I’m sure someone with a sense of humour thought up this acronym.

Now some of you may be asking what an earth is FATCA? It is the: “Foreign Account Tax Compliance Act” to be imposed by the United States of America in 2013. What does this mean for little ol’ New Zealanders in the financial industry?

To put it simply the USA is going to impose fines on any financial company, investment portfolio or custodial service who do not collect tax for them and pay to the Inland Revenue Service.

Why is the rest of the world bowing to this draconian imposition from the USA? Are we all running scared – and from what I ask?

I bet there are quite a few countries that totally ignore this imposition and tell the USA to run and jump.

Anyway, back to FATCA, what does it mean for us?

From what has been issued to date, it is going to be a huge cost to companies in the financial sector.

The following are just a few things I have heard about:
• First you have to become a registered company and enter into an agreement with the US.
• You have to investigate all of your customers to find out if they should be US tax payers and,
• Annually report to the US.
• Also there is a requirement to withhold payments for ‘recalcitrant’ US folks (the naughty ones who try to avoid paying tax back home) – 30% of both Income and proceeds from sale, I have heard.

You might think how will they know, but if any other financial organisations you deal with in the chain is registered they have an obligation to report. And it seems that most of the global companies are already acquiescing. I suppose with electronic trading they can trace all sorts of things.

If you think you can avoid this problem you will have to: restrict who you deal with and what you invest in – that is, no US folk and no US assets.

Probably well nigh impossible so we will all have to run along like little sheep and agree to do the USA’s work for them.

Why didn’t the rest of the world just say, “No”?

I’ve said it before and yesterday’s savings policy announcement from Labour demonstrates it again.

Labour understands savings issues far more than National.

Its package is potentially a circuit breaker for this year’s election and will get people talking.

Raising the age of entitlement for NZ Super is a no-brainer. It has to happen. Good on Phil Goff and the Labour Party for being prepared to address this issue.

Sure the increases it talks about are pretty small, but at least it is starting the process off and that is the hardest part.

John Key’s pledge to resign rather than change the entitlement is one of the most stupid policy things he has ever said.

Making KiwiSaver compulsory isn’t as clear cut. You would think that fund managers and the savings industry will be rushing to party vote Labour. After all such a move helps to underpin their businesses and for advisers it’s a huge plus as regulation has made it harder for new competitors to set up shop.

I must admit the comments former finance minister Michael Cullen used to make about compulsory super still echo with me.

His line was that compulsory super was the state going too far and interfering with people’s rights and decisions.

Again an odd comment from someone on the left of politics.

He is right, but then there are bigger issues and trends to consider.

With trends New Zealand for years has bucked what you could say are the international norms around savings policies. That is all changing now and compulsory super is part of the big package.

Unfortunately the government has some idea that we should be getting closer and closer to Australia on savings issues. Compulsory super is one of those things that is likely to happen over time anyway.

It is, though, frustrating that this is more tinkering with KiwiSaver. It was inevitable that politicians just wouldn’t leave it alone.

There are many other parts to Labour’s policy worth exploring, and we will do that later.

The funny thing is that many of the things it is campaigning on you would expect to see from a more conservative party than Labour.

A comment I read yesterday summed it up.

“Holy cow – now I’m really confused. I’m as right-leaning as they come, but now I’m wondering whether I should consider voting Labour?! Raising the retirement age is so obviously needed it’s not funny, and a capital gains tax makes a lot of sense.”

I suspect those comments will be shared by many others in the savings industry today too.

Is it ethical for fund managers to continue to get management fees on funds that have been frozen?

Fund managers should not get paid management fees – or at best should have them severely discounted – for the period the funds are frozen.

It is immoral that trapped investors are forced to contribute to the profit of their tormentor, against their will and with no option to get out and prevented from making new investments of their choice.

Further, a fee cut would serve as a disincentive for fund managers to get in that position or to keep funds closed.

Currently it is quite attractive (especially in a bear market) to close funds indefinitely. This forces investors to withdraw from other liquid investments or when rebalancing, funds have to come from elsewhere.

It also retains a handsome profit for incompetence.

Maybe a receiver should be appointed to determine if the manager continues?

It seems incredible that investors are still trapped after three years in mortgage funds, infrastructure funds and other hedge funds etc, and with no say whatsoever and paying full fees for non-performing investments.

Regulators could include in the new legislation that fund managers who fail to provide the liquidity promised should forgo profits.

In many cases, when funds are frozen management fees are fixed at the old high levels. That’s not right.

Of course the corollary would be that advisers should not assess fees on frozen funds – and certainly not at moratoria value, not that many of those are left.

Moratoriums didn’t work did they?

The poor suckers who invested then voted for the perpetrators to stay in the existence to manage something they couldn’t manage in the first place – another bite at the cherry.

