Taking Stock

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Taking Stock 21 January 2021

THERE is an explanation for why New Zealand has more family trusts per head than almost any other country.

The truth is the trusts were mostly established to avoid or reduce tax, and to avoid the means testing that precedes the granting of social welfare, from the dole right through to rest home subsidies.  Trusts avoided death duties.

They continue to help avoid judicial interference with estates, trust structures foiling those who would contest what would otherwise be dictated by wills.

And, of course, they enabled professional people to hide assets that a creditor might target. But the prime explanation is that in NZ, where we have income-tested or means-tested social welfare, a family trust has been the most frequently used device to access a benefit that otherwise would have been unavailable.

Former National Party leader, and Prime Minister, Jim Bolger brought in a surtax to divert the NZ Pension away from well-off retired people, in the 1990s, a time of fiscal austerity.

The family trust thwarted his plan. That single event gave birth to more than 100,000 family trusts.

Lawyers, and various rogue organisations, like Money Managers, constructed complex trust arrangements, in so doing earning fat fees and circumnavigating political intervention.

But that was yesterday.

Today, most of those motivations to form a trust are falsely based.

Death duties are zero-rated (no tax payable). The rest home subsidy is approved, or not, only after examining family trusts, and other benefits examine all potential assets and income.  You can run but you cannot hide.

That leaves as legitimate motivations a few objectives, including asset protection from creditor claims, and the avoidance of judicial interference with estates.

That is where we are today.

Within weeks, the scene will have changed again.

New law, coming into effect next month, is targeting trusts, already under pressure from those who enforce anti-money laundering, who discourage trusts with endless disclosure requirements, including such matters as ''source of funds'', a declaration most often answered by the one-liner – bank deposits.

The new law will make it harder for the settlors of trusts (those with the money) to create a trust that exonerates trustees from the banal penalties that attempt to enforce ''conventions'' on funds investment, with many such intentions based on the big lie, that equity investments always grow over time.

Trusts must advise all beneficiaries of their existence. There will be no secrets.

A settlor can no longer stipulate that trustees can sidestep risks by investing only in asset classes like cash or fixed interest. And from next month all potential beneficiaries (eg grandchildren) must have their investment horizons and risk tolerance taken into account by trustees.

A trust which might have described one's spouse as the primary beneficiary might have commanded trustees to prioritise his/her needs and ignore potential beneficiaries until he/she should die.

Furthermore, from next month, trustees must regularly disclose to all beneficiaries the assets in the trust and discuss investment strategy, providing beneficiaries with an opportunity to complain, or even litigate.

There are no doubt some good intentions in this new law.  My preference would have been to authorise the defining of primary, secondary and tertiary beneficiaries, enabling trustees to prioritise the primary beneficiary, if needed.

My other preference would have been to abolish trust management companies, or failing that, require them to advise all beneficiaries of their plans and their costs, and to have a sunset clause, enabling a majority of beneficiaries to sack the trustee. Currently trust companies can milk trusts for as long as they like. And boy, do they exploit this.

I will explain my logic in the Taking Stock item that follows.

In general, trust management companies are fee greedy, have inappropriate ownership aspirations (focused on dividends and imminent sale) and have no ability to attract the sort of investment skills that would justify their role in funds management.

The new law should have addressed these issues.

Sadly, as was the case with the Insolvency Practitioners Act, those who conjured up the law had far too little contact with those who pay for the service. The Old Boys Network has had another victory.

The focus was on those who benefit from the law.

As a result, the only remedies now lie in the registration process that leads to licensing of trust managers, and the much tougher use of the fit and proper person assessments by the regulators.

The Public Trust would be the closest to a credible organisation in the sector though it, too, has had dark periods of atrocious leadership and ham-fisted policy.

The ape in the trust jungle is Perpetual Guardian, an organisation with a short history, though its origins, Perpetual Trust, NZ Guardian Trust and Covenant Trustees had their own histories.

None were respected. Some of their behaviour had been appalling.

Amalgamating three disrespected, poor performing trust companies was hardly a formula likely to lead to any shade of excellence.  Indeed, the transaction aspired to flog off the new group, before mezzanine borrowing costs began to bite.

