CAPE TOWN – When you are only four years from retirement and request financial advice from a high profile institution, you hope that your investments will be guided into stable, secure vehicles. What you don’t expect is to be advised to invest in something that just a few months later is suspended due to a lack of liquidity and then starts to suffer write-downs in value.
This, however, is unfortunately exactly the experience of a Moneyweb reader who was advised by FNB to invest in the EEA Settlements Fund. He invested over $100 000 into the fund on June 1 2011, but on November 30 2011 the fund’s board of directors suspended the fund after a high level of withdrawals.
Initially, FNB assured investors that it believed that “the quality of assets in the fund” and its “highly conservative and transparent valuation methodology” meant that there would be no losses. Investors just needed to wait until the fund re-opened.
However, that didn’t turn out to be the case. While the fund was still under suspension, its auditors Ernst & Young refused to approve its 2011 accounts and claimed that the valuation placed on the fund’s portfolio was at least 10% too high. The fund subsequently announced that it had changed its valuation methodology and devalued in its net asset value.
The fund was able to restructure and re-open in January 2014, although investors were not able to withdraw all of their money. They were restricted in how much they could take out.
Subsequently, in January this year, the fund announced that it had again had to change its valuation methodology. The result was a further write-down.
The Moneyweb reader contends that FNB has failed to properly respond to these developments. The bank has not even communicated this most recent change to its clients.
In fact, he says that the bank has not communicated anything at all on this fund since June last year. FNB was given a chance to respond to this allegation, but chose not to comment on it.
Was the investment mis-sold?
What this investor and others like him are particularly upset about, is that they believe FNB did not conduct proper due diligence on this product. They say it was recommended to them as a low risk investment, when it was nothing of the sort.
To back up that contention, they point to the events that led to the fund’s suspension. On November 28 2011 the UK Financial Services Authority (FSA), now the Financial Conduct Authority (FCA), issued a warning that life settlements funds should no longer be sold to retail investors in the UK as it was planning to ban to them from being marketed.
It called these funds “toxic” and “high risk”, citing significant problems in their sale, marketing and design. This warning caused a flood of redemption requests, which ultimately forced the EEA fund into suspension as it no longer had the required liquidity to pay out.
The FSA’s 2011 announcement was however not out of the blue. As early as February 2010 it had issued a statement regarding the complexity and risk factors of traded life policy investments.
The first major concerns about these instruments were raised in 2009, when UK life settlements firm Keydata collapsed, causing losses to investors of an estimated £260 million. In May 2011 the FSA even fined a UK building society for mis-selling the Keydata product as a low-risk investment.
What is a traded life policy investment?
In simple terms, what the EEA Life Settlements Fund and other similar vehicles do is buy life policies from terminally ill US citizens at a discount. They continue to pay the premiums on the policies, and then earn their profits when the policies pay out. Because their returns are uncorrelated to other asset classes, they appear an attractive way to diversify.
However, there are some very obvious problems with their structure. The most obvious is liquidity. There is a very limited secondary market for life policies, so if funds need cash in a hurry they have to sell the policies in their portfolio at a significant discount.
Effectively, this creates a natural Ponzi-like structure in these funds. This is because any existing investor who wants make a withdrawal is likely to be paid out from money put in by more recent investors while the fund itself waits for policies to pay out.
How and why FNB overlooked what appear to be very obvious risks, it hasn’t explained. Moneyweb sent a list of questions through to the bank, but despite being given more than a week to provide a response, the CEO of FNB Financial Advice, Corne Burger, chose only to give a written statement.
“FNB’s practice is to ensure that all products and services offered to clients adhere to strict governance protocols,” he said. “We are committed to providing customer solutions that address our customers’ needs in an efficient and beneficial manner.
“In respect of the EEA Life Settlements Fund investment we are currently investigating concerns that have been raised by our clients,” he added. “We are in communication with our clients around their respective investments and this matter is receiving the highest priority at FNB and RMB Private Bank. We have committed to clients to have a proposed solution to their concerns by the end of May and we are committed to meeting this deadline. In addition clients have been advised to contact us directly should they have any concerns.”