Small investors have been left exposed to some particularly risk investments over the past decade-and-a-half.
The approach in Australia is one of allowing markets and market participants to operate with as little regulation, red tape and oversight as possible.
It is a policy that has bi-partisan political support and continues to be endorsed by the regulator, despite ample evidence that it fails investors.
It is mostly about ensuring proper disclosures about the risks of the investment. It is about prohibiting misleading or deceptive conduct rather than banning risky investments or limiting access to them for wealthy investors.
Over the past 15 years, billions of dollars belonging to hundreds of thousands of Australians have been lost.
We are not talking about losses from markets. Often, life savings have been lost through failed investment schemes and dodgy financial advice.
While the disasters have prompted improvements in consumer protections, particularly with respect to financial advice with the phasing out of sales commissions, for example, it remains the case that investors are on their own. Starved for yield
With interest rates at record lows, investors and savers are starved for yield. That leaves them particularly vulnerable to investment scheme promoters offering higher yields while talking-down the risks.
They are usually marketed under the guise of being just as safe as bank deposits. They spruik much higher yields than the 3 per cent paid on term deposits.
However, unbeknown to the investor, the investment promoter is putting their money into risky activities – such as property development – or taking on a lot of debt.
The danger is not just one of being caught in an investment collapse that makes the headlines. Even licensed providers operating fully within the law have half-a-dozen tried and proven ways of profiting at the expense of investors.
Sometimes the risks do not become apparent until markets suffer big declines, after which it is too late.
That was the case during the global financial crisis when Australian share prices dropped almost 50 per cent. It brought to the surface the risks that were always embedded in the investments or financial advice.
Re-visiting some of the biggest disaster of recent times, hopefully, will better equip investors this time around. Property disasters
It is not just shares-related investments and their investors that come unstuck.
Property development is always a risky activity. Westpoint was a property developer that collapsed losing investors hundreds of millions of dollars.
Financial planners put their clients in Westpoint in exchange for outsized commissions. Some financial plans had two thirds of investors’ life savings in property development.
Then there were the investments that lent money to property developers.
One of largest of the many that collapsed was Provident Capital, which issued debentures to retail investors.
Similar sorts of investments are advertised heavily today, often on daytime radio.
Provident Capital lent most of the money to property developers. It also ran a mortgage fund.
It went into liquidation in October 2012, leaving 3000 debenture holders with losses of $130 million. The likely return to debenture holders is not more than 19 cents in the dollar.
Dozens of mortgage-backed debenture schemes were “frozen” during the global financial crisis. Freezing is where investors can only withdraw capped amounts of their money at regular intervals.
Mortgage funds were popular with retirees because they paid steady interest, while keeping the capital invested stable.
Most of the money was lent to property developers.
The funds always had a contradiction. Investors could get their money back on a daily basis. However, the money was lent as mortgages to property developers, which is repaid over several years.
That is not a problem, normally. But when the Rudd government, as part of its response to the financial crisis, guaranteed bank deposits in 2008, investors pulled money from mortgage funds, which are not covered by the guarantee, to invest in term deposits covered by the guarantee.
Seven years later, most of the money has been returned to investors, at least by the big mortgage funds which continued to pay investors their interest along the way.
However, with the smaller funds, progress has been slower. Investors in some of these funds are unlikely to receive all of their money back. Tax advantaged
Tax should never be the main reason to invest.
Just before the end of the financial year the ads for the latest tax-effective investment schemes would start appearing. Each year there would be new themes, one year macadamia nuts, the next, tea-tree plantations.
They were pitched at higher-income earners, such as pilots and dentists, who had a “tax problem” (paying too much tax) and were in need of a quick fix prior to June 30. Accountants and financial planners were involved, taking big commissions for recommending them.
It was the spectacular crash of the two giant sharemarket-listed schemes – Timbercorp and Great Southern, in 2009, that marked the death knell for the whole tax-driven investment industry; at least for the time being.
In the end, they were caught out by excessive levels of debt, the sharemarket crash and a crackdown by the Tax Office. Too-clever-by-half
Then there are the too-clever-by-half investments. These include the securities based on derivatives.
And many local councils in Australia were also caught out with CDOs.
