KEY POINTS:
Q. What suggestions do you have for someone looking at newspaper ads for finance companies?
A. When it comes to entrusting someone with your savings, it pays to take the time to look beyond the interest rate and do some research of your own.
Q. But those
high interest rates are really compelling!
A. If it sounds too good to be true, then it probably is. Risk and return are the drivers of the finance industry. Generally, the higher the advertised rate of return on an investment, the greater the risk should be.
Q. What sort of questions should potential investors be asking?
A. Kiwis should be asking where their money is going, what it's being used for, who is looking after it, and what policies and procedures are in place to ensure their money is being well looked after.
Q. Where do I find this information and should I be looking at the credit rating?
A. Finance companies seeking deposits from investors are required to have a prospectus and investment statement. These are statutory disclosure documents, which specifically deal with risk disclosure and return disclosure, and should form an essential part of your research. Credit ratings are an important first step in research because they indicate the credit-worthiness of the rated entity. For example, UDC has an AA rating from international agency Standard & Poor's - increasing from AA- earlier this year. In advising UDC of the improved rating, Standard & Poor's commented on UDC's strong brand and market profile, the diversification of the loan portfolio, and the broad-ranging distribution strategy.
Q. How does a finance company manage to change its credit rating?
A. It can't simply apply for a rating increase. Any change is the result of regular reviews by the agency. BBB- is generally regarded to be the lowest rating that can be considered "investment grade". Any rating lower than that is generally regarded to be "non-investment grade".
Q. What does a Standard and Poor's rating tell you and are all ratings agencies the same?
A. It provides an indication of credit-worthiness to an investor, and the assurance the company is being regularly reviewed and considered by an objective and expert third party, using a globally established benchmarking process. Other well-known international agencies are Fitch and Moody's. It's worth checking which agency has issued the rating, whether the rating is relative or actual, and that you understand what is being rated.
Q. Should we be looking at how and where the money is being invested?
A. Kiwis are always warned not to keep all their eggs in one basket, and it's no different for finance companies. A portfolio mix policy ensures your money is being invested in a stated range of activities, and in specific proportions. Portfolio mix policies can also dictate where your money is spent. UDC, for example, invests only in NZ because it knows the market, has strong industry relationships, and has an extensive regional infrastructure. Other finance companies will have different approaches.
Q. How do you find out about the level of risk being adopted by the finance company?
A. A "risk profile" is the nature and extent of risk that the company is able to take on when lending investors' money. It reflects diversification of investment. Different companies have different risk profiles These should be reflected in the advertised rate of return.