COMMENT:

The recently released Bonus Bonds annual report shows that the scheme continues to be, in this columnist's view, a massive gravy train for ANZ Bank New Zealand.

The report coincided with Simon Burnett's attempt to publish his book on two failed ANZ/ING funds nearly a decade ago.

The Bonus Bonds Scheme and Burnett's publication, which is only available on Kindle at present, show that bank products can deliver extremely poor results for investors.

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Bonus Bonds were established by the Crown in 1970 and sold to ANZ Bank in 1990 as part of Postbank's privatisation.

The scheme has total funds of $3355 million and is managed by ANZ Investment Services (New Zealand), a fully-owned subsidiary of ANZ Bank.

Investors pay $1.00 per unit and redemptions are at the same price.

They receive no interest on their money, and receive a return only if they are successful in the monthly draw.

The proceeds for the draw are derived from surplus funds, after expenses and taxes.

In last month's draw there was one prize of $1m, one of $100,000, one of $50,000 and 21 prizes of $5000 each. There were a further 99,120 prizes, mostly of $20 each.

The figures in the accompanying table highlight the major financial aspects of the scheme.

Total investment income has declined from $124.0m to $101.0m since the March 2014 year, and prizes from $54.8m to $45.9m. Meanwhile, fees and costs have risen from $41.5m to $43.8m.

In percentage terms, prizes have fallen to 1.34 per cent of total Bonus Bonds funds while fees represent 1.28 per cent of total funds.

ANZ is sitting on a proverbial honey pot, as it receives a fee of 1.17 per cent for managing a conservative passive portfolio while the remaining fee of 0.11 per cent goes to the supervisor and on other expenses.

Bonus Bonds' 1.17 per cent management fee is bizarre, in this columnist's view, when it is considered that the funds are all invested in New Zealand cash, bank deposits and government securities.

Meanwhile, ANZ has a 0.96 per cent management fee for its KiwiSaver Balanced Fund, which has 44 per cent invested in NZ, Australian and international equities.

In the 12 months to March 2018, Bonus Bonds had a total return of 1.2 per cent, after fees and expenses, while the ANZ KiwiSaver Balanced Fund reported a 5.2 per cent return on the same basis.

In addition, nearly 24 per cent of the total Bonus Bonds portfolio is invested in ANZ Bank New Zealand securities which are then on-lent to bank customers.

This is another benefit as far as the bank is concerned.

Another feature of Bonus Bonds is that ANZ will be paid an amount equivalent to 24 months of fees — approximately $80m — if they are removed by a special resolution of bondholders, the supervisor, or by the High Court.

The continued strong support for Bonus Bonds is extraordinary as they offer a nil return, unless a prize is won, and there is only one $1m prize per month.

Another major issue with the scheme is tax, which is 28 per cent of pre-tax earnings.

Prizes are tax-free but individuals on lower tax bands are disadvantaged because they effectively pay a 28 per cent rate.

The annual investment performance of the fund has deteriorated dramatically, from 7.1 per cent in the March 2009 year to only 1.2 per cent in the latest period, mainly because of the sharp decline in interest rates.

Meanwhile, fees and expenses as a percentage of investment income have soared from 17.3 per cent to 43.4 per cent over the same nine-year period.

This shows, in my opinion, that there is limited alignment between the interests of investors and ANZ.

There is an argument that Bonus Bonds are a "fun investment" and there is the prospect of a $1m win each month.

In addition, investors get their money back whereas Lotto gamers don't.

The negative features are high fees, low returns, and investors miss out on the huge advantages of compounding interest.

As well as that, disclosure is poor and the tax structure is high for individuals on a low tax rate.

However, ANZ Bank won't be in a hurry to discourage investors because it is an extremely profitable product for the country's largest financial institution.

Simon Burnett, a New Zealand freelance writer based in Germany, has written a book about the ING Diversified Yield and Regular Income funds. These two funds caused considerable investor distress nearly a decade ago.

Burnett has had problems publishing his book in hard copy but it is available for Kindle devices from Amazon.com under the title Blunder.

How ANZ and ING squandered 800 million dollars in a Wall Street casino — and ignited a revolt of small-time investors.

The origins of Burnett's story go back to 2003 when ING (NZ), which was 49 per cent owned by New Zealand's ANZ Bank, established the Diversified Yield Fund as an Australian unit trust aimed at NZ investors only.

The Fund was promoted to financial advisers and investors as "moderate risk".

Two years later, ING (NZ) launched the Regular Income Fund as another Australian trust aimed at NZ investors only.

It was described "as a low to moderate risk" investment.

However, both funds invested in Collateralised Debt Obligations (CDOs) and Collateralised Loan Obligations (CLOs), which proved to be a disaster during the GFC.

The Commerce Commission investigated the two funds and determined that the marketing material had the following characteristics:
• They understated risks associated with the funds
• They made incorrect comparisons to, or described the funds as being viable alternatives to, other types of investments (including to government and local authority stock, bank deposits and finance company debentures)
• They contained misleading, or insufficient references to the liquidity risks associated with the funds.

The commission concluded there was sufficient foundation for it to commence legal proceedings against ING (NZ) and ANZ Bank but decided not to do so.

Burnett, who received back only 66.46 per cent of the money he invested in the ING Diversified Yield Fund, has harsh words to say about ING and ANZ.

Burnett quotes a financial adviser who believed that interest rates were rising and ING (NZ) was concerned that investors would withdraw money from the two funds.

To compensate for this, the manager invested in high yielding CDOs and CLOs to encourage individuals to keep their $850m invested in the two funds.

Burnett takes a much harsher view. He believes average fund balances were small — less than $60,000 per investor — and ANZ/ING, and most other banks, don't connect to these investors. They fail to realise that these are "real people trying to provide for their old age or for their children or grandchildren".

The final words are left to Queens Counsel Tony Molloy who told Parliament's Commerce Select Committee that "the lamentable fact is that none of the legal advisers consulted by ANZ clients seem to have been advised of the existence of the fiduciary relationship, or of the bank's breach of the fiduciary obligation imposed on it by that relationship".

Molloy suggests that investors should have taken legal action but Burnett writes that they were told that they would have to pay between $700,000 and $900,000 up front before lawyers would take the case.

Bank culture, particularly an emphasis on sales ahead of clients' best interests, has been put under the spotlight by the Australian Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.

New Zealand banks will be hoping that a similar inquiry is not established in this country.

- Brian Gaynor is an executive director of Milford Asset Management.
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