Select Committee on Treasury Minutes of Evidence

Examination of Witnesses(Questions 720-739)



  720. So far as the high gearing is concerned, at what stage did you recognise it was a problem?

  (Mr Crawford) In terms of recognition of it being a problem, it was clearly when assets started falling quite dramatically in equity markets. That is not to say people are not putting out geared structures at the moment. For example, I think it was Cazenove who launched a product for Aberforth recently which was 50 per cent geared, so the concept of gearing is not necessarily negated, it just depends when you take it out, when it is appropriate to take it out in terms of where equity markets are going. I think it is worth pointing out the large investment banks, to whom we all defer in terms of equity market forecasts, were predicting equity markets to continue to grow throughout the late 1990s and the early part of this century. So we cannot say that we were not surprised by falling equity markets, because we were clearly, and we were caught out.

Mr Beard

  721. There is a general understanding that the risk associated with zeros depends on the quality of the underlying investment. Have you in your advice distinguished between different types of zeros on those grounds? Particularly, have you distinguished those which involved a substantial cross-investment in other splits?

  (Mr Hall) The answer is, we certainly were not doing that. Early on, it was certainly felt that the fund of fund approach in fact gave more reassurance rather than less and that it was spreading the risk. Of course, we all can see with the benefit of hindsight where it led. The truth of the matter is, and experience has shown us, that it all depended on the quality of management and how those funds were invested.

  722. So you saw no risks involved in the cobweb of cross-investment between these various splits?

  (Mr Hall) The prospectus of these splits sets out quite clearly how much they intend investing. Of course, how they were actually invested one did not know, but the structure clearly sets out how much they intended investing and of itself the fund of fund principle should not have caused the problem it has.

  723. Mr Thomas, you seem to have been fingered as the brains behind the split capital trusts. Have you read Professor J K Galbraith's book, The Great Crash?

  (Mr Thomas) No, I have not, Sir.

  724. If you had, you would have seen he says that in those times all that was required to be dubbed a financial genius was borrowed money and a rising market, but the disillusionment came when the market fell. Would that be an adequate description of the circumstances now and should it not have been foreseen?

  (Mr Thomas) No, Sir, I do not think so. I see the crash we have suffered slightly differently. I do not think anybody in any of the discussion I have watched so far has pointed out that the geared nature of the equity, that is the geared ordinary income share at the bottom of the capital structure, was the first thing to crack. They lost their assets fastest. Their prices after 9/11 fell like a stone. Because those prices fell and because of the cross-holdings, you found assets fell and the cover of the zeros then started to decrease, and then people started to realise. It is only when you have nothing left for the ordinary share, something but not much left for the zero, and a socking great bank borrowing which you cannot repay that you are suddenly starting to look at this peculiar structure of a bank loan over a zero. A lot of the work which has been done very, very recently has been to try to explain things as they are now, after the event.

  725. Are you not really just elaborating Professor Galbraith's phrase?

  (Mr Thomas) I am aware of one other fact which is related to Galbraith and America. They have a phobia for pyramiding and cross-holding and they prevent one fund of funds owing too much of another fund of funds. As I understand it, there is no such legal prevention in this country.

  726. Do you think there should be?

  (Mr Thomas) I would not dream of suggesting things to politicians, Sir.


  727. We are trying to encourage you out of your shyness here. Give us an opinion. Come on, you are here before the Committee, you are the master of the splits, but you cannot give us an opinion. Come on!

  (Mr Thomas) I have been taught not to talk too much, Sir.

  728. As the Chairman, I am giving you latitude.

  (Mr Thomas) Thank you, Sir, that is very kind of you. I suspect that is one of the possible changes in the legal structure which obviously you are going to have to be thinking about.

  729. So you say yes?

  (Mr Thomas) Yes.

  Chairman: That is fine. Good.

Mr Tyrie

  730. I wanted to come back on one point. I have in front of me here, Mr Thomas, a note you wrote called Enhanced Zero Trust Exploits An Anomaly, written in February 1999. I wonder whom this was aimed at. This was extolling the advantages of the Enhanced Zero Trust plc managed by Aberdeen Asset Management, the launch of which was sponsored by Brewin Dolphin. Who was that aimed at, would you know?

  (Mr Thomas) I cannot place that document, Sir. Is this the one published by Aberdeen?

  731. I do not know whether they published it. It says here, "Further information is available from Brewin Dolphin" so it looks as though it came from you and it has your name at the bottom. It says, "A quick NB for readers . . .", and this is a bit that is in bold, ". . . who equate gearing with greater volatility and therefore risk. This [trust] is the one example where this cannot be done! The gearing's effect on volatility is almost non-existent. All the gearing does is to produce a faster rise in value in the equity." To whom were you targeting these comments?

  (Mr Thomas) I was talking only to my institutional holders. I suppose we might have printed 30 copies of that bit of paper.

  732. Do you think that even an expert might have been slightly misled by that?

  (Mr Thomas) I think not, Sir, because at that time if you had looked at the performance of all sorts of zeros—I have an index which started at an index level of 100 in 1991—and if you drew that graph of the zero index between 1991 and the year 2000, all it did was to go up and up and up and up; there was no interruption. You have heard this said by other people. I think somebody standing in the year 2000 saying, "Zeros are safe" was quite within his rights to say that for that reason. What I was doing was gearing apparently certain growth.

  733. How many stock market crashes have you seen in your time?

  (Mr Thomas) I lived through 1974, Sir.

  734. That is the only one you can remember?

  (Mr Thomas) The others were small in comparison. I looked into that kind of thing very carefully when we were judging the life of a zero, for instance, and how quickly would the market recover.

  735. It seems to me, Mr Thomas, that not only were Brewin Dolphin's private investors likely to be seriously misled, because you had not advised them of the change in character of these trusts, and because this information was not passed on, not only that, but even the institutional investors were getting notes which were nothing more than advertising hype that were not serious analysis at all. Do you really think that that description of a highly geared structure is valid, given the possibility that markets can fall as well as rise or, to put it another way, past performance is not a guide to performance in the future?

  (Mr Thomas) As you say. That is hindsight, sir. Nobody thought those zeros were going to come undone like that.

  736. But you would not write a note again like that, would you?

  (Mr Thomas) I have been working on some completely new way of explaining how to analyse zeros but I have not had time to finish it yet.


  737. I will finish up if any of my colleagues do not want to add anything else. Could I ask Mr Crawford a few questions. What connections are there between Collins Stewart Limited and Collins Stewart Fund Manager?

  (Mr Crawford) Collins Stewart Asset Management, and Collins Stewart Limited are part of the group.

  738. Can I ask whether Collins Stewart clients were advised to invest in CI Income Fund Limited shares?

  (Mr Crawford) Without seeming obstructive, that is not my area of expertise. I am afraid I can only talk about the institutional business at Collins Stewart.

  739. You know those shares are currently suspended?

  (Mr Crawford) Indeed they are.

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