Lesson from London Capital & Finance: risk and return are always related

I’ve been reading a lot about London Capital & Finance (LC&F) recently.

In case you haven’t seen the story, they are a UK investment firm that went into administration a few weeks ago. ​​​​​

They had 11,605 investors who had invested GBP236 million and who now stand to lose a significant part of their money (administrators think they could get as little as 20% of their savings back). Many of these investors were simply looking for a home for an inheritance or the tax free lump sum from their pension.

To add insult to injury, they are unlikely to be covered by the Financial Services Compensation Scheme (FSCS).

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The investment in question offered a fixed return of 8% pa over 3 years which is obviously appealing in a world where the Bank of England base rate is 0.75% and most fixed rate ISAs pay around 2%.

However, the investors money went into mini bonds and there are unregulated, very illiquid and high risk.

I don’t necessarily think that this is simply a case of something being “too good to be true”. The potential return was actually quite reasonable when taking the level of risk involved into account.

The problem is that investors were unaware of the level of risk involved. In fact, the investment was marketed to those “looking for higher returns than the highstreet”. It was pitched as being low risk and equivalent to a fixed rate ISA.​​​​​​​

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As you can see from the above image, LC&F were aided by a firm of rocket scientists who created a number of “best savings rate” comparison pages (now offline) showing LC&F as the best deal in town.​​​​​​​

Takeaway 

The key takeaway here is that we, as investors, need to remember that risk and return are always related.  ​​​​​​​

If an investment is offering a significantly higher return than its peers (with LC&F it was 4 fold) then, somewhere, the level of risk must be commensurately higher too.

 

Further reading/listening:

London Capital & Finance: 236m firm collapses

Money Box – London Capital & Finance

 

Friday fact

If you had invested from 1960-1980 and beaten the market by 5% each year, you would have made less money than if you had invested from 1980-2000 and underperformed the market by 5% a year.

Source: The Twenty Craziest Investing Facts Ever