Why Select raised the alarm about Trio Capital

Dominic McCormick explains the reasoning behind Select's decision to raise concerns regarding Trio/Astarra.

Coming out recently and announcing that we first alerted fund manager and blogger John Hempton about concerns regarding Trio/Astarra in the middle of 2009 (who then passed his own analysis on to the Australian Securities and Investments Commission (ASIC)) has been an interesting experience.

While there have been a number of supportive calls, there have also been a few aggressive ones from parties linked to Trio/Astarra questioning our character and motivations.

It is clear to me now why so few whistleblowers come out publicly in situations where they suspect something is seriously wrong in the investment industry.

We get no pleasure from seeing the demise of a financial services business. We know that a significant number of the employees were likely to be hard working individuals focused on their clients’ best interests.

The same could be said for many of the staff at financial planning firms caught up in this.

In the real world however, they are the resulting collateral damage from a difficult, complex and ultimately ugly situation. Still, it could have been avoided.

Along with John Hempton, we were simply messengers about a state of affairs that, in hindsight, needed to be investigated.

The appropriate regulators and administrators are undertaking the investigations, which are still not complete.

It is not as if ASIC takes its instructions from bloggers. Despite the ugly revelations so far (and even more concerning, the lack of revelations in some cases), some former Trio employees and supporters believe they are the victims of unnecessary intrusion and victimisation.

This seems to imply that ASIC will soon turn around, red-faced, and announce: “Oops, we got it wrong. Nothing of interest here.”

It is true that, so far, the specifics have not been proven and no one has been formally accused or charged with wrongdoing.

In the meantime however, the most important thing that has not been proven is the very existence of a significant proportion of the client money Trio was ultimately responsible for managing.

For this alone — the inability to find and confirm the missing funds (and to have the records to do so) for a period now stretching to almost six months — the directors and senior investment staff at Trio have displayed their unsuitability for managing clients funds.

Even if all the money were suddenly recovered tomorrow (a development I don’t expect) this glaring failure would remain.

We certainly do not underestimate the enormous stress and difficulties that these situations can cause for employees and families of the affected firms.

However, they are not alone. Employees of victims of the global financial crisis (GFC) such as Babcock, Allco, MFS and Storm have found themselves in the same boat.

For employees who have done nothing wrong it is a case of picking up the pieces and moving on — just as many former employees of these groups have done.

However, the stress and difficulties that Trio clients are experiencing in the vacuum of information is in some respects worse than the above examples.

Trio investors have been left in limbo by the situation, not knowing how much of, or when, their capital will be recovered and available.

There have been wildly differing views about the recoverability of the funds. Investors in the companies and funds mentioned above saw big losses, but at least they quickly knew where they stood.

The grinding uncertainty and complexity in the drawn-out Trio situation adds another dimension of stress for investors.

It is Trio investors who should be the highest priority here. Our motivation in acting has primarily been about reducing the risk of further losses for these and other clients, and to help prevent similar situations occurring in the future.

Ironically, some have accused us and the media of making things worse for the investors. In this fantasy world it is the whistleblowers and media who have caused the company’s collapse and even the (unknown) losses for clients.

Such critics seem to want to pretend that all the money is still there, and to allow clients to write it all off as a bad dream.

This would only set those investors up for more disappointment.

The supreme irony is that we are being accused of making the situation worse for investors by the very people who are responsible for looking after them in the first place. One accusation has even been made that we were “jealous of performance”.

That is not the case. With missing and mis-valued assets, Trio’s past performance record is as real as the tooth fairy.

In coming out, we are also aiming to highlight that this situation was avoidable.

This was not some black swan event that advisers or investors could do nothing to avoid.

There were plenty of red flags that objective and experienced investors could have identified (as described in my previous Money Management article in the 18 February issue).

At a time when the credibility of the investment industry has been sorely tested, it is important to promote the fact there are conscientious, proactive professionals and organisations that can help investors and advisers avoid bad investments and situations like this.

After the GFC, I think the value of these organisations is slowly being realised.

But it is clear that some elements of the industry have not shown their true colours throughout this drama.

How much due diligence was actually done on the funds, and what were the commercial arrangements for distributing Astarra products?

Some parties that recommended or supported investments into Astarra seem to have spent a significant amount of their time and focus recently on defending the Astarra principals (suggesting the worst they could be accused of is “sloppy paperwork”).

The full facts will eventually emerge, but wouldn’t these groups be better off focusing on their clients and their processes?

They should be working out what went wrong, what can be done for clients and what needs to be done to prevent similar situations occurring in the future.

The focus on defending the people who were responsible for managing the funds where client assets are now missing has arguably set a new low point for the financial planning industry in terms of looking after clients’ interests.

I noted in my previous article that the mainstream research houses had little involvement in producing research on the various products in question.

One smaller research house did produce a brief report on the Astarra Strategic Fund (ASF) for a fee (reportedly $30,000) in 2007.

However, the depth of this report into what is a complex area leaves much to be desired. It illustrates the worst of the ‘pay for ratings’ research model.

Indeed, while the major research houses can count themselves lucky not to have produced research on the ASF, this lack of broader coverage also highlights flaws in the research industry structure.

If the majority of research houses were not primarily paid by the managers whose products they research, but instead by the advisers and investors, perhaps those research houses would have the time/motivation to research and uncover some of the flawed products out there and highlight which products and strategies should be avoided.

A research industry with such a focus would probably do a better job for investors and advisers than one focused on ‘boiler plate’ product reviews paid for by the managers.

The Astarra/Trio situation has considerable distance to run, given its complexity. It remains to be seen whether the various participants (which includes numerous offshore parties) will be shown to have been naïve, incompetent, or fraudulent.

Most likely it will be a combination of these. We will leave it to the various investigative processes to sort out the details.

However, we do defend our decision to act and to come out and talk about this situation now. Dissecting and analysing how such problem investments/situations come about is essential for an industry trying to rectify its reputation after the mauling of the last few years.

Denying the reality of this situation and its seriousness will only prevent the industry learning important lessons that reduce the likelihood of it happening again.

Perhaps the biggest lesson is that identifying good investments and parties that can be trusted with clients’ money is not a part-time job.

It requires a passion for investments, sufficient resources and extensive experience.

Even then mistakes will be made, but sensible portfolio construction and asset allocation — supported by comprehensive risk management processes — can prevent these mistakes becoming catastrophic for clients.

The various disasters of the last few years have shown that an ad hoc, part-time or under-resourced approach to managing client investments is prone to failure.

Let’s face it, most (but not all) financial planners and planning firms are not well positioned to deliver on the investment front, simply because they don’t have the time, experience, systems or focus to do so.

It’s time that financial planners who continue to believe that their role is to act as the ‘chief investment officer’ for their clients started to question whether they can deliver in that role, and what kind of business they are really in.

Dominic McCormick is chief investment officer at Select Asset Management.