Friday, August 23, 2013
Sharemax - How do investment managers make money?
PART 2 How do investment managers make money?
By Cilleste van der Walt 2013
The explanation in Part 1 is far removed from what happened in the Sharemax case. Up until now, no one has really asked how Sharemax, apart from the financial advisors, made their money. Sharemax is the proverbial “asset manager” in this case.
To begin with, Sharemax paid the advisors an advance commission of 6%. Thus, if you invested R100 000, only R94 000 was left over once the fee had been paid. For this fee, the advisors did no market research, no benchmark was set and it was one of the most illiquid investments in the market to boot. It was the first layer of fees. In the case of the investment discussed in Part 1, Solidarity Financial Services builds a relationship with the client for eight years before getting to the advance fee of the Sharemax advisors.
The advisors and Sharemax proclaimed far and wide that the 6% advance commission did not affect the clients’ investments and that Sharemax paid the commission. My question is then: Where did Sharemax get the 6% to pay in advance? A Sharemax consultant tried to convince me that Sharemax earned its money from the rental income yielded by a building. Sharemax took a portion of the rental income, which was how it made money. If Sharemax only started making money when the rental income realised, where did it get the 6% advance commission?
If, for example, Sharemax took 8% of the rental income on a building valued at R10 million that yielded a rental income of 10% per annum, then Sharemax’s fee should have been R80 000 (8% of R1 000 000) per annum on the building. The R10 million building was sold to 100 investors who invested R100 000 each. At 6% advance commission to the advisors, R600 000 should have been paid out in commission, which is equal to 7,5 years of Sharemax rental income. Is the picture beginning to take shape?
If Sharemax had sold the R10 million building for R20 million to 200 unsuspecting investors, the calculation would have been as follows: R1 200 000 could have been paid to the advisors (6% of R20 million), leaving R18,8 million. Sharemax would then have hoped for the building’s value to double in six years and, therefore, the building should have been worth R20 million after six years (which was the case in some instances). Meanwhile, the rental income was still only R1 000 000 per annum, but Sharemax had to pay out an income for 200 investors. Consequently, Sharemax had to subsidise R1 000 000 per annum for six years. Of the R18,8 million, R12,8 million therefore remained and the building had cost R10 million. Therefore, the advance profit on the project was 28%, after the advisors had taken an exorbitant commission and the rental subsidy had been paid.
The above situation still may not seem too unfavourable for an investor if the property market is experiencing an upward swing, which is why Sharemax managed to stay afloat for 12 years. The problem is that Sharemax eventually became such a web of cross-subsidies, commissions and fees that not even reasonably bright people could unravel it. The death knell came when Sharemax started financing developers and devising a stiff profit for itself in the projects before there was a rental income from the buildings. The cost to erect The Villa in the east of Pretoria would have been higher than Menlyn’s valuation at the time – absurd!
The Fais ombudsman, Noluntu Bam, has described Sharemax’s last two syndication schemes, the Zambezi Retail Centre and The Villa in Pretoria, as pyramid schemes. There is one big difference between Sharemax and a proper pyramid scheme, which is that an ordinary pyramid scheme pays out your returns using another investor’s money, whereas Sharemax paid you with your own money!
I have one question for everyone who still claims that Sharemax did nothing wrong: Why did Sharemax have to close its doors when it stopped getting investments? I am convinced that Allan Gray will remain standing if it doesn’t get any new investments.
I also have a question for the investors: If you had known beforehand how Sharemax made its money, would you still have invested with the company? Apart from all the laws that were broken, it was bad business. It’s high time that the directors were held accountable for the losses that the investors suffered.
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