Warren Buffett once famously described derivatives as "financial weapons of mass destruction". Sometimes dubbed the "Sage of Omaha", Buffett is known as much for his great wisdom as his great wealth. His ability to distil complex matters of financial markets is second-to-none.
This is why the founder and chairman of the Berkshire Hathaway investment empire detests derivatives. He knows well the only people who make money out of derivatives - be they warrants, options, futures, CFDs, CDOs et al - are the people who concoct them and/or sell them not those who buy them.
"I view derivatives as time bombs, both for the parties that deal in them and the economic system," Buffett once said. It is no small irony then that an Australian firm is actively promoting a Warren Buffett derivative: "The opportunity to invest in Berkshire Hathaway" no less, "the company owned and run by the greatest investor of all-time Warren Buffett".
That's correct, self-professed "leading investment services company" JB Global does not describe its Berkshire Hathaway Income and Equity Accelerator offering as a derivative at all. JB founder Justin Beeton is rather more effusive than that, telling a recent investment seminar that this was a "capital protected investment in Berkshire Hathaway".
Our source at the seminar however, having captured the proceedings on tape, makes the point that there is no capital to protect. Neither is the product a mere derivative. It is a "derivative squared", a "derivative of a derivative" if you like.
How that gels with what Justin Beeton was telling wide-eyed investors at the seminar ... well, readers can be the judge: "What I'm talking about is just buying the one company ... What I'm talking about is refinancing your properties. Getting all the equity you can, putting your superannuation ... set up a self-managed super fund, put it all in Berkshire Hathaway. Call up your grandma and say, 'Look, I'm not going to wait for you to die before I want your inheritance. I want it now'." And invest it all, all that money, in Berkshire Hathaway.
"Who's confident to do that?
"Why not?"
Why not indeed?
Let's preface our remarks with the observation that Beeton and his structured products partners at the Royal Bank of Scotland (RBS) have made it nigh-impossible for your humble reporter to adhere to his New Year's resolution to give up sarcasm.
We beg your forbearance, dear readers, if we momentarily lapse and descend into snide and flippant commentary.
More from Justin at the meeting: "So that's if it just goes up 22 per cent per annum. But as I said before, the returns where Warren Buffett has been phenomenal have been the years following a crisis.
So if history repeats itself, the next three or four years should be pretty spectacular.
"Let's look at the rate of return 364 divided by 200 is 82 per cent over the three-year period. Return on your investment, you've made 164 grand divided by 37, that's a 438 per cent return on your investment.
"Because we can overlay capital protection with leverage, the actual return on your investment can be phenomenal. And that's just if it does 22 per cent per annum like it has done the last few years.
"You should have enough confidence to invest even grandmum's money in the shares."
What, exactly, would grandmum be buying? Buffett himself would be hard-pressed to make head or tail of this PDS but it seems 20? of grandmum's $1 would go into a call option over Class B shares in Berkshire Hathaway. Grandmum's remaining 80? seems to be placed in a bond issued by RBS.
Amid the expanse of abstruse jargon in the PDS, JB refers to the purchase of "units", as if there were an actual investment here. Rather, these "units" are a Deferred Purchase Agreement, or nothing better than a right to some "Delivery Assets" - shares in BHP, Westpac and the like, not Berkshire Hathaway - at some future point.
There appears to be a promise from RBS that it will pay out a return calculated by reference to "volatility managed exposure" to call options in Berkshire Hathaway. This is not even an investment in a derivative over Berkshire Hathaway. It is an investment in a promise of returns that are derived from a derivative. A synthetic exposure to a synthetic exposure.
As for the RBS bond bit here we scale the pinnacle of structured finance. RBS is both the issuer and holder of the bond the bond is nothing more than an unsecured obligation of RBS to RBS.
Such is the complexity and circularity of this byzantine offering that perhaps it should not have been marketed at all to retail investors, even more so as it is an over-engineered derivative masquerading as a "safe investment" and marketed at the very risk-averse retail investor who is seeking capital protection.
