Risks of Investing

A. General Investment Risks

  1. Market risk: It concerns the price level of the market, either in its entirety or in part, diminishing.

The five most common market risk factors are:

  • Share risk: risks associated with fluctuating share prices, caused by a wide range of factors.
  • Interest rate risk: upwards or downwards.
  • Currency risk: fluctuations in the value of sterling against other currencies.
  • Commodity risk: fluctuations in the price of commodities such as gold or other precious metals.
  • Changes of a share or other market index: can affect most investments but particularly if invested in index tracker funds
  1. Credit risk: Concerns the potential weakness of a contracting party fulling its obligations. This could be a dividend or interest payment for example.
  2. Liquidation: Sometimes known as ‘settlement risk’, it concerns the risk that one party will fail to deliver the terms of a contract with another party at the time of settlement.
  3. Liquidity risk: A financial risk caused when an asset cannot be sold on time or at a reasonable price.
  4. Transaction risk: The risk associated with unfavourable moves in a currency between the time a deal is agreed and settled.
  5. Fiduciary risk: The risk that an agent handling funds on behalf of a principal (e.g. a trustee) will not live up to his/her full fiduciary responsibility or act in the client’s best interest. This could be due to negligence or fraud.
  6. Diversification risk: Is the risk taken by an investor who invests all his money in only one financial instrument (i.e. too many eggs in too few baskets).
  7. Performance risk: The risk relating to the fluctuation of performance of the assets of the investment.
  8. Deflation (Inflation) risk: The General Index of Consumer Prices (RPI or CPI for example) affects the real value of invested capital and desired performances.
  9. Tax risk: Most or all investments fall within a particular tax regime which will be taken into account by your adviser. These are subject to change however and it has been known that such changes can be carried out on a retrospective basis.
  10. Systemic risk: Caused by the weakness of a financial institution fulfilling its obligations and having a ‘domino effect’ on other financial institutions or businesses being able to fulfil their own obligations.

B. Dangers/risks per category of investment instruments

Independent Financial Planning Ltd provides investment services which lead to transactions in the following financial instruments, thus involving the following basic risks:

  1. Bonds

A bond is a security which embodies the issuer’s promise to give money to the beneficiary. This obligation usually comprises the payment of capital during expiry and interest payments during the agreed period. They can be issued by governments or governmental bodies or by companies (known as corporate bonds). They are effectively a form of state or company borrowing.

The basic characteristics of each bond are:

a) Its nominal value which is not the same as the negotiation price, but is the sum which the issuer must pay at expiry of the bond

b) The interest rate (known as the coupon)

c) The expiry of the bond.

They are issued in various forms:

a) As non-secured bonds: the owner of the bond has a claim against the issuer like the rest of his creditors.

b) As secured bonds:

i) by real security in the favour of the issuer’s assets

ii) by guarantees of third parties

iii) by assigning claims etc.

Furthermore, the owners of bonds may enjoy additional protection according to special agreements with the issuer or because of their privileged standing against other bond owners or creditors.

c) Low security bonds: In case the issuer goes into bankruptcy the bond owner is satisfied only after all other creditors of the issuer. This is higher risk and is likely to be rewarded by a higher return.

d) Convertible or exchangeable bonds which embody conversion rights in shares or other financial instruments or exchange with other financial instruments.

The issuers must take the responsibility to pay the interest rate which might be stable or fluctuating, or determined on the basis of a generally well-known interest index rate such as EURIBOR, FIBOR or LIBOR.

Special attention must be given to complex bonds, whose interest rate is determined on the basis of complex interest rate indexes coming from product agreements. These indexes, which determine the interest rate on the basis of financial instruments products or other techniques for risk handling or for improving performance, are embodied into the entire structure of the bond. These bonds are included in the category of complex financial instruments and investing in these requires great attention and specialisation.