There are some things I don’t get about the newly regulated world at the moment.

One is the story we ran yesterday where to advisers with dishonesty convictions recently in Australia are allowed to be registered advisers.

We are still trying to get to the bottom of this and will report in again when we know where regulators sit on this.

Meanwhile the organisation they worked for reference checked them using Google and was happy with what he found.

I plugged their names into the search engine and the top results were ones which would make anyone wary about employing these people in a role like this.

The second is a speech Simon Power made a little while ago at the loan sharks conference.

While we didn’t attend the conference there was some interesting research which showed how many low income earners were being ripped off by loan sharks.

The stories are truly ones of woe. Ones where unscrupulous operators prey on the vulnerable.

These are people who are being ripped off daily. These are people who are having their lives ruined.

If there was an area of financial services which needed cleaning up it is the loan sharks. It’s not the financial planners and fund managers.

Yet, Power disclosed that between 35 and 40% of third-tier lenders are not on the Financial Service Providers Register, as they are required to be by law.

It is disgraceful that the good end of the financial services market is being maligned and put through significant regulatory hoops and hurdles, but this crowd isn’t. Yet the government knows they are out there breaking the law.

Here’s what Power said: “It’s clear to me that this fast-growing industry fuelled by advertising focused on ease, speed, and normality of third-tier loans all aimed at those on low incomes and beneficiaries is a recipe for, if not disaster, then danger.

“Add in the fact that sole lenders are not complying with regulations and do not belong to a dispute resolution scheme and you know we have a lot of work to do.

“I know that the Registrar of Financial Service Providers is taking a keen interest in this aspect,” Power said

Surely more than a keen interest (and a gabfest) is required here.

There are lots of things on my mind at the moment, but the one for today is the government’s proposed sale of state assets. It’s on my mind as National Radio asked me about it yesterday.

As a general comment the funds management industry are supportive of the idea – no doubt for their own commercial reasons as well as philosophy.

In a speech this week Bill English talked about Kiwis lining up to buy into these companies. Part of the logic was something about failed finance companies and less interest in property investment than before.

It’s hard to see people lining up to buy into these companies. I don’t detect strong investor demand. Am I missing something here?

Here’s where the problems are:
1. Polls show the electorate is against the idea of state asset sales (no matter what euphemism you wrap them up in.
2. The public aren’t stupid. They understand that they already own these assets and paying for something they already own is a bit like robbing Peter to pay Paul.
3. Likewise getting EQC, ACC or the Super Fund to invest is just transferring money within different Crown owned entities.
4. It’s hard to see KiwiSaver funds racing for these assets. The majority of money sits in default and conservative funds. These beasts are big buyers of NZ shares.
5. Do we really want a sharemarket that is overweight in energy companies, and has little resemblance to the NZ economy? How about getting more primary sector businesses on the bourse.
6. These companies aren’t the exciting growth type stories. They are not Apple or Microsoft, or Rakon or 42 Below. They are stodgy infrastructure companies that always have the sceptre of price regulation hanging over them. It seems to me Kiwi investors are quite comfortable with term deposits as their income plays these days.
7. Likewise I can’t see residential property investors ditching their boxes in the burbs for some energy company shares. That’s like asking a Muslim to go to communion.
8. Selling shares does nothing to help these companies raise capital. These proposed floats are a transfer of existing capital. Air New Zealand, with its current bond offer, has shown us there are options for raising funds.

Then of course there are all those chestnuts like foreign ownership.

National has got a massive sales job on its hands with this one. One thing that maybe in its favour, and this was demonstrated yesterday in the panel discussion I took part in, is that many people don’t know enough about these things.

We all learned from the finance company debacles that valuing a portfolio with a capital item that remained at the same value, lulled many financial planners into a false sense of security. That is, using finance company debentures in investment portfolios reduced volatility and so they assumed this was reducing the risk in the portfolio.

The capital value of a debenture in a finance company never reflected that company’s strength or otherwise. Unfortunately for their clients, a permanent loss of capital was a massive risk.

So, why do research houses still use volatility as the only measure of risk?

Correct me if I am wrong but quantitative research and hence technical analysis is the sole basis of most ratings. And, what does that measure – the past.

Sure, volatility is one measure but it is not the only answer to understanding risk in a portfolio.

I believe the clients’ of financial planners have a very clear understanding of risk, “Will I lose my money?”

What does not seem to be in the forefront of minds with those who construct portfolios, is whether the selected investments can battle through a huge storm without total loss?

The true test of risk – the survival of a Black Swan Event (of which we seem to have quite a few in recent years). The Black Swan Theory was developed by Nassim Taleb and he argues the silliness of trying to predict the unpredictable.

