First Principles: Identifying The Source of Investor Risks

This article was originally published on Financial Newswire on 17 September 2025. You can view it here

When investors lose capital, the industry naturally seeks to identify who is to blame. Was it the Responsible Entity? The Trustee? The Platform? The AFSL Auditors? The Regulator? The AFS Licensee? The Adviser?

Accountability matters. But finger-pointing could take years to produce meaningful change, by which time the next “First Guardian” or “Dixon” may have already attracted millions from unsuspecting Australians.

Investors cannot afford to wait for another royal commission, regulator overhaul, or lengthy courtroom battle. Learning from past mistakes is essential, but the immediate priority is clear: act now to put stronger protections in place for investor funds.

Stripping Back to the Real Sources of Risks

A first principles approach breaks a problem down to its most basic components and builds back up from there. It avoids labels, assumptions, or conventional wisdom. Labels like MIS, MDA, ROA, or IDPS can obscure the real question: Where does risk to investors actually arise?

Pillars of Investor Protection

First principles highlight six pillars to assess investor safety:

1. Ownership: Who truly owns the assets?  Can their existence be independently verified?

2. Liquidity: How fast can the portfolio be converted to cash?

3. Execution: How quickly are manager decisions reflected in portfolios?

4. Portfolio Construction and Rules: What limits (e.g. asset class, sector and security level) ensure diversification and discipline?

5. Asset Scope: What is allowed or excluded? Unlisted related-party MISs are a red flag.

6. Governance: What ongoing accountability checks exist e.g. daily valuation, fee clarity, independent oversight, audit trails?

These pillars shift the focus from labels, marketing, or promises to the real question: What are the risks to capital?

Appling the Framework

A service built around these pillars might operate like this:

• Ownership – Assets are always held in the investor’s name and can be reconciled through CHESS, an independent source of truth.

• Execution and Liquidity – Manager decisions implemented within minutes. Full portfolio can be liquidated in a single trading day.

• Rules and Portfolio Construction – Strict exposure caps and diversification limits at asset class, sector, and security level.

• Asset Scope – Only cash, term deposits, and listed securities on regulated exchanges are permitted. Related-party lending or other assets, derivatives, leverage, and structured products are excluded.

• Governance – Daily mark-to-market pricing, separation of decision-making from implementation, fee clarity and a full real-time independently verifiable audit trail ensure accountability.

  
  

Comparing options against these criteria makes it easier to identify and manage risk. Awareness of potential red flags, such as lending to parties related to the investment manager, can prevent avoidable losses.

The Way Forward

Breaking risk down to first principles provides more clarity than waiting for others to accept responsibility or relying on broad labels like “MISs are risky” or “MDAs are risky.” The more practical question is whether these core protections are present.

Significant losses have already occurred while the industry waits for change. Advisers and investors cannot afford to wait. A path forward is to demand clarity on ownership, liquidity, portfolio rules, asset scope, and governance, and to avoid products that do not provide it.

If these principles are applied consistently, investor outcomes improve. If not, the cycle of failures will likely continue under new names and even greater losses.