My advice, as will be in part justified by the next item, is to use the Public Trust if one must use a trust company, but preferably never to use any trust company, if you can find a lawyer or family members who would apply the new laws cheaply and without self-focus.

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REGULAR readers of Taking Stock may recall that last year I recorded a dispute over the fees, and the skills of the staff, of Perpetual Guardian.

While walking the beach during the April Covid lockdown, I took a cellphone call from a woman who had become distressed by Perpetual Guardian's management and charges.

Unwisely, her mother had been persuaded to appoint Perpetual Guardian to act as executors of her estate.

She had died, leaving behind a modest family home and around $30,000 of bank deposits, instructing that these be cashed up, any incidental dues be paid out, and the residual amount to be split between her offspring. The total involved was around $430,000.

These simple tasks, somewhat slowly, had been performed, with modest skill, without adequate communication, and at ridiculous expense.

The big issue was Perpetual Guardian's charges.

Perpetual Guardian's website confirms it is by far the most expensive trust company, and if all websites were forced to display complaints, it might also confirm it has been what I might politely call a controversial service provider.

The woman who rang me told me that Perpetual Guardian had charged around $65,000 including GST for their role in appointing a real estate company to sell the home, collecting those proceeds within a few months, retrieving the bank deposits and storing them before disbursing them to the beneficiaries of the estate.

With apologies to her, I must record that originally I did not believe the story.

Having been involved often in such transactions, I knew the standard rate might be around 2% of the estate's $430,000 value, say $8,600, plus GST. A charge of $65,000 sounded like fiction, or a typing error.

I rang a friend in the Public Trust to confirm my knowledge. They confirmed the fee would be around $10,000.

I rang the co-owner of Perpetual Guardian, Direct Capital.  Its managing director, Ross George, graciously agreed to poke his nose into the minutiae.  He is a decent man.

He confirmed later the figure and, to the extent that a non-executive business owner can intervene, he sought to help, but no refund of this impost was offered.

PGT's senior person in charge of the case was unbending.

So I advised the angry woman to contact the disputes resolution company, Financial Services Complaints Ltd, an organisation run largely by empathetic, wise women, quite independent from the companies like Perpetual Guardian, which are forced to pay them to resolve the complaints of unsatisfied clients.

To cut to the chase, after several months of unpleasantness, Perpetual Guardian has apologised, returned a chunk of their absurd fees, and the senior person who resisted the complaint is pursuing a new career, presumably still believing a charge of some 15% of the estate's assets was justified.

I could easily stretch out this article by itemising many other disputes with Perpetual Guardian that have been referred to me, usually at the suggestion of lawyers.

Some have been resolved to avoid public discussion, some have yet to be resolved.

I could also discuss the hundreds of dreadful examples of incompetence that occurred during the finance company bonfire, where Perpetual, NZ Guardian Trust and Covenant were almost wilfully incompetent, obvious victims being those who invested in Lombard, Strategic, St Laurence, Hanover, Bridgecorp and Dominion Finance.

Those who were supervising company trust deeds displayed the intelligence, inquisitiveness and courage that one might expect from an ancient Egyptian mummy.

Reader ennui may legitimately discourage my reciting evidence of such appalling behaviour, leadership being invisible, skill levels displayed at primary school standards, rich rewards offered to people whose personal achievements deserved only clerical-type remuneration.

Suffice to say that the trust company model, always threatened because its foundations were built on a fault line, was shattered years ago.

Only its involvement with the nauseating Old Boys Network of greedy law firms, big banks, greedy liquidators and receivers and lazy regulators has allowed the trust company model to persist.

Who will be the disruptor that applies euthanasia to this network?

Will it have to be the great manufacturing disruptor, Nick Mowbray and family, to find a way to move us into the 21st century?

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THE elevation to the stratosphere of the share prices of Meridian Energy and Contact Energy has been so well explained to the media that no one should now be wondering what caused these pricing anomalies.

Foreign Exchange Traded Funds were committed to buy, at any price, a large number of shares in Meridian and Contact. Naturally they were gamed by real fund managers and serious investors.

