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Cooking up a Storm

March 5, 2009
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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.

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Comments

  • Richard C says:

    Gary the comments in this weeks journal reinforce the basic human emotions of fear and greed. I agree that the financial planners in this case acted in a grossly irresponcible manner purely focusing on the ability to earn commisions based on the assests under management. The greater the amount of money invested the greater the revenue stream they recieved. This was obviously their primary focus,and not what was in the best interests of their clients.

    Some of the mums and dads that invested in these products either were fooled into thinking that the returns of the previous 4 to 5 years would continue and obviously had no idea of the risks involved in using this type of stratergy. They were caught up in the hipe and the promise of large returns that had been achieved over the past serveral years. Fear and Greed.

    There is an old saying greed is good getting caught is bad.
    lets hope that some leasons are learned from this.

  • Anthony Berge says:

    I liked your article very much,very informative and i agree with you totally.i am not as financially inteligent as i would like to be but by reading articles such as your is very helpful…thanks

  • Vic says:

    and the ban on being paid to buy crashing stocks has been extended. now isn’t that just silly?

  • Jay Bell says:

    As a potential client of Storm, in my experience only 6 months from the bitter end & after the stock market started 2 stall in early 08 b4 it’s dramatic slide from July, I felt the salesmen (advisors) were aware of the slippery slope but determined 2 sign up ever more customers 4 the banks & themselves tho it is likely the banks were already calling in the loans even then from info. the co. wanted potential investors 2 supply up front then even in initial enquiry stages

  • Harald says:

    Thanks Gary, enjoyed the article thoroughly. Unfortunately there will always be the charlatans out there and there will always be people falling for their spin, even well-informed people who should know better. Greed gets the better of all of us at some time in our lives’.

    After having been caught out in a high revenue scheme some years ago (fortunately I did not have much money to invest) I tend to be over-cautious and extremely conservative in all investment decisions.

    One “fact” that your readers should always remember: If it sound too good to be true, it usually is!

  • maxpemberton says:

    to me it all boils down to when is enough enough while people keep wanting more and more this will keep happening i started investing last year and have not had the best of runs but i cant remember the last time i have felt so challenged to get something rite if it all boiled down to dollars and cents me being as iam would probably get bored and walk away its the journey more than anything and trust me i hate losing money

  • GES says:

    Congratulations, Gary – an excellent article in every way. The nub of the problem is, as you point out, right at the source; in the examples you give, the problems are embedded in the sales and trailing commission structure and in the lack of ethical supervision within the banks who provide the means without which the scam could not operate. 93% of financial advisers are purely and simply salesmen armed with an instruction manual on how to close a sale. Who in his right mind would use an accountant or lawyer who charged according to the size of his client’s assets yet people willingly entrust their life savings to such people. And are encouraged to do so at every turn by fund managers and regulatory authorities.
    If the system is wrong, no supervisory authority on earth will or can ever police it effectively – in fact, we are quite unrealistic in our expectations of what our regulatory authorities, who are chronically underfunded and under-resourced, can do. If we are serious about attacking these repeated human and financial disasters, it must be through banning dangerous and counter-productive marketing systems and insisting on strong ethical and financial internal audit structures within our banks that report directly to their boards outside the operating structure of the organisation and, if necessary, directly to the regulating authority itself, much as doctors and others must report to police in defined circumstances.

    Whilst we wait for that (and it may be a long wait), the safest path is, as you suggest, to take responsibility into our own hands and put in the necessary hard work that entails.

  • Louis Nilant says:

    Hi Gary, and similarly minded individuals.

    The mantra now flaunted is : “the only good thing is at least we’re all in the same boat!” Huh? Not me!What boat is that? The Titanic? Not a fun cruise!
    Why not me? ‘Cause I was fortunate in gaining the education via the likes of your excellent systems and courses over the years tweaked to suit me and applying the most basic elements of risk management. Simple. Yet Gary, one cannot say this out too loudly for fear of incurring societal wrath, hatred and getting shot at dawn!It was always thus! And being right as you are will make not change the established wisdoms and structures at all.
    Better to keep doing what you do so well, serve us your grateful clients and have fun as the opportunities arise again!

  • Max says:

    Good article Gary;

    I share your views on the vested although not necessarily malevolent actions of financial advisors receiving commissions. While personally I don’t understand the actions of people who seek financial advice from financial planners operating out of small rented offices selling packaged products (I’d want my financial advisor to drive a Ferrari or Porsche, minimum), I sympathize with the many who were unfortunate enough to consult those marketing highly leveraged and risk-flawed products. I also regard ‘financial intelligence’ as extremely important and agree with your suggestions of taking an active approach and responsibility for your own affairs. There will be a learning curve of a few years, but it’s not out of reach of moderately intelligent people who are willing to read, learn and work hard.

    For those who might criticize the actions of people that were ‘sucked in’ by these products, consider that the action of seeking financial advice is at least a proactive step towards seeking financial independence and consulting a financial planner is an accessible first step for those who do not believe they have the individual ability to manage their affairs, and a step above and beyond what the majority of the complacent population do. Unfortunately many advisors will then seek to reinforce the idea that self management is beyond the client’s abilities and that their professional skills are ‘invaluable’.

    I was at a trading seminar a while ago and after the talk a few people approached the speaker at the side of the stage to ask questions. The lady before me proceeded to ask a pretty basic question preceded by ‘I’m actually a financial advisor but I’ve never bought or sold a share…”. These people are not necessarily experts.

    Your article reminded me of similar comments by Alan Kohler in an ASX podcast I listened to some time ago (‘Escape the System – How to invest without being ripped off’, Alan Kohler, Eureka Report). It’s available on the ASX website; perhaps yourself and other readers may be interested.

    Regards, Max.
    Professional trader.

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