Unit Trust Risk-Return Part 1: The Sharpe Ratio

In any financial investment, risk and return go in parallel. Guaranteed return is known as risk-free return, and almost always refer to either Fixed Deposit rate or Malaysian Government Securities coupon rate. If you are buying government bond such as Greece, it is no longer risk free anyway! FD rate seldom goes beyond 4%; here's a summary of the current risk free rate of return (FD).


Sharpe ratio of an investment refers to how well the investment generates a return taking into consideration the risk. Risk is high when the investment nature has high volatility - tendency for its value to soar or to plunge excessively within a specific timeframe when benchmarked against the overall market activity.

The Grim Reaper Investment Fund

...aka the controversial Life Settlement Fund.

What happens is this:

1. A life insurance policy owner has coverage of $1 million, and has paid a total of $200k premiums for the last 20 years.
2. The policy owner offers to sell his policy at $500k.
3. A third party pays the policy owner $500k cash, and essentially becomes the legal beneficiary of this policy.

Motivation for policy owner to do this

1. No longer need the policy, but instead of letting it to lapse, which essentially means insurance company pocket up the $ 200k premium, he can make immediate cash out of it.
2. The surrender value of the policy is way lower than its sale value or total premiums paid.
3. No longer can afford to pay the premiums - but reselling it for quick moolah is better than letting it lapse.
4. Need additional, immediate cash for medical treatment after exhausting every financial channels.

Imagine you are the third party who purchased this policy - you rate of return is directly related to how soon the policy owner dies. I was like "WTF?, there is not other investment more ghoulish than this!" And this is actually near to risk-free, say if he dies after 1 year, your rate of return is (1 mil/0.5 mil) x 100% = 200%!. Even if he dies after 5 years, your rate of return would have been 14.9%, guaranteed! 

They say, there are only 2 things in life are certain- death and taxes!

Seems like a win-win situation? Not so.In most investments, either the seller or the buyer will be the loser in a zero-sum game but here, the biggest loser is the rightful beneficiaries of the policy owner - the spouse (if still alive) or the children (that's if the policy owner intends to leave the $1 mil as an estate to them). Still, I think if there's no surviving spouse or children, then this could be close to a win-win scenario. However, another argument is, if there's advancement in medical technology which prolongs the life expectancy of the population, then investors' rate of return would be drastically reduced. In other words, the key to profitability is an accurate projection of life span.From investor standpoint, the risk is reduced if the policy owners are those in their twilight years. Ah, how morbid!

Again, Malaysia being a conservative nation, you don't have this. Then again, would you be able sleep to sleep at night knowing there is someone out there who is eager to see you kick the bucket ASAP so he can reap a profit? That's why it is almost irrational to trade these investments Over The Counter; in reality, they are managed as mutual funds. Hey, those funds are somehow as good as high grade corporate bonds, but with higher yield! Better yet, they are absolutely negatively correlated with the business cycle. You still get your ROI, albeit variable - due to one and only factor - how soon people die! Widespread, unexpected early deaths (a pandemic of sorts, more deadly swine flu anyone?) will result in windfall for life settlement funds investors.

I bet if this is legalized in Malaysia, Ah Longs' drastic shift in their modus operandi would be to buy their borrowers' policies, and when borrowers failed to pay up, they will happily chop you up, no questions asked! No more taunting or splashing red paints or hanging pigs head!

What is bond?

Bond is a fixed income securities. If issued by private sector, it is known as corporate bond whereas government bond is also known as Malaysia Government Securities (MGS). It is considered a debt instruments to raise capital to finance expenditure or working capital, without diluting the ownership rights (unlike shares).

Bonds are usually risk free investment, especially for government bonds unless you are living in nation like Greece where government could default on its debt. From investor perspective, they will lend an amount of money to the bond issuer, and in return they will get a predetermined rate of return (coupon payment, usually within 5 to 10 percent) from their capital annually/semi-annually/quarterly. In addition to this, the capital will be repaid to the investor when the bond 'matures', normally within 1 year for short-term bond (aka Treasury Bills) and 10 years for long-term bond (MGS) . This final capital repayment actually be more or less than the initial capital invested, the former known as discount bond and the latter as premium bond. In short, investor is guaranteed to be compensated in periodical coupon payment in addition to the value of discount of the bond 'price'.