I read an amusing article on on the weekend in which an investment advisor noted he finds many clients and even other advisors struggle with the concept of risk adjusted returns.

The greater the risk an investment might not be returned, the higher the return expectations.  Why would anyone  make a high risk investment without motivation; ( e.g., a higher return).

For Example

The article was about a typically Canadian investment vehicle, the Mortgage  Investment Corporation (MIC).  Created years ago by the Federal government to entice some alternate funding into a generally highly regulated sector (retail mortgages).

The advisor in question noted how a number of high net worth investors crowed to him each year how they were invested in a low risk high return mortgage investment corporation.

He asked these investors why the borrower took a mortgage loan from the MIC at 9% when all the major banks were offering mortgages at around 3% or less.

Do you think maybe the banks considered the loan too risky with a higher potential for loss.   That is the borrower represented a high risk investment.

In that case, the borrower took a mortgage from the MIC because they were the only ones that would take a chance on him.  And for the privilege he paid a premium (i.e., 6% above mortgage market rates).

Smarter than the Banks

It is doubtful those that invest in MIC’s have a good understanding of risk adjusted return, but these mortgage investment corporations are a great example of the principle.

Unfortunately there are far too many ill informed investors (and the MIC salesman isn’t going to tell them). It is not unusual for someone to make a large investment in an MIC only to be stunned when they can’t get their money back.

So, while these funds sell well, probably only a small number of the investors won’t be surprised if they suffer a risk event.  Sadly many are potentially in for a shock.