Steering the ship into safe waters

In the 1980s, Bankers Trust was a hotbed of creative financial minds, flourishing in the era of bank deregulation pushed through by the Hawke government.

Those creative minds continued to prosper in corporate Australia, long after the British-owned derivatives and trading house hit the rough and was sold in the late 1990s.

A former managing director, Chris Corrigan, became a household name, not just for his role in the infamous waterfront dispute but also for building Patrick, one of the most successful stevedoring and transport businesses in the country.

Another managing director, Rob Ferguson, now sits on the boards of property trust GPT, listed litigation funder IMF and Primary Healthcare. And another leader of BT, Jillian Broadbent, sits on the Reserve Bank of Australia, and has gigs on the boards of the ASX and Woolworths.

You can add Dominic Stevens - at 46 a good deal younger than his former bosses - to the list of Bankers Trust veterans continuing to make waves in Australian business.

As chief executive of financial services firm Challenger, Stevens is promising nothing less than transforming the retirement of thousands of Australians.

The promise includes saving Australians from the harsh ups and downs of the sharemarket by giving them a reliable fixed income over a long period.

Challenger is selling products called annuities that are being marketed as retirement "safe havens".

Stevens credits skills picked up with BT for allowing him to steer Challenger to become Australia's largest provider of annuities, reaping handsome profits along the way.

But not everyone agrees with Challenger's "safe haven" characterisation of the product. Brett Le Mesurier, a banking analyst with stockbroker BBY, released a provocative research paper in April headlined bluntly: "Why a term deposit is better than a fixed term annuity."

Le Mesurier also has concerns about the risks in Challenger's business model - but more on that later.

As a graduate with a University of NSW degree in commerce, Stevens remembers the excitement of entering a business that was focused on the fast-moving and relatively new world of financial derivatives.

The excitement was possibly enhanced by Stevens starting his career at BT in 1987, the year of the October Black Monday crash.

In an era in which carefully vetted chief executives relentlessly sell the virtues of their current employer, Stevens describes his time at BT as "the finest time in my career".

He remembers when Australia's financial institutions were starting to adopt what is now taken for granted: widespread foreign exchange dealing, interest rate swaps and trading in other derivatives.

"We came in ... just as the whole market was starting," Stevens says. "BT globally was at the forefront of this ... everything was new, everything was growing."

Those lessons are still bearing fruit in Stevens's role leading Challenger since September 2008. In that time Challenger has sprung to prominence from its own grave global financial crisis problems.

Challenger has carved out a niche selling Australians on the idea that investments regularly paying a fixed 6.5 per cent offer a safer form of retirement than what's available through the stockmarket.

Challenger has cemented this position through advertisements with the tagline "Future-proof your retirement". Stevens also uses language such as products are "effectively providing very long-term deposits".

But, as Le Mesurier points out, investments in annuities are certainly not a deposit with a bank.

Sure, annuities products have the benefit of life-insurance regulations, meaning they are placed in statutory funds with regulation by the Australian Prudential Regulation Authority. However, there is no government guarantee, as currently exists for depositors of up to $1 million in banks, for 100? in the dollar to be paid out if the bank fails.

Le Mesurier also warns those looking to recoup their funds early from an annuity are at risk - under the terms of the Life Act - to receive a sum "perhaps considerably lower than the original value of their investment".

Then there is the paradox that a financial services company savaged in the financial crisis - with shares plunging 87 per cent from their peak to 88? - has become synonymous with reliable payments over the long-term. (Challenger currently trades around $4.60.)

The erratic sharemarket returns of the past three years have become part and parcel of Challenger's rhetoric. "This whole GFC experience will put a scar on a generation around the riskiness of investing," Stevens says.

Challenger's comforting message has attracted Australian investors to annuities in droves. In 2010 Challenger sold $933 million. In 2011 Challenger sold $1.46 billion. And next year it is predicting sales of at least $1.8 billion.

Stevens equates the skills necessary to run a long-term annuities business with the skills he brought from BT, describing those skills as the mathematical bent contained in a "derivatives mindset".

"It's just a matter of working it out. There is always an answer to everything. And so you just have to work out what the answer is," he says.

After an entrepreneurial detour with some former BT staffers to the insurance firm Zurich in the early 2000s, it was those skills that proved valuable when he was hired by Challenger in 2003.

He credits the attitude imbued by his derivatives experiences that allowed him (and what has become a sizeable former BT cohort within Challenger) to refine the annuities model pioneered by Challenger's founder, Bill Ireland.

"On coming here I think what we brought was a state-of-the-art, 15 or 20 years experience in running a business like that, to a business that you probably would say was more entrepreneurial than operational," Stevens says. "In some sense it was an optimisation process."

The mathematical trick to Challenger's business is to match payments to investors over a long time with the payments it receives from its own investments. Challenger targets a return on its own investments of an average of 9 per cent.

If you subtract 6.5 per cent it has to pay for investors from its own target of 9 per cent, you can see that Challenger is hoping to put into its pocket an average of 2.5 per cent.

In these times a fund manager returning 9 per cent over the long term is generally regarded as a genius, but Stevens prefers to think of the business in banking terms, making a "spread" above the money provided by its investors. In this light, he claims the business as having the same kinds of margins that banks have in their loan books.

But Le Mesurier questions just how sustainable this kind of spread is.

"The issues that we see include the following: sustainability of the investment margins, the quality of the investment assets and, the consequence of these two issues is the volatility of returns to shareholders," he says.

Le Mesurier accepts that Challenger's property portfolio, making up 18 per cent of its total investments, would make a return of 9 per cent. But he questions how its fixed interest investments, making up 73 per cent of its portfolio, can hit this kind of target.

"It's unlikely that it will achieve 9 per cent per annum on its fixed interest portfolio unless it takes some substantial risks," he says.

Stevens is eloquent about how Challenger survived the financial crisis, and he sees the survival addressing concerns about its sustainability.

He points out that Challenger did not have to raise extra capital from the market, and its conservative positions allowed it to survive and continue to prosper.

For the many Australians now investing in annuities, it is in all their interests that Stevens and Challenger have got it right.

THE CV

STEVENS, Dominic

Born: Sydney, 1965

Education: First class honours, Bachelor of Commerce, University of NSW.

Career: In 1987, joined Bankers Trust in its derivatives division, in time to witness the October 1987 sharemarket collapse.

In 2000, after BT was bought out, Stevens and a group of former BT staffers joined as a division with the Swiss insurance company Zurich.

In 2003, he joined Challenger, becoming chief executive in September 2008.

Family: Married, with three children aged 14, 12 and 10.

Pastimes: Particularly enjoys travel and skiing, making time to get away twice a year.