Investing with Him VS her?
Investing is historically a male-dominated industry; therefore it’s logical that there are significantly more male fund managers than female fund managers. Yet statistically, female and male fund managers approach decision-making differently. But how does this affect the return I earn? If I’m comparing the results of two funds which are both managed by men, I’m not really allowing for any differentiation, am I?
So why this fascination with gender in investing?
It all started when I was doing some research on the internet to assist me in how I personally invest. I found a simple questionnaire that I could answer to assist in deciding how to allocate my money, which for a while let me think I’d discovered the pot of gold at the end of the investment rainbow. I like questionnaires – they’re objective and have helped me determine which ‘Friends’ and ‘Sex and the City’ character I was in the past… so I proceeded to answer the questions…
It seemed to be a personality test, assessing how much risk I was willing to take; whether I could handle a crash in the market and what my investment horizon was. At the end I was given the following result:
If you are male: Allocate 100% of your investment to equity.
If you are female: Allocate 70% of your investment to equity and 30% to money market.
What! Why was I being given different advice because I’m female?
So this is where this story really begins. The reason I was ‘classified’ differently based on my gender is because of certain behavioural biases known to affect the way people invest – which manifests differently in men and women.
The most notable of these behavioural biases is ‘risk-aversion’. We all know that a person’s propensity to take on risk is a significant determining factor of their investment behaviour. Men were found to make larger investments and buy riskier stock than women, who are statistically more conservative. Why this risk-aversion from women? Well, it’s been said that from a biologically-based, evolutionary point of view, women are required to be risk-averse. Being mothers, the survival of the human race is dependent upon their ability to give birth and protect their young, which requires an element of conservatism. Men, on the other hand, need to take risks to go out and ‘hunt’ that perfect mate. Men tend to interpret a risky situation as a challenge and want to engage, spurred by their egos. Women, on the other hand, tend to interpret the same situation as a threat and be more averse to competition.
Men also have the propensity to be more overtly confident in their knowledge and investing ability, akin to the caveman days when men were required to confidently go out and hunt, thereby providing for their families. Men generally rate their own capabilities higher than women do, even though, there is little actual difference between men and women in conventional intelligence, i.e. IQ. Furthermore, men often exhibit an interesting phenomenon, known as the ‘self-attribution bias’. When they perform a task well, they attribute it to their skill – but when they perform a task poorly, they’re more inclined to say they were unlucky. Women, on the other hand, exhibit a ‘negative recall bias’, whereby they tend to remember their poor performance, which then negatively affects their belief in their own competence going forward.
So how does this all affect the way men and women invest? Well, men, being more confident than women, due to stronger belief in their own competence and the self-attribution bias, will accept more risk and trade more often than women do.
In a study performed by Barber and Odean (2001), they found that men trade 45% more than women. Being ‘overconfident’, men were found to trade more than the ‘rational’ trader, which reduced their expected utility.
So, does all this also apply to us in South Africa?
To answer this question, an undisclosed investment house was kind enough to give me some data which calculated the internal rate of return (IRR) earned by 11 000 individual investors over different time periods from 1 January 2007 to 31 December 2011.
Correlating investor return to trading frequency, I was able to confirm that over-trading does lower investor return. This phenomenon is attributable to friction and the effects of mistimed trades. Investors should rather buy-and-hold than trade vigorously to maximise their returns.
Furthermore, it was found that men trade more than women.
So now what about the actual return? Interestingly enough, no differential was found in the return earned by men or women over any of the periods analysed. However, an interesting observation was noted on the variability of return earned: Men were found to
have significantly higher variability in their return!
So, let’s make this practical. You have the choice of giving your money to Bob or Sally. Both Bob and Sally will most likely earn you a return of 5%. Having your money with Bob, your return could be anywhere between -5% and 15%, but most likely 5%. Having your money with Sally, your return could be anywhere between 3% and 8%, but most likely 5%. No difference in the absolute return, but on a risk-adjusted basis, you’re ‘safer’ with Sally.
This begs the question: “Shouldn’t there be more Sallys than Bobs in the investment world?” If your money is safer with conservative, risk-averse Sally than slightly overconfident Bob, surely we should be encouraging the training and support of more women in the profession? And putting our money into the careful, considered hands of a female fund manager? But I might just be saying that because I’m a woman… ❐
Author: Gizelle Willows CA(SA), MCom (Finance), is a lecturer at the University of Cape Town.
The folly of ‘breaking’ Trusts.
While recently analysing a trust deed for a client, I started wondering why so many individuals who use trusts in their estate planning – and their advisors – are so intent on ‘breaking’ their trusts? Why would a planner go to the trouble of creating a trust, the expense and effort of transferring assets to a trust and of administering a trust – to then deprive him or her of the benefits offered by this versatile estate planning tool?