The last word should go to our source: "You have a 'loan' that is never lent, a 'bond' that is not an obligation of any person, an 'investment amount' that is never invested, and 'capital protection' where there is no capital to protect.
"This is Through the Looking Glass nonsense: "When I use a word," Humpty Dumpty said, in rather a scornful tone, "it means just what I choose it to mean - neither more nor less."
Humpty Dumpty was not just a fictional character. He is alive and well and drafting product disclosure statements for RBS and JB Global.
mwest@fairfaxmedia.com.au
See smh.com.au/business on Monday for further revelations.
Frequently Asked Questions about this Article…
What is JB Global’s “Berkshire Hathaway Income and Equity Accelerator” and how does the structured product work?
According to the article, JB Global marketed the Accelerator as a “capital protected investment in Berkshire Hathaway,” but the product is actually a complex structured offering. It allocates a portion of money into a bond issued by the Royal Bank of Scotland (RBS) and the remainder into exposure tied to call options on Berkshire Hathaway Class B shares. The “units” sold are Deferred Purchase Agreements (rights to future “Delivery Assets” such as shares in companies like BHP or Westpac), not direct shares in Berkshire Hathaway — effectively a synthetic, layered derivative exposure rather than a straightforward stock purchase.
Is the JB Global product truly capital protected?
The article says the product’s claim of capital protection is misleading. The so‑called protection relies on an RBS-issued bond that, in the PDS, functions as an unsecured obligation of RBS to itself. The reporter’s source argues there is “no capital to protect,” so retail investors should not assume the offering guarantees their original money.
How does this product use derivatives, and why is that important for everyday investors?
The offering creates a synthetic exposure to Berkshire Hathaway via call options — in other words, a derivative — and the returns being promised are derived from that derivative (a “derivative of a derivative”). The article highlights Warren Buffett’s long-standing warning that derivatives can be extremely risky («time bombs»), and points out that sellers and arrangers, not buyers, are typically the parties who profit from complex derivative structures.
Who are the key parties involved and what risks do they introduce (JB Global, RBS, promoters)?
JB Global marketed the product and its founder Justin Beeton promoted it at seminars. RBS acted as the structured‑products partner and issuer of the bond component. The article flags issuer and counterparty risk (the bond is an unsecured obligation of RBS), marketing that may overstate protection, and a high degree of complexity and circularity created by the arrangement — all of which increase risk for retail investors.
Are investors buying actual Berkshire Hathaway shares when they invest in this product?
No. The article explains that investors are buying “units” that are Deferred Purchase Agreements, not direct shares in Berkshire Hathaway. Those units may entitle investors to receive other “Delivery Assets” (examples given include Australian stocks such as BHP and Westpac) at some future date, rather than Berkshire Hathaway stock itself.
The promoter suggested refinancing property or using super to invest — is that advisable for retail investors?
The article describes the promoter encouraging aggressive moves like refinancing properties or putting super and inherited money into the product. Given the product’s complexity, leverage, synthetic exposures and the questionable nature of the capital protection claim, the article implies such strategies would be risky and likely inappropriate for risk‑averse retail investors.
What red flags should everyday investors watch for in a product disclosure statement (PDS) for structured investments?
Based on the article, watch for: unclear or misleading use of terms like “capital protection,” whether your money is actually invested or merely used to create synthetic exposures, who the issuer and counterparties are (and whether bonds are unsecured), heavy use of derivatives or multiple layers of derivatives, circular or opaque structuring, and marketing messages that promise outsized returns or encourage leveraging personal or family assets.
How can Warren Buffett’s views on derivatives help everyday investors evaluate complex structured products?
The article cites Buffett calling derivatives “financial weapons of mass destruction” and “time bombs,” warning that the creators and sellers of derivatives are usually the ones who profit. For everyday investors, that caution translates into skepticism toward over‑engineered or highly leveraged products: ask who benefits, how transparent the exposure is, and whether simpler, direct investments (like buying shares) would achieve the same goals with less counterparty and structural risk.
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