Case Studies

Case Study 1

In this example, a retail client complained to a financial institution and a financial advisor about a product's investment performance.

A client was advised to invest into an offshore hedge fund.

The client laid a complaint on 1 April 2003 that he had been given inappropriate advice and that he had lost money in South African Rand terms.

This is how we responded to the client on behalf of the financial institution and the advisor, based on the information supplied.

"Regarding your comments, we hereby place the following on record:

1. You were risk profiled as a “conservative” investor;
2. In SA Rand terms you invested a total of R 525 000.00 (before costs);
3. As at today’s date, the total amount invested in US Dollar terms (after costs amounts to USD45,900.79;
4. The total value of investment as at 2 April 2003 is USD46,100.02
5. Unlike other investors who are invested in offshore equity markets and have lost between 45% to 50% of their capital over the past year, you have actually made a small amount of money in US Dollar terms;

See the graph below that shows that all major markets have has negative returns over the past two-odd years:



6. A Hedge Fund is designed as a low volatility investment in keeping with your risk profile. Hence there has not been a drop in the value of this investment in US Dollar terms;
7. No economist could have predicted the strong recovery of the SA Rand recently and know one can tell its future movements with any accuracy. All we know is that we are living in a country with a higher inflation rate that our major trading partners and in order for SA to remain a competitive exporter, the SA Rand is more likely to depreciate over time. For your information, over approximately the past 20 years, even taking into account the recent strength of the SA Rand, our currency has depreciated at an average of 10% per annum.
8. 8.Your question: Why did you, as my financial advisor and so-called financial expert not advise me that there were problems in the market?

Our response is that the nature of your investment of one of low risk and it is common knowledge that there have been “problems” in the markets since 2000. (See the graph above). Hence my advice to you to invest in the M Cubed Global Hedge Portfolio and therefore there was no need to contact you about this investment. We do not believe in redeeming an investment when the market is down or if there has been an unforeseen currency movement. Did anyone foresee the major depreciation of the SA Rand by the end of 2001, where the SA Rand hit almost R20.00 to the British Pound and about R15.00 to the US Dollar?

Our advice is to keep this investment intact as a longer-term strategy, being one of having a rand hedge and the possibility of growth over the longer-term. This type of investment is not for the short-term and is marketed with a medium to longer term investment strategy. Its performance must always be assessed in US Dollar terms and not in SA Rand terms.

Case Study 2

In this example, a retail client reported a financial advisor for inappropriate advice to the relevant Regulator. The complaint dealt with an Equity Linked Living Annuity allegedly being an inappropriate investment and an investment loss.

Silke on Finance Law was briefed to act on behalf of the financial advisor.

The facts of the case and the response are as follows:

Background

Our client [the financial advisor] consulted with the complainant with regard to this matter on 21 January 2000, 4 February 2000, 23 February 2000 and 22 March 2000. The discussions, inter alia, related to the maturity of her Old Mutual retirement annuity and the options available to her in terms of this investment.

Our client established directly from her that she did not need the relatively small annuity of some R 787.00 offered by Old Mutual at the time. The idea of a living annuity appealed to her on the basis that our client explained the mechanics of the living annuity concept on these four occasions, the salient factors being:

1. An investor enjoys full flexibility in determining the appropriate investment mix from a wide range of portfolios. There is also the added flexibility of being able to switch between underlying portfolios as investor’s needs and circumstances change;
2. The ability to choose one’s income stream between a range of 5% up to 20% per annum;
3. The ability to change the frequency of one’s annuity stream;
4. The fact that the growth in the underlying portfolio is free of income tax and capital gains tax, only the income withdrawn being taxed;
5. The fact that, where income is not a priority, the living annuity can carry on in perpetuity by simply appointing additional beneficiaries or may be encashed under certain conditions;
6. The fact that on death, unlike a conventional guaranteed annuity, the capital is not lost. The capital value of the living annuity passes on to beneficiaries and escapes Estate Duty and Capital Gains Tax.

