# IFSRA and geared tracker bonds



## Brendan Burgess (10 Nov 2003)

According to recent articles by Niall Brady in the Sunday Tribune and Eoghan Williams in the Sunday Independent, ACC Bank has been lending money to its customers to invest in tracker bonds. Irish Life is due to launch a similar product in the coming days. 

According to Niall Brady:





> An IL&P spokesman said the product had already been submitted to the Irish Financial Services Regulatory Authority for approval, adding that the government’s financial watchdog had not raised any concerns about consumers borrowing to invest in products that are linked to stock market performance.



Eoghan Williams says:


> Speculation is intense that similar loan schemes are under investigation by IFSRA. Irish Life says it has submitted its plans to IFSRA and has net no objection. IFSRA has a policy of not commenting on its investigations, but the regulator is understood to be concerned at the lack of transparency prevalent in tracker bonds



So IFSRA is concerned about the lack of transparency in tracker bonds? But it has no objection to lending to invest in these products?

I don't know or need to know the detail of these products, but they are deposit based products. You cannot borrow to invest in a deposit based product and expect to make money. It just does not make sense. To make it worse, the return on the tracker will be subject to 20% Dirt or 23% exit tax. 

IFSRA should proactively stop them before they are launched.

Brendan


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## RAIPI (11 Nov 2003)

*Tracker Bonds and gearing*

I think there is some confusion about the role of IFSRA...IFSRA has no statutory role to 'approve' or not approve financial products before they're launched.

So some suggestion that a particular product was referred to IFSRA and they didn't raise any objection to same, is a form of 'approval' is dangerous and misleading nonesense.

IFSRA and IFSRA Consumer Director's role is more 'information giving' than acting as the ultimate arbitrator of what a good and bad product is.

See the enclosed from legislation setting  up IFRSA which outlines the role of the IFSRA Consumer Director:

"(4) This section does not oblige the Consumer
Director to identify specific costs to
consumers, risks or benefits in relation to the
provision of a relevant financial service."

Having said all that I agree totally...this lending to invest in a tracker is complete nonesense and is so laughable that you woudl think that a person with some part of their brian still functioning would see through it. But its Buyer Beware ...don't expect IFSRA to shoot all the bad guys for you.


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## Skinflint (11 Nov 2003)

*.*

Cue cries of "eircom" from certain idiotic members of our middle classes when they get burnt by this one. My heart bleeds...


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## nike (12 Nov 2003)

*trackers*

Not sure I fully understand.  Why is it so bad to borrow to invest in a tracker, when we're borrowing huge amounts every day to invest in property.  In fact, is it not better that it's a tracker, as you're guaranteed to pay off the loan - which isn't the same with property.


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## rainyday (12 Nov 2003)

*Re: trackers*

Hi Nike Trackers  

Think about it for a minute - You are running a bank. You have lets say €50m under your desk waiting for something to do with it.

Your choice is;

a) Stick it in a nice safe tracker bond being offered by another bank - good safe investment with capital guarantees and no administration fees (if the brochure is to be believed).

b) Lend the money to suckers (oops sorry) punters at a nice interest rate, and let the suckers bear the risk.

Why do you think the bank choose option b?

Regards - RainyDay


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## Brendan Burgess (12 Nov 2003)

*Re: trackers*

Hi Nike

Trackers are simply deposit accounts. Most of the time they will return less than the deposit account rate. Some of the time they will do better.

It makes no sense to borrow to put the amount on deposit. 

Brendan


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## Brendan Burgess (12 Nov 2003)

Sorry nike

Let me clarify...

It makes no sense for the customer to borrow to put the money on deposit. Of course, it makes a lot of sense for the bank to lend money to their customers at one rate and take it back from them on deposit at lower rates.

Brendan


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## None (12 Nov 2003)

*Do the sums add up?*

The Geared Tracker Investor at Work


I invest 33 of my own money and borrow 67 for the gearing giving total investment of 100

80 of the 100 goes to a deposit account to repay the 100 at the end.

