Taking Stock 20 February, 2020

IF one has a family trust and one responds to the signals from politicians, this may be the last year of the trust.

By 2021, most family trusts are likely to have been dismantled, the assets distributed either to the settlor or to the beneficiaries.

The merit of most trusts will have become negative.

By year end, no trustees of a family trust should be unaware of the changes in legislation that have negated the principal benefits of a trust.

If we cast our minds back to the 1980s and 90s we will recall that in those years we had a number of parties frenetically advocating or advising on trusts. People like Douglas Lloyd Somers-Edgar at Money Managers, Martin Hawes, Ross Holmes and countless lawyers wrote books about trusts or advocated them on radio shows and at seminars.

The three principal benefits were said to be:-

1) The ability to hide income, thus avoiding the National government’s surtax on the NZ pension, a tax that clawed back the pension from those with even modest levels of other income;

2) The ability to hide assets and income in order to access a government subsidy for those who lived in rest homes;

3) A legal structure to avoid punitive death duties.

Very little discussion focused on the real value of a family trust, which was, and is, to divert assets from a future estate and thus avoid family squabbles or judicial interference with the final wishes of the owner of the assets.

The family farm, business, home or financial assets could be placed with the trustees, effectively indefinitely, meaning the trust could continue to set the rules, rather than have those rules transferred to an estate, where any scorned beneficiaries could mount a judicial challenge.

That benefit remains intact but it raised problems which I will discuss shortly, the elephant of all problems being the greed and self-focus of all the trustee companies licensed to provide the administration of trusts.

The number of trusts in existence in New Zealand will now begin to dwindle for three logical reasons:-

1) Even the most cynical of advisers/lawyers will not be seeking fees by designing trusts to avoid asset or income testing. The Crown and the tax authorities routinely regard ‘’trust’’ assets as the property of the settlors and beneficiaries and disallow subsidies for those who might have access to trust assets.

Death duties are now rated zero. There is nothing to avoid.

2) New law will require trusts to disclose trust assets and income to all potential beneficiaries, thus ending the doubtful value of ‘’hiding’’ wealth from one’s ultimate heirs and beneficiaries. The quaint notion of not revealing wealth to one’s offspring is officially anachronistic.

3) The governments of the world regard a trust as a device that is widely used by money launderers and other evil forces.

There will be increasing pressure on trustees and beneficiaries to comply with invasive anti-money laundering protocols.

Indeed, some intermediaries required to apply AML protocols will not act for trusts involving overseas residents. The administration and the risk far exceed the value.

So only the most logical and necessary trusts should be in existence by 2021.

Trusts will be dissolved cheaply and efficiently. Law firms will dissolve them at minimal or even no cost, assets like shares and bonds simply being transferred to the settlors or the beneficiaries, properties re-registered in the appropriate names.

The elephant in the room is the problem of escaping from inappropriate trustees, an issue for those trusts that do have a logical existence and want to continue.

I refer here to legitimate trusts that, for example, define assets that may have preceded a second marriage or may be intended to protect needy beneficiaries, such as the disabled or afflicted.

At issue is the now absurd involvement of trust companies, the largest of which is now Perpetual Guardian Trust (owned by a UK asset arbitrageur), the Public Trust and Trustees Executors, (owned by John Grace, an American investor).

The trust companies today are licensed and regulated by the Financial Markets Authority, but that has done nothing material to alter their self-serving behaviour that has made me so critical of trust companies.

Perhaps this behaviour began when the Public Trust was challenged by the Crown to make profits, rather than just supply a public service to those who would not naturally engage a lawyer to design a trust or an estate, and outline an administration programme to ensure the trust was managed sensibly.

As the Public Trust degenerated into corporate aspirations, the other trust companies, led by NZ Guardian Trust, accelerated a pursuit of fast profits. These came from absurd fees and morally bankrupt practices, like encouraging dying people to form testamentary estates with a corporate life of decades, contractually feeding years of fees to the trust company.

Presumably it was this focus on profits that led to the loss of the more competent (and expensive) staff, in favour of a dumbed-down service.

Simultaneously, we witnessed a surge of corporate trust interest in administering the deeds of finance companies and managed funds.

High fees did not equate to administrative excellence or devotion to duty. For those in doubt about this, read my book The Billion Dollar Bonfire!

Well do I recall the former employer of one high-profile corporate trustee describing his previous manager as being suitable for no more complex task than an accounts payable clerk.

Competent and ambitious financial market participants would regard trust companies as the bottom rung of any ladder.

The hungriest of the trust companies now is Perpetual Guardian Trust, owned by ex-Macquarie executive Andrew Barnes, who arrived in New Zealand a few years ago after leaving the millionaires’ factory, as Macquaire was disparagingly named, to take on governance roles with a fund manager in Australia.

When this company made unwise investments, Barnes, to his credit, resigned and sought a new home.

New Zealand allows businesspeople to obtain residency and citizenship if they invest large sums here.

Barnes bought Perpetual Trust from George Kerr, himself an asset arbitrageur with a colourful background. The two knew each other well.

The Perpetual deal was convoluted. Indeed all its internal circuitry perhaps is still not unentangled, Barnes and Kerr both commencing and withdrawing legal cases against each other.

Barnes tried to list Perpetual after buying NZ Guardian Trust and a minnow or two (Covenant was such a minnow) but the capital market leaders in New Zealand rightly judged that PGT was more suited to a private trade sale.

Barnes announced triumphantly that he had sold PGT to two very young Australian lads, neither of whom had relevant experience, for an astonishing sum of around $200 million, a figure perhaps three times the value I could see in PGT, a company I regarded as a poor performer in a sunset industry.