It is emphasised that the market value of these bonds is materially affected by the risks incorporated in them which shape the interest rate. They are not recommended therefore to non-specialised investors. The interest is paid, usually, in predetermined time intervals such as monthly, quarterly, half-yearly, annually or during the expiry of the bonded loan. Bonds without an interest share (coupon) are also issued and interest is incorporated in the value of the bond. The investors do not collect interest during the bond but obtain the bond with a discount to its nominal value, whereby the discount corresponds to the interest.

Investing in bonds has risks such as:

i) Insolvency risk: The issuer of the bonds might become insolvent and as a result be unable to pay its creditors interest or even the capital corresponding to the bonds. Special care must be taken when investing into low security bonds as the risk becomes much greater and it is possible to lose the entire investment.

ii) Interest rate risk: This risk increases as the duration of the bond increases, especially when interest rates are low. Changes in the interest rate can greatly affect the market price of the bond. When interest rates increase, the prices of bonds previously issued with lower interest rate will fall.

iii) Credit risk: The bond would have no value if the credit of the issuer was diminished.

iv) Premature repayment risk: It is possible, for bond issuers to predict in the schedule of the bond, the possibility of premature repayment, in case interest rates fall, in which case the expected profit from the bonds is altered.

v) Market liquidity risk: This risk is important in case the investor wishes to liquidate the bond before the expiry date. The lack of tradability might result in a lower nominal value of the bond.


C. Collective Investment Schemes (commonly known as ‘Funds’)

Funds are asset groups which are comprised of cash and movable values, which are under collective management and are kept by a trustee. For each of the elements of these asset groups there is co-ownership (sometimes known as ‘pooling’) of investors. Every investor has an independent ownership right in relation to the shares which he has bought. The collective management of the total assets of the Funds is being made by the management company and is always in the interest of the shareholders who mutually share all the profits or losses which might burden the Funds.

Investing in Funds can be doubly profitable for the investor. He might collect dividends provided that it is a Fund which distributes profits. In addition the investor might also benefit by any increase in the assets of the Funds because of an increase in the value of titles in which the Funds are investing in the market.

The risk in relation to a fund depends upon the structure of its assets, the chosen investment strategy and the skill-set of the manager. Their investment risk therefore will therefore vary  depending upon the underlying assets held within a Fund.

Detailed information concerning the risks relating a particular Fund can be found in the information document of each Fund. In every case it must be borne in mind that investing in such Funds does not offer guaranteed performance and involves a risk of losing some, or even all of the entire original investment.

D. Investment Trusts

Investment trusts are publicly listed companies that invest in financial assets or the shares of other companies on behalf of their investors. When you invest you are buying shares in an investment trust, the value of which fluctuates based on:

  • The underlying value of the assets they own; and
  • The supply and demand for their shares.

Investment trusts, unlike unit trusts, can borrow money to buy shares, which is known as gearing. This extra buying potential can produce gains in rising markets but also accentuate losses in falling markets.

Also, unlike with a unit trust, if an investor wants to sell their shares in an investment trust, they must find someone else to buy their shares, usually achieved by selling on the stock-market. The investment trust manager is not obliged to buy back shares before the trust’s winding up date.

The price of shares in an investment trust can be lower or higher than the value of the assets attributable to each share – this is known as trading at a discount or at a premium.


Investment Trusts will be subject to a combination of the risks associated with shares, bonds and funds in which they are invested – as such:

  • The value of the investment trusts, or the income derived from them, can decrease as well as increase and you may not necessarily get back the amount you invested; and
  • The level of risk and return will depend on the investment trust selected.

E. Enterprise Investment Scheme (EIS)

An EIS is designed to help smaller trading companies to raise finance by offering a range of tax reliefs to investors purchasing new shares in those companies. An investor must be aware of the following:

Investment risks:

a) There is generally no external market for shares issued by EIS Qualifying Companies and it could be difficult or even impossible, to realise the investment or obtain accurate performance information.

b) The return on any EIS Portfolio will depend greatly on the Manager’s performance. Past performance of any Manager is no guide to future performance.

