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Oran Hall A painful investment loss

QUESTION: Years ago, I invested over US$7,000 with a local stockbroking company. This was from my gratuity received on retirement from the Government of Jamaica after over 40 years of service. They invested it in Digicel bonds. I didn’t sign a high-risk form. The broker claims it wasn’t high risk at the time the investment started and accepted no responsibility for my loss. I received interest payments over the years. When the bond was due for maturity in 2020, I contacted the broker, only to be told something had gone wrong.

I took the matter to the Financial Services Commission, which advised that they could do nothing as the bond had been issued in the United States and they had no jurisdiction. I took it up with the Ministry of Finance and the Public Service, which didn’t even acknowledge my letter. I was asking why the Government allowed companies to invest our money in bonds if our regulators have no jurisdiction. My initial loss was US$5,000. So far, I have got back less than US$650. Good thing I had not put more in the investment.

– Dawn

FINANCIAL ADVISER: I am so sorry to learn of your loss. Your experience shows that bonds are not risk-free and that investment professionals have a responsibility to ensure that the investment instruments their clients purchase with their guidance are suitable for them.

Investment professionals have a duty of care to their clients, which requires them to assist them to make decisions that do not expose them to harm. Investment policy statements and risk-tolerance questionnaires are used in the industry to help them know their clients and thus determine what is suitable for them.

Additionally, investment professionals are expected to know the products they offer to their clients. A product that is quite suitable for one client is not necessarily suitable for another for a host of reasons. From what I have been able to learn, Digicel has maintained that the bond issued in the US was not meant for all retail clients but rather sophisticated retail investors and institutional investors.

Generally, investors from many countries invest in bonds issued in the US and other countries. Investing in global bonds is good for diversification, provides an exchange rate hedge, helps to reduce risk and increase total returns. On the other hand, there is exchange rate risk and regulatory issues that may arise, among other issues.

Digicel did make efforts at refinancing its debt with terms that included a later maturity date, a lower coupon rate, and a very significant cut in the capital value of the instrument. Some investors accepted but others did not, so in effect, no investor was left unscathed.

Each country is responsible for regulating its securities market. Generally, many do. The onus is on professionals in the industry to do the necessary research and evaluation of the securities. Critically, they should know what is suitable for their clients and try to steer them away from high-risk situations.

Investors need not take a passive approach to decision-making. They should interrogate the professionals before making their decisions and only commit to a position when they are satisfied that they understand what they are doing and appreciate the possible implications. Investors should not invest in ignorance.

As for the FSC, it only has jurisdiction over securities issued under the laws of Jamaica, so it did not have jurisdiction over the instrument in which you invested.

Can the quality of a bond change? Yes. The issuer of a bond is required to pay interest when it is due and principal when it matures. Sometimes, issuers of bonds create additional issues, which increase their fixed charges of interest and principal repayments and thus affect the quality of their bonds. Additionally, profit levels may fall or not grow sufficiently to generate the cash flow to make these contractual payments on time or at all.

Apart from the risk of default, there is purchasing power risk. This has nothing to do with money not being repaid or bond quality. It is about the investor not being able to buy the same basket of goods and services with each dollar – of interest and principal – as before. To make matters worse, in the case of fixed-rate bonds, the interest that is paid throughout the life of the bond remains the same.

Contrast this with the dividends on ordinary stock, which generally grows over time if profit levels increase.

Although I do not know the size and composition of your portfolio, I am surprised that all the funds you invested then went into one instrument, more so because of your status as a retiree. Was there no thought of diversification, even among bonds, to manage your risk? As you see, one issue failed to make it, and you lost a big chunk of your retirement funds.

Bonds are good for portfolios. They generate income. They maintain their value in money terms if they are held to maturity but lose value in real terms, that is, after taking inflation into consideration. Those denominated in foreign currency add the edge of exchange rate protection.

For best results, investment professionals should only offer what is suitable for their clients, who should themselves play an active part in the decision-making process.

Oran A. Hall, author of Understanding Investments and principal author of The Handbook of Personal Financial Planning, offers personal financial planning advice and counsel.

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