Friday 23 February 2018

Savers: Have you risked it all for a quick buck?

Irish savers have poured almost €300m into products set to be banned elsewhere

Illustration Tom Halliday
Illustration Tom Halliday
Louise McBride

Louise McBride

Many Irish savers are in danger of losing a good chunk - if not all - of their money after pouring hundreds of millions of euro into complicated products that are promising better returns than ordinary deposit accounts.

These products - called credit-linked notes - are set to be banned in Germany because of "significant investor protection concerns" that the German financial regulator Bafin has about them. Earlier this month, the Central Bank here warned that credit-linked notes are very risky and unsuitable for most consumers. Yet last year, Irish savers put €275m into credit-linked notes - in a bid to earn better returns than the paltry deposit interest rates being paid by the banks. 

With credit-linked notes, you essentially invest in a borrower's credit risk. As long as the borrower (which is typically a company and is described as 'the counterparty') does not experience a 'credit event', you receive interest payments and - once the notes have matured - your original money back. If a credit event occurs, however, you could lose a lot of the money you originally invested and you can also kiss goodbye to the interest you were expecting.

"If you are a cautious and risk-averse investor, it's important you know that when you invest in a credit-linked note, you could lose a significant portion - or even all - of your capital," says Vincent Digby, managing director of the financial advisers Impartial. "The risk with credit-linked notes is that the counterparty could go bust - and you could lose all of your money if this happens, depending on how the note is structured."

Furthermore, it's not just a company liquidation which could see you lose money. With credit-linked notes, you are exposed to the risk of a credit event - which has wider connotations than a liquidation.

"That credit event could be a restructuring - rather than the company going bust," explains Digby. "Restructuring can be a long process so you could be a long time not knowing if you'll get 50c in the euro for the money you've invested, 5c in the euro - and so on. That uncertainty could go on for months - or years."

Even government intervention to prop up a company could be deemed a credit event, according to Heber O'Farrell, director of financial services with Finance One. "So too could the failure of the company to repay a corporate bond," says O'Farrell. "You'd want to be fairly confident of a company before investing in it through a credit-linked note."

Many of those investing in credit-linked notes don't understand how the products work - and how easy it could be for them to lose their money.

"Investors don't have a proper understanding of how much money is at risk," says Digby. "There is potential that some of these products are being mis-sold. They often come with 25-page brochures. Which investor or advisor takes the time to go through these brochures line by line?"

Not only is it difficult to gauge the risk that comes with a credit-linked note, but it is also hard to understand exactly how that note will deliver the return it is promising, according to Gary Connolly, managing director of the investment consultants iCubed.

"With credit-linked notes, you typically enter into an agreement with a counterparty to pay you back in three to four years time," explains Connolly. "The risk is that the counterparty could go bust and refuse to pay out. The risk may well be low, but people have no real way of doing due diligence on this other than looking at the credit rating of the counterparty - which is a very opaque system and you'd wonder [about] the extent to which you could rely on it. It's hard to assess what the expected return is based on. Instead of returns which are based on the tracking of an index, your returns are often linked to esoteric investment indexes and funds."

The Central Bank is also concerned about the increased take-up of tracker and investment bonds. Last year, almost €700m was invested in such products despite the poor returns often delivered (which are regularly worse than the interest paid on ordinary deposit accounts) - and the 'soft' capital guarantees included in many of them. With soft capital guarantees, you only get back the money you originally invested in a tracker or investment bond in certain scenarios - such as if the value of a particular investment asset, fund or stock market index does not fall below a specified level.

"The Central Bank has taken a dim view of such guarantees as the client may think it is a guarantee - but it's contingent for example on a stock market index not falling by a certain amount," says Connolly. "The Central Bank's concerns are legitimate. If you invest in one of these products and the index falls by a certain amount, you'll make a big loss. Remember, we've had two scary bear markets in the last 15 years where stock markets declined by more than 50pc. People are equating these tracker and investment bonds with products of old which had a 100pc capital guarantee. People are not that au fait with these products."

Unlike the capital guaranteed products sold in the past, many of today's tracker and investment bonds only offer capital 'guarantees' of 90pc or 95pc. So you could lose 5pc or 10pc of your money after investing in them.

There are other products being eyed up by investors as alternatives to deposits which savers could easily lose out on.

"We've seen significant solar, biomass and wind energy funds," says Connolly. "There's a lot of [government] subsidies available for companies within this space and they are able to structure products with attractive yields. The problem is that it's difficult for a would-be investor - who is coming off deposit - to understand the risk or complicated nature of wind or biomass funds."

The multi-asset funds offered by life assurers have also become popular among investors chasing alternatives to deposits, according to O'Farrell. With these funds, your money is placed in various types of investments - depending on your appetite for risk. However, the charges on such funds can be high - and while the returns on a well-chosen fund may well beat deposit interest rates, you could lose money if you choose a fund which performs poorly or was more risky than you thought.

The moves by some banks to start charging corporate customers for money kept on deposit could encourage more people to jump into risky investments which they don't understand.

Bank of Ireland will soon become the first Irish bank to charge customers for placing their money on deposit with the bank. From next month, the bank will charge a negative interest rate of 0.1pc to large corporate customers with deposits of €10m or more. The bank has no plans to charge personal or business customers for placing their money on deposit.

Ulster Bank, which is owned by the British bank Royal Bank of Scotland, has already introduced negative interest rates for a small number of large corporate clients. Personal or business customers of the bank haven't been affected. AIB and Permanent TSB don't charge any of their customers for deposits and said they have no plans to do so. A spokeswoman for the Belgian-owned KBC said the bank "does not currently" apply negative deposit interest rates to any personal, business or corporate deposits. "KBC reviews all product pricings on a continuous basis," she added.

In recent months, the South African-owned Investec Bank - which operates here - started to charge its institutional and corporate customers for large deposits kept in its demand and short-term deposit accounts.

Although the financial advisers we spoke to believe it unlikely that banks will ever start to charge ordinary savers for money kept on deposit, the move to apply negative interest rates on corporate deposits is worrying. It could encourage more people out of deposits - and into complex and risky products which will ultimately cost them money.

"There are a lot of complicated products out there which people don't understand," says Connolly. "It's important to get independent advice in all of this."

Sunday Indo Business

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