Storm's doomed model
December 22, 2008
PORTFOLIO POINT: At its core the Storm Financial model relied on an ever-rising sharemarket. Its crisis has wounded the advice industry as well as clients.
I've just spent an hour with a client of Storm Financial. This is someone within a few years of retirement, who was working part-time and sought financial advice from Storm Financial. The advice provided seems to be typical of the Storm Financial model: they should borrow heavily, invest in equities and wait for the market to go up.
After the 50% fall in the value of shares, the investor I spoke with, like many others, is left with very little in the way of investments and significant debts.
Appropriateness of the advice: the core scandal
That someone close to retirement could be encouraged to borrow so much from an institution offering "financial advice" is the disgrace at the centre of this situation. While Storm's PR firms has been somewhat successful in clouding the issue in the media by implying that Commonwealth/Colonial are somehow at fault, or suggesting that the "unprecedented" situation in global markets is to blame or (and this is the most disgraceful) "people should have taken into account their own circumstances before doing any geared or un-geared investment", the reality is that the advice to borrow so heavily close to retirement is fundamentally flawed.
Investors sought advice on their financial situation, and Storm Financial advised them to borrow heavily. It appears that it didn't seem to matter if they were retired, close to retirement or had little income. The answer was the same: get your hands on some debt, gear it up further using an aggressive margin loan facility and then wait for the sharemarket to work its magic
What's wrong here? It's not the products, it's not even the structure of the investment (index funds). The problem is bad advice!
The underbelly of the Storm process
My discussions with the Storm client gave me an insight into how Storm Financial set about promoting their heavily geared investment scheme.
The process typically starts with the use of fear: statistics about how many people retire on the inadequate age pension; and a bit of hope: people could invest in shares, which provide a safe way of improving their position.
True diversification was not on the menu. It seems Storm has been "totally negative about property". It encouraged people to sell their property or, when people were unwilling to do this, borrow up to 80% of the value of their property to invest in shares - an investment that was then increased with further borrowing through a margin loan facility.
With increased borrowing always on the agenda, most investors found their links with the group continually deepened; few moved on.
Crucially, there does not seem to be any tailoring of advice to a client's situation. It didn't matter whether you were a pensioner, a disabled war veteran or a few years from retirement as the investor I spoke to was; you were still advised to borrow as much as you can and throw it all into equities.
The initial contact between an investor and Storm Financial was often through a seminar. Once there was agreement to go ahead, clients were given a 105-page document, The Business of Making Money - Statement of Advice.
The underlying investment scheme was to use index funds - whole-of-market funds that deliver the market rate of return in a diversified and (usually) low-cost way. Storm portrayed the use of index funds as a signal of its conservatism. The emphasis on index funds meant Storm salesmen could suggest they "don't speculate" in the stockmarket by trying to pick stocks.
Of course, the reality is that there is nothing more speculative than borrowing large amounts of money to invest in shares, especially for investors near or in retirement.
The fees on the Storm Financial index funds were expensive. The entry fee was up to 6.6% and the ongoing fee 1.14% per annum. An entry fee of 6.6% reminds me of the sort of fees being charged in the 1980s; no one (except Storm) charges 6.6% entry fees any more.
A person encouraged to borrow $250,000 from their "home equity" and then geared up through a margin loan to invest a total of about $500,000 into a Storm Financial index fund would be paying entry fees of about $33,000. Extraordinary!
A way to think about this fee might be like this: the long run average growth in value of shares is not much more than 6% a year. The Storm Financial entry fee equals about a year's worth of average sharemarket growth. Of course, sharemarket returns are risky, where the Storm Financial's 6.6% fees are a risk-free revenue to Storm!
Storm scheme was guaranteed to fail
Given the aggressive way that clients were continually encouraged to "step up" their sharemarket exposure - by borrowing more when asset values increased or they came across further funds (such as an inheritance or by accessing their superannuation at retirement) - it means that investors' gearing would be at its highest when a market downturn hit.
Therefore a 50% sharemarket drop would mean investors would have a portfolio worth less than the value of their loans invested, triggering margin calls and the forced selling of their sharemarket assets.
It seems to me that there was no way the average Storm Financial investor would be able to navigate a steep sharemarket downturn. As of today, December 22, Storm Financial continues to trade. Its website is "closed for maintenance" and there have been reports of seminars being cancelled.
The Storm Financial story is one of a failure of advice. Specifically, a failure to accommodate personal circumstances.
Some investors will lose their house. Others who believed the Storm Financial approach and sold their house to start their investment strategy will walk away with nothing.
Presently many, like the investor I spoke with, have been encouraged into the ridiculous situation of maintaining a largely cash investment balance and a margin loan at the same time. Of course, the cash investment is earning a lot less than the margin loan is costing, creating an effective "risk-free" loss for the investor.
It's another reminder of the poor advice from Storm Financial.