c) EIS Shares are not be listed on a recognised Stock Exchange. An investment in EIS Shares should be regarded as a longer-term investment, with a minimum of three years to retain the tax reliefs, but potentially much longer for disposal or realisation of an the EIS investment. Realisation will generally depend on the exit strategy available to the Managers and this can be significantly affected by external market circumstances over which they have no effective control.

d) Investments in small or medium unquoted companies by their nature involve a high degree of risk and there is a strong possibility of EIS Qualifying Companies failing. Your capital is at risk and you may not receive back the amount invested or any return.

e) There is no guarantee that the market value of an EIS company will fully reflect the underlying net asset value. Investors should be aware that the value of an investment in an EIS Portfolio and the income (if any) derived from it may go down as well as up

f) The expected life of each EIS investment is three to five years or more.

g) EIS Managers reserve the right to realise an investment within the three-year period if this is considered by them to represent a worthwhile return on the investment. As this would jeopardise the availability (or continued availability) of appropriate EIS tax reliefs and benefits, it is only done under exceptional circumstances.

h) Any returns accrued from cash deposits will principally be affected by movements in interest rates

Commercial risks

a) Investee Companies may be exposed to exchange rate fluctuations which affect both the profits of the company and the value of the shares.

b) EIS Qualifying Companies typically have small management teams and are highly dependent on the skills and experience of a small number of individuals.

Tax and regulatory risks

a) Tax reliefs are subject to approval by HMRC in accordance with their qualifying rules, which could change from time to time.

b) It may take some considerable time from the date shares are issued to obtain the income tax relief.

c) Business Relief for inheritance tax only applies when an IHT event takes place and applies to shares but not to cash proceeds or cash awaiting investment. Shares must have been held for two or more years and must still meet the qualifying requirements.

d) There is no guarantee that EIS qualifying investments will be available for further reinvestment when the investment proceeds are returned to the Administrator.

e) The various tax benefits described in this Guide are based on Independent Financial Planning Ltd’s understanding of the current tax legislation and HMRC practice. This interpretation may subsequently be found to be incorrect. Tax legislation and HMRC practice may change in the future in a manner which could adversely affect your investment.

f) The amount of tax relief you may gain from subscription through Independent Financial Planning Ltd depends on your own personal circumstances. You are strongly advised to seek independent professional advice in relation to the tax implications of your investment.

g) The Managers will take all reasonable steps to make sure that tax relief is available on all investments made by the Portfolio. However, tax relief could be withdrawn or modified in certain circumstances and neither Independent Financial Planning Ltd, nor the Managers, nor the Administrator accepts any liability for any loss or damages suffered by you or other person as a consequence of such relief being denied or withdrawn or reduced.

h) You may lose some or all of the tax benefits derived under the EIS if you fail to comply with the relevant legal requirements. Such a situation might arise, for example, if you cease to be a UK tax resident during the Relevant Period or you receive value from an Investee Company, other than by way of an ordinary dividend, in the period commencing one year prior to the issue of EIS Qualifying Shares to the end of the Relevant Period.

i) Where an Investee Company ceases to carry on a Qualifying Trade during the Relevant Period, whether through the actions taken by the Investee Company or otherwise, its EIS qualifying status may be adversely affected and so could the tax relief available to you. No guarantee can be given that all investments made by the Managers will carry on a Qualifying Trade, or continue doing so, for the purpose of claiming tax relief. The Managers will, where possible, implement measures to reduce this risk, such as seeking advanced assurance from HMRC that each company in the Portfolio is an EIS Qualifying Company.

j) The Investor is advised that there may be a delay in investing into funds after the Acceptance Date and that certain Tax Benefits may not apply until the monies are fully invested in accordance with the Investor Agreement.

k) No guarantee can be given that an Investee Company will retain EIS qualifying status.

l) Any disposal of EIS Shares during the Relevant Period will crystallise an obligation to repay the income tax relief claimed in respect of those shares, and any capital gain will be subject to capital gains tax.


F. Venture Capital Trusts (VCT)

VCTs offer investors the chance to invest in small firms to help them grow. The government offers generous tax breaks to VCT investors, but they are higher-risk and longer term than conventional investment – e.g. investors would be exposed to substantially higher risks than mainstream equities for example.

