English lessons for Australia's financial planners

As Australian planners seek to come to terms with the Government’s Future of Financial Advice changes, Paul Resnik outlines events in the United Kingdom and their impact on planners.

A recent guidance paper produced by the Financial Services Authority (FSA), the United Kingdom’s equivalent of the Australian Securities and Investments Commission (ASIC), outlines the process that advisers must undertake to prove the suitability of their investment recommendation with regard to the investor’s willingness and ability to take risk.

The FSA’s approach is to promote the personalisation of advice consistent with the practices adopted by high-end financial advisers.

• This generally entails a solid emphasis on cash flow analysis and planning;
• It sees the demise of simplistic ‘Portfolio Picker’ risk questionnaires as impersonal shortcuts to a portfolio;
• It recognises the separate roles of risk tolerance and risk capacity in the advising process and the requirement for the adviser to show reconciliation of any differences between them; and
• One issue that is not resolved is how advisers who have used inappropriate tools for risk profiling in the past (nine of the 11 tools reviewed by the FSA did not pass muster) should deal with clients who have been potentially misadvised.

High-end independent financial advisers in particular are significantly more optimistic about their future than most others.

A good number of the better advisers are oriented towards detailed cash flow planning for their clients and construct passive or semi-passive portfolios. Most felt the banks and life companies were at a disadvantage in terms of momentum to the new standard, and had lost the regulator’s and community’s confidence and trust. 

To give you a sense of the FSA’s ‘take no prisoner’ approach to regulation just listen to Margaret Cole. In her role as interim managing director of the Conduct Business Unit, Cole has detailed her experiences with the major banks. 

“I am not in the business of banker bashing, but if you look at the evidence, it was really the big retail banks who were the major players,” Cole said.

She said various miss-selling issues have emerged over the past 20 years costing consumers £24 billion. She added: “It is particularly striking to me that when we have done business model analysis we have seen how much of the business models of major institutions are being driven by aggressive product sales. We have to be prepared, to be more interventionist to head off those issues before they really get going.”

To the best of my understanding two of the major UK banks have withdrawn from the general advice market in the past six months. 

Here are 10 of the other major themes developing in the UK: 

1. The number of advisers is expected to reduce from around 30,000 by as much as 25 per cent over the next three years.
2. There looks to be an over-supply of wrap platforms. Currently there are 29 in the market and several more in the wings. It’s difficult to see how they can all be adequately resourced, built and distributed. Fewer than six platforms are currently profitable.
3. There is an ever increasing recognition that the investment decision is the last component of the planning process. The amount of investment risk taken on is decided after all the other lifestyle options available to the client have been explored.
4. Growing recognition that, on average, portfolios have not adequately rewarded clients for taking equity risk over the last 40 years. Rolling 10 year average returns for 50/50 growth and defensive portfolios are similar to Australia. They delivered around 2.1 per cent a year before fees and taxes, above a purely defensive portfolio. The extra risk and return for moving to 100 per cent growth assets (1.1 per cent per annum in the UK, 1.7 per cent per annum in Australia) is also a surprise to many advisers.
5. An understanding that the sustainable investment proposition for clients promotes wealth preservation rather than wealth creation.
6. There is a very visible move to model portfolios away from customised portfolios. This is accompanied by a continuing shift from active to passive asset management. Both are widely recognised as necessary to increase business efficiency and to improve the consistency and add quality to returns. 
7. Investment products are expected to become simpler, guarantees and product ‘tricks’ to diminish, and fees come closer to those offered by index funds.
8. Growing recognition of the cost to consumer confidence caused by the failure to appropriately and consistently label funds, explain risk and to frame investors’ expectations.
9. Business processes will move from adviser knows best to informed client consent. 
10. A growing acceptance of the need to add to the advisory business’ client proposition non-investment related services and benefits.

There is a broad recognition now that all participants in the value chain must play a role in bringing consistency and integrity to the advising process. This methodology is the integration of five fundamental building blocks that enable a client to make a properly informed commitment to his or her plan. 

They are:

• A reliable personal risk tolerance assessment tool;
• A consistent, realistic and understandable method for both financial advisers and fund managers to explain risk and return;
• A cash flow planning tool to illustrate the client’s spending against available assets taking into account the asset mix consistent with risk tolerance, risk required and testable for the client’s risk capacity;
• A proven methodology to make future capital market assumptions to be used in the cash flow planning process; and
• A proven capability to deliver portfolio outcomes consistent with pre-agreed benchmarks with the client.

Consequently, almost all product and service suppliers engaged in reframing their business proposition to take account of the impending regulatory changes, or building to take advantage of the opportunities created by the failure of competitors. 

Paul Resnik is director and co-founder of FinaMetrica.