So 20 is left
The broker gets 5
The Life Company gets 5
And 10 buys the Equity Option


So at the start 
I had 33 of my own money and have given away 10
I have borrowed 67 (on which I must make interest payments) and put it into a taxed deposit

In retrospect, perhaps I am not too shrewd an investor after all.

The result of the above is a big likelihood I will simply loose all of the interest payments on the borrowings I make...........and end upwith my original 33


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## Pat H (12 Nov 2003)

*ISFRA's role*

Although ISFRA have no role in approving products, they are meant to have a role in supervising the sales of the products. They are clearly failing to ensure that potential investors have a clear understanding of trackers, particularly the liklihood in more complex trackers of getting a decent return.

I sometimes wonder what ISFRA's view of their role is.  They give the impression that they are much more concerned with making sure the rules are obeyed and they don't get blamed rather than taking a broader view of ensuring that the public are protected.

Pat


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## Skinflint (12 Nov 2003)

*.*



> I sometimes wonder what ISFRA's view of their role is.



Seems to be simply a new slant on prudential supervision and, in spite of all the hype, not much in the way of consumer protection as far as I can see.


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## Nike (13 Nov 2003)

*trackers*

Thanks for the replies, but I'm still not entirely clear.

Rainyday:  You are saying the bank will choose to lend the money out than invest in a tracker.  Isn't that their business so of course they'll lend it out?  You say they wouldn't invest it in a tracker - but equally they wouldn't invest it in property?  My question was on propertyvgeared tracker.

Brendan: What you're saying makes sense, I think.  But isn't what you're saying really the case with normal trackers?  In normal trackers, you're simply putting most of your own money on deposit and some to buy equity exposure.  Do normal trackers make sense that you would tie most of it up just to get the original amount back (with no interest)?   

None: I don't get why there's a big liklihood I will simply lose all of the interest payment and end up with the money I put in.  Surely if equities make any return, then the gearing will ramp up?


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## darag (13 Nov 2003)

*Re: trackers*



> Do normal trackers make sense...



i've being arguing for a long time on this site that trackers
make no sense for anyone no matter what your risk tolerance.
after sucking out commissions and slick advertising costs,
they lump a below inflation paying deposit or bond-based
product with a negative expectation gamble using a 
derivatives purchase.  the former can be purchased on it's
own for much better value and purchasing the latter is 
gambling not investing since the expected return is negative.

for me this discussion is nonsense as trackers are crap 
products full stop.  discussing the pros and cons of borrowing
to invest in property or equities is reasonable. discussing
whether it would be sensible to borrow to put money on the
3:15 in aintree is nonsensical.

there still seems to be a general feeling that trackers have
their place but a logical case for them has yet to be
presented on this site despite me opening this topic a
number of times.  

going back to the subject, banks will encourage people to
borrow to buy all sorts of rubbish; that's part of their
business. and as long as they know that they'll get the 
money back off you, they don't care whether you spend the
money on a tracker or an unnecessary new car and they
gear their advertising campaigns accordingly.  i don't see
any particular reason to get any more indignant about this
than many of the other loan marketing campaigns which
crop up every now and then - for example to extend your
home or go for a holiday or whatever.


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## rainyday (13 Nov 2003)

*Re: trackers*



> Isn't that their business so of course they'll lend it out?



If they believed they would make MORE money by investing the money directly in the trackers themselves, they would choose this option, rather than lending it out to suckers. They don't choose this option, because they know very well that the trackers are a hiding to nothing. 

But the suckers will bear all the risk of seeing inflation eating away at their so-called 'guaranteed' funds.


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## Brendan Burgess (13 Nov 2003)

*Re: trackers*

Hi Nike

I don't like trackers. But let's take the plain vanilla tracker. It said "We will give you 60% of stock market growth, but if the stockmarket falls, we will limit your fall to 90%. We won't give you any of the dividends which you would receive from investing directly in these shares. "

That's fairly clear. As an investor, you were limiting your potential return as a trade-off for limiting your losses. My perception of risk might allow me to invest in that product. But, at least, I knew what I was getting or losing.

