I REFER to media reports that various measures may be put in place to ensure that investment products better match investors' needs.

These responses to the fiasco over structured products like Minibonds seem to be focused on risk reduction.

But emphasising the risks of particular products, while well-intentioned, may in effect cause more problems and higher risks for most investors.

As most investors are risk-adverse, they may end up having investment portfolios that comprise entirely of apparently low-risk products.

For example, if one only has bank deposits which by definition have the lowest risk, the portfolio may not even be able to beat inflation, resulting in one's money literally getting smaller all the time.

Another example: if one invests entirely in bonds as they are the next least risky asset class after cash deposits, the portfolio may fall drastically in value, like in the early 1960s to early 1980s, when rising inflation and deposit rates resulted in bond prices declining by more than half.

The most sold product class in Singapore in volume since 2000 has been structured products that were capital guaranteed or capital protected.

I understand that more than three quarters of such products actually returned less than fixed deposit rates. The root of the problem may be the risk classification of such products as low-risk, which may have assured their popularity among investors.

Why do we keep coming up with "uniquely Singapore" risk classification systems, when there are established global best practices?

In my view, perhaps the simplest and surest measure we can take to ensure that what happened will not occur again is to ensure that the issue of diversification is addressed by every person recommending an investment product, and that every investor is aware of this.

The risk history and profile of investment products withinan asset class or type may change over time. For example, with the problems of CDS (credit default swaps), bonds as an asset class may become inherently more risky, as less of CDS may mean higher risk of default, higher funding costs, and so on.

Avoid complacency

We must avoid the complacency which led us to believe or perceive that most structured products were lower-risk.

The greatest risk maybe not taking any risk.

In this connection, I think it is instructive to note that, as I understand it, trustees in the United States are generally required to invest at least 20 per cent in equities, in order to "reduce risk"!

When more and more people believe that the risk is low, relative to the returns, for an investment product class (like structured products), you may have the makings of another investing bubble waiting to burst.

The key to helping Singaporeans to manage the risks of investing, is not risk reduction through risk classification systems, but rather to focusonrisk diversification.

From reader Leong Sze Hian

This article was first published in The New Paper on December 2, 2008.