Special Report: Realities of Retail

Provided by The Australian Investor

Friday 6th July 2001

It can be a losing battle for retail investors. When companies fail they're the least well equipped to cope with their losses, but they're also the least likely to have foreseen the fiasco. It's by no means an impossible fight, but their small size and even smaller sway means retail investors should work hard to watch their backs.

Retail investors, better known as "mums and dads" have collectively "lost billions upon billions of dollars" in recent months, as some of the most "successful" companies of recent times flee the market, like brokers to a bar on Friday night.

"Mums and dads" are typically those investors who first entered the share market with the float of well-known corporations like Telstra or AMP. And although their investments are proportionally small, the individual impact when a company goes under can be devastating.

When companies fail, under inefficient management and unaccountable directors, investors are left with huge losses. Technically, the directors are liable for these losses, but it can be a hopeless cause to make them truly accountable. So who pays? Or better still, how can these losses be avoided in the first place?

According to the ASX share-ownership survey, 52 per cent of Australian adults are involved in the share market either through direct shareholdings or via a managed fund. Around 40 per cent, or 5.7 million adults, have direct shareholdings, with 11 per cent of these entering the market for the first time in the past twelve months.

So "mum and dad" investors make up a large proportion of the population. As a result, a notable number of Australians became unsuspecting victims of the recent collapse of companies like HIH, One.Tel and Harris Scarfe.

"It's really a losing game for small investors," said Peter Swan, National Australia Bank Professor of Finance at The University of Sydney.

When companies collapse "small retail investors tend to be the hardest hit," said Professor Swan. Investors incur losses both directly, through their shareholding in these companies, or indirectly, through their investment in other companies which, in turn, hold large shareholdings in the collapsed company.

This was the case in One.Tel's collapse. Small and large investors suffered losses through either their One.Tel shares, or through their shareholding in Publishing and Broadcasting Limited or News Corporation Limited, both of which lost millions of dollars in the collapse of the telecommunications carrier.

To magnify the losses of "mums and dads", many small investors increased their stake in One.Tel immediately prior to its collapse, as former director, Rodney Adler, reportedly sold off much of his stake.

So there was a "failure of corporate governance" in these companies. Some directors had long since sold-out and fled the board by the time investors realised the "ship was sinking".

It's difficult for small investors to monitor companies, despite current regulations. "Directors of these companies are supposed to provide continuous disclosure to the Australian Stock Exchange (ASX). Clearly this didn't work in the case of [One.Tel and HIH] and also with Harris Scarfe," said Professor Swan.

While, the information that does filter down to investors "tends to be based on rumour and speculation," often coming "from stockbrokers, who obviously have an incentive to encourage trading."

Inaccuracy in the information shareholders had access to was also crucial in the collapse of HIH and One.Tel. This became "obvious in hindsight, when assets were shown to be grossly misvalued in the accounts," said Professor Swan

It's easy to say now that it would have been beneficial for HIH, One.Tel or Harris Scarfe shareholders to conduct more thorough monitoring of these companies. But generally small investors "cannot put a great deal of money into monitoring," said Professor Swan, because "they hold only a tiny percentage of the company," so the cost would far outweigh any benefit.

So how is it realistic to expect small investors to monitor effectively when they lack the resources? How can they monitor when not even the biggest shareholders appear capable? In the case of One.Tel, "even the two largest investors claimed they knew absolutely nothing" about the impending collapse despite having put their best financial experts in the company.

The Australian Shareholders Association (ASA) advocates that, despite the difficulties, individual shareholders should attempt to take an active interest in managing their investments.

Tony McLean, Executive Director of the ASA, said shareholders can take a number of avenues to keep informed about their investments. "In monitoring announcements to the ASX, in reading the financial press, in accessing information sources on the Internet, and also by membership of the ASA," shareholders can manage their investments.

Mr McLean said "the ASA provides resources, has regular meetings and there's a network of other investors to communicate with." Also, the ASA's website contains details of forthcoming company meetings, including who will be the ASA's representative, and how the ASA intends to vote at that meeting.

"So there are resources available to small investors if he wishes to avail himself of this," Further, investors should "get professional advice if at all unsure about the prospect of any of the companies in their portfolio."

So volume of information that is available to investors under current regulations is quite sufficient, according to Mr McLean, but "there is a need to ensure the information provided is accurate and credible."

The accuracy of company reporting is hugely important, as shown by the collapse of One.Tel and HIH, and "hopefully there will be some lessons learnt," said Mr McLean.

"I think that reflects poorly on those companies that have collapsed. They have really failed to provide shareholders with information representing the true position of the companies," said Mr McLean.

In order to improve the accountability of directors in failed companies, Mr McLean advocates a restructuring of company boards "by increasing the number of executive directors and decreasing the number of non-executive directors." This would serve to improve the board's capabilities because executive directors have a better knowledge of the activities and financial status of the company and, "by virtue of their exposure to the company, they have a greater degree of accountability."

However, despite their apparent disadvantage, some mums and dads are reaping the rewards the share market can provide. An index of ten of the shares that provided many small investors with their initial exposure to the market, the Commonwealth Securities "Mums and Dads" index, has outperformed the market index by as much as five per cent over the past year.

The "Mums and Dads" index is made up of ten shares: AMP, Coles Myer, Commonwealth Bank, Qantas, TAB(NSW), Tabcorp (Victoria), Telstra, Woolworths, Suncorp Metway and NRMA. "Mums and Dads" who have benefited from investing in these stocks can attribute much of this success to both share price and the diversification of the portfolio.

Mr McLean of the ASA hopes all investors hold diversified portfolios, which would lessen their loss from the collapse of companies such as One.Tel, HIH and Harris Scarf.

"Hopefully, people have got sufficient spread [of risk]," so the losses they incur from unforeseen company collapses "won't be too substantial."

According to Shadow Minister for Financial Services and Regulation, Stephen Conroy, to prevent the recurrence of these corporate collapses, corporate governance practices need to be improved to better align the interests of management with the interest of shareholders.

A spokesperson for Mr Conroy says the Federal Opposition has released a plan to increase the accountability of management to shareholders which is "in recognition of the increasing number of retail investors."

Labor's policy focuses on the low level of voting by Australian shareholders on company resolutions and improvements to the enforcement of continuous disclosure requirements of the Corporations Law.

The policy would also "strengthen the disclosure requirements on executive remuneration packages" and would "require the independence of auditors". This would toughen up the potential conflict of interest with the external auditor, who has increasingly offered a range of other services to corporations.

So it doesn't have to be such a struggle for the "mums and dads", as long as they are willing to put in some effort to monitor their investments.

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