If it sounds too good to be true…
One of the reasons I write these blogs is to rip the veneer and mystique off the financial services industry so that everyone out there can become better informed, especially when it comes to the crucial decisions that need to be made with investments. Way too often an episode like the ‘Stringfellow’ affair will shock an already reluctant investor into absolute paralysis. Procrastination can be just as deadly, so I try and point a spotlight on the crucial questions you need to be asking your broker/advisor/planner/asset manager. In a climate where the returns from investments have been lackluster, it is understandable that higher than average returns can be attractive – but this latest little lark has shown us that you can offer returns that appear just above the market and still get ripped off. The major disappointment for me is that a Trusted Advisor (and Trust is absolutely key in this profession) with hundreds of millions in Assets Under Management and an award-winning Unit Trust has single-handily undone years of work done by hundreds of investment professionals to clean up the industry.
Here are some of the questions you need to ask your advisor/planner/broker:
Is the person/company an FSP (Financial Services Provider) you can check this on the FSCA (Financial Services Conduct Authority, previously the FSB). This is no guarantee that you’re not going to get ripped off mind you but is a start. The FSCA number should be on all correspondence.
Is the person is a registered representative or key person of such Financial Services Provider This should be in their ‘letter of disclosure’ along with the products they are accredited to provide advice on. Again, no guarantee that you’re not going to be ripped off.
Are the investments ‘regulated’? This means that the investment is regulated by either the FSCA, Life office of SA or CISCA, and that will be in the paperwork you sign (application form or mandate). If you’re not sure, ask (you’ve got the acronyms now). Unit Trusts are regulated by CISCA, Bespoke Investments (investments run by Asset Managers that mimic Unit Trusts) are JSE regulated under the FSCA. Pension investments are regulated by the Pensions Fund Act and the Life Offices’ of SA. (Are you still awake? Yup, boring stuff). This should be made clear in the paperwork (now that you know what you’re looking for), but it may be in the small print. Ask your advisor to show you where it states who the regulator is in the paperwork. Don’t be shocked if they haven’t a clue – this is a complicated industry and those kinds of specifics often go right over the advisor’s head because it is complicated and boring and with so much else that has to be absorbed, this might have been glossed over – but recent events have highlighted just how important it is.
Do you know the ‘normal’ rates of return and associated risks? Comparing apples with apples when it comes to investment returns is important. The compounded interest on money market for money on call (immediate availability) is, 5 – 7% pa is average (you can get a bit more from the ‘good’ part of a certain bank that has seen a miraculous resurrection of late), up to 9.5%pa for a fixed 5 year term (mid July 2019). High-quality Bonds can range from 8% to 10% (more than 12 % you need to question the quality). JSE stock market has been pathetic for 5 years now, with the odd pocket of opportunity now and then. Historically the JSE has given some of the best returns of any stock market in the world, and might return to glory one day. Abnormally high returns should be a red flag, keep the ‘greedy’ devil on your shoulder under control.
Do you know what ‘normal’ fees are? In this new-normal of low growth, high fees can erode your investment dramatically. Your proposal should clearly spell out fees and make it easy for you to determine the ‘effective annual cost’ (EAC). Some brokers (usually if they are used to working on an insurance platform) still take ‘upfront fees’ and a maximum of 3.5% is allowed. If you follow my blogs you’ll know that I abore insurance-based investments because of early termination penalties caused by upfront commission. ‘Ongoing’ fees range up to 1.5%, and are usually charged on a sliding scale. 1% is average for investments under R5m, but should drop sharply thereafter, with 0.5% usually being the bottom of the range.
Do you know the difference between ‘simple’ interest, ‘compound annual interest’ and ‘effective annual interest’ ? This little trick is being used by a couple of big banks out there, and quite frankly is a perfectly legal but sleazy “pick me” advertising technique to fool anyone who can’t or doesn’t want to do the math. Admittedly it isn’t simple maths, which is why the slick wunch of bankers can get away with this nonsense (by putting the details in incomprehensible small print to keep it legal). You’ve probably driven past billboards shouting out a 13.2% interest rate. Great! You can’t read the small print from your car, and if you could, you’re unlikely to understand all the different ways they can work out interest. The graph below is a screen-grab of a Certain Bank in RSA’s offerings (16/7/2019.) The issue I have with this sort of sleight of hand, (in my humble opinion), is that it opens the doors for other less-than-scrupulous operators to offer 14% and for the average person to assume it is not far off that these big banks are offering and because it is not a ‘greedy’ return it’s kosher. This is exactly what Mr Stringfellow allegedly did, he offered 14% annual interest on his ‘investment’ – not exactly shoot the lights out, and quite close to the interest rate that banks charge to that sort of venture.
Are the funds held in a custodial account? For years now, regulated funds have to have a ‘custodial partner’ with a completely separate Financial Services Provider who accepts the client’s funds. Your funds will be deposited into that account and not into the account of the FSP, the key person or representative. This should be a huge red flag.
None of these precautions is going to protect you from a liar. Recent events have also shown us that even someone who has been in the profession for decades is no guarantee that they aren’t pulling a fast one. The fallout from the Arthur Brown case put a whole lot of new regulations in place, including the use of custodial accounts. Interestingly, despite the rampant corruption and mismanagement that has taken place over the last decade, Mr Brown is the only white-collar crook of this ilk to face jail time. In the Stringfellow case (which has still to go to court so I will not assume that he is guilty), the money that is in the Collective investments is still safe because it is in a regulated fund. These regulated funds do not pay out to ‘third party’ accounts and will only pay into the client’s FICA’d account. The R100m that might be ‘lost’ in the Stringfellow case looks like it was invested as a ‘loan’ to (his wife’s company) Lorna Jane SA, which may or may not be considered ‘private equity’ (and, of course, there are questions of conflict of interest). Private Equity (companies that are not listed on the JSE) is actually allowed to have a (regulated) portion even in pension funds, but this is rarely used (except by PIC – Public Investment Corporation that controls the government pension funds, not always with great consequences, they are risky).
Just one last cautionary note… When markets are as volatile as they are at the moment – all over the world – it is natural to be apprehensive about your hard-earned investments. Unscrupulous advertisers will use this ‘fear’ as a new “Pick Me” tactic, but unless the advice is to diversify your portfolio, with unsexy fixed income products and cutting back on high-fee products, be careful that you’re not being played. Investing in the advisor’s wife’s company so she can play Gym Barbie is not a sound strategy.
Action: You can do everything right, ask all the right questions and still come short so keep your eyes open and ask the questions and don’t let it stop you investing for your future.