What Mum And Dad Investors Will Never Get

Mum and Dad investors getting ripped off is a recurring theme in New Zealand’s investment industry.

I used to have sympathy for these people. Now I wonder how they possibly accumulated enough money to invest while simultaneously being so ignorant of how the real world works.

You can only trust yourself with your money. Just because you have a financial advisor who came highly recommended or they work for a well known investment company, doesn’t mean you can back off 1 inch on the level of due diligence necessary on anyone who comes into contact with your hard-earned cash. Relying on credit ratings, fancy pants directors or “believable” returns is a shortcut to disappointment.

You can’t rely on anyone else to look after your money. Everyone needs to take responsibility for their money. You can’t outsource this stuff to someone whose incentives are not aligned with yours. If you can’t spend the time to read extensively about finance and economics, you have no business going outside of a savings account. There is so much cheap or free content on the internet about these topics you have no excuse not to be able to explain the trade-off between risk and reward or understand intuitively how fees impact compounding growth rates. No excuse whatsoever.

You can’t blame the government or regulators. It never ceases to amaze me that investors who stuffed up want the government to fix things for them. They want their money back, they want a government guarantee or they want justice. Newsflash : regulators don’t have much power, they rely on disclosure initiated by the people they’re regulating and don’t actively go out hunting for people breaking the rules. They’re only human and it’s plain silly to think they can do anything in the face of the incentives faced by investment industry operators.

What “mum and dad” investors will never get is that no one will help them but themselves. They can’t rely on anyone else and need to wake up to how the real world works.

Because of asset-price inflation, a lot of these “mum and dad” investors have suddenly found themselves with a spare $250,000 or more. This means that they could get wholesale investor accreditation if they ask their accountant nicely.

It also means they are ripe for the plucking when it comes to the shadier side of the investment industry. Lower regulation for “rich” or “experienced” investors is an invitation to the slaughterhouse for “mum and dad” types who could no sooner dissect a product disclosure statement than build a model to recreate the likely investment returns of the product they’re thinking of investing in.

You are living in a fantasy world if you think professionals can do anything more than inform your own thinking about investment opportunities. Even then, you still have to spend the time.

If you don’t want to spend the time necessary to educate yourself, don’t participate in the investment industry by purchasing products you can’t understand and writing cheques to people because they’re “good blokes”.

You can start by having a look at Khan Academy or Investopedia.

Ross Asset Management Cash Flow 2000 to 2012

“It was not the financial elite, [it] was ordinary New Zealanders who are working hard and have saved money,” he said.

I am pleased to read that there are rumblings of net winners having money clawed back from the Ross Asset Management scheme.

In the recovery of assets in the Madoff scheme, Irving Picard has pursued “net winners” who received more from the scheme than they put in. He has achieved several substantial settlements, notably the estate of Jeffry Picower and the NY Met owners who used Madoff like a checking account.

The comment by investor Bruce Tichbon that his group of investors want to limit the fees charged by receivers and liquidators is entertaining.

The cost of recovering funds from fraud is high due to the need for forensic accounting experts and civil suits against “net winners”. Many of the transactions over the past few years could qualify as voidable preference, meaning the liquidator can claw them back.

The process will also take years to wind down. There are no quick resolutions to situations like this. You can’t just get a court order one month and have the “net losers” bank cheques the next.

We are yet to hear back from the Serious Fraud Office on whether charges will be laid against David Ross.

But by representing the cash flows identified by PWC in its report to the High Court graphically, we can see how these schemes work:

The net difference over the 12 year period, which excludes activity before 2000, is -$15,774,673.59. But over $303 million was contributed to the scheme and almost $290 million withdrawn. Management fees accounted for almost $30 million dollars.

The onset of the global financial crisis seems to have set the unwinding of David Ross into motion. A substantial increase in withdrawals along with a major reduction in contributions rapidly altered the mathematics here.

It’s clear that although management fees of $30 million were a factor in the collapse of the scheme, they are dwarfed by the mathematics. It’s simply not possible to keep adding substantial investors to finance the withdrawals of other investors in a global financial crisis where people are cautious about investing outside of lower risk assets.

I am extremely concerned that anti-money laundering rules didn’t pick up on really odd cash flow patterns like this. I hope the FMA will use this occasion to instruct the commercial banks to identify high cash cash flow patterns like we saw above.

The “unusually large” number of brokerage accounts held by RAM and its associated entities are also major red flags. If you have hundreds of millions of dollars under management, maintaining accurate performing reporting over a handful of accounts is difficult enough – dozens of accounts would require a substantial back office operation.

With respect to overseas asset recovery, if a substantial portion of the management fees has been transferred offshore best of luck to PWC in getting any of that back.

This is going to be one of the most interesting cases to come out of the global financial crisis in New Zealand. The fact that nobody has done serious due diligence does not bode well for any notion that investors are capable of managing their own money without enormous investment in education and financial literacy.

Red Flags And Ross Asset Management

The report by High Court appointed receivers PWC regarding Ross Asset Management makes for sober reading. In the wake of several ponzi schemes being uncovered as the global financial crisis led to more withdrawals than contributions, we have to think carefully about the enormous red flags that presented themselves when it came to Ross Asset Management.

Brian Gaynor wrote in the Herald:

Investors deposited funds with RAM, assets were purchased and sold on their behalf and held by RAM. The investment performance of these funds was reported by RAM without any independent verification or audit. RAM clients had their own individual portfolio and, as a consequence, could have widely differing investment returns.

As he notes, this was exactly the same structure employed by Bernie Madoff. The cash flowed into a single account and back out again when withdrawals were requested. The PWC receivers have identified just $10.2 million out of a supposed $449.6 million in assets under management. The cash flow analysis in the PWC report makes for sobering reading.

When you think about due diligence on potential investments, the Ross Asset Management proposition sets off multiple sirens. The lack of independent verification of returns, the use of an accountant who shared the same address as the firm, the absence of an independent custodian and maintenance of client records in a single Access database are just the tip of the iceberg.

There was quite a disturbing interview on Radio New Zealand where the poor lady involved had all of her savings with David Ross. It is clear that Ross Asset Management was operating on the down low, relying on referrals and word of mouth.

With the high average account balance of around $500,000 many investors would have been wholesale investors / accredited investors. That means lower disclosure is required and filing prospectuses with the FMA isn’t necessary.

It’s clear that having $500,000 to invest is not sufficient evidence of an ability to manage your own wealth. An enormous amount of reading and careful thinking needs to be done before writing a cheque to anyone – let alone to an asset management firm that operated completely outside standard practice.

Since the collapse of MF Global it has been clear that you are an unsecured creditor to any investment firm you have an account with. Every single dollar of your wealth is at risk – your term deposit, your bonds, your shares, your derivatives trades – they all require ongoing monitoring and tough questions being asked of the people you’re dealing with.

When the most clued up fund managers in the world regularly clear different types of trades through different prime brokers to reduce the counter-party risk involved, that’s a clear signal to ordinary investors that breaking up where you put your money is the bare minimum of risk reduction you can do.

I am surprised that accountants performing the foreign investment fund tax calculations for investors in Ross Asset Management didn’t double check shareholdings via the registry. How could you file accurate tax returns reporting foreign capital gains and dividends without double checking the relevant share registries?

I will follow the development of this case with interest. Because Mr Ross was an “Authorised Financial Advisor”, it will be interesting to see whether more background investigation will be conducted to see if other AFAs are running investment funds of this magnitude on the side and outside the regulatory framework the FMA oversees.