The answer, it would seem, is the result of forgetting why the trust was created in the first place, while not understanding the concept of having a vested right in trust assets.
Let us begin by looking at why clients typically decide to create a trust. Speak to an advisor regarding trusts and they’ll usually tell you about its many advantages. Trusts, we are told, can be used to reduce income tax, postpone capital gains tax and save on estate duty. It can also be a means for safeguarding assets from attachment by creditors and preventing these from falling into the hands of spouses during divorce proceedings. These last two are the reasons most often given by my clients – including the one mentioned at the beginning of this article – for using trusts as estate planning tools.
An ‘inter vivos trust’ can be either a discretionary trust or a vesting trust. In this article we deal mainly with discretionary trusts. Let us now look at the concept of a ‘vested right’ as it pertains to trust assets.
1) According to the case of Jewish Colonial Trust v Estate Nathan1, a right can be said to vest in a person when he/she owns it. Secondly, the case tells us, the word ‘vested’ can be used to draw a distinction between: “what is certain and what is conditional: a vested right is distinguished from a contingent or conditional right”.
2) The case of Goliath v Estate Goliath2 points out another interesting aspect of vested rights, namely that the right is ‘immediate’, but ‘the enjoyment thereof may be postponed’. A right can be said to be immediate if it is not dependant on any further contingency, such as the survival of the beneficiary to a given age or the death of a given person3.
3) It is also clear, from the case of Jowell v Bramwell Jones4, that once a right is vested in this sense, it is transmissible to the successors of the beneficiary on death or insolvency and it forms an asset in the beneficiary’s estate. A contingent right on the other hand does not form an asset in the beneficiary’s estate at death.
I see trusts ‘broken’ most often due to a common trust bookkeeping practice that is often recommended to clients. Briefly, this involves the allocation in the trust’s accounts of a certain portion of the trust’s income or capital gains to a specific beneficiary, and then crediting the amount to that beneficiary on loan account. In this instance the income or capital gain is said to be allocated to beneficiary ‘X’, but the money is not actually paid and a loan account is created in beneficiary X’s favour in the trust books, while the trustees still administer those amounts on that beneficiary’s behalf.
This is done to reduce the trust’s liability for income tax and capital gains tax by means of the conduit pipe effect created by section 25B(2)5 and Paragraph 80(2)6. These sections allow trust income or capital gains to be taxed in the hands of a beneficiary at that beneficiary’s marginal rate of tax, as opposed to the trust’s flat rate of 40%. However, this will be the case only if the allocation is done within the tax year in which it accrued to the trust. In this way the trust acts merely as a conduit pipe, in that the trust income or capital gains flow through it to the relevant beneficiaries.
At first glance this practice may seem beneficial, as it could give rise to a tax saving. However, the allocation of a trust asset or of income or a capital gain to a beneficiary has serious consequences of which advisors and their clients often lose sight in their eagerness for tax savings. This is the case even if the date of delivery is entirely at the discretion of the trustees.
Such allocations, as shown earlier in this article, create vested interests in favour of specific beneficiaries and as such exposes the assets to:
• estate duty in the estate of that beneficiary
• executor fees in the estate of that beneficiary
• potential attachment by spouses or creditors of that beneficiary.
These are exactly the negative consequences the trust planners were trying to avoid!
It should also be borne in mind that there will always come a time when such amounts will in fact have to be paid out, either to the beneficiary or the beneficiary’s estate. Keep in mind also that trustees are obligated to at all times have sufficient assets in trust to settle all such claims.
Their failure to do so could lead to personal liability on their part. It must also be mentioned that clients and their advisors often attempt to circumvent these negative effects by including all manner of clauses in their trust documents purporting to say that these assets are excluded from attachment until such time as the assets have been paid over to the relevant beneficiary, and that should the beneficiary be declared insolvent prior to receipt of such assets, that the asset will revert to the trust. Such attempts or pretences contained in a trust deed are usually a ‘nudum praeceptum’ or ‘nude prohibition’ and therefore invalid, as shown in the well-known cases of Vorster v Steyn7 and Du Plessis v Pienaar8.