A derivative is nothing more than a piece of paper whose price derives from an asset. They can have a legitimate role in helping companies spread their risks to others.
The same goes for other types of derivative such as contracts for difference (CFDs) and securities that speculate on currencies, futures and commodities.
There has been rapid growth in the number of software trading platforms in recent years offering all types of derivative-based investments and other exotica to Australian retail investors.
Some financial instruments allows traders to bet on markets falling, so called “shorting” and differences or spreads in markets.
They do have ‘stop losses’, where the downside can be limited, and they do have their place. But they are really more appropriate for traders than set-and-forget long-term investors.
One particular type of derivative, called collateralised debt obligations (CDOs) may be familiar.
That is because CDOs played a key role in the global financial crisis.
Australian-based fund manager Basis Capital invested in them before first striking trouble in 2007, eventually collapsing and losing several hundreds of millions of dollars of investors’ money.
Basis Capital invested in CDOs over American “subprime” mortgages.
They are priced on the underlying parcel of mortgages, in this case high-risk US mortgages.
ANZ Bank compensated thousands of investors in New Zealand, mostly retirees, who lost hundreds of millions of dollars in 2008 in funds invested mostly in CDOs and other high-risk investments.
Here is what the Australian Securities and Investments Commission has to say about them: “CDOs are complex products. Even big institutions have lost fortunes when trading them. We recommend you do not invest in these products unless you have a written statement of advice from an independent, licensed financial planner stating that the product is suitable for you.”
And so ends our potted history of some of the biggest disasters of recent times, but the list is much longer.
With each new generation of scheme promoters comes the same greed, deceptions and misleading disclosures. With them comes another generation of investors who invest more on faith than than merit. They are left much poorer, or sometimes with debts, with their dreams of a comfortable retirement destroyed. Out of the ordinary
There are a host of high-yield investments today that are coming from non-traditional sources.
There are schemes such as those where investors can buy or lease their own ATM and even shipping containers. Money does not know if they are good investments or not. But they certainly need to be approached with caution.
They are being pitched particularly at those with self managed superannuation funds where the entry costs are less than, say, an investment property.
There are schemes that allow people to buy or rent ATMs.
Some make claims about minimum investment returns. Usually, there is another party involved that looks after the ATM. The machines are usually installed at clubs, RSLs and supermarkets as well as in remote areas where there are no other ATMs.
This usually allows the operator to charge more for withdrawals compared to locations where there are several machines.
There are even companies that allow investors to own shipping containers, sometimes promising fixed returns of more than 10 per cent a year.
These physical investments are usually unregulated; without the usual disclosures and protections of regulated investments. The promoters are often based overseas. All in all, they are usually a gamble. Six signals that scream ‘Stay Away’
GUARANTEES Nothing is guaranteed absolutely, except for Australian government and state and territory bonds. The first $250,000 on deposit with a bank, credit union or building society is covered by the government guarantee.
Guarantees are often used to give comfort to investors to invest in risky investments that without the guarantee they would not make.
They are usually provided by another party, such as an insurer, with its own interpretation of how the guarantee will be triggered.
TAX-EFFECTIVE Investing for tax savings is almost always the wrong reason to invest. Numerous tax-driven schemes have fallen over in recent years, particularly those connected with the agricultural and forestry industries.
The single exception is superannuation, which is very tax-effective for most people and is well regulated.
OUTSIZED RETURNS Any investment promising a yield of much more than about 3 per cent a year is taking on more risk.
It may seem like a conservative investment that is “just like having money with the bank”, but there are always risks.
LIQUIDITY MISMATCH Generally, listed investments are to be preferred over unlisted.
Listed markets do sometimes fall spectacularly, but at least they are much more transparent than unlisted investments, which usually have minimum periods when the investor’s money is tied-up.
HIGH COSTS There is no more sure-fire way of reducing returns than high fees and costs. Over time, the fees and costs compound and really eat into the returns. Investment’s markets returns are out of the investors’ control, but costs are within the investors’ control.
COMPLEXITY Simplicity in an investment favours the investor.
Complexity favours the provider as it leaves the investor will very little chance of being able to understand how the investment works.
The greater the complexity, the easier it is to hide fees and charges