Examination of Witnesses(Questions 720-739)|
TUESDAY 29 OCTOBER
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.
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
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
(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
729. So you say yes?
(Mr Thomas) Yes.
Chairman: That is fine. Good.
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 zerosI have an index which started at an index level
of 100 in 1991and 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
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
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.