Cameron et al, in Honoré’s South African Law of Trusts explains as follows:
“When a testator gives someone the ownership of property or an immediate right to the corpus or capital of an estate or fund the testator cannot then impose restrictions on the use of the property by the heir or legatee or in any other way impair his freedom unless this is done in the interest of a person or persons other than the beneficiary or for a defined impersonal object… A restriction imposed purely in the interests of a beneficiary who is in the above sense owner does not bind the beneficiary and is termed a nude prohibition (nudum praeceptum). If the testator purports to impose such a prohibition by way of trust, the trust is not in general invalid, since there is a beneficiary, but the latter is not bound by it and may insist on administering the property to the exclusion of the trustee, as may his trustee in insolvency.”9
I therefore suggest that any trustees and their advisors, when tempted to allocate trust income or capital gains to beneficiaries for no reason other than to reduce the tax liability resulting from the receipt of such income or capital gain, should first think long and hard about the reasons for which the trust was originally created. Remember that the trust’s assets will repeatedly pay out estate duty and executor fees. The first instance will be upon the client’s death and repeatedly thereafter in the estates of heirs as they in turn pass on and leave the assets to their own heirs. As long as the income and capital gains are kept solely in the trust, these will not be liable for estate duty and executor’s fees in the hands of a nominal individual and the savings on estate duty and executor fees can keep repeating through the generations. The same principle applies to allocating other trust assets besides the income or capital gain.
I am of the opinion that, if you consider the potential savings through the generations and also the protection that trust assets enjoy from creditors, a short term tax saving by allocating and vesting assets to individuals does not justify depriving the beneficiaries of the protection that the trust has to offer. Trustees and advisors should guard against losing sight of the objectives of the trust and take care not to deprive the authentic beneficiaries of this protection. ❐
Author: Franscois van Gijsen, CFP®, BProc; LLM (Tax Law); Dip. Legal Practice; Post Grad Dip. Financial Planning; Adv Post Grad Dip. Financial Planning is Director Legal Services at Finlac Risk and Legal Management.
Real time Management of Fraud Risk
Companies are at risk from a range of fraudulent activities – from high flyers like Bernie Madoff to suspicious procurement contracts for widgets. According to 2010 figures from an IT Web survey, 71% of South African companies had discovered fraud committed by their own staff—and yet only 38% had strategies in place to prevent data leakage.
According to other research, 62% of South African companies reported they had fallen victim to economic crime of some sort or other during the preceding 12 months.
The global picture is not much better, and regulators have responded with a raft of measures designed to force companies to strengthen their internal controls. South Africa introduced King III and the USA passed the Foreign Corrupt Practices Act, while the UK passed its Bribery Act in 2010 – which makes failing to prevent bribery a specific corporate offence.
The responsibility for ensuring the effectiveness of internal controls tends to fall squarely on CFO shoulders. And yet most CFOs continue relying on traditional strategies such as fraud risk assessments, prevention and anti-corruption plans, integrity strategies, fraud awareness campaigns and whistle-blowing capabilities. These are all important components to a successful fraud risk management programme, but lack two important capabilities: the ability to detect fraud as it happens, and a comprehensive overview of transactions.
Traditional approaches are periodic and always operate after the event. However, it stands to reason that it is better to detect and remedy a fraud before it harms the company’s overall health. For that reason, then, it would be highly advantageous for the CFO to receive information that is not only relevant and reliable, as mandated by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) – but also timely.
In addition, traditional approaches focus on policies and procedures, but the complexity of the corporate finance process and its underlying systems means that new applications and sub-processes can get overlooked, and so might escape even ex post facto scrutiny. These policies and procedures need to be supplemented by an overview of the transactions actually carried out by the company – as this is where fraud occurs. COSO has identified continuous monitoring as the route to: “better monitor the effectiveness of their internal control systems and take timely corrective actions if needed.”
Big data to the rescue
There’s a lot of hype about big data—the staggering volumes of data that company systems collect—and how valuable it can be as a mine of information about customer behaviour, among other factors. Much of this data is financial and transactional data, and continuous monitoring applies analytics to this data to overcome the challenges of effectively managing fraud risk.
Specialised continuous monitoring software extracts data directly from the enterprise resource planning (ERP) software via a connector and places it into a common data model. Typically the software would be configured to extract only that information that has changed since the last extraction, reducing the load on the ERP system. A key functionality is the ability to set the frequency of data extraction: this would be determined by the frequency with which certain transactions take place and also their impact on the company. For example, certain types of transaction could be monitored as frequently as every couple of minutes.
Once in the common data model, this data can be analysed very rapidly to detect trends and patterns. Crucially, data from external data sources can also be included; for example, lists of blacklisted service providers or buyers provided by third-party agencies.
The continuous monitoring application can also be set up to direct specific exceptions or red flags to specific individuals for resolution. It also provides a comprehensive audit trail. And because it’s automated, there is reduced dependence on — and vulnerability to — humans.
