Finance industry under serious scrutiny

Hanover Funds Management's rap over the knuckles from the Securities Commission for misleading advertising is being seen as a sign the finance industry needs to rein itself in.

It also flags an industry, burned following three finance-company collapses this year, that is losing investors. In an effort to lure them back, it is offering more and more creative opportunities.

This month the Securities Commission banned Hanover's ads for its new capital-protected fund, the Global Growth Fund, and ordered it to contact all investors to make sure they understand its terms.

Commission chairwoman Jane Diplock was unambiguous in her disapproval. "The way the returns on these securities are structured is unusual. Therefore they should be described clearly and precisely to avoid being misleading or confusing," she said.

Capital-protected products promise to return the amount the investor has put in, no matter what. But what the Securities Commission's director of primary markets, Kathryn Rogers, says the Hanover advertisements did not make clear is that a profit is not guaranteed. "We felt it was [acting] like it was a fixed debt security, but it was not that sort of product. In another ad they promoted the 50 per cent potential return, but the only other option is zero [return]." She added it was not Hanover Finance that caused concern, it was a fund management unit trust within the company.

"Sometimes I think companies looking to diversify have not clearly appreciated the particular nature [of the market]."

Rogers feels people do not really appreciate the risk they are taking with products from the finance industry. "We want to make sure that the companies are explaining the risks accurately and fully." So woe betide any other finance companies looking to overstate the attractions of their products.

Janine Starks, director of Liontamer, a three-year-old investment-management company which specialises in capital-protected investments, says she hopes Hanover's mistake will not impact on the rest of the industry. "I can only sit back and watch the car crash.

"It's a very bad example. I wouldn't want everybody in the industry to be tainted. It's a huge embarrassment."

The New Zealand market is in some ways very innovative, says Starks.

In the UK there are a lot of vanilla products linked to the FTSE 100. Liontamer was set up to give Mum and Dad Kiwi investors access to these kinds of investments.

"We stick to markets where there is unlimited growth. Our typical Mum and Dad investors have got a lot of money and live out in the provinces; they're farmers. Our core holding want international exposure and they want it with protection," she says. Liontamer encourages people to buy through an independent financial adviser, and rarely advertises in the paper.

As the finance industry goes through a sticky stage following the three casualties this year, companies are trying to create some interest in a market where the rate of rollover from one investment vehicle to the next is down. Introducing innovative products with more international appeal such as the Hanover fund is generally seen as a good idea.

Michael Lodge, director of Fund Distributors which markets investment products on behalf of fund managers, says, "I think there's a real need for new products. What the [New Zealand] market has missed out on is innovation. If you look at a lot of the investment products in equities, the products are very old. If you look overseas at what you can invest in there's some very very creative product out there... It's about diversification."

Scale is important to create a home for these new products. "The Australian market is the third-biggest asset-management industry in the world because of the compulsory super, which enables fund managers to be creative."

In New Zealand "fund managers are pulling their hair out". They are restricted by the yield-driven investor "who likes their annual 7 or 8 per cent", he says. Industry observers are warning that when looking at new products, consumers must understand the true risk of the investment, and not be led by the headline figure.

Jeff Matthews, senior financial adviser at Spicers Wealth Management, says his company's researchers are having a close look at the offers out there at the moment. "Like most things, if they look too good to be true, if they are not as good as the ads would have you believe, then they are not going to get the general public roaring in droves."

What less experienced investors don't understand, says financial adviser Nick Stewart, is if you add in all the costs, those of the capital protection, the insurance, the running costs, on top of the flagged return, then that is the true risk to the investor. He says often the finance companies will advertise a lower yield than the product could produce, because they don't want it to be seen as too risky.

Stewart, executive director of the Hawke's Bay-based Stewart Financial Group, tells his clients to stick to simpler products which do not have high cost structures.

The financial adviser says that in Australia, the market is pushing to make the total cost of a product's fees more comprehensible. "We have not really gotten to that yet. There's so much legislation going through in New Zealand."

Finance companies joined ranks last week to restate their purpose in the market.

Finance industry veteran Glenn Walker, who set up Geneva Finance almost five years ago, says for his semi-retired or retired customer base, there is no need for innovative products. What his customers want are simply explained, transparent investment vehicles which make good their promise, rather than sophisticated ones no one understands. "Like most things it is about relationships and confidence," says Walker, who has a high level of contact with his investors. The company is not working on any new products at the moment, he says.

Walker does admit it has been a volatile year for the industry and that the rollover of investors from one fixed term investment to another is down on previous years.

Helen Mexted is the director of funding at St Laurence NZ, known for its portfolio of debt and equity products, including the Aorangi syndicate fund which recently wound up, giving investors 16 per cent per unit. "Sometimes companies can be innovative for the innovation's sake - they don't get the need that products are very easy for investors to understand, are essential and that they suit the target market," she says.

There is no doubt that in the past few months some people have taken their savings from their investments when they came to term, and, instead of rolling them over, have put them in the bank.

Mike Heath, general manager at RaboPlus, the online savings and investment bank, says anecdotally the bank has inherited some new clients from finance companies. "There has been a flight to safety in finance products. We have had feedback from our call centre that there have been some inflows in terms of customers. People are realising that for an extra 1 or 1.5 per cent interest it's not worth putting all their cash at risk."

RaboPlus now has deposits of $740 million, and last Thursday put its interest rates up to 7.7 per cent on both its six-month and 12-month term saving accounts.

Ross Butler, acting chief executive of the Institute of Financial Advisers, adds there are steps a consumer should take before deciding on a product. Have a good look at it, then consult a financial adviser.

Then look to the Securities Commission. He says misleading advertising [such as Hanover's] will get picked up.

"Sometimes they do it in response to a complaint but they are very proactive. They can act quickly," he says.