VCTs should only be considered by sophisticated investors with significant investment portfolios who can take a long-term view and are comfortable with higher risks. The Financial Conduct Authority (FCA) suggests a sophisticated investor is somebody who self certifies that they have the skills to hold these investments, due to specific previous investing experience.

VCTs are unlikely to be suitable for mainstream investors who may need access to their money in the short term, or for whom loss of the investment will cause financial hardship. VCTs invest in smaller, sometimes fledgling, companies, some of which could struggle or fail altogether, meaning losses for investors. The VCT manager may also have difficulty selling the underlying investments. Investors should also be aware that VCT shares are illiquid. This means they can be difficult to sell (and buy) on the secondary market. Although shares are fully listed on the London Stock Exchange, there might be only one ‘market maker’ for the shares, which means investors may have difficulty selling at a price that fairly reflects the value of the underlying holdings or, in extreme circumstances, at any price.

Often the VCT manager will offer to buy back investors’ shares at a target discount to the value of the underlying holdings. Details of any such buyback schemes can be found in the prospectus. They are subject to conditions and not guaranteed.

A long-term horizon is essential with VCT investing. Aside from ‘limited life’ VCTs that look to wind up after a 5-7-year time period, a ten-year time horizon is desirable. This is because it takes time for expanding businesses to fully realise their potential.

Investors should also be aware of risks affecting specific VCTs and VCT types. For instance, a further issue arises from smaller VCT funds who fail to raise enough money at launch. The resulting portfolio of investments may be more concentrated, and it could increase the risks and charges. It is also worth noting that all VCTs tend to have higher charges than other types of fund and usually have performance fees.

As well as investment risks, it is possible that HMRC could withdraw the tax status of the VCT if it fails to meet the qualifying requirements. If this happens any tax rebate may have to be repaid. Each VCT will issue a prospectus at launch which gives details of specific risks and it should be read thoroughly before considering an investment.

G. Structured products, including structured deposits

A structured product is a kind of fixed-term investment whose pay-out depends on the performance of something else, like a stock market index. There are two main types of structured product:

  • Structured deposits – Structured deposits are savings accounts, offered from time to time by some banks, building societies and National Savings & Investments, where the rate of interest you get depends on how the stock market index or other measure performs. If the stock market index falls, you will usually get no interest at all. But – unlike structured investments (see below) the money you originally invest has the same protection as you get with any other savings account.
  • Structured investments – Structured investments are commonly offered by insurance companies and banks. Your money typically buys two underlying investments, one to protect your capital and another to provide the bonus. The return you get depends on how the stock market index or other measure performs. In addition, if it performs badly or the firms providing the underlying investments fail, you might lose some or all of your original investment.

When you buy a structured deposit, you agree to tie up your money for a set time – often five or six years – in return for a lump sum at maturity. The amount you earn depends on how well something else performs – often a stock market index such as the FTSE 100.

When you buy a structured investment, you also agree to tie up your money for a set period. Some of these products offer you a lump sum at maturity depending on the performance of the stock market index or other measure.  Others may mature early and provide a bonus, for instance at policy anniversary if a market condition is met.

Risks of structured products

a) Structured deposit: these give you the possibility of getting a stock market return without risking your capital as you would if you invested directly in shares. But bear in mind that:

  • You might get less interest than you would have done with an ordinary savings account – or no interest at all.
  • If you invested in shares instead, you would potentially benefit from a rise in the stock market index (share prices) – and you would usually receive income in the form of dividend payments as well.

b) Structured investments: If you take out a structured investment the insurance company will buy some underlying investments from one or more other companies, often referred to as ‘counterparties’. These investments can often be complex in nature.

You will not be a client of the counter-parties, and therefore you won’t have any agreement with the counterparties. As such, if any of them fails, so that your structured investment fails to give you your money back or provide the promised return, you will not have any direct claim on the counterparty and no compensation scheme would apply. Instead, you would have to try to seek redress from the insurance company that sold you the product.