Cooking up a Storm

The current controversy surrounding Townsville based financial planning group, Storm Financial Group, should serve as a wake up call to ALL Australian investors – not only those that invested through the use of Storm’s highly geared, and ill-advised strategy, but everyone involved in the stock market. Storm’s plight needs to serve as a wake up call to investors and to the so-called market regulators otherwise the painful heavy losses of those concerned has been in vain.

What is blatantly obvious to everyone in hindsight – that Storm were using gearing in a dangerous and ridiculous manner – was evident from the outset to those who understood the risks involved with these strategies. One publicised Storm client was leveraged at 9:1!! Whilst sure to produce fantastic returns in a rampaging bull market, which they did, the whole strategy would implode in a bear market, which it did! The promises of huge returns to investors simply could not be sustained once the bull market ended and the market corrected, which was an inevitable certainty.

These over-geared ‘investments’ quite simply caved. The uneducated, unprepared, and unsuspecting investors watched helplessly as their investments collapsed to initially be worth nothing, and then recoiled in horror as they became subject to margin calls and huge interest payments on their extended borrowings. Many of these people will be forced to sell their houses and other assets to meet their responsibilities, which I’m sure many did not have a full understanding of when they were enticed into the ‘investment’ in the first place.

Storm is estimated to have had around 14,000 clients being serviced by 34 investment advisers – around 400 clients per adviser! Could these advisers seriously claim to realistically know and understand each of their clients’ financial situations? Or were they merely interested in acquiring new clients in order to generate more commission based revenue? It has been reported that clients were paying around 7.5% commission to have their money placed into the index related products being offered. Financial planners earning commission based on the size of investment is a flawed system that needs to be totally reformed. Commission based financial planners are simply not incentivised to share the same objectives as their clients and, once capital is placed into the managed funds that pay their commissions (which ultimately comes from their clients’ capital injections), have no responsibility for the performance of their clients’ investments.
Storm also had a mutually beneficial relationship with the CBA. Whilst Storm needed the bank’s financial backing it reciprocated by using the geared investment products offered by Colonial Geared Investments and Colonial First State. The bank thus earned huge fees from the business being generated by Storm’s over-geared investment strategies. Colonial Geared Investments provided the margin loans that were then used to increase the size of the investments made into these funds generating more fees. Challenger and Colonial First State were also the responsible entities for the Storm funds – charging them for this service as well.

This is what happens when all concerned, the fund manager, financial planner and client, become euphoric through magnified returns. Euphoria induces a riskless state of mind where large downside can no longer be perceived. Cloud this further with massive revenues through fees and you have a recipe for disaster. When profits were being raked in, the riskless state of mind couldn’t perceive downside and when leveraged at such high levels, unless profits are realised on the way up, when the market corrects ALL capital, profits and base capital, are at risk at the same level of leverage. (It was only realised AFTER the fact that the client geared at 9:1 was geared to that level.)

Where were the regulators when all this was happening? Why is it that despite all the hype of the relevant authorities and government bodies, that none of this was exposed or investigated BEFORE it imploded? Quite simply, none of this should have been allowed to occur in the first place. It is unfortunate that it is only after the fact and the damage has been done to the ‘mum and dad’ investors that the authorities step in and rattle their blunt sabres and chant their worthless rhetoric.

The regulators have introduced draconian compliance processes in the last few years that are not only a drag on the industry but have also added huge costs to the industry. These costs have fostered a brand new revenue stream for auditors and accountants. And investors are still getting fleeced by unscrupulous operators like Fincorp, Westpoint, Opes Prime, Storm Financial, MFS and plenty more that have been and are still to come. It is at the conceptual level of types of financial products that the regulators need to step in, not with draconian compliance processes that line the pockets of auditors and don’t stop con artists dreaming up any kind of financial product that is doomed to collapse at some stage. Greedy people in the USA did just the same as Storm at an even higher level of leverage (30:1) and now people the world over, innocent and implicated alike, are paying for their greed.

The shear size and complicated nature of the dealings and relationships involved in the Storm mess will take years to sort through and resolve and will continue to impact people financially and psychologically for the rest of their lives.
In short though, it highlights a number of key points that we here at Share Wealth Systems are constantly reminding our clients of:-

1. Take responsibility for your own financial situation. No-one knows and understands your position as well as you do, and no-one will manage your money as well as you can with the right tools, education, and support. (i.e. Start the journey yourself rather than totally outsourcing your financial future)

2. Learn and understand risk management and money management techniques. Why would anyone who understood risk borrow money and then “invest’ it with someone who then geared this borrowed money still further through the use of highly geared and over-leveraged margin loans? This is what Storm did. Risk management and money management techniques should ensure that you will never lose your entire investment capital base and certainly not two or three times your total capital base.

3. Become your own fund manager. Why pay exorbitant fees and charges to a financial planner, fund manager, or investment adviser to manage your money when you can learn to do it yourself? In the vast majority of cases these advisers are simply placing your money into the products that generate the most fees for them or into the products that are on their list. The advisers are guaranteed an income stream off the back of your investment, in some cases for years and years, regardless of the performance of the fund or structured product and regardless of the fact that very little additional time is required to manage your investments on an ongoing basis once they are invested. This is what Storm did and what most other commission based financial planners do.

4. Be aware. Ask questions. Delve deeply into anything before throwing your money at it. If the majority of Storm’s clients had truly understood the nature of the investment vehicles they were being exposed to, would they have still invested in them?

5. Be realistic. Promises of massive returns for little or no work on your part are doomed to failure at some stage. The share-market works in cycles, and extended bull runs will always come to an end – usually when people least expect it, and usually when the unsuspecting public are the most exposed! This is what Storm did.

Many lessons can and need to be learnt from the Storm debacle. The risk of not learning from this and other simular cases is that it can and most certainly will happen again. It has before, is now and will again.

In my honest opinion the financial service industry needs to be reset. The days of the lumpy financial planner sitting behind an oak desk and watching his money pour in due to him selling trail fee based products rather than providing a service for a fee and producing performance, needs to end.

The unfortunate thing is that it funnels down and rots from the top. Fund managers providing financial planners with commissions based on the funds under management, needs to stop! The opulent junkets in exotic locations enjoyed by financial planners being wooed by fund managers using their investors’ money, needs to end forever, not just while the going is tough. Now is the time to act and reset the financial planning industry.

Investors who are using financial planners need to change to fee based planners and not trail based financial planners and/or advisors. From all reports only 7% of the industry is currently fee based; a pathetic attempt by the industry, given the call to end this nonsense has been going on in the press for nearly 20 years.

In closing, I challenge passive investors to strongly consider active investment. By “active” I don’t mean trading shares in the short term, I mean acquiring the investment skills to take control of your money and manage your own portfolios either through your own Super Fund or through other entities such as a trust or your own investment company. You can establish processes that take no more than 15 minutes a day. The benefit may be that you are hundreds of thousands dollars better off over the remainder of your investing lifetime.

Don’t worry, you’re not alone. Currently more than 450,000 Australians have established a Self Managed Super Fund. Although some have established a SMSF for taxation reasons many have done so to take control of their finances. It’s by taking control of your financial destiny that will allow you to be able to sleep well at night.