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[The Wrap] The danger in FMA focusing on “fair outcomes”

When Don Brash became the first central bank governor in the world to target a specific inflation outcome, then zero to 2%, he stumped the country with his message about how bad inflation was, often calling it “the thief in your pocket.”

Wednesday, November 22nd 2023, 6:31AM 2 Comments

by Jenny Ruth

Brash would tell the story about his uncle who sold an apple orchard in Motueka in 1971 and used the proceeds to buy 18-year government bonds, then yielding 5.4% a year, to finance his retirement.

But the rampant inflation after the oil-price shock in 1973 meant the real value of his uncle's investment had fallen more than 90% by the time the bonds matured in 1989.

That certainly demonstrated the evils of inflation, but the story contained another lesson: we don't know what the future holds and so an investment strategy that looks very reasonable today might look exceptionally foolish in hindsight.

This lesson is what makes the Financial Markets Authority decision to focus on what it calls “fair outcomes” so problematic.

As FMA general counsel Liam Mason put the regulator's new approach: “We believe that beginning our conversations with firms based on the outcomes we want to see will help prevent harm in the first place.”

We don't need to look as far back as the 1970s for lessons which show that the best advice can still lead to poor outcomes.

Cast your mind back to 2021; the Reserve Bank's official cash rate was 0.25% and, in its May monetary policy statement, the central bank forecast annual inflation in the June 2022 quarter would be 1.5% and that it would reach 2.1% in the September quarter of this year.

As we now know, the inflation rate peaked at 7.3% in June 2022 and by September this year it was still nearly three times the mid-point of RBNZ's target at 5.6%.

RBNZ governor Adrian Orr had been exhorting savers to take more risks since 2019 – he was still trying to get inflation up to 2% at that point and said in September that year that those “in low-risk deposits will need to invest more actively.”

The $3.5 billion that mostly elderly investors lost on finance company debentures in the late 2000s was still a living memory, giving Orr's urgings to take more risks a particularly cruel edge.

He told Parliament's finance and expenditure committee in September 2019 that such people should be "putting your capital more to work, which is about creating real investment rather than just sitting in the bank account with all of the returns going to the owners of the bank."

Outside of the KiwiSaver scheme, savers in our economy tend to be those approaching retirement or the already retired who want to earn enough from their savings to ensure a reasonable standard of living.

Back in the first half of 2021, investing in bank term deposits was a poor option, made all the poorer as inflation ramped up.

ANZ Bank was offering to pay 0.8% interest on term deposits between six months and a year and up to 0.9% for three to five years for amounts between $10,000 and $5 million.

No wonder that advisers back then were searching for “safe” alternatives to recommend to their clients.

Property stocks and utilities have traditionally been regarded as relatively safe alternatives to bonds so it would have been reasonable to suggest that investing in Meridian Energy,  Kiwi Property or Ryman Healthcare shares would have been good options.

Anyone who invested in these three companies at the beginning of February 2021 would have seen their Meridian shares fall 28.3%, their Kiwi shares down 34.5% and their Ryman shares drop 64.3%.

Does that mean the adviser gave bad advice? Was she negligent or irresponsible? When she was doing exactly what the RBNZ governor had been calling for?

Tags: FMA Opinion

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Comments from our readers

On 22 November 2023 at 3:16 pm Aggressively_passive said:
well, possibly. Because switching from a TD to a portfolio of shares can be problematic, especially if that investor is making regular withdrawals or considers themself to be "conservative".

I'd also make the argument (Jenny brought it up) about conflating finance company debentures and low-risk deposits. THEY ARE NOT THE SAME. Any person who lost money in a finance company collapse was NOT in a conservative investment. They were taking signifcant risk, and accepting only partial reward for it. Lessons "learnt" from losing money in Hanover don't correlate or belong in a discussion about bank deposits vs shares or the proportional mix thereof.
On 23 November 2023 at 3:49 pm Ontheotherhand said:
Did the regulators force funds to mislead with their "risk indicator" guidance notes? They would argue the infamous clause 6 causing bond funds to under rate risk should have been ignored by managers. Did retail bond fund investors expect to lose 15% based on the mandated risk ratings?
"In every case, your overriding obligation under the legislation is to choose a risk indicator that reflects the potential
future volatility of the fund. If the clause 6 methodology and the CESR alternative methodologies do not work for your
fund, you must use a different method to calculate your fund’s volatility. If you have concerns about the methodology
to use or the resulting calculations, it is important to talk to us to present and explain your proposals. We will be happy
to discuss the issues and options for you" Did any fund managers push back and argue for higher risk ratings for the "safe" investments in their PDS?

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Last updated: 7 December 2023 9:28am

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