See the benefits
Leading companies are already seeing benefits from continuous monitoring. One example is a European mobile telecommunications company which uses this type of software to identify and prevent unauthorised access to sensitive customer information by service agents. This access is captured in logs maintained in the various databases. Continuous monitoring software collates data from several systems that track access, as well as from a customer relationship management (CRM) system. Service request tickets entered into the CRM system are used to reduce false positives by validating reasonable access to sensitive customer data. Unusually high numbers of accesses are flagged, as well as too many without a corresponding service request in the CRM system.
In the first month, an instance of a customer service agent accessing one customer’s data more than 350 times in one month was identified. This kind of proactive analysis is necessary, given the types of information being produced by the growing trend towards mobility. This information would include location data that could be used by fraudsters and worse, terrorists. For this reason, personal data is increasingly being protected by stringent data privacy laws.
Another example concerns a global media organisation whose distributed accounting functions gave local offices significant discretion in attributing revenue to business units. This state of affairs increased the risk of fraud as business units rushed to meet targets, so resulting in higher audit costs relating to the verification of revenue. An automated continuous monitoring system was implemented to inspect manual and system-generated journal entries according to revenue.
The benefits have been immense. The audit scope was reduced by 750 hours per annum, and the internal audit function now has the ability to identify fraudulent and/or unusual journal entries.
Other applications too
Continuous monitoring is also useful in identifying procurement fraud, by tracking duplicate payments and vendors, as well as unusual spending trends. It can monitor payrolls for ‘ghost employees’, large or unusual payments and help ensure the accuracy of deductions. This process also helps to manage travel and expense claims by monitoring claims and spending patterns against company policy.
Implementation of the right technology could also serve as a vital element of an effective programme of a risk-based due diligence on third parties to help flag those agents and business partners that pose a threat to the company’s integrity. These technologies enable forensic data analysis to detect patterns of behaviour that, in the words of Ernst & Young’s 12th Global Fraud Survey 3: “can be identified, either based upon the identification of known indicators (such as the use of unexpected banking locations) or through the detection of behaviour that is simply anomalous when compared to the norm for a class of vendor or location. Such analysis can be achieved using the right combination of text mining, statistical analysis and pattern matching with the results presented using advanced visualization techniques to enable rapid and effective review”.
CFOs have a great and growing burden of responsibility in assuring the integrity of financial processes and the ‘bottom line’. They should carefully examine continuous monitoring tools as the path to stepping up fraud prevention capabilities, while reducing the burden of this responsibility on their employees. ❐
Author: Mike Roos CA(SA) is a Director of Barnstone Corporate Services.
IFRS for SMEs
By now all accountants should be aware that most companies and close corporations are required by the Companies Act to comply with International Financial Reporting Standards (IFRSs) or International Financial Reporting Standards for Small and Medium and Entities (IFRS for SMEs).
In addition, as announced by the APB and the FRSC, the South African Statements of GAAP (SA GAAP) standard is being withdrawn for all year ends commencing on or after 1 December 2012.
But, did you know that you do not simply apply IFRSs or IFRS for SMEs from now on? It is important to be aware of this fact, as many have assumed that because IFRS and SA GAAP are virtually identical, you can simply change the wording in the financial statements and continue as before. For the most part, you are required to apply IFRSs, or IFRS for SMEs retrospectively, which means that your comparative information and the opening retained earnings at the beginning of the comparative period may need to be restated.
Specific guidance is available on how to convert to either IFRSs or IFRS for SMEs. You need to be aware of and apply:
• IFRSs – apply IFRS 1 – First-time Adoption of International Financial Reporting Standards.
• IFRS for SMEs – apply section 35 – Transition to the IFRS for SMEs.
• Irrespective of whether you are a company that applied SA GAAP, or a close corporation that applied GAAP or your own accounting policies, this article is relevant to you. Its aim is to make you aware that a transition process is required, therefore do read on regarding the requirements for IFRS 1 and/or section 35.
If you are transitioning from SA GAAP to IFRSs, you are required to apply IFRS 1. Its options, together with fact that IFRSs and SA GAAP are virtually identical, should make the change painless, unless you decide to apply one or more of the allowed alternatives.
In this case, and for all other transition processes, you may require professional assistance from your auditors, or independent experts on IFRSs and/or IFRS for SMEs.
High level requirements of IFRS 1
1. Prepare an opening IFRS statement of financial position (SOFP) at the date of transition to IFRSs.
2. With limited exceptions, prepare the first IFRS financial statements (FS) using the same accounting policies in the opening IFRS SOFP and for all periods presented in the first IFRS FS.
