How do you know it is a ponzi scheme?

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The recent Western Cape Relative Value Arbitrage Fund (RAVF) scandal that led to suicide shooting of Julian Williams by his associate, Herman Pretorius, is estimated to have lost investors around R1.8 billion. While investors, and financial advisers who recommended the fund, throw up their hands and say “how could we have known”, the simple investment rule is that when returns promised are too good to be true – they usually are.

“If the product sounds too good to be true, it usually is. One common characteristic of a scam is guaranteed high returns for example guaranteeing 30% per cent returns, this should ring an alarm as it is not realistic,” says Paul Roelfse from the Financial Planning Institute (FPI).

When an investment promises any return above cash, the first question you need to ask is: what is it invested in? Interest on cash is considered a “risk-free” return which suggests that any return above that is taking some risk in order to achieve that return. You need to understand exactly what that risk is and what it means to your investment. Investing in equities (shares listed on the JSE) carries risk and your investment could fall in the short-term, but for a longer term investor the risks are lessened. However if an adviser recommends returns well above stock market returns then you really need to be asking questions. In the case of RAVF returns in excess of 20% were being promised while the market was averaging around 10%.

What investment could be offering a return higher than shares listed on the JSE and what additional risk is being taken in order to achieve those returns? If the answer is complicated and doesn’t make sense then it is best to walk away. Most of these scams are Ponzi schemes where the returns are paid by new investors into the fund rather than actual returns on underlying investments. It is only once the fund cannot find new investors that the fraud is discovered.

What you need to know:

  • Always be careful of sales men who knock at your door, selling you products with high returns – especially if they use words like “guaranteed”. Cash is the only guarantee anyone can promise. Do not buy a product because of promised returns but ask how this fits into your financial plan.
  • Be wary of taking advice from friends and family about “great investments”. Many of the investors in the Relative Value Arbitrage Fund were enticed by claims by friends and family of spectacular returns on their investment. The problem was that the returns were on paper only, not actually paid into their bank account.
  • Before you agree to buy any product, a “record of advice” must be issued by the adviser and the recommendation from his research. In the recommendation, the adviser needs to explain why that particular product was chosen above the other. You should have this “record of advice” in writing to protect yourself should it happen that the advice given was incorrect and the product was inappropriate to your needs.
  • If your adviser is pushy and puts you under pressure to sign the forms so he can close the deal as soon as possible, this should ring an alarm. If he charges extremely high commission, this is another red flag; he must fully disclose his commission in rands and cents, not in percentages.
  • Consumers must do their homework to ensure that the product they are investing in is approved by the Financial Services Board (FSB) and that the adviser is licenced. When you do this, you are protecting yourself if you later discover that the advice given was inappropriate and the product recommended was not appropriate to your needs. If it happens that the advice given was inappropriate, the consumer will get recourse from the FSB.“A Ponzi scheme is a fraudulent investment operation that pays returns to its investors from their own money or the money paid by subsequent investors, rather than from profit earned by the individual or organization running the operation. The Ponzi scheme usually entices new investors by offering higher returns than other investments, in the form of short-term returns that are either abnormally high or unusually consistent. Perpetuation of the high returns requires an ever-increasing flow of money from new investors to keep the scheme going” – Wikipedia

This article first appeared in City Press

2 CommentsLeave a comment

  • Dear Maya

    I was reading an article on Mail and Guardian and it prompted me to look at what people are saying about investments and returns. This is the article:

    http://mg.co.za/article/2012-09-28-00-caught-in-the-unsecured-credit-trap

    What struck me in particular is the following quotation regarding a microsaving group in Kwa-Zulu Natal called SaveAct:

    “The group also has a savings book of R15million and a loan book of R10million. It allows members to borrow up to three times the amount they have saved with it, and gives members a 30% average return on savings a year.”

    Surely there is something fishy going on here?

    • Will definitely have a look at it. At that rate of return one definitely needs to ask questions. I imagine they are providing returns based on the interest charged to borrowers but then depositors are fully exposed to defaults

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