Recently there have been major losses for investors due to the failure of the Shield and First Guardian Master Funds. Apparently some people invested their superannuation in these funds and will now live a much poorer retirement.

There are common factors between these failures and others in the past such as Dixon Advisory, Mayfair 101, Storm Financial, LM, Pyramid Building Society and Estate Mortgage. Even now there are other investment funds being promoted that have similarities to those failed ones.

Much can be learned from looking more closely at investment fund structures and the flaws in some.

Most investment funds are very sound. Money goes into arms-length assets that are market listed, frequently traded and fully transparent. There are no conflicts of interest. The managers’ aim is simply to achieve what the prospectus says, so investors will be happy, generating management fees.

The market listed investments are shares, property and infrastructure securities, government bonds, bank bills and high-grade fixed interest securities in Australia and on major overseas markets. They will fluctuate in value but not fail.

Funds investing in unlisted property, physical buildings, can be very good but can experience liquidity problems if many investors want their money out when it is tied up in the properties. Usually, they come good eventually.

Shares in unlisted companies that aren’t traded on any market can have more serious problems. Many are new, small companies that may fail. If there is no regular market, how are they valued? Does the manager do it? If independent valuers are used, are they changed frequently?

Private equity is another opaque investment category. What are the underlying assets? Usually only the manager knows. How good are they? That’s not known to the investors. Again, how are those assets valued?

Private debt funds may collect money from investors and lend it to high-risk borrowers. They could be property developers with questionable projects and poor credit ratings. If they don’t repay, investors lose their money.  

A common cause of failures are structures involving in-house assets and conflicts of interest. For example, money invested may be lent to businesses owned by the promoters, which they are focusing on. If anything goes wrong the investors will be the losers.

The vast majority of managed funds offered to the public are sound and reliable. However it is best to totally avoid any that have conflicts of interest. Also avoid most investments that lack transparency. And take care if assets could become illiquid.