Money: How not to get lost in the woods

By MARK FRYER

When is money in the forest not the same as cash in the bank?

No, it's not one of those pointless questions that philosophy students debate, it's a warning about the dangers of making comparisons between very different investments.

The Securities Commission, which oversees the way investments are offered to the public, this week warned promoters of some forestry schemes that they are stepping dangerously close to the line.

The commission has two main worries: the way some forestry investments advertise the potential returns, and the way they use the internet to reach investors.

It has written to 15 promoters of such schemes, warning them of the consequences: it can ban their advertisements and documents, including internet sites, and may invite the Registrar of Companies to look at prosecuting.

It also has the power to prohibit distribution of an investment statement and make a promoter return investors' money, effectively putting them out of business until they can come up with new documents.

The warning follows a commission survey of forestry investments.

One thing which got it particularly upset was the way some schemes advertise the potential returns as "equivalent" to a certain interest rate on money in the bank.

If a promoter reckons their scheme will return 8 per cent, for example, they might advertise that as equivalent to a bank interest rate of 13.1 per cent - because, if you are in the 39 per cent tax bracket, you need to earn 13.1 per cent at the bank to end up with a net return of 8 per cent.

The problem, says the commission, is that interest on money in the bank and the return on a forest investment are far from "equivalent."

What's the difference?

Risk, for one thing: you can be reasonably sure about the interest rate you'll get from the bank, but the return on a forest investment depends on everything from future log prices to the fertility of the land in question.

There's also a timing issue: the bank pays interest at a set time, but there may be a 28-year gap between buying a piece of a forest and getting a return.

The "equivalent" return will also depend on the investor's individual tax rate.

The commission also claims some promoters mix up pre and post-tax rates in their comparisons with bank investments.

All in all, argues the commission, the return on money in the bank is relatively certain and easily calculated, while the return on a forestry investment is neither.

But doesn't everyone already know they're very different investments?

If that's the case, retorts the commission's chief executive, John Farrell, "then why do they draw a parallel between them? They obviously assume that people won't distinguish. That's the inference I would draw."

That's not the way it looks to Roger Dickie, managing director of Roger Dickie New Zealand, one of the best-known forest investment promoters.

"The sort of investor that is going into forestry, they know it's totally different to a bank deposit," he says.

Making the comparison with a bank investment is useful, he argues, because a non-expert investor has no understanding of the internal rate of return - a more technical way of expressing the return on an investment - and therefore has no way of comparing a forest investment with the alternatives.

Most people would not invest in forestry if it were not for the tax advantages, says Mr Dickie. The equivalent bank interest rate is a useful way of demonstrating the effect of those tax benefits, as long as it is done in a way that is not misleading.

However, he says he will concede by adding a further qualification to the way his company's publications express the equivalent bank interest rate.

Steve Wilton, business director of Forest Enterprises, says he can understand the commission's concern, "because it is simplistic in itself to say, 'invest in forestry and you will get the equivalent to a bank interest rate of XYZ per cent' because the reality is that we can't say that with certainty, whereas with a bank clearly they can."

"The difficulty we have in the industry is communicating the return on a forestry investment in concepts that our prospective investor ... might understand or more directly relate to."

While he would hate to lose the ability to make an equivalent interest rate comparison, "I believe that they're right, the balance has shifted to put too much emphasis on this ... It's one of the ways of comparing but the assumptions need to be much more clearly stated and the distinct differences made much more clearly."

The real issue, say some people in the industry, is the inconsistency in the way potential returns are calculated.

While some promoters use registered forestry consultants who assume that log prices will remain at recent levels, that is not a legal requirement.

Instead, a promoter can assume that prices will rise by a certain percentage every year, producing a much more impressive potential return.

For investors, the only answer is to be aware of the assumptions behind the forecasts.

As well as looking at the way returns are expressed, the commission also took aim at the use of the internet to promote forestry investments, saying many websites don't comply with the law.

Websites should not include forecasts unless they are included in the registered prospectus, which gives full details of the investment, including details of the assumptions used when making forecasts.

One of the principles of the law relating to investment offers is that investors should not be asked to part with their money without being given an investment statement which details things such as the nature of the investment, the risk, who the manager is and so on.

If an investor can show they were not given an investment statement, they might be entitled to get their money back.

Which is why investment application forms are usually found in the back pages of the investment statement, and why advertisements typically include words to the effect that applications must be made on the form included in the investment statement.

The commission says websites should follow a similar approach. However, the sites for some forest investments have prominent links to the application form from some point before the investment statement - effectively inviting users to bypass the details and go straight to the application form.

Just getting the investor to tick a box saying they've seen the investment statement is not enough, says the commission.

It says that if an investment statement is available online, it should include a downloadable version or instructions on how to save the contents of the web page as one complete document. It's not acceptable for the document to be available only as a number of web pages that need to be saved individually.

* Contact Personal Finance Editor Mark Fryer at: Business Herald, PO Box 32, Auckland. Phone: (09) 373-6400 ext 8833. Fax: (09) 373-6423. e-mail: mark_fryer@herald.co.nz