High-Risk Investments: Which Ones Are Losing Value?

High-risk investments are not for the faint-hearted. While they may offer the prospect of substantial returns, they are marred by various types of risks. Some of the riskiest investments that have been decreasing in price include cryptocurrency, consumer discretionary stocks, high-yield bonds, stocks of highly indebted companies, and cyclical industrial companies. Cryptocurrency, for instance, is not backed by the assets or cash flow of any entity, and its value is solely determined by market sentiment. Similarly, consumer discretionary stocks are vulnerable to economic downturns as they depend on the overall health of the economy. High-yield bonds, meanwhile, can be issued by good or awful companies, making it crucial to assess each firm's quality. Highly indebted companies, on the other hand, face challenges in a downturn due to their debt burden, and cyclical industrial companies experience rapid fluctuations with the economy.

Initial Public Offerings (IPOs)

An Initial Public Offering (IPO) is the first time a private company sells shares of its stock to the public on a stock exchange. This is also known as "going public". IPOs are often used by companies to raise significant capital to fund new growth, pay off debt, or pay off early investors.

The IPO process is lengthy and involves a lot of preparation. Companies must meet requirements by exchanges and the Securities and Exchange Commission (SEC) before holding an IPO. Investment banks are hired to market the IPO, gauge demand, set the IPO price and date, and more.

There are several advantages to a company going public, including:

• Access to investment from a wide range of investors, which raises capital
• Increased transparency, which can lead to better credit borrowing terms
• Higher exposure, prestige, and public image, which can help sales and profits

However, there are also disadvantages, such as:

• Fluctuations in share price can be a distraction for management
• Increased time, effort, and attention required of management for reporting
• Loss of control and stronger agency problems due to new shareholders
• Increased risk of litigation

The price of an IPO is usually set by the underwriters through a pre-marketing process. The most common technique used is discounted cash flow, which is the net present value of the company's expected future cash flows. Other methods include equity value, enterprise value, and comparable firm adjustments.

While IPOs tend to be popular among investors due to the potential for volatile price movements, buying shares during an IPO comes with high risks. There is no guarantee that the company will perform well in the future, and the offering price announced ahead of the IPO is usually reserved for institutional investors, employees, and large clients.

Overall, while an IPO can provide a company with many benefits, it is also a complex and costly process that requires careful consideration and analysis.

Venture Capital

In recent years, there has been a decline in VC funding and a decrease in the number of deals and total investment amounts. The total amount of VC investment in 2023 was $170.6 billion across 15,766 deals, a significant drop from the $242.2 billion invested across 17,592 deals in 2022. This decline can be attributed to various factors, including the collapse of Silicon Valley Bank, a challenging market for exits and fundraising, recession fears, an unstable geopolitical situation, and relatively high-interest rates.

The decline in VC investment has led to a decrease in the number of startups receiving funding and the level of funding committed. The number of mega-funding deals, where a startup receives $100 million or more, has also decreased sharply. Additionally, there has been a pullback from non-traditional investors, such as hedge funds, private equity firms, and corporate investors, who have refocused on their core businesses.

The challenging market conditions have particularly impacted late-stage and expansion investments, which saw a 23% decrease in the first quarter of 2016 compared to the previous year. However, seed- and early-stage investments have shown some resilience, with a 17.7% increase in funding during the same period.

Despite the overall decline in VC investment, there are reasons for optimism. Artificial intelligence (AI) companies accounted for about 20% of VC deals in 2023 and one-third of all VC dollars invested. AI and generative AI are expected to attract significant VC attention and investment in the coming years. Additionally, there are hopes for a recovery in the M&A and IPO markets, which could provide liquidity to VC funds. Gradual declines in interest rates and a large amount of dry powder available for investment could also contribute to a VC market recovery.

Real Estate Investment Trusts (REITs)

REITs are companies that own and operate real estate properties. They are traded like shares of stock on exchanges, providing exposure to diversified real estate holdings. REITs can be a great way to invest in real estate without having to own property yourself.

REITs are required to meet certain standards set by the IRS, including:

• Returning a minimum of 90% of taxable income as shareholder dividends each year.
• Investing at least 75% of total assets in real estate or cash.
• Receiving at least 75% of gross income from real estate sources, such as rents or mortgage interest.
• Having a minimum of 100 shareholders after the first year of existence.
• Ensuring that no more than 50% of shares are held by five or fewer individuals during the last half of the taxable year.

By adhering to these rules, REITs don't have to pay tax at the corporate level, which allows them to finance real estate more cheaply and earn more profits to disburse to investors.

There are three broad categories of REITs: equity, mortgage, and hybrid REITs. Equity REITs operate like landlords, collecting rent and providing upkeep. Mortgage REITs, on the other hand, don't own the underlying property but instead own debt securities backed by the property, such as mortgages. Hybrid REITs combine both strategies.

