Of one debit credit and another

In the world of finance, it is often plagued with complicated words, terminologies and most times ambiguous sentences describing the investment instruments, the criteria and even the risks as highlighted in various pamphlets. However, I guess it is the same in most fields, be it in engineering, IT or even in the music field.

Most recent case highlighted in the business news everywhere is the Madoff Ponzi Scheme in the US. Essentially, for those who have heart palpitations just by hearing the word "Finance" or even the words "Debit/Credit", it is where profits are paid to existing investors with the money received from new investors.

Usually, these investments tend to promise high returns, and the returns are "made" from money received from new investors who also want to enjoy the high returns. So, it is a cycle, and the cycle will carry on building and building until one day, something happens and it will fall flat on its face. This pyramid scheme will collapse if:

a) earnings (inflow of cash from new investors) are less than payments (outflow of cash to existing investors);
b) existing investors ask to get their money back;
c) regulatory or supervisory bodies clamp down.
Of course, there could be other reasons for the sceme to fail.

So, in such difficult financial investment landscape for 2008, where the Malaysian stock market was down over 40%, and bond funds barely touched the annual fixed deposit rate of 3.70%, it makes one ponder how an established fund in the domestic market was able to provide dividends of 9% and above. Most funds lost capital last year, and some barely made it to the positive territory to at least preserve capital.

Of course, who doesn't want the high returns promised and more importantly, delivered? So, as more and more funds chase the returns, is this a precursor to troubled times ahead? Scary thought.

So if you have queued extra early just to place money in the fund, and lamented system issues for not being able to handle the processing volume before the fund size is achived and the fund closes, I would actually closely relook at the terms in the pamplets and get a better sense of any of the investments made (if at all).

Of course, the pamplets could be speaking greek for all you know, with investments structured to generate Alpha, and price volatility within a certain 95% confidence interval, it is Delta hedged, with limited probability of default, etc... What? Don't understand? "Don't worry!!" as most financial sales personnel would tell you, "it is 100% principal protected, will get money back!". But really, who or what is providing the principal protection? What are the underlying investment instruments? Which markets? Sometimes these are not so clear cut. Better read the fine prints... but wait! don't understand? it has complicated words in it? Oh my...