid scams

How to avoid scams

21, March 2010 by Wilfred Ling Leave a Comment

In the quest to find better returns at a lower risk, many people have been attracted to alternative investments. If these alternative investments do fall under the Securities and Futures Act (SFA), they are normally only available for Accredited Investor to purchase. Most common examples are hedge funds. However, many of these alternative investments do not fall under the definitions as “securities” under the SFA. Because the Financial Advisers Act only regulates advice on life insurance and on securities (defined under the SFA), those selling these alternative investments that is outside the SFA are not regulated.

Of concern are alternative investments that could be scams. Almost everyone I know has already been prospected to buy such products. Some of these products have already been exposed as scams. For example, I remembered clearly that Swiss Cash was openly marketed at well known hotels. Many of my friends sign up for it. I told them to stay away from it but very few listened. Some of my clients consulted me and fortunately everyone of them took my advice not to invest in it. Subsequently Swiss Cash scam was exposed but many people lost their life saving as a result. The list of existing scam can be found at MAS website: http://www.moneysense.gov.sg/Understanding-Financial-Products/Investments/Investor-Alert-List/IAL-Listing.aspx. Unfortunately this list is always outdated. It tends to be a few years outdated. Because MAS wouldn’t want to be sued for defamation, only schemes that have been proven to be scams are listed there. However, a scam can only be “proven” to be a scam when all investors lost their money or when the companies involved “disappear.” Hence, this explains why the list at MAS Alert List tends to be outdated all the time.

The only solution I see is to self-educate so that you can avoid becoming a victim of a scam. Here is a check list you can use to determine whether the product prospected to you is worth your investment:

1.      What is the underlying economic basis of the investment? Is it based on the profits of a business? Does it rely on prices of commodity? Does it rely on membership fees (pyramid selling)? Or based simply on a promise? These questions are actually the most difficult to answer. Take for example: a (hypothetical) company sells Copper at 25% premium over spot price on 31 Jan and write a put option at strike price 30% premium over spot rate (based on 31 Jan’s spot price) which can be exercised 1 month later. This means that the investor buys the copper at 25% above market value on 31 Jan but is permitted to sell the copper at 30% above 31 Jan’s market price on 28 Feb. If this is true, the investor earns (1.3/1.25)-1 = 4% of his capital in just one month or 60.1% in annualized return. For such an example, actually the copper being sold has nothing to do with the investment. It is just a distracted. The underlying investment is merely a promise by the company to honour the put option. Thus, the risk is the counterparty defaulting on the put option. To make the risk less “risky”, it has been said that the investor’s worst case lost is 25% as he get to keep the Copper. Actually the worst case lost is not 25%. It is much more than this as the sale of Copper is subjected to bid-ask spread, GST, liquidity risk and market risk. The ordinary man-in-the-street is unable to enter into future contracts or forwards and hence has to sell his Copper OTC for immediate delivery.

2.      After identifying the underlying economic basis of the investment, you will need to ask how much the company is earning and how they do it. For proper investment, the company would normally take X% in management fee or Y% in performance fee. You always see that in hedge funds. The fundamental rule is that the investment itself must make more money than what you earn. Take for example a traditional unit trust. If the fund earns 20% over 1 year period before cost, you must only earn say 18% because 2% is being taken away as management fee and expense for the fund manager. This simple illustration shows that the investment must earn more than what you earn. Hence, if the investment promises you a put option allowing you to earn 60.1% per annum unconditionally, it means the company must be able to earn higher than this so that it can give you this promised profit and yet still can keep some for itself. Thus, it is important to ask how the company earns such a return. If the company refuses to tell you, you know something is fishy.

3.      Finally, ask yourself whether are you just greedy. Once you become greedy, you’ll lose objectivity and refuse to listen to good advice. You’ll make irrational decisions which you will regret later.

If you cannot remember the above points, just remember this: you could only help yourself by educating yourself and do your own research.

For a related article, you can read this article: Turning to friends for advice turn out to be a bad advice.

This blog was first published in CPF Board’s IM$avvy  / IMSavvy Blog Corner:http://www.cpf.gov.sg/imsavvy/blog_post.asp?postid=352872310-73-8040887712

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Filed Under: CPF Are You Ready?, Investments, Scams

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