Nissim Taleb said: “We Don’t Quite Know What We are Talking About When We Talk About Volatility”.

If you believe the investments you have chosen will survive severe storms (irrespective of the volatility they may suffer during the storm) then you have de-risked your client’s portfolio.

If on the other hand something is dropped into the portfolio because the capital value is stable, maybe it is actually stagnant (i.e. difficult to value or not regularly valued), then risk persists.

For this very reason, some of the hardest hit during 2008 were the ‘so-called’ conservative portfolios.

You would be better off in most circumstances ignoring volatility – it is probably one of the contributors to many losses incurred since the jolly measure was introduced as a proxy for risk.

Sorry Mr Markowitz.

Can anyone enlighten me on why so many slavishly follow and utilise research house material which is a regurgitation of the past with one of the main measures applied being volatility?

Anecdotal evidence would suggest we would be better off without them. Maybe it is just simple ol’ human nature: “Got to have someone to blame when the going gets tough?”

Here is one of our first videos. In it Philip Macalister asks Darren Pratley about the NZMBA/PAA tie up; what it means for members; whether it’s a merger and what the possible roadblocks will be.

Too many advisers remain fixated on the outmoded income or growth bias when constructing portfolios.

This is short-sighted and leaves the client losing out on returns they could achieve in many economic cycles, as well as living less comfortably than they could.

There is only one optimal way to construct a portfolio – to maximise Total Returns (within a given risk profile).

Then all one needs to do is manage drawings as an annuity, keeping the portfolio in line with future financial planning.

The objective is to put the investor’s needs first.

The individual’s cost-of-living does not change with the fluctuations of a portfolio’s ability to produce income, and nor should it.

Those still trying to construct a portfolio looking for income investments to match clients’ cost-of-living are doing their clients a disservice.

They may also be subjecting the client to more taxes than is necessary.

Part of this misguided mode of constructing portfolios comes from old trusts that were structured with ‘Income’ benefits to surviving partners and residual ‘Capital’ to other beneficiaries.

We all know the court cases of this misguided approach when trustees focused excessively on the surviving partner not taking sufficient account of capital beneficiaries’ rights – and hence not growing capital to even modestly keep pace with inflation.
‘Income’ and ‘Capital’ beneficiaries’ interests must be, and can be balanced.

Another reason for some advisers not pursuing total returns may be that they do not manage the cash component of their clients’ portfolios very well. Cash is an asset class.

Beyond receiving interest, coupons, dividends and distribution, a cash component to a portfolio is essential to facilitate rebalancing and re-investing.

People giving free advice in the mainstream media have recently bewailed a perceived ‘gap’ exists in New Zealand with few annuity funds available for people to utilise when they get to the age they can pull money out of their KiwiSaver scheme savings.

A balanced fund is just such a scheme and can readily be utilised to meet cashing-up KiwiSaver’s required expenditure in retirement.

Also consider, that annuities (and I am sure there will be a plethora of them in New Zealand shortly as the insurance companies look to make a buck) consist of an underlying pool akin to balanced fund, one from which the insurance company pays out the regular annuity and pockets the remaining portfolio for itself as the profit.

Of course the annuity does spread the risk that an investor will outlive drawings from their own portfolio, by packaging their odds with another poor devil who dies early and misses out on both income and capital.

But this can be countered by really good financial advice, calculating and fostering sufficient client savings (portfolio) to outlast their lifetime of drawings.

Investors with a good level of savings will be more efficiently served to go for the self managed balance portfolio or fund approach.

A warning – don’t get glassy-eyed when the avaricious insurance companies come to town with their glossily packaged, ‘new’ annuity products.

You can be sure their actuaries will have worked out a handsome profit. Doing what is best for clients may be managing the portfolio for Total Returns, keeping residual capital for the client’s estate. Added value for your clients is a fee well-earned.

Some (young rascal) sent me this….I had a good chuckle. Read on!

“I’d like to buy a pair of black leather shoes, please”

“Sir, if it were only that simple. Here’s my card and here’s your Buyer’s Guide.”

“What’s this for”?

It tells you that I can only talk to you about shoes and allied products sold by this shop. I can’t talk to you about shoes sold by any other shoe shop, nor can I give any advice on, say, sausages, for example.

“Err”?

Probably the best way to proceed is to show you where we fit into the footwear industry. We buy in most of our products from the Far East at a fairly modest price and sell them on to the public at a considerably higher price; but of course, out of the mark-up we have to pay for transportation, import duties, rent and rates, display, staff, sales staff, cleaners and administration, etc, and our shareholders have to be paid a dividend out of the remaining profits. Not many people think about this when they buy their shoes, but we think it’s important. With this in mind, I’d like to ask you a few questions to make sure you get the shoes, or even boots, which are exactly right for you. It may be that when we have all the facts, I recommend that you do not buy my footwear at all. May I proceed?

