Case Study: when investments go very badly wrong

What can would-be investors learn from failed investments? Investment Research.

Learning from the Lessons of Failure

The recent collapse of the FCA-regulated firm London Capital & Finance PLC (LCF) and the resulting fall-out for a large swathe of unsuspecting mini-bond investors has personal stories of human tragedy.

Here’s just one very sad example:

BBC News : ‘My life savings have been wiped out’…

What can would-be investors learn from this: how could the damage have been avoided or prevented?

Last month, insolvency administrators Smith & Williamson issued a Bondholder Communication to the beleaguered investors highlighting their findings so far.

The company in administration and some apparently serious errors made by the company are finally coming to light. We have seen that there were two key reasons for the wide impact of the failure on investors:

1. Improper marketing of the mini-bond

There are it seems, examples of where the company and some of its promoters underplayed their legal requirements. All investors should be experienced in these types of investment and understand that there is a risk of loss of capital, and/or have the capacity for loss.

Capacity for loss simply means losing all your money without it having a life-changing impact on you.

The company is allowed to appoint anyone they choose to sell for them, provided the seller sticks to the government-led rules of selling. It seems that the marketing materials failed to emphasise that the product was suitable only for certain groups of investors, and the likelihood is that the wrong people were targeted for promotion in order to maximise sales.

2. Poorly executed business model

The company’s stated model was to act as a “middleman” to corporate borrowers chosen by them with a responsibility to the Bondholders to provide a balanced spread of borrowers to smooth out the Bondholder risk of one or more borrowers defaulting.

The administrator discovered that one single borrower in particular was loaned a very high amount compared to the others. This exposed the bond to the risk of that single borrower. That borrower was unable to meet their commitments and the bond itself failed and collapsed.

Where were the operational checks and balances to prevent this? They could and should have been in place, and this traditionally is a role of the security trustee that represents the Bondholders.

There are even accusations of fraud, but these are we believe yet to be proven.

How can we learn from the lessons of the failure of others and become better investors?

When discovering a new investment that offers temptingly high returns, potential investors can either:

  1. Go ahead on the word of the promoter alone and hope for the best!
  2. Make an immediate subjective and emotional judgement that the investment “too risky” … or
  3. Keep an open mind and carry out (or get) independent, deep investment research to make a fully-informed investment decision one way or the other.

I am pretty sure I can say without contradiction that the first option is never a good idea. The promoter profits from the sale of the investment, not its success. Even an enlightened promoter committed to the long-term success of the customer for repeat business can come unstuck. If that promoter had not commissioned independent due diligence, they can also be swayed by the promises of the product. They could lack a realistic view of the risk, as well as the reward.

However, when the honest promoter has obtained independently-produced product research to show to their prospective customer in a way that they can clearly understand, the credibility goes up exponentially. If the promoter does not have such a report, the investor should get their own before making any decision.

Until now, this kind of independent reporting has simply not been available to investors in an affordable way, leaving the investor with the option of DIY research (which has value, albeit limited), or to take Option 2 above and play it safe by simply doing nothing. It’s one strategy, but leaves opportunity lost. This is ultimately an uninformed decision. As ever, the best investment is knowledge.

Just some of the key areas checked by Diligent Eye:

  1. Viability and track record of the business model
  2. Background checks on the Persons of Significant control
  3. Checks on the experience and credibility of the Security Trustee
  4. Legal opinion on the Bondholder Agreement and when relevant, the Security Trust Deed.
  5. Analyse of the methods of promotion
  6. Assess the quality of the promoter network and the commission levels available to them.

Whilst there are no guarantees these aspects alone provide strong indicator of the likely success or otherwise of the investment.

At Diligent Eye we have over a decade of hard-won experience, both good and bad, with these types of product. Our team comprises industry experts, lawyers, business analysts and systems engineers. That’s why so many of our customers see us as a crucial resource in their investment success.


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