Learning the hard way only to invest in stuff you really understand

Even the professionals sometimes lose sight of the fine details

The events of the past week have underlined the importance of only investing in things you really understand. We look more deeply at the fallout from the Credit Suisse (CSGN:SWX) rescue job in a separate feature but a key reason it has not fully ended the concern over the banking system is the way holders of AT1 bonds or ‘CoCos’ have been wiped out.

If they’d read the small print on these instruments, they might have been aware of the risks but it seems many failed to do so. A colleague chatted to the manager of a bond fund not too long ago who happily talked about investing in these vehicles but then seemed unable to explain how they worked.

As an individual you could almost take some comfort from the fact even professionals can make these mistakes, yet it is somewhat worrying on a wider level. The great financial crisis arose in large part because institutions had invested in instruments where the risks were not fully understood.

As markets become more unforgiving it’s going to be even more important to do your homework properly. The stress created by a rapid and aggressive increase in interest rates is starting to break things and you don’t want to be stuck holding something which is vulnerable.

So often assets like AT1 bonds only come to the market’s attention at times of market stress. Just look at how LDIs (liability-driven investments) were put under the spotlight off the back of the miniBudget in September 2022 and few people knew what they were.

What does all this mean for the way you should manage your portfolio? Newcomers to the world of investing should consider testing the waters by allocating their cash to firms whose products they recognise, understand and can easily research.

Don’t be afraid to admit that you feel out of your depth with certain parts of the investment world. There is nothing clever about leaping in with both feet only to face big losses.

This does not mean investments in more complex areas such as technology or natural resources are entirely off limits, particularly if you have relevant knowledge or experience, but they should be approached with more care and it is worth swotting up on key industry jargon before getting involved. Often it makes more sense to invest through a fund where you can spread your risks.

When entrusting your money to a fund manager, longevity is a key consideration. If the person at the helm has experienced a few market or economic cycles there is less risk of them getting caught up in putting cash into something without substance which is flavour of the month.

At the end of the day, it is no good pleading ignorance if you are caught out by investing in an area you didn’t understand. Just ask holders of Credit Suisse AT1 bonds.