Lessons from the 'death bonds' debacle

'Death bonds' have recently run into trouble. John Stepek explains what they are, and what two lessons investors can learn from them.

Funds investing in 'death bonds' (or less melodramatically, "traded life policies") hit the news again this week. These funds buy life insurance policies from the ill and elderly in the US. They pay the premiums, and when the original policyholders die, collect the payouts.

It sounds a reasonable idea if macabre but the funds ran into trouble. People are living longer than expected (so payouts are slower in coming and more premiums have to be paid). And the market for the policies is illiquid, so selling them to allow investors to cash out has been a problem too.

It arguably didn't help that in 2011 Britain's then-financial regulator, the FSA, described the investments as "toxic", effectively leading to a run on the schemes, many of which are now frozen.

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Richard Dyson in The Daily Telegraph notes that investors are considering legal action against one provider EEA Life Settlements while Judith Evans in the Financial Times notes that the value of another fund the MPL Traded Policies fund has dropped by 60% in a year.This is a miserable situation for the investors involved, with no clear route to resolution amid the various parties arguing over what to do to maximise the value of the remaining portfolios.

But there are a couple of broader lessons here for anyone who wants to avoid getting caught up in this sort of situation. Firstly, don't put all your eggs into one basket, and particularly not an exotic basket like this. The FT article talks to at least two investors who had invested hundreds of thousands of pounds between them, which they can ill afford to lose.

You'd have to be stone-hearted not to feel sympathy, but it very painfully flags up the dangers of taking big bets on one asset class. The reality is that decent diversification can be achieved for most investors by spreading your money across a mix of shares, bonds, property and cash, with a bit of gold for insurance anything more elaborate should be treated with caution and a sceptical eye.

Secondly, even if you are taking financial advice, you have to understand what it is you're investing in and where the potential risks lie.

For example, many of the celebrities who have recently been caught out in tax-avoidance scandals probably didn't grasp the details of the various film schemes their advisers were putting their money in but they're the ones who paid the reputational price when the news broke and the schemes went sour. If your adviser can't or won't explain a recommended investment in a way that you can understand, then don't invest in it. And get a new adviser.