The Quadruple Growth Bond and other trackers have become so complex, that it's impossible for 95% of people to understand the likely outcomes. And the likely outcomes are that they will not make as much as they would get from putting their money on deposit. 

If you invest in property or shares, you can expect to get a good positive return over the long term. Even still, most people would advise against borrowing to invest. 

If you invest in tracker, the expected return is well below the cost of borrowing, so it makes no sense to borrow to invest in it. 



Brendan


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## RAIPI (14 Nov 2003)

*Borrowing to invest in Tracker*

A few points about geared Trackers:

(1) investors will need index growth of about 30%, just to pay for the interest they will have to pay until the Bond matures, never mind make an actual profit. So to make any type of decent profit to make the whole thing worth while, you're looking for index growth of 50%+. It starts to look improbable, to say the least.

(2) I understand the loans are not non recourse, i.e. you're personally liable to pay the interest on the loan ..if you default they'll come after you.Assigment of the Bond takes care of the capital repayment but you're exposed for the interest payments.

(3) Consider this scenario ...you're in the last year of Bond and the index is heading south. At this stage you know it wirtually certain that the BOnd is a dead loss and you're going to get nothing back. Interest rates are rising...you have to keep paying 'dead money' in interest to Permanent TSB or whoever. Imagine how sick you'd feel.


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## Nike (14 Nov 2003)

*geared trackers*

My gut feeling from listening to the above is that geared trackers are probably not worth it.... but I can't help thinking the points a lot of people are making are based on a guess rather than fact, and also that the comments apply to trackers generally or even to other investments generally.

Both Brendan and darag refer to likely returns are such the tracker will not make as much as they would get from putting their money on deposit.  Darag even says "purchasing the latter is gambling not investing since the expected return is negative"!!  I don't understand what the 'expected return' is based on, other than perhaps a guess?  But if it is a guess both of you seem to be convinced that not only will you not make money, but it's close to certain you'll lose.  Did I forget to pick up my crystal ball or how can you guys tell this?

RAIPI in point (3) talks about a scenario where the index is heading south in the last year, and interest rates rising.  Isn't this exactly the sort of scenario we've been dreading on property, for which most people are loaned to the hilt?  So, is this not just a comment on investments backed by loans generally?

RAIPI in point (2) talks about them coming after you for the interest if you default... now, maybe I'm missing something but I didn't think it possible you could simply default on a loan and they wouldn't come after you??  Can you put me in touch with this bank!

Probably the clearest point here is RAIPI in point (1).  If I would need an index return of 50% for things to make sense, then it does seem like a fairly tall order.  But equally once it goes over 30% (which you say is the break even) then presumably things gear up fairly quickly??


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## darag (14 Nov 2003)

*Re: geared trackers*

nike, historically an investment in equities or property 
will provide a positive return.  unless you're predicting 
the failure of capitalism, there are many reasons why
this is so.  admitted this can not be proven to be the
case scientifically.  however, this is generally accepted
by nearly everyone.

one way of looking at derivatives is that they are tools 
used by businesses to insure themselves. if your business
involves coffee beans, for example, you can effectively buy
insurance against a particular movement in coffee bean
prices by purchasing suitable derivatives.  there are
also derivatives which cover almost everything but in
particular, the ones sold as part of a tracker are based
on financial indicators.

derivatives are traded on markets so you can expect that
their cost reasonably accurately reflects the risks associated
with them. in other words, they are not expected to provide
a positive return.  in the long term, if you bought a basket 
of derivates you would be expected to lose money given the 
trading and administration costs.  this is why i don't see
them as an investment.


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## Brendan Burgess (14 Nov 2003)

*Re: geared trackers*

Hi nike

It all comes back to what IFSRA's role should be. 

darag and and others have given our opinion. Presumably Irish Life and ACC disagree. I do think that IFSRA should express some opinion on such complex products for the guidance of consumers. 

With due respect to Mary O'Dea, I don't think that "If an offer is too good to be true it usually is" is sufficient advice to consumers.

