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#fakefixedincome rears its ugly head again

September 10, 2020

Fake fixed income is a form of investment offered to unsophisticated people who may be “retail investors” or may qualify as “wholesale investors” because they are relatively wealthy.

Promotors knowingly design #fakefixedincome products to look like and compete with prudentially regulated guaranteed bank deposits, without any prudential integrity other than some generally flimsy self-imposed concepts. These products have been around for ever and morphed from debentures, to managed funds and wholesale trusts. These products spring into life in low interest rate environments.

More recent products have concerningly involved exploiting the regulatory arbitrage between retail and wholesale clients. A product only open to wholesale investors bi-passes a range of legislative conduct and disclosure obligations and the need for external audit. However, a lot of hard working self-funded retirees without much investment experience can sail past the “wholesale clients” asset test meaning they are particularly vulnerable.

How the promotor tries to achieve constant higher yield is perhaps the most alarming feature of #fakefixedincome. They gamble on speculative investments. The most heinous examples are on-lending to related parties who effectively bet on highly risky ventures. Or they might bet on property developments that tend to struggle for finance from main stream lenders. The investments are almost always illiquid and longer in term duration than the promotors’ commitments to investors.

How does the promotor deal with the liquidity mismatch while waiting for their bets to pay off? The marketing engine steps in to attract capital inflows to fund investor outflows and expenses. So long as capital is flowing into the vehicle, the show can keep going. Charles Ponzi would blush in admiration.

Who are the promotors of these products? Normally we see a figure head at the helm of these products who is generally sunk at the end (either jailed or banned) – like the former vacuum salesman who fronted Fincorp. However, for #fakefixedincome to come to the market, there are a range of additional financial services professionals that are knowingly involved and whose hands are sullied.

It’s a sad reflection on the industry that these collapses keep coming back each cycle.

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