Examination of Witnesses (Questions 119
THURSDAY 11 JULY 2002
119. Good morning, gentlemen. Can I welcome
you to the Committee meeting. Would you formally identify yourselves,
(Mr Godfrey) I am the director general
of the Association of Investment Trust Companies.
(Mr Townsend) I am the chairman.
120. I have a general question to start with
which is what are your observations on the previous session?
(Mr Godfrey) Clearly the split capital trust sector
has been having a very difficult time, and the managers of that
sector are under a great deal of pressure. I think that was evidenced
in the session we have just witnessed.
121. Can you empathise with the views we have
put across on behalf of ordinary investors and what reassurance
do you have for ordinary investors? It is a rather short answer
you have given.
(Mr Godfrey) The Association of Investment Trust Companies'
mission is to work with our member investment trust companies
to add value for shareholders. We are an organisation funded by
the shareholders' funds of investment trust companies so we regard
our primary objective as being to work in their interests, and
we share this with the boards. In the context of that, therefore,
we are deeply distressed by the losses that they have experienced.
122. Putting it another way to you, given the
quote that I gave from Martin Dixon regarding the fact that they
deserve no sympathy, they have tarnished the whole of the split
capital sector, and the stain may have spread through the investment
trust industry as a whole, do you agree with him?
(Mr Godfrey) I think it is a matter of the greatest
possible regret that the good name of the investment trust industry
123. But do you agree with Martin Dixon's quote?
(Mr Godfrey) I would agree with it in part.
124. What parts do you agree with and what parts
do you disagree with?
(Mr Godfrey) I would agree that the good name of the
investment trust sector, certainly of the split capital sector,
has been blackened and that the stain has started to spread through
the investment trust industry as a whole.
125. So you do agree with the whole quote, because
there are two parts to it: that they have tarnished the split
capital sector and that the stain may have spread.
(Mr Godfrey) Yes, I do agree with that. I thought
you were asking me whether I had any sympathy for Aberdeen Asset
Management or not as well.
126. In your view, should zeros ever have been
marketed as a low risk investment?
(Mr Godfrey) There was a long period of time during
which I believe it was entirely appropriate for zero dividend
preference shares to have been marketed as low risk investments.
One of the things we heard in the previous session was that they
were low risk, and one of the statistics mentioned was that some
of the zeros issue could suffer a fall in the value of supporting
assets by 11 per cent per annum and still pay out. That is only
one of the methods of analysis. Clearly what one also has to look
at is the quality of the assets underlying that structure and
then take a view as to how risky one thinks it is that those assets
will fall by 11 per cent per annum. The assets are not necessarily
related to the market as a whole, so if you feel that you have
assets which are vulnerable to falling considerably then clearly
the chances of them falling by 11 per cent a year become much
127. What do you think an ordinary investor
understands by the phrase "low risk"?
(Mr Godfrey) I think an ordinary investor understands
by the phrase "low risk" that they are not likely to
lose very much money. If they lose anything at all it will not
be very much.
128. Is that what happened in the case of zeros?
(Mr Godfrey) It is not what happened.
129. So they were not low risk then?
(Mr Godfrey) From that perspective they were not low
risk but if I can please just return for a moment
130. But the industry cannot hide behind its
own self-helpful definition of what "low risk" is. You
used the phrase, or they used the phrase, or your people used
it, in promotional material and in articles.
(Mr Godfrey) I could not agree with you more that
the industry should not hide behind its own definition of "low
risk" which may not accord with that of its customers. I
think it is incumbent on us to make sure we understand what the
customers believe and make sure we inform them accurately about
what they are getting but the fact is that zeros, up until a few
years ago, could suffer big falls in value and were backed by
fairly conservative portfolios as well so the chances of them
suffering any catastrophic loss were infinitesimally small. What
happened over the last few years was that the portfolios backing
that supposedly low risk investment started to change because
of the introduction of investment in other split capital trustswhat
we have referred to today as cross-holdingsand it started
to change also because of the introduction of bank debt which
destabilised the whole structure in the event of serious falls
in the market. So I do believe that the risk profile was changing,
and it is also my belief that the industry did not go out of its
way to communicate with potential investors that the risk profile
131. So investors were being misled in that
(Mr Godfrey) Investors were not in receipt of sufficient
132. Which means they were being misled?
(Mr Godfrey) It depends what you mean by "misled".
If you mean that they were being told something proactively that
was wrong, I think probably not; if they were not being told something
that perhaps they should have been told, then yes.
133. Pretty crucial information was being withheld
(Mr Godfrey) They were not given crucial information.
134. And you accept that that in a sense defines
(Mr Godfrey) No, I do not.
135. I thought you did.
(Mr Godfrey) I cannot go to the motivation of the
people who did not give them the information so it is impossible
for me to say "withheld". It would depend on whether
they recognised it themselves or not.
136. So they could have been absent-minded?
(Mr Godfrey) They may not have recognised it themselves
137. Fair enough.
(Mr Godfrey)And that is a separate issue, whether
they should have done or not.
138. According to your memorandum, concerns
about the merits of splits emerged in the press as long ago as
November 1998. What action did you take?
(Mr Godfrey) The concerns that were being raised in
1998 were concerns about what has become known as the "magic
circle". We started to hear rumours about the magic circle;
we were reading reports in the press; we looked into those rumours
and we could not find any corroborating evidence. Again, there
is a big issue of intent here and intent is always the hardest
thing to prove. The fact that a number of managers issue new funds
and invest in each other's shares is not of itself evidence of
collusion. They may think that those shares are the most wonderful
thing since sliced bread and may want to invest in them without
any collaboration between them, and that is something that is
quite difficult to prove. The rumours we were hearing were only
of the nature that managers who were not participating in this
were being invited to participate, and that in itself does not
represent a misdeed being donejust an attempt to purloin
them. We then, I think perhaps wrongly, after that period began
to get more comfortable and the reason was that the argument was
being madeand I think to a certain extent we accepted itthat
the fact that more managers were coming into this sector and more
of these holdings with other splits were being launched was leading
to diversification which was reducing risk. The other factor which
made us more comfortable was that increasingly the new issues
were being issued purely into the institutional market place by
way of placing. What we were not picking up on was that the intent
was to push them out into the secondary market over time so I
think we may have been wrong in buying that argument.
139. So in hindsightthat sacred wordyou
made a mistake?
(Mr Godfrey) I am not going to use the word "hindsight":
I think we made a mistake.