Brendan


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## RAIPI (14 Nov 2003)

*Trackers*

darag

The point I made about the interest was simply to correct a misunderstanding that some may have had ..that the loan was non recourse, i.e. the mistaken impression that the only secuirty was to be the tracker bond itself.

Re possible returns, the point is that there is a probability of different returns...what we can say is that as you go up the scale of potential returns, the probability of achieving that return falls..therefore the probability of getting, say, a 20% rise in the index is higher than getting a 30% ...the probability of getting, say, a 30% rise in the index is higher than getting a 40%..and so on. In other words there chances of getting a 50% return are much lower than getting a 30% return.


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## Amellion (14 Nov 2003)

*another solution*

If someone is prepared to put the interest payments over 5 years at risk in a geared tracker,he/she would be much better off buying a tracker with gearing inbuilt.
By investing in a structure which put all of that capital at risk the upside potential would be comparable to investing a much larger amount with a 100% capital guarantee.

As others have pointed out borrowing money to put most of it on deposit is probably quite inefficient and that is before charges.
We truly are an extraordinary lot if we are willing to take on (say) 100k of borrowing and put about 20k of interest at risk in preference to putting the 20k at risk in a 'proper' geared tracker.Admittedly the latter requires a cheque for 20k to be written up front.


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## Brendan Burgess (14 Nov 2003)

*Re:  another solution*

Amellion

That's a great way of looking at it. If I am going to risk €4k a year for 5 years, why not put it in a very high risk/return product? It wouldn't have to be a geared tracker, it could be a geared equity fund, if such things exist. Or a technology fund. 

Brendan


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## rainyday (16 Nov 2003)

*Re:  another solution*

Eoghan reviews Permanent TSB's offering in today's SIndo.


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## Brendan Burgess (16 Nov 2003)

*Re:  another solution*

There is also a very interesting article by Niall Brady in today's Sunday Tribune. He has seen some confidential discussion papers circulating around the Society of Actuaries.

Tony Gilhawley estimates that there is a one in three chance that many trackers will return nothing more than the saver's original cash.

Brian Woods or AIB concludes that the expected return from a typical geared tracker( which I believe is the Irish Life and Permanent tracker) is €21,000, while the interest will cost €28,000. So, the expected loss will be €7,000.

As I understand the article, here are the possible outcomes for someone who borrows €100,000 to invest in the Irish Life tracker

30% chance of a nil return on the tracker, so the loss would be the €28,000  interest.

1% chance of hitting the maximum return of 80%, which would give a profit of €33,600 after interest. 

The average expected return is €21,000, or a loss of €7,000 after interest.

So you are taking a 30% chance of losing €28,000 in exchange for a 1% chance of making €33,600. 

Bill Hannan of Irish Life disputes these figures on the basis that an upward movement in stock prices is more likely than a downward movement. 

The product is aimed at "sophisticated" investors. You must be able to show a minimum income of €75,000 and the minimum investment is €100,000. But if you have an income of €75,000 and you have experience in borrowing to invest in the stockmarket and you expect the stockmarkets to rise over the coming years, surely you can tolerate a fall if it happens. These investors would be far better off investing directly in the stockmarket.

Brendan


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## Savvy (16 Nov 2003)

*Stockmarket models*

Brendan,

Clearly the model being used by BW *does* assume a more likely chance of markets rising than falling - otherwise the chances of Nil return would be 50%.

I think BH's argument is that none of these Models ever assume that we may be in a cyclical trough with a bias looking forward for a significant upward correction. 

BH does not himself argue that we are due a bounce but merely that some investors may think that way.

But, as you correctly point out, if that's what you believe there are far more tax efficient and cost effective means of enjoying that bounce.


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## Undertaker (16 Nov 2003)

*Niall Brady Does it again*

Niall Brady has written the epitaph for geared trackers. Great to see these creatures strangled at birth, but its a REAL worry that, once again,consumer protection in Ireland's financial market has been left to the media, and some outspoken industry people prepared to blow whistles.

Brady's piece should accompany every geared tracker sale. IFSRA are a disgrace - but hadn't we been well warned about that too? And if I recall Niall Brady ran up the flag on that one as well.


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