Proper Risk Disclosure
As someone who is new to investing, I am still getting familiar with the terminology that investors are exposed to on a day to day basis. The risk warnings contain a lot of strong wording, and they were really intimidating to me at first. But upon further review, a standard risk warning only does so much to warn investors of the risks associated with any particular fund. Let’s take a look at a standard risk disclosure, and examine about what risks it actually warns investors.
The risk disclosure found on the Index Fund Advisors website is an example of a standard warning. It reads like this: “WARNING: Past performance does not guarantee future results. Investment returns and principal value will fluctuate, so that investors’ shares, when sold, may be worth more or less than their original cost. Investing in any mutual fund, index or actively managed, does not guarantee that an investor will make money, avoid losing capital, or indicate that the investment is risk-free. Actively managed funds sometimes outperform index funds. An investor cannot determine in advance which actively managed fund will outperform the appropriate index. Just because a mutual fund is an index mutual fund, it does not guarantee a performance superior to an actively managed mutual fund. There are no absolute guarantees in investing.”
Some of the statements in this warning may lead us to believe that we can lose all of our money in an investment without legal recourse. For example, they say that no investment is risk-free and that they can not guarantee that you will not lose capital through investment. However, I recently found out about fund managers who sold LJM funds without disclosing the risks and now they could be in big trouble. People who invested in the LJM Preservation and Growth Fund were prompted with a standard risk warning similar to the one seen above. In February, that fund lost more than 80% of its value in just two days. This fund was partaking in extremely risky and complex investment strategies. They gave investors a standard warning, but failed to disclose the inherent risks with their unique tactics.
Surprisingly, there is actually a limit to how much one can lose before a hedge fund is considered to be acting negligently under the law. Investors recognize that by investing in mutual funds or index funds, they run the risk of losing a certain portion of their assets should the economy collapse or a certain sector do poorly. These investors are okay with this and in the worst situations they may end up losing a portion of their capital. Almost no investors will invest in a fund that exposes them to the chance of losing 80% of their investment, however. This is considered to be an extremely dangerous investment. Because of the inherent risks, LJM had a legal obligation to disclose their tactics to investors. When they failed to do this, they became legally responsible for the losses that their investors incurred. Thankfully, the attorneys are Erez Law are working to get this money back for investors.