Investments that crash: how to be wise before the event

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Can past investment failures act as a guide to what investors should avoid in the future? Keydata bonds and Arch cru absolute return funds collapsed separately six years ago, but it is only now that important new details about who and what caused the multimillion-pound failures have emerged – highlighting the potential pitfalls for investors.

Keydata

The latest "truth" to emerge about Keydata – which sold more than £350m worth of bonds invested in second-hand life policies (referred to as "death bonds") before it collapsed in June 2009 – is that its directors told investors the fund was performing much better than it really was.

Finance director Craig McNeil was "masking problems" from the then City regulator, according to the Financial Conduct Authority (FCA). In September it fined Mr McNeil £350,000 and banned him from working in financial services for life.

The FCA also plans to ban the former Keydata chief executive Stewart Ford and fine him £75m, also for misleading the regulator about Keydata's performance, and for selling the failed products as eligible for Isas when they were not, causing the investments' failure, the FCA said. But Mr McNeil and Mr Ford have come out fighting, disputing the FCA's claims and blaming Keydata's problems on the regulator as well as "an elaborate fraud".

Arch cru

New evidence has also now come to light on Arch cru – a range of funds that invested in everything from student accommodation to Greek shipping lines before it collapsed in March 2009. Investors who , as with Keydata, poured £350m into the fund range are still trying to get some of their money back.

Blame for the funds' pricing errors – a fatal flaw at the heart of the failure – has recently been levelled at their administrator, Bordeaux Services, by the Guernsey Financial Services Commission (GFSC), which has fined the company and its directors a total of £260,000.

Prior to Arch cru's collapse, financial advisers and potential investors in the fund range were shown impressive performance graphs, with a diagonal, straight line travelling from the bottom left corner to the top right representing the fund's continually rising net asset value (NAV).

But the NAVs on display, produced by Bordeaux, were inaccurate and "not properly reflective" of the actual value of the fund, the GFSC found.

This means that, during 2008 and 2009, investors were not given up-to-date information on which to base their decisions, and so continued pouring money into an investment that one of its creators, Jon Maguire, apparently knew was in enough trouble in November 2008 that he pulled his pension out of it.

Spotting the duds

So what do these two examples teach us about how to avoid potentially disastrous investments?

Russ Mould at the pension and investment platform AJ Bell said investors should be wary of unusual assets promising high returns, like Keydata and Arch cru. "A lot of the past failures seem to be invested in the same types of underlying assets – property, overseas hotels and real estate, life insurance investments and unlisted securities. So any investment promising headline returns from those types of assets should raise a red flag."

Other investments that should be treated with caution at the moment, he added, are car parking spaces, carbon credits, storage pods and renewable energy.

For Mould, the typical warning signs that the risks may be too high include:

* Investments that offer "guaranteed" returns. Are they really guaranteed, and if so, guaranteed by whom? If the returns are that good, why is someone prepared to share them?

* Unregulated schemes that deal with illiquid assets. Markets are very perverse in that liquidity – defined as the ability to sell when you want, in the volume you want and at the price you want – is plentiful when you don't need it but dries up when you do (usually at times of market stress). Investors should be very wary of assets they cannot sell easily or without the help of an expert – such as wine, car parking spaces and storage pods.

* Esoteric investments that promise much. No one really wakes up thinking that their finely tuned portfolio would be absolutely perfect if only it featured property in Grenada or a stake in a Chinese bamboo forest. This sort of investment is usually sold (hard) rather than bought and is more suitable for direct investors than advised clients.

* Complicated structures where the risk-reward balance is not clear. If a qualified financial adviser can't understand an investment, it is highly unlikely to be appropriate for a retail investor.