Secondary

The Risk of Giving Financial Advice

In view of the heated response to Monday’s article on the focus on commission, I was a little concerned about placing yet another contentious issue on the table. Some of our readers are no longer in their prime, and you cannot rev these old engines too high, too often, you know.

In an article on 28 February, we posed the question whether the Ombud’s access to facts, after the event, and based on hindsight, did not count against financial advisors.

Magnus Heystek published an article on Moneyweb where he expands on the theme. We publish an extract below that relates to the content of our article:

In November 2007, when the great stock market crash took place, the client’s fund values declined. They sold (at the bottom in a panic) and wanted compensation from the advisor for their loss.

Fortunately for the advisor the amount in question was not too large, about R39 000 in total, but it is the legal principle that has now been established: when all goes wrong with your investments, sue the advisor!

My first concern with the Ombud’s ruling is that the advisor’s reliance on the information contained in the fund fact sheet was dismissed.

“I am cognisant that the MRP fund fact sheet lists one of the advantages of the fund as ‘low risk.’ However, given the fund characteristics as set out in para 11, an FSP could not reasonably conclude that the MRP fund is a low risk investment.”

Does this now mean that the information provided by product suppliers needs to be questioned and overridden by the investment advisor? How scary is that?

The irony of it all is that listed property has, apart from a brief four-month period from end-November 2007 to April 2008, been an astonishing investment, the best asset class with both capital appreciation and growth in the income generated, beating every other asset class in SA by a substantial margin.

Had the complainants stuck with their original investment, they would have doubled their income as well as their capital.

This is precisely what they required and that is what they were given by their advisor, who could easily have put all their capital in an unlisted property syndication and lost all of it.

Investment advisors, by virtue of this ruling, have now become the ultimate guarantor of the investment industry. Note: not the product provider, but the advisor.

Much of the determination deals with paperwork, what was said and what was written down and communicated to the client.

A further worrying aspect of the ruling is that despite the clients signing a mandate, acknowledging that the products were properly explained and that they understood the relationship between risk and return, she still ruled against the advisor.

And if that is not enough, a further reading of the Ombud’s ruling in point 20 of the determination adds the following “The flaw in the respondent’s argument is that it ignores the fact that the complainants drew an income from the MRP fund. They had an immediate need to supplement their small pension. As such it cannot be said that they had a long term investment horizon. The need to withdraw funds during inevitable market downturns in the security market compounds and irreversibly locks in losses. I could not find anywhere in the respondent’s papers that he warned the complainants about the potential adverse implications market volatility may have when drawing an income from an investment.”

Isn’t this precisely what happens with a living annuity? You draw down an income from your capital and future capital growth, which cannot be guaranteed.

Every single investment advisor who uses living annuities needs to read this determination and protect them against an inevitable and sustained downturn in the market.

A lot of the changes in the investment advisory space have been necessary. However, one gets the feeling that the pendulum has now swung way too far in the other direction

I now know why international investment applications, especially in litigious USA, often have several pages of disclaimers. We, too, are rapidly approaching such a scenario.

Some commentators are of the view that the introduction of TCF and Twin Peaks will address the issues raised in the article above.

I am of the opinion that it may be too little, too late, for many honest financial advisors.

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