Unsurprisingly, this deal collapsed, so Barnes was left with a debt-funded purchase of a company that had no obvious appeal. He has since described his position then as uncomfortable.

But in came the canny Direct Capital owner, Ross George, who became a half owner of PGT at a price that George would have seen as credible. The deal was structured as a loan convertible to shares, on George’s terms.

PGT remains the biggest in its market, by far the most expensive with its fees, but celebrated for its discussion of the four-day working week, and its linking of work hours to productivity.

As an example of its fees that I regard as excessive, it charges $22,500 per annum to manage a $1million estate, according to its website. The Public Trust’s fees would be less than half of that and are themselves excessive.

PGT also sought to innovate, aspiring to create efficiency by sending its clients’ wills and trusts to the ‘’cloud’’, enabling digital signatures to affirm updates to documents.

The law did not and does not allow such documents to be altered by digital signatures so this campaign may have subsided.

I have not observed any trust company providing as much trust administration expertise as I would expect of a trained lawyer, nor have I seen any lawyer’s bill being anything like the size of trust companies’ bills.

In my view, those who allow trust companies to administer wills or estates are simply throwing away money that should go to beneficiaries.

So in 2020 I expect change to be game-changing. Many, probably most, family trusts should be unpicked. A competent lawyer could oversee this at minimal cost, hundreds, not thousands.

Those trusts that should remain intact need to review the trustees and in my opinion would be likely to replace trust companies with a better and cheaper alternative.

A trust or estate managed by competent family or friends, perhaps with an obligation to consult a lawyer or accountant, would find annual savings that over a decade or so might be in the tens, or even hundreds, of thousands.

Trust companies would then be seen as being in a sunset industry, as I surmise.

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ANOTHER sunset industry is that routinely described as Peer-to-Peer (P2P) lending.

As is the case with trust companies, the demise of this sector has been frequently discussed in Taking Stock.

P2P was a product that grew out of technology as a solution for those who could not borrow from the traditional sources of lending, such as banks, finance companies, credit unions, family and friends.

It was seen as a way of reducing bank intermediation costs and of cutting time delays for borrowers.

A P2P company would use a matrix of data to assess the creditworthiness of the borrower, would allocate an interest rate that represented the perceived risk, and then allow those with money to fund some, or all, of the loan, charging a modest fee for the intermediation role.

The problem I foresaw was the impossibility of assessing and pricing risk accurately.

Like other dinosaurs from the banking practices of the 1970s and 80s, I knew the irreplaceable value of eyeball contact with potential borrowers and recalled the techniques used to filter out tall stories.

Matrix lending supposedly charges a premium to cover inevitable bad debts, just as bank credit card loans demonstrate.

I am certain that the individuals funding P2P lending would never easily accept bad debts.

The concept was interesting but would fail, at least in New Zealand, where trust is still highly valued.

Last week, Harmoney, the P2P market leader, acknowledged that the experiment had failed.

It would now fund these matrix loans with institutional money sometimes also called Other People’s Money.

As the institutions have or should have vast capital, no investor ever has to recognise a bad debt personally.

So the flawed project (P2P) is ending.

My guess is that the next projects to fail will be the group funding sites, where people seek to raise money through loose concepts like crowd funding, and pledges of money to help those who have had bad luck.

The crowd funding of those who want to fund their shoe shops with Other People’s Money (OPM) is destined to come under pressure in the next business cycle. The concept is based on caveat emptor – buyer beware (at your peril).

The pledging of money to help others will always be a practice that is regarded warmly by New Zealanders but the administration of such a fund should always be audited and priced minimally.

In the past, the churches provided this redistribution of charity, with very little intermediation cost.

Churches may not be completely transparent, but the likes of charities and churches are unlikely to invite into their congregations those who are looking to make their living as a middle man, intermediating OPM.

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NO subject arises more frequently, day to day, than the end-play of the Coronavirus.

Naturally, everyone who has read official or social media comment will have a view on how this virus might affect us.

Those who currently are simply being prudent will be reviewing their investment strategies and portfolio to ensure they can cope should the outcome be as dramatic as social media is forecasting.

A sensible position is to ensure enough cash is held to avoid the obligation to sell any securities in the midst of any group panic.

Trimming off enough cash to meet a year of needs seems to be a cautious but not extreme position.

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AUGUSTA enthusiasts have a rare opportunity to enjoy a free lunch.

For years, Taking Stock has advocated that the real jam in Augusta’s property syndication business was reserved for the owners of the funds management business. The property syndicate investors took a risk to get a return but the ticket clipping for the managers involved virtually no risk.

When Centuria arrived from Australia, it had its eye on the ticket clipping and bid to buy out Augusta for $2 cash per Augusta share or a fixed percentage of a Centuria share.

The Centuria share price has risen significantly so the $2 cash offer is now obsolete.

Canny Augusta shareholders can sell on the open market for much more than $2.00, or they can accept shares which seem to be rising in value.

Those who are cautious about Australian buyers of our funds management businesses can enjoy a free lunch, selling at a cash price that does not rely on the unknown forces that have lifted Centuria’s share price.

Free lunches are rare.

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TRAVEL

David Colman will be in Palmerston North on 26 February, and New Plymouth on 27 February.

Mike will be in Auckland on 25 February, Hamilton on 26 February and Tauranga on 5 March.

Edward will be in Nelson on 3 March and in Napier in April.

Johnny will be in Christchurch on 25 March.

Chris Lee

Managing Director

Chris Lee & Partners Ltd