3. There are other key requirements, as well as 20 optional exemptions and five mandatory exceptions.
4. Provide an explanation of the transition to IFRS.
Opening IFRS SOFP
This does not need to be in published form and is the starting point for accounting under IFRSs As an example, for a company or close corporation that adopts IFRSs for the first time in December 2012, the date of transition would be no later than 1 January 2011.
The accounting policies must comply with the Standards that are effective at the reporting date for the first IFRS FS. With limited exceptions, these Standards are applied retrospectively, therefore the same accounting policies are applied to comparative information and to the opening IFRS SOFP. The implication of this is that:
• Different versions of IFRSs that were effective at earlier dates may not be applied.
• The specific transitional provisions in an IFRS should be ignored for the purposes of the first IFRS FS, unless any specific guidance in IFRS 1 specifies otherwise.
It is possible to adopt early an IFRS that is not yet mandatory, provided it is permitted in terms of that specific IFRSs.
Other Key requirements
Other than the optional exemptions and mandatory exceptions (refer below), an entity should:
• Recognise all assets and liabilities that recognition is required by IFRSs.
• Not recognise items as assets and liabilities if IFRSs does not permit them to be recognised.
• Reclassify items that were recognised as assets, liabilities or components of equity under previous GAAP, but are a different type of asset, liability or component of equity under IFRSs.
• Measure all recognised assets and liabilities using IFRSs.
• Ensure that any accounting estimates are made in accordance with IFRSs.
• Recognise any differences between the accounting policies that were used under previous GAAP and those required to be used by IFRSs in retained earnings (or another category of equity) at the date of transition to IFRSs. This is because those adjustments arise from events and transactions that arose before the date of transition to IFRSs.
Note that previous GAAP could be SA GAAP, GAAP or your own accounting policies.
20 optional exemptions and five mandatory exceptions
IFRS 1 grants limited exemptions from the requirements above in specified areas where the cost of complying with them would be likely to exceed the benefits to users of financial statements.
There are 20 optional exemptions (not outlined in this article), but these may be worth applying and therefore should be carefully understood. For example, one exemption that preparers often use is that they can choose to revalue some or all of their property, plant and equipment at the date of transition (i.e. a one-off revaluation).
IFRS 1 also prohibits retrospective application of IFRSs in five areas, particularly where retrospective application would require judgements by management about past conditions after the outcome of a particular transaction is already known. These exceptions generally deal with more complex issues like embedded derivatives and hedge accounting, therefore they should be properly understood.
Explanation of transition to IFRS
In addition to other disclosures, the transition from previous GAAP to IFRSs should be explained – specifically how the reported financial position, financial performance and cash flows were affected. This requires:
• A reconciliation of equity reported under previous GAAP to that reported under IFRSs at the: a) Date of transition to IFRSs and b) End of the latest period presented in the entity’s most recent annual FS under the previous GAAP.
• A reconciliation of total comprehensive income reported under previous GAAP to total comprehensive income reported under
• IFRSs, at the end of the latest period presented in the entity’s most recent annual FS under previous GAAP.
• The disclosures required by IAS 36 (Impairment of Assets), for any impairment loss/reversal recognised in the opening IFRS SOFP.
These reconciliations should provide sufficient detail for users to be able to understand any material adjustment to the statement of comprehensive income, SOFP and statement of cash flows. In addition, changes in accounting policies should be distinguished from the correction of errors.
High level requirements of IFRS for SMEs
The requirements of section 35 of the IFRS for SMEs are almost identical to those in IFRS 1. There are also five mandatory exceptions, but only 12 optional exemptions. In addition to the previously explained deemed cost exemption for property, plant and equipment, there is an exemption for deferred tax at the date of transition, if the recognition of those deferred tax assets or liabilities would involve undue cost or effort. It is important to note, however, that this is not a blanket exemption for recognising deferred tax – it applies at the date of transition only. Furthermore, because deferred tax was recognised under SA GAAP, it will be more difficult to argue that undue cost or effort existed.
The other variation from IFRS 1 states that if impracticable for an entity to restate the opening SOFP at the date of transition in accordance with the transitional procedures, the entity must apply the transitional procedures in the earliest period for which it is practicable to do so. Applying a requirement is regarded to be impracticable when the entity cannot apply it after making every reasonable effort to do so. If this is the case, disclose the date of transition and the fact that data presented for prior periods is not comparable.
As you can see, conversion to either IFRS or IFRS for SMEs is not always straightforward. A simple change of words in the financial statements is not sufficient. Time and effort is necessary and this process may result in one-off transition costs. ❐
Author: Glynnis Carthy CA(SA) is an independent financial reporting consultant, who focuses on learning and advice in respect of IFRSs, SA Statements of GAAP and IFRS for SMEs.