Clients need to come before financial planning reform

Despite the current emphasis on FOFA, Ian Knox explains why it is that clients, not reform, should come first.

Having spent the last few weeks meeting with over 30 Independent Financial Adviser (IFA) practices, I openly acknowledge that a theme dominating the industry on the ground is the difficulty of winning new clients.

This is the elephant in the room – not the fee-only financial adviser (FOFA) reforms or any other debate about the industry.

After being battered by the GFC and a relentless industry funds campaign that undermines the value of advice, investor confidence in financial advice continues to wane.

And even the non-aligned, exemplar advisers are feeling the pinch.

Confidence is an all-consuming issue, and therefore one that is complex to address.

Obviously volatile markets, losses in portfolios and low returns dent consumer confidence – but so too does the incessant and unnecessary industry fund advertising which, disappointingly, has recently restarted.

The campaign destabilises the true meaning of advice and is a self-serving fear campaign aimed at helping industry funds retain members so that they can grow their own business aspirations. In the end no-one wins.

Australia needs economic growth, markets need confidence and investors need confidence in both the system and the advisory community.

If the industry fund movement was legitimate in its campaign it would address its own challenges.

This includes thousands of members leaving the funds to seek Self-Managed Super Funds (SMSF) solutions and thousands of members needing advice on issues other than what risk profile they should be invested in within the fund.

Limited advice is something we will all pay for in the long run; it means just that – limited advice is limited in its value.

A few years ago when limited advice was introduced, I listened to an industry fund adviser recommending a member move from a defined benefit fund to an accumulation option.

The process guided the member out of a security blanket and into a market-related return with a different risk profile.

All of this without a fact-find, a risk profile or regard for the member’s external wealth position, a position which inevitably includes a large single asset called property.

From my observation it was a combination of poor direction and poor advice, both ungoverned from a regulatory perspective.

But the adverts will still chip away at consumer confidence in the real system by condemning it because of the dated commission argument which is now all but finished.

The adverts would do better to focus upon what planners in industry funds can do to build retirement security and give fund option advice so that all members become more confident of the system.

From a regulatory perspective, a licensed representative doing what the industry fund adviser did would result in remedial action being taken because the licence holder is obliged to supervise and monitor the quality of advice and ensure that a member’s circumstances are taken into consideration so that there remains a reasonable basis of advice.

In the industry fund sector we don’t hear a lot about the funds undertaking external reviews of their governance, their compliance obligations or their adherence to the Financial Services Reform Act (FSRA) obligations.

Perhaps the movement should reflect on this and lead by example, by adhering to and working within the same level of regulatory pressure as those everyday advisers they are so swift to criticise.

Then we would see the true cost of advice being identified and paid for by the fund members whose requirements are not currently being met.

Back to the confidence issue. It is unlikely we will see markets returning to normality in the near future as the long-term effects of the GFC reverberate and world economies continue to de-leverage.

This means we have a genuine problem occurring in the structure of the advice industry because the long-term earning rate of, say, 8 per cent, looks like being below the return available after fees and charges from a term deposit without inherent equity risk.

With confidence low and the cash rate likely to remain high because of Australia’s two-speed economy, planners may have to adopt new programs and shift the paradigm if they are to grow their practices profitably in the next few years.

This issue is taking shape amidst a battle between the emergence of managed accounts as an alternative solution to managed funds and platforms.

The difference between these options is a topic for a separate article.

However, the point is that if the overall cost of the industry is too high, then advice, investment management or platform costs have to come down so that portfolio earnings after advice and fees are greater than cash rates. Now that’s confidence-inspiring.

Advice is, of course, more than returns.

Indeed, it is the backbone of the industry but is often positioned in the lowest part of the (so-called) value chain.

This is because it is paid for via the manufacturers, these being the banks and insurance companies that own the platforms that pay the planners.

The battle of the managed accounts versus managed funds isn’t purely about cost, it’s about taking control, creating different value propositions for clients and forcing down the cost structure of parts of the value chain that should be commoditised (by the way, that is the platform market and managed fund operators that deliver index returns with active fees).

Today’s question in the minds of most planners should be all about the post-FoFA world.

It’s how to go up the value chain (without conflict, preferably), how to maintain a sensible cost structure so that clients are confident with their future direction.

It is also about creating value at the practice level – not dealer level. This is a new phenomenon because in the past, dealerships were valued by virtue of the volume bonuses that lubricated them in return for distribution rights.

Significantly, we allegedly have more than five IFA dealers for sale in Australia at the moment.

This is quite extraordinary for a country that is the fastest growing and fourth largest superannuation system in the world today and with a Government committed to increasing the pool, together with a complex tax and super system that needs advisers.

Finally, good planning practices achieve targets of 40 per cent EBIT (earnings before interest and tax). Why then would a dealership want to sell, one feels compelled to ask?

It might be preferable to work out how to build a better model, perhaps because the outlook is the best of times, rather than the worst of times.

In the post-FOFA world, it may emerge that dealer heads conclude that they need to be product managers to survive.

Planners however, may determine that advice is more valuable than anything else in the chain and that a well-run small practice with a regular fee system in place is more valuable than a dealership value.

Now there’s a thought, a structural change and, dare I say it, a role for managed accounts to play in helping the transition to occur.

Ian Knox is managing director at Paragem.