“What do you want to know”?

“Well, how many arms and legs have you for a start”?

“What have arms got to do with shoes”?

“Well sir, if, for example, you only had one arm and I sold you a pair of shoes with laces, that could be construed as bad advice by LAUSTRO”.

“What is LAUSTRO”?

“The Laced and Unlaced Shoe Trade Regulatory Organisation.”

“What do they do”?

“Put the boot in. A friend of mine had to leave the industry.”

“What did he do wrong”?

“Sold a pair of carpet slippers”.

“What’s wrong with that”?

“Turned out the guy didn’t have carpet. So you see, I need to build a full picture for you. For example, do you need shoes for business or pleasure, or business and pleasure? How many shoes do you have already”?

“How many brogues, casuals, suedes, plimsoll’s, slippers, sandals, Wellingtons, etc? How many suits? what colour are they? Do you have athlete’s foot? Can you touch your toes? Any corns or bunions, or does your family have a history of dropped arches? What kind of socks do you wear?

How often do you cut your toenails? How much do you earn and what is your overall clothes budget? ? Well, thank you for that information. I’ll give it some serious thought and- get back to you”.

Two weeks later?

“Ah, good morning sir. I’ve given serious thought and what you need is a pair of black leather shoes”.

“Isn’t that what I asked for in the first place”?

“With respect sir, you have now had the benefit of my professional advice, based on all the relevant facts as given, and you now know with some certainty that what you need is a pair of black leather shoes. All the guesswork’s been taken out of it. Here’s your Reasons Why letter. I recommend that you buy these black leather shoes because they’ll keep your feet dry, match your suits, look smart and you can afford them”.

“Well, I’m glad that’s settled.”

“You want the shoes, then”?

“Yes, please.”

“Right, if you’d like to complete this application form, here’s your illustration, which I’d like you to sign. It shows a complete breakdown of costs and profits and includes my commission”.

“Your Product Particulars describe in great detail how the shoes are made and the Key Features are a summary of the product’s particulars, highlighting the risk factors.”

“Risk factors”?

“Yes. For example, if you Jive too long, the shoes may need repairing. On the other hand, if you die before you’ve had your wear out of them, I’m afraid there’ll be no refund, even if they don’t fit any other member of the family”

“I see”.

“So, just to recap. You’ve got my card; your Buyer’s Guide; Product Particulars; Key Features; Illustration; Reasons Why letter. You will get a letter from my Head Office telling you that I do, in fact, work for this company and also a Cooling Off notice. You can return the shoes within 14 days and have a full refund if you don’t like them for any reason.”

“How would you like to pay sir? “Cash”. Ah, well, would you mind nipping home for a copy of the gas bill or something to prove your identity, as you are not known to me. “

“One last thing sir, do any of your friends require shoes”?

Amongst the comments we’ve seen in recent days, we’ve seen a challenge for us to give advisers more guidance on what we expect from them.

That process started some weeks back when a small group of the first AFAs were asked to send us their Adviser Business Statements.

To recap, the ABS is intended as an efficient way for you to record evidence that you’ve thought about your obligations and for FMA to understand the business you do.  It’s important to emphasise that the ABS does not represent our entire monitoring methodology.  It’s just one tool.

Our early monitoring work, including ABS reviews, has two objectives:

1.      Assess the range of advisers and advice practices in the industry, so that we can prioritise our future monitoring work and resources

2.      While regulation is new, many advisers will need additional help to understand exactly what the obligations mean. Making the expectations clear and ensuring advisers understand the next steps they need to take are important investments we are making in the early stages of this brand new regime.

We have just completed a review of the first batch of ABSs, and in the main it has achieved what we wanted.  At this stage of the regime, an ABS is a window into how an adviser interprets and performs their legal and professional responsibilities.  Our initial selection covered a wide range of business models, including AFAs who don’t spend all their time providing retail investment advice.

Generally advisers have responded constructively and in good faith to the feedback. If you were one of those advisers, thank you. Your attitude speaks to your engagement with the new regime and is likely to result in a smooth relationship with the regulator.

Overall the documents gave us good information, though some, perhaps through efforts to be succinct, had compliance gaps or did not do justice to what is actually happening in their business. How advisers deliver their advice/service is the key point, so we asked for more information on this in most cases.

Discussions with the first group of advisers about their ABS helped fill in these types of gaps and allowed us to complete the assessment.  We trust it has also given the advisers a better understanding of the sort of processes we’re looking for the document to describe.

To most of the first advisers selected we’ve said, ‘thanks and bye for now’, letting them get on with running their businesses.

We intend to provide wider feedback to the AFA industry once we’ve reviewed a few more ABSs.

Mel Hewitson