When the funds telegraphed their robotic buying intentions, alert people bought as well, and then sold at higher prices each day, until the index fund buying programme was replete.

I guess this exploitation was a legal and moral version of the old, outlawed model of front-running that attracted dishonest and weak people – cheats – in the 1990s, one well known example leading to a young man disgracing his family, and having to be fired, eventually to reappear in an organisation that forgave such people.

Today there is nothing illegal or immoral in reading the covenants of passive or robotic index fund managers and positioning oneself to exploit their braindead model.

If I told a house seller that I was compelled by law to buy his house next week what do you think his price would do? No buyer would be so stupid.

The concept of such robotic funds is commercially naive.

The short-term price rise was nice for all who benefitted.  Indeed the buying in the future might continue at even higher figures if the US public continue to pour money into those robotic funds.

What this event did also uncover was the futility of any campaign to include passive fund managers in private boardroom conversations on strategies or tactics.

Here in New Zealand one of those mice that roar had publicly complained that the passive fund he founded was not winning airtime with public company boards. His phone calls were not being answered.

On subjects he wanted to discuss, putting forward his somewhat irrelevant musings, he was being ignored.  He wanted support from real fund managers who he wanted to see behaving like activists, demanding that companies in which the real fund managers invest, be open to hear the views of those with the power to invest or not invest.

As the Meridian/Contact transactions displayed, the robotic managers were going to invest at any price because they were compelled to do so by their own trust deed and covenants.

Whether they liked the strategies or tactics of Meridian/Contact or whether they disliked those plans, they were obliged to invest.  Why, therefore, would Meridian or Contact offer such people any time at all?  Such business models are leeches, not scorpions.

Further the Meridian/Contact people would be absolutely right to assume that a robotic fund manager need not have the faintest clue about any strategy or tactic.  Such a buyer is not an analyst, a researcher, or even a thinker. He is much more likely to be a salesman.

Whereas a real fund manager requires street wisdom, knowledge, experience, and relies on research, an ETF or passive fund just buys and sells, its rules pre-determined and telegraphed.

Of course its deed and covenant had once to be written but it cannot then be adjusted each day to take account of the whims of its irrelevant administrators and salesmen.

In New Zealand we have had countless examples of passive funds being gamed.  Synlait Milk's share price rise (to $14) was singularly the result of index buying, just as its fall to a current $5 has been at least partly the result of index weighting changes, resulting in selling.

The administrators who run index funds cannot have it both ways.  They are cheap, because they have no value to add, no relevant skill to sell.

They can hardly be expected to arrive without credentials or credibility at a boardroom door and expect to be regarded as an essential element in strategy-setting.

As a matter of scale, a passive KiwiSaver fund in NZ with $2 billion of other people's money to invest by rote will have around $400 million (at most) to invest in the NZX-listed companies.

The NZX market cap is around $200 billion, meaning that $400 million is one-fifth of one percent of the market.

It is hard to imagine any sizeable company being so time-rich that they would meet with any such roaring mouse.

By comparison, broking firms like Craigs and Jarden probably have the power to invest tens of billions into NZX companies. Their analysts would be entertained carefully by most listed companies.

If you add Milford, Fishers, Harbour Asset Management and the like, you might find a small number of people who can access boardrooms, because of their buying power.

And we cannot overlook the small matter of insider information! The likes of Craigs and Jarden would have very strict protocols to avoid criminal offences, like misusing inside information.

Passive funds obviously have their place in the financial markets. They are cheap.

But they are very different beasts from those with the access to the inner corridors, for a very obvious reason.

The Meridian/Contact Energy index fund behaviour underlined this limitation.

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Kevin will be in Timaru on 12 February.

Johnny will be in Christchurch on 4 February

Edward Lee will be available in Albany on 28 January, in Nelson on 3 (now full) and 5 February and in Napier on 11 and 12 February.

David Colman will be in Lower Hutt on 2 February.

Chris will be in Albany on Feb 9 and in Christchurch on February 16 and 17.

Please contact our office for an appointment.

Chris Lee

Managing Director

Chris Lee & Partners Ltd

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