5 Questions to Ask When Someone Promises 'Guaranteed' Returns: A Guide for UAE Investors

What are 'Guaranteed' Returns?

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Every investor asks the same old question before investing: Are the returns guaranteed? But what exactly are guaranteed returns and can returns truly be guaranteed?

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Wealthy individuals seek protection. They have worked hard for their money, fought to advance their careers and businesses, and amassed wealth through tireless dedication. Now, with wealth in hand, their primary goal is consistently to safeguard it over extended periods. Hence, discussions on guaranteed returns and principal protection invariably grab their attention.

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Unfortunately, the notion of 'guaranteed returns' is akin to believing in unicorns – both are nonexistent. The term 'guarantee' is essentially a myth. Even the money in your pocket or your home vault isn't guaranteed; it can be lost or stolen. Surprisingly, even investments in fixed deposits in banks don't 'guarantee' returns! Banks can only assure returns under normal circumstances, yet instances of banks failing, like Lehman Brothers or Northern Rock, have been witnessed. In such cases, people lose not just their returns but can lose their entire capital.

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Trusting guaranteed returns is like pretending everything is fine when it's not. The reliability of the guarantee depends solely on the credibility of the guarantor, primarily corporate entities that can cease to exist. When opting for guaranteed returns, you essentially entrust your funds to a corporate legal entity. This entity, in turn, assumes a certain project risk, offering you a fixed return as compensation for their confidence in generating a superior variable return based on the success of the undertaken project.

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In the contemporary landscape, esteemed banks or corporate institutions engaged in lending can effortlessly attract significant capital by guaranteeing the return of principal and promising returns within the range of 5% to 6.5%. Consequently, when confronted with an offer of guaranteed returns exceeding 7%, a thorough exploration of associated risks becomes important. The rationale is that, in the absence of substantial risk, these entities would have been capable of attracting significant capital at lower rates comparable to established institutions like CitiBank or LVMH. Hence, the main focus of this article is to evaluate the inherent risks associated with a heightened guaranteed return, especially one as extraordinary as 18%.

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Let’s look at a few questions that are fundamental to making informed and responsible investment decisions, when promised guaranteed returns in the UAE.

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Questions to ask when someone promises you guaranteed returns

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Who regulates this entity that's promising the guaranteed return?

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It's crucial to identify the regulatory body overseeing the entity making promises of guaranteed returns. A reliable and reputable regulatory body, such as the Financial Services Regulatory Authority in the Abu Dhabi Global Markets or the Dubai Financial Services Authority in the Dubai International Financial Center, ensures that the organization operates within legal and ethical boundaries, offering a layer of protection for investors.

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How is it guaranteed?

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Understanding the mechanism behind the guaranteed returns is essential. Whether it involves insurance, collateral, or a specific financial instrument, investors should have clarity on how the promised returns are secured. This question aims to reveal the transparency and reliability of the guarantee, helping investors assess the legitimacy of the investment proposition.

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Who ensures the protection of my investment, and has due diligence been conducted on the company's financials?

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This question addresses the protective measures in place for investors and emphasizes the importance of due diligence. Investors should inquire about risk mitigation strategies, insurance coverage, and the thorough examination of the company's financial health. Verification of financial statements, audits, and a comprehensive understanding of the company's fiscal responsibility are crucial components in ensuring the protection of investments.

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What happens if the institution ceases to exist?

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Contingency planning is vital. Inquiring about the consequences if the institution offering guaranteed returns faces financial difficulties or ceases operations provides insight into the potential risks involved. Understanding the exit strategy and safeguards in place ensures investors are prepared for unforeseen circumstances and potential financial downturns affecting the institution.

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Is the investment logical?

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Assessing the logic behind the investment proposition is fundamental. Investors should scrutinize the business model, market conditions, and the feasibility of the promised returns. If Company A is guaranteeing an 18% return but has a similar credibility to Company B that is able to source billions of dollars from investors by guaranteeing a 10% return, why would Company A be promising 18%? Logical investments are grounded in sound financial practices and a viable strategy, contributing to investor confidence and reducing the likelihood of unexpected setbacks.

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A note on government guarantees or lending

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Governments secure funds to finance their public projects and expenditures. Two crucial aspects to consider:

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What is their capacity to return the funds?

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An illustrative example is the US Government, which essentially controls the flow of USD. If you are holding USD and intend to continue holding the currency, US Government guarantees represent the safest, most secure form of lending. However, the viability of such lending depends on the sustained purchasing power of the USD. Conversely, when a non-US government acquires funds to finance its projects, an assessment of their ability to repay becomes important, given historical instances of government defaults, as witnessed in events like the Greek debt crisis.

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FX risk

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Additionally, when a non-US government seeks funding while guaranteeing principal and returns, it's crucial to recognize the presence of FX risk. Consider Egypt or Turkey as examples; they have frequently borrowed in USD, yet their government tax income and project revenues are denominated in EGP or TRY, which have significantly devalued over time. Consequently, while they owe money in USD, their assets and income are in a currency that’s significantly less valuable, making it quite challenging for repayment. In their perspective, every depreciation in their currency's value elevates their debt burden, intensifying the difficulty of repayment.

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Conclusion

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Asking these questions is crucial for making informed and responsible investment decisions.

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It's important to realize that guaranteed returns are a myth. Every investment should be supported by thorough research and proper calculations. Investors need to understand the associated risks and assess whether the investment aligns with their risk profile. This can be done through self-analysis or by consulting a financial advisor. Investors should participate only when they understand what are the risks they are subscribing to and be comfortable with the reward given for this risk.