REITs can also be classified as publicly traded or non-traded. Publicly traded REITs are traded on exchanges and tend to have better governance standards and transparency. Non-traded REITs, on the other hand, are not publicly traded, making them harder to value and less liquid. They may also have higher fees and account minimums.

When considering investing in REITs, it's important to keep in mind the potential risks involved. These include:

• Interest rate sensitivity: Rising interest rates can lead to a decrease in REIT prices as investment capital flows into bonds.
• Choosing the wrong sector: Investing in REITs focused on declining sectors, such as suburban malls, can be risky.
• Tax implications: REIT dividends are taxed as ordinary income, which may result in a higher tax rate for investors.
• Property-specific risks: Certain types of REITs, such as those focused on hotels, may perform poorly during economic downturns.

Despite these risks, REITs offer several advantages, including:

• Steady dividends: The high dividend yields of REITs make them attractive for investors seeking regular income.
• High returns: REITs have the potential to outperform equity indexes, providing attractive returns.
• Liquidity: Publicly traded REITs offer better liquidity compared to buying and selling actual properties.
• Lower volatility: Due to their larger dividends, REITs tend to be less volatile than traditional stocks.

In conclusion, REITs can be a valuable addition to a diversified portfolio, offering exposure to the real estate market and the potential for strong returns. However, investors should carefully consider the risks involved and conduct thorough research before investing.

Foreign Currency

A country's currency exchange rate is influenced by several factors, including inflation rates, interest rates, account deficits, trade balances, and public debt. A country with a low inflation rate typically experiences a higher currency value, as its purchasing power increases relative to other currencies. On the other hand, higher inflation rates can lead to depreciation in a country's currency compared to its trading partners, often accompanied by higher interest rates.

Interest rates also play a crucial role in currency values. Higher interest rates can attract foreign capital and cause a country's exchange rate to rise. However, if a country's inflation rate is significantly higher than that of other countries, the impact of higher interest rates may be mitigated.

Currency risk, also known as exchange-rate risk, refers to the possibility of losing money due to unfavourable changes in exchange rates. This risk is inherent in investing in foreign securities or operating in overseas markets. For example, if a US investor holds stocks in Canada and the Canadian dollar depreciates against the US dollar, their realised return will be lower than expected.

To manage currency risk, investors can consider investing in countries with strong and rising currencies, such as Switzerland, known for its stable political system and low debt-to-GDP ratio, or New Zealand, which benefits from stable exports in the agriculture and dairy industry. Additionally, investing in countries that have their currencies pegged to a stable currency, like China, can be a strategy to mitigate currency risk. However, it is important to note that central banks may adjust these pegging relationships, potentially affecting investment returns.

Another way to manage currency risk is through hedging, which involves using forex, futures, options, or other derivatives to offset the impact of currency fluctuations. Many institutional investors and multinational corporations employ these strategies to protect their investments and business operations from unpredictable losses due to exchange rate changes.

In summary, foreign currency investments carry a high level of risk due to the constant fluctuations in exchange rates, which can be influenced by various economic factors. These changes can impact the competitiveness of exports, revenue for multinational companies, and investment returns. To mitigate this risk, investors can consider investing in countries with strong currencies or those with pegged exchange rates, as well as employing hedging strategies using forex, futures, and options.

Penny Stocks

However, penny stocks can offer the potential for high returns. Their low market capitalisation means that it takes a relatively small amount of money to move their share prices substantially. Positive news, such as signing a major customer, can lead to sizable returns. Penny stocks also attract investors with a small amount of trading capital, as their lower share prices allow investors to buy thousands of shares.

• Myomo Inc: A medical robotics company that has grown substantially after Medicare said it would cover its flagship product, the MyoPro brace.
• Expion360 Inc: An electrical equipment company that makes lithium iron phosphate batteries for recreational vehicles, as well as battery charging systems and home energy storage products.
• Akebia Therapeutics Inc: A pharmaceutical company that produces therapies for individuals with kidney diseases, both dialysis and non-dialysis dependent.
• FLJ Group Ltd: A China-based real estate company that leases apartments and offers utility services to tenants.
• Inhibikase Therapeutics Inc: A biotech company that develops pharmaceuticals to treat Parkinson's disease.
• Regent Enterprises: A company that has demonstrated impressive income growth, with a 25.09% increase in total income in the quarter ending in March 2024.
• Oricon Enterprises: A company that has shown variability in total income but remains on a growth trajectory, with a notable 23.61% increase in total income in December 2023.

In summary, penny stocks can be a risky investment option due to their low liquidity and potential for sudden price fluctuations. However, they can also offer the potential for high returns, making them an attractive option for investors with a high-risk tolerance.

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