The financial advice ombud has ruled against two advisers who put a retired couple into high-risk commodity funds at the height of the 2008 financial crisis, resulting in the loss of up to half of the capital they used to fund their income.
Noluntu Bam, the Ombud for Financial Services Providers, took R S Walsh Investment Consultants of Port Elizabeth and its representatives, Ronald Walsh and Guy Coleman, to task for advising GB and EB to invest in high-risk funds that were unsuitable for their needs, and for not enabling them to make an informed decision about the implications of the investment.
The ruling, issued this month, is the outcome of a complaint lodged by GB and EB against the firm.
The couple first met Walsh in 2006. At the time, their income was from fixed-interest investments and rental income. They asked Walsh whether unit trust investments would provide a better return, and he said that they could.
As a result, GB and EB invested R70 500 and R97 421 respectively, via Investec’s investment platform, in a high-equity multi-asset fund (Allan Gray Balanced Fund), and two general equity funds (Allan Gray Equity Fund and Nedgroup Rainmaker Fund).
In November 2007, on Walsh’s advice, GB and EB each invested R500 000 in a number of Stanlib funds: two general equity funds (Stanlib Capital Growth Fund and Stanlib Value Fund), a small and mid cap equity fund (Stanlib Small Cap Fund), and a high-equity multi-asset fund (Stanlib Stability Fund, later renamed the Stanlib Balanced Fund).
In April 2008, again on Walsh’s advice, the couple switched out of the Allan Gray Balanced and Nedgroup Rainmaker funds into an equity resource fund (Investec Commodity Fund), a general equity fund (Investec Equity Fund) and a high-equity multi-asset fund (Investec Managed Fund).
In June 2008, the investment in the Stanlib Small Cap Fund was switched into the Old Mutual Mining and Resources Fund. In addition, 20 percent of both the Stanlib Capital Growth Fund and the Stanlib Value Fund was switched into the Old Mutual fund.
Some of the funds in which they were invested lost 50 percent of their value, and the couple had to sell their units at reduced prices to draw an income. Eventually, they stopped making withdrawals and one of them had to come out of retirement and return to work.
They each initially withdrew R4 575 a month, decreasing to R3 575 in October and November 2008 before ceasing. Their withdrawals resumed in November 2011.
In a 2009 fund fact sheet, Old Mutual stated that the Mining and Resources Fund “may be riskier than a diversified general equity investment, because its assets are concentrated in the mining sector of the stock exchange. In addition, exposure limits to a single security may be higher than those of a general equity fund.”
Bam says it should be noted that the switches into the two resources (commodity) funds occurred during the global financial crisis of 2008. She says that many would regard these switches as “counter-intuitive, because they increased risk during a volatile period. By investing in a specific sector of the economy, one reduces diversification and, in so doing, increases risk.”
In his response, Coleman said that Walsh moved many clients into resource-based funds at the time, because this was the only sector providing positive returns. He says he was “outraged” by Walsh’s actions and asked the firm’s compliance officers to intervene, but to no avail.
The ruling says that between April 2008 and January 2009, GB raised his concerns with Walsh about market volatility. He says Walsh told him to “stick it out”, that there would be a change in the markets and that he should not worry.
GB says that, in December 2008, he decided to stop making regular withdrawals, on his own “instinct”. At this point, the couple started to draw on their emergency savings.
In their complaint, GB and EB said:
* They would not have invested in such aggressive funds if they understood the volatility to which they were exposed;
* The advice made no provision for their short- or medium-term financial needs; and
* The advisers switched their investments, and some of the switches were made at the height of the global financial crisis.
In his response, Walsh says the changes to both the commodity and the equity funds were aimed at enhancing the couple’s ability to grow their capital and income over the long term, which the balanced and moderate funds could not do. Therefore, this was not a contravention of the Financial Advisory and Intermediary Services Act, but a means of meeting their interests, needs and objectives. He says that, had the couple not panicked and acted contrary to the advice, which was to allow the markets to correct, they would have recovered a significant portion of their investment.
But Bam says the couple did, in fact, remain invested in the portfolios – until December 2011. It was only at this point, and after the markets had recovered to some extent, that they restructured their portfolio with the help of another adviser.
Walsh also contended that he followed all the procedures required by the FAIS Act.
Accordingly, he says, the couple made an informed decision.
But Bam says there is no evidence to suggest that the couple’s circumstances were considered.
In his response, Coleman says he had no say in the allocation of the portfolios, and this was the reason for his resignation in January 2009.
Bam says the FAIS Act contains provisions aimed at ensuring that investors are provided with appropriate advice.
“A risk profile on its own can never be the sole determiner of a client’s risk profile. In order to appreciate how much risk a client can afford to take, reference must necessarily be made to what the client has by way of assets and financial arrangements. To put it in simple terms, clients must be in a position to understand what they are letting themselves in for.”
Bam says it is clear, based on the evidence, that the couple was not able to make an informed decision.
She says there was no record of advice that explained why a move to higher-risk, single-sector commodity funds in the midst of the financial crisis was likely to satisfy the couple’s needs and objectives. Likewise, with regard to the R1 million invested in the Stanlib funds, there was no record of advice that indicated the potential risks or the options to moderate such risks, particularly given the couple’s income drawdown.
Bam says that, whereas Walsh tried to justify the advice, Coleman tried to shift the blame onto Walsh. But she says they both breached the FAIS code by failing to render financial services with the requisite due skill, care and diligence.
She ordered the respondents, jointly and severally, to pay GB and EB R102 148 each. The compensation was based on what the couple’s investment would have been worth had they been invested in a balanced fund between November 2007 and December 2011.