Investor beware
August 23rd 2008 10:40
By Chris Champon
There is an illuminating commentary at ezinearticles.com describing four common dirty tricks used by investment advisers.
In short, if you meet an adviser who offers advice for free, who confides that he is paid for performance only, whose portfolio performance indicators omit funds which died and went to hedge fund heaven, or who drops a few well-known names from his client list, then run away.
These activities are either misleading or illegal, or both.
Free investment advice sounds good, in the way that a free lunch with a vacuum cleaner salesman sounds good. Those three words - free investment advice - should set off alarm bells. And they probably do for experienced investors. The problem is that most of the people who need investment advisers are not experienced.
Or, as E. Y. Harburg said, "The Lord made Adam, the Lord made Eve; he made 'em both a little naïve" (The Begat, 1947).
The investment adviser industry should be about gathering information about your assets and your financial goals, analysing the information and formulating an appropriate investment strategy for you. It takes time, knowledge and experience to do this well, not to mention the integrity to give honest advice and to disclose any conflicts of interest in the asset allocation process.
Anyone offering to do this for free is certain to be long on high-risk, high fee-paying ventures, and short on the time, knowledge, experience and integrity part - and probably all four.
The author of the ezinearticles.com feature, Australian investment commentator James Cooper, labels these dodgy investment advisers "sales people" because, despite high-octane promises of full and caring service, their ultimate aim is to sell you high-risk investment products which are rarely what you really need.
The harsh news is that, according to Cooper's estimates, 60 to 70 per cent of investment advisers fall into this category. Caveat emptor.
The second dirty trick is more word twisting. Your sweetly smiling investment adviser pronounces, in comforting tones, that she is "paid for performance only". Well, that's a relief. Not like those shysters who get a fixed management fee.
The implication is that advisers who get a fixed fee have less incentive to work hard to maximise your investment returns. The truth is that such advisers receive a remuneration package involving a fixed fee and a year-end performance bonus. This leads them not into the temptation of highly leveraged products. It leads them instead to the righteous path of forming long-term relationships through clear and honest service.
James Cooper once again has a sting in the tail, or should that be tale, saying that "most" investors don't see the problem of a "paid for performance only" arrangement. "After all," he says, "if a manager cannot hit a certain benchmark in terms of return, he or she won't get paid, that's fair game, right?" Wrong.
Trick 3 is presenting, with due modesty, proof of solid investment portfolio performance. Except it's a misrepresentation of reality when it leaves out the bad news, such as funds which went out of business. This usually works because few investors think to question the fact that their potential adviser's track record shows dealings only with living and apparently healthy funds. Out of action, out of mind, leaving your humble adviser implying that she never made the mistake of directing client money to a fund which subsequently curled up and died.
And, finally, we have the name droppers. If you sit down with an adviser who casually mentions some important names who have entrusted their money to him, then recognise this for what it is - a grossly unethical breach of the confidentiality clause which exists in every service agreement worth the paper it's printed on.
Or you could ask for details on how well the adviser's advice paid off for the dropped celebrity name, and see how far that gets you.
It's easy at times to be scornful or flippant about people who are burned by dodgy investment advisers, but it is perhaps surprising there isn't even more of it given the polished promises and convincing pitches of many advisers. Most people do not understand just how the maximised tax refunds and offshore tax havens work. They don't actually want to understand - don't have the time fort energy for that. But the adviser obviously does and how comforting is that! Make note to self to buy her a nice bottle of chardonnay for her efforts.
So how to survive in these shark-infested waters?
First, get an independent second opinion for everything. Second, remember the following sales pitch lines. They sound too good to be true, and they almost invariably are:
... You don’t need credit or asset checks, we’ll lend you the money
... Even if the investment doesn’t go ahead, you’ll still make a profit from your tax refund
... Sign this secrecy agreement – we don’t want our competitors stealing our ideas
... There’s no need to ask the tax office if it’s okay. We already have a ruling
... You’ll receive cash back in your pocket as a commission rebate
... You can get up to 100% tax deductions fully supported by tax office rulings
... A top lawyer and/or accountant have looked at the investment and they think it’s great
... Your funds will be managed by an international bank (or an international trust, or global corporation ...)
... We’ll put your money in a tax-free overseas account
... You can run your business through your own offshore company
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