"This investment is only available to sophisticated and wholesale investors'.
That is a phrase many ASX investors might be familiar with. Here in Australia, we have a plethora of rules and regulations safeguarding our financial system and the investments within it.
One of those rules governs who can invest in what.
For an investment product to be available for general public use, it has to jump through a number of compliance hurdles. These include providing disclosure and risk assessment documentation to investors. Think prospectuses or product disclosure statements. Something I'm sure the managers at Platinum Asset Management Ltd (ASX: PTM) or Magellan Financial Group Ltd (ASX: MFG) could tell us more about.
The idea is that there needs to be a rigorous regulatory framework that protects ordinary 'retail' investors, like you or I, from spurious or dubious investment products.
An air of sophistication…
However, not all investment products in Australia have to comply with these rules. If an investor meets the qualifications of being a 'sophisticated' or 'wholesale' investor, they can be given an exemption.
The federal government's moneysmart.gov.au website tells us what this means. People who qualify as sophisticated or wholesale investors "can buy financial products without a regulated disclosure document such as a prospectus or product disclosure statement".
In other words, they are permitted to access a world of investment products that are not available for ordinary investors.
So what does one have to do to qualify as one of these elite investors?
According to the Australian Securities and Investments Commission (ASIC), to become a sophisticated or wholesale investor, one has to obtain a "certificate from a qualified accountant certifying they have a prescribed net asset or gross income level".
That net asset or income level?
You need either a "gross income of $250,000 or more per annum in each of the previous two years". Or else have "net assets of at least $2.5 million".
So why this two-track system for investors?
ASIC tells us the following:
The rationale is that people meeting one of these criteria are more likely to be able to evaluate offers of securities and some financial products (such as interests in managed investment schemes) without needing the protections of a regulated disclosure document.
How many sophisticated or wholesale investors are there?
A lot more than there used to be.
According to a report in today's Australian Financial Review (AFR), there are now more than 3 million Australians who meet the qualifications. The report quotes modelling from the Australian National University (ANU). This found that "1.09 million households (or 3.25 million individuals) meet the legal definition for a sophisticated or wholesale investor".
There were only 104,000 households that met this definition back when this system was introduced in 2002. That means this number has ballooned by roughly 10 times over the past 2 decades. And the report reckons that this number could hit 6.78 million adults by 2031. And 11.5 million by 2041. The ranks are being further swelled by the rapidly rising property market, as the family home is not exempt from the asset test.
Associate professor from the ANU's Centre of Social Research and Methods Ben Phillips called this situation the result of an "oversight" by policymakers:
Clearly the share of Australians earning $250,000 in gross income over two consecutive years, or those with more than $2.5 million in net assets, has changed dramatically over the last two decades because of income and asset price inflation…
These changes arise as a result of the failure of the legislation to index the… wealth tests in the Corporations Act's sophisticated investor definition… to the increase in both income and wealth over the 20 years since the definition was introduced.
However, if you're one of the lucky investors who now qualify as sophisticated or wholesale, don't get too carried away. Dr Phillips warns that "meeting the requirements of the sophisticated investor definition is unlikely to guarantee that an investor is immune to poor investment choices or being misled by shady deals".
Something to keep in mind if you are aiming to be, or already are, an official sophisticated or wholesale investor.
