Whether it’s cryptocurrencies or investment trusts, make sure you know what you’re investing in

Cryptocurrencies are popular – if you aren’t a curmudgeonly old fuddy duddy you probably own a lot by now. Even I, as curmudgeonly as anyone, own a few.

Last year, the Financial Conduct Authority (FCA) put the number of people in the UK owning cryptocurrencies at around 2.3 million; given the publicity around the various currencies, it makes sense to think that number is already rather higher.

Several surveys back that up. Interactive Investor research suggests that some 45% of young adults (18-29) made their first ever investment in cryptocurrency. Data from Boring Money has 11% of young adults (18-44) saying they own or have owned cryptocurrency assets.

Among those who have only been investing – in anything at all – for a year or less, that number rises to 16%. That’s nice, you might think, young people engaging with money and markets.

Unfortunately, it is more complicated than that. An “alarming number” of new buyers are “funding this through a cocktail of credit cards, student loans, and other loans,” says Interactive Investor. A survey from the FCA suggests 58% of people trading these kinds of “high-risk products” are taking their advice from “social media and their friends”, a strategy that, financially speaking, does not have a stellar success record.

The Treasury is concerned. It noted this week that, while the number of people holding cryptocurrency is rising, “understanding of what cryptocurrency is is actually declining, suggesting that some users may not fully understand what they are buying”.

That may be particularly the case if they rely on the ads on social media and the London Underground for their information. Consider one of the most discussed of these last year, from Luno Money.

It said, in very big letters: “If you’re seeing bitcoin on the underground, it’s time to buy.” It did not mitigate that appeal to the fear of missing out, even in very small letters, with the information that in doing so you’d be buying a volatile, speculative maybe-asset that comes with a high chance of capital losses – and that could soon be banned by the Russian government.

There’s a reason supervision of cryptocurrency advertising is now likely to be transferred to the FCA. Such ads will now (like all other ads for financial products) have to be “fair, clear and not misleading”. I can’t imagine how a cryptocurrency ad will be all these things – upfront about having no yield, no obvious fundamental value and no accepted valuation method, for example – and still be compelling. Something to look forward to.

But here’s a question for you: would more accurate ads have made any difference at all? After all, when it comes to not understanding how investments work, this isn’t just about cryptocurrency.

Do you really know how your investment trust works? 

If only it were. Last week, Interactive Investor produced a piece of research I loved. I often say here that the retail investor should outperform the professional for the simple reason that we have something they don’t – time. We are not answerable to anyone for our quarterly performance, only to ourselves for our long-term performance. Our retirements rely on us getting more right than wrong.

I was therefore delighted to see that over the past year the Private Investor Performance Index showed ordinary investors outperforming the professionals by a couple of percentage points. Younger investors, aged 18-24, have also done remarkably well over the past two years – up 22.8%, against 17.2% for a mainstream index – the Investment Association Mixed Investment 40-85% shares sector.

And the “secret sauce” driving the returns? A higher allocation to investment trusts.

I love investment trusts. But do the newish investors, or for that matter older investors, buying them know what they are buying? That’s partly a question about the structure of investment trusts. Their share prices can move some distance from their net asset value. You could buy them at a premium, something none of the investment platforms alert you to on their trading pages.

But if sentiment turns against them you might end up selling at a discount to their net asset value. Result? You’ve lost a lot more money than the change in the share prices of the underlying holdings of the trust might suggest you should have.

But it is also about what is in them. The top holding for the 18-24 age group is Scottish Mortgage, which holds lots of wonderful and exciting stocks with fascinating stories to tell which you might want to hold for the very long term.

Some make real money now; others do not. But they do promise huge growth and huge profits in the (uncertain) future. Those future profits are valued by discounting them with reference to today’s interest rates. The lower interest rates are, the more future profits are worth. So the lower rates have fallen, the higher the prices of growth stocks have gone. That’s one of the reasons – alongside good stockpicking – that Scottish Mortgage has done so well for so many people.

You will see the problem. You might think you bought a fabulous story about longevity, digitalisation, artificial intelligence, space travel or fossil fuel-free energy. But in fact, you may have bought an asset that is super-sensitive to changes in interest rates, or what is known in the business as a “long duration asset”, the price of which will whipsaw as the discount rate used to value it does.

“If inflation comes about – or rather looks a realistic possibility,” said Ruffer’s Jonathan Ruffer a few years ago, “you won’t see government bonds or tech stocks for dust.”

Well, here we are. European value stocks outperformed growth stocks by almost 10% in the first 17 days of 2022 and US value shares are ahead of growth by 6.4% this year, says Duncan Lamont of Schroders. The Goldman Sachs index of unprofitable tech companies was earlier this week down 14% from its peak.

And Scottish Mortgage? I hold it and will keep holding, as I think the future usually comes good. But, while you are still up 230% in the past five years, if you only came in three months ago you are down 23%.

Did everyone who put their money into expensive growth stocks last year, when it was already obvious that inflation was not transitory, know what would happen to their duration story stocks when it was clear rates would have to rise?

The ads for tech funds told you there was risk but this big one wasn’t exactly highlighted. You might ask yourself about some of your other holdings too.

What about all those ESG funds? What’s really in them? Are they perhaps too reliant on long duration assets too – it’s easier to shoehorn a low-profit tech stock or lossmaking renewable energy stock into your average ESG portfolio than it is a high dividend paying miner? Owning them at extreme valuations is obviously different to owning a portfolio of cryptocurrencies, but there are similarities. Think about how far away the promise is and you might think of cryptocurrency as a long duration asset too.

My point? Anyone who has been having a bit of giggle about naive newbie investors and their 10% losses on bitcoin so far this year might want to have a quick check that they really know what is in their own portfolio.

• This article was first published in the Financial Times