Why we went looking for an alternative philosophy – eight years ago

Some years ago the directors of Financial Service Brokers were entertained in the offices of a well-known Wellington based finance company.  The offices palatial, the view over a particularly beautiful Wellington harbour magnificent, and the food, sumptuous.  We had come to the notice of ‘suppliers’.  Finance company debentures were becoming more main stream as part of portfolio recommendations.  Although ratings agencies remained reluctant to measure the risk, research houses were finding it harder to leave them (finance companies) off their recommended lists, and clients were enthused by mainstream direct marketing using NZ personalities.  The quoted yields (returns) were appealing and investors flocked to these products unaware of the risk (how the finance companies were investing their money).

Our involvement in the ‘marketing’ activity of debenture providers (finance companies) was part public relations and part promotion on their part.  This era remains strong in the memory because it was an awakening for our company.  We had grown from a purely product focus in 1996 (Financial Service Brokers Ltd) to a more multi-faceted organisation by 2000.  Personal insurance and personal superannuation had been our primary product offering.  We embarked on an educational crusade because it was obvious that financial planning and advice based service would be our ‘product’ offering of the future due to the influence banks were now having.  Their technological capability to promote and service products which were our former domain – at a better price.

We developed a multi-faceted offering focused to advice.  Mortgages, Fire and General, Personal insurances, Investments, Superannuation and to do so with any confidence and competence we would need to be professionally qualified at a more academic level.  Off to Uni for a couple of years dedicated to formal qualifications.

When the technology stock market crash occurred at the turn of the century it was too much for many NZ sharemarket investors and advisers.  They went looking for less volatile investment products.  A ‘safer’ haven.  Two eventuated over time – fixed interest and hedge funds.  Previously unrelated, but now entwined through residential mortgage backed securities.  So arrived the NZ finance company era and even more disastrous the internationally infamous collateralised debt obligations and collateralised loan obligations.  Both structured around mortgage debt.  The international products created by US investment banks such as Lehman’s, Bear Stearns, Morgan Stanley and Goldman Sachs, made credible by ratings agencies (Standard and Poor’s, Moody’s) and marketed through commercial banks worldwide.  NZ finance companies created debentures and ‘investing’ in car finance and mezzanine mortgages – far greater risks than the investing public was lead to believe.

The NZ finance company industry grew within a largely unregulated financial environment.  The outcome, at least 50 finance companies fell over in NZ leaving investors (both direct investors and investors with debentures as part of managed funds portfolios) billions of dollars out of pocket.  The mortgage backed securitisation dreamed up by Wall St investment bankers as a result of the Enron debacle through ‘convertible bonds’ issuance – were even more of a financial Armageddon.  The global financial crisis was born, Lehman Bros bankrupted and liquidity dried up worldwide.

Prior to the GFC the management of our company (now FSB⁴ Financial) had embarked on a transition.  We needed a new set of beliefs founded on a more academic rationale for investment and a new financial planning procedure focused on clients’ goals and aspirations.  Whilst the collapse of finance companies in NZ and the Mortgage back securities worldwide were an enormous financial disaster, thankfully we and our clients were not overly affected.  It had taken some years for us to become involved in using either debentures or CDO’s – certainly the schmoozing in Wellington had not convinced us.  We could not measure the risk.  On reflection I only wish we had remained true to our intuition – one dollar ‘lost’ for a client was too much.  Eventually the weight of market sentiment and research house recommendations saw us relent – thankfully we chose finance companies who survived the early defaults and most clients exited without loss (early in the debacle).  We learned a lesson.

1. The market experts (research houses and ratings agencies) were not full proof.
2. The NZ fund managers were not as smart as they lead us to believe.
3. The NZ market was not quite the Wild West – but we knew regulation had to follow.
4. The bond and debenture market (fixed interest) lost investors their shirts whereas share market investors only lost their shirts if they lost their nerve.  Those that sat through the volatility lost nothing. 

Equity markets as history had shown over numerous occasions always returned to record levels, it never lost capital when investors had diversified their securities and remained in the market. 

We went looking for a philosophy which answered our questions – around ABC and D.  Thankfully we found that philosophy through asset class investing.  Index funds and Exchange Traded funds have become the big movers in capital markets around the world.  NZ will follow. 

Next week – Why.