From the outset our client established, by in-depth questioning and risk profiling, that the complainant was risk averse to the extent that she wanted an investment with a level of security of 50% of the net value of her portfolio with some exposure to the equity market in order to enjoy further growth potential together with the incumbent risk of partial loss. (Her original gross investment was R 72 833.03 and after costs, her net investment amounted to R 70 342.14). It is for this precise reason that her investment was originally split up as follows as at the date of the investment, being 27 March 2000:

50% was invested in the Investec Fully Vesting Bonus Fund (providing capital security). The remaining 50% was placed in the Investec Optimum Deposit Feed Fund (which is a deposit call account) and phased into the following funds on a equal basis over a 6 month period in order to reduce volatility:

• Sanlam Technology Fund
• Standard Bank International Fund
• Old Mutual Financial & Industrial Fund
• Old Mutual Global Technology Fund

This strategy was indeed appropriate in that, as at 6 September 2000, the investment value of the complainant’s living annuity was R 74 533.44 after all costs. By 17 May 2001, the value of her aforesaid investment had dropped to R 64 624.56, during the extremely volatility of worldwide markets and bearing in mind that, at that time, she had had an income payment of R3 337.86 from this investment.

On reviewing the complainant’s portfolio at this stage and her complaint made to our client at that particular time that she had made the “wrong” decision to place her money in a living annuity, our client sent her a letter on 21 May 2001 requesting her to make an appointment to review her investment. No less than five follow-up phone calls were made to the complainant but she did not appear to take any further interest in this investment. One cannot expect our client, a respected financial advisor, to do more than this.

The complainant did not reply to our client’s letter of 21 May 2001 and eventually consulted with our client on 20 December 2001. At this meeting, our client again performed a risk-analysis for the complainant and she profiled as a "conservative" investor. (This implies a maximum equity exposure of between 25% to 30% with the balance being invested in fixed interest investments.) Consequently, she signed a Switch Request Form and converted her entire portfolio as follows:

• Prudential Inflation Plus Fund* 30%
• Liberty Income Fund 35%
• Investec Cash Plus Fund 35%

* Note that the Prudential Inflation Plus Fund is a fund that is designed to outperform inflation by 6% over a rolling 3 year period before all costs. This Fund invests primarily in Inflation Linked Bonds with a smaller exposure to the equity market in order to achieve out-performance in excess of inflation.

Allegation of poor performance

It is submitted that the complainant’s Living Annuity has not performed poorly. As at 19 March 2003, the net value of her investment was R 72 197.59.

In summary, an amount of R 72 833.03 was initially invested in the Investec Linked Life Annuity on 27 March 2000. After initial fees of 3% (3.42% plus VAT), of which our client received a fee of a paltry R 1092.50 (1.5% plus VAT), the after cost investment was R 70 342.14. As at the date of this letter, the complainant has received compulsory withdrawals amounting to R 6 689.18

If one had to add back her compulsory withdrawal amount, the complainant’s Living annuity has attained positive performance of a total of 9.5% (after costs) over the two-year period in question.

The graph below shows that over the same period of the complainant’s living annuity, being 27 March 2000 until 19 March 2003, all the major indexes of the world have performed negatively in South African Rand terms:

It is to be noted that our client reviews the complainant’s portfolio on a monthly basis by having Investec e-mail a statement to him. (This can be verified by Investec). Further, our client does not possess a mandate to manage the complainant’s portfolio and he is not a registered investment manager.

Note that the complainant may convert her living annuity to a conventional guaranteed annuity. In practice, based on the experiences that our client is having with two of his clients, this is easier said than done. These existing clients applied to transfer their living annuities from Investec to Ovation Global Investment Solutions and there has been a hold-up at the Financial Services Board in terms of approval for this transfer for over 6 months now. It would appear that the Financial Services Board is allowed to operate without the threat of legal sanction even though clients may lose money in the process.