Looking behind the curtain of the financial advice industry

Robert Keavney discusses platform commissions, proposals to merge the FPA and AFA, intra fund advice, and pro bono advice.

A magician will often perform a flourish with one hand to divert attention from the other. Some providers of platforms are using the same sleight of hand with their argument that wraps are services rather than products, and therefore should be exempt from commission bans.

This diverts attention to the service versus product argument, and away from the real issue.

Whether one supports the ban on commission or not, or whether one believes it will achieve desirable results or not, it is hard to argue with the objective.

Clients should be given advice that is in their interest, rather than advice that is in the interest of the adviser.

When a planner/dealer is paid to recommend a product, or paid more to recommend one product than another, it introduces the risk of compromising advice due to a conflict of interest.

However if we replace ‘product’ with ‘service’ in the previous sentence, the principle remains intact.

When a planner/dealer is paid to recommend a service, or paid more to recommend one service than another, it introduces a risk of compromising advice due to a conflict of interest.

But the labels ‘product’ and ‘service’ are irrelevant. The point is whether making payments to planners/dealers can influence their recommendations.

Why do product providers make payments to planners?

To encourage and reward the recommendation of their products. There is no other possible rationale.

They would not pay commission unless it was good for business, through increased inflow and retention.

So, why do platforms make payments to planners? For exactly the same reason — to persuade dealers/planners to favour their product/service.

Skirting the issue

Over the years many words have been used to avoid the indelicate word ‘commission’: sponsorship, advertising subsidy, volume bonus and brokerage are a few examples.

As part of the argument for exemption from the ban on commission, payments from platforms to advisers are being labelled ‘rebates’ or ‘discounts’.

Both of these terms mean a reduction of the sum to be paid. This would imply that planners pay wraps and are merely being offered a discount.

However, generally clients pay wraps — not planners!

Some platforms make payments to dealers/planners from their own revenue. The conventional term for this is commission. (This should not be confused with deductions from clients’ accounts to pay agreed fees to planners.

The latter comes from clients’ funds while the former comes from the wrap providers’ funds.)

Platform providers ought feel no concern about the banning of commission. The clear majority of advisers see a platform as essential in providing efficient clients service.

Platforms should compete for support from advisers on the quality of their product/service, not based upon which platform pays the highest commission.

It is a sign of the strangeness of our industry that platform providers are fighting to preserve the right to pay commission (ie, to stop a cost disappearing).

Most industries love to see costs reduce. The fundamental problem here arises not from platforms but from planners/dealers. While they are unwilling to charge directly for their service, it puts pressure on other service providers (investment products, platforms, etc) to feed them.

The ban on commission is a step towards each party in the service chain (eg, advisers, platforms, fund managers, etc) being paid directly by the party that engages it — just like a normal industry.

From commissions to salaries

What could be more conflicted than paying a commission to encourage recommendation of a product? The answer: a fund manager, which makes most of its revenue from products, paying a salary to an intra fund adviser.

If a business makes its revenue from products, and employs advisers on salary — intra fund advisers or otherwise — why incur the cost of those salaries?

It could be, in part, as a service to clients. But could it also be to retain funds under management (FUM) and encourage additional investment, through the reassuring tone and positive message of intra fund advice and answers to enquiries?

When the Board was setting the budget, and came to the line showing the cost of these salaries, would it have discussed the revenue preservation and/or enhancement it expected in return for this expenditure?

Speaking between ourselves as sophisticated industry insiders — no clients and no regulators listening in — is there any doubt that there is an expectation of enhanced revenue? Why else incur the cost?

The reality is that, in the majority of cases, one function of intra fund advice is to ‘sell’ the product. In terms of conflicts of interest, paying an adviser to perform this function on salary is equivalent to paying that same adviser commission from the product (remember, this applies only to cases where the corporate revenue comes entirely or mainly from products).

If a business earns its revenue solely through fee-for-service, the only way to increase revenue is to attract and satisfy clients.

In this case it doesn’t matter how planners representing this business are paid (a share of fees, salary, bonus, etc) — the essential conflict is eliminated.

Paradoxically, if a business’ revenue is earned from products, it also doesn’t matter how advisers working for this are paid - the essential conflict is preserved, even if they are paid a salary. In such cases the authorities have missed the target in banning commission.

The problem is that intra-fund advice usually has several objectives, one of which is income generation/preservation (ie, biased advice).

Surveys of the employees of financial institutions have revealed widespread sales pressure. No doubt this will continue to be applied to intra-fund advice.

Often the real purpose of intra-fund advice is disguised disclaiming statements.

For example “You should weigh up the benefits of extra super against … paying off your credit card or other debts,” followed by a recommendation to increase contributions to the fund, perhaps to the maximum. Ironically, this example was taken from Australian Securities and Investments Commission’s guide (RG 200) as an example of acceptable intra fund advice.

The problem for the regulators is that they can’t regulate tone of voice. In-house advisers can open their response to an enquiry with, in a formal and correct tone: “I need to make clear that I can only talk about our product and you need to consider whether other products might suit you more.

"However [cranking up the enthusiasm level now] I can tell you about the range and quality of the options we provide to meet your needs.”

It is regrettable that the authorities failed to recognise an old principle: when a business espouses one thing, but makes its income do another thing, the second will always prevail. ‘Advice’ given by tied advisers should have been called something else and regulated separately.

Two become one — and then two again

At the start of the 1990s there were two professional associations representing planners. Neither had any influence with the public or the regulators.

One (ASIFA, formerly AIPA) initially represented independent dealers and subsequently opened to all dealers and the other (IAFP) was a broad church of individuals working in financial services.

At the start of the 1990s the leadership of both groups abandoned their personal fiefdoms and created a unified body for the long-term benefit of the provision of advice.

The Financial Planning Association (FPA) was created and quickly became an organisation of substance and genuine influence.

The battle to unify the voice of advisers was won, resoundingly, about two decades ago.

Yet, once again, we now face calls to unify the voice of advisers. What happened? People created small associations to pursue their sectional interests (which may be worthy interests), and risk adviser associations expanded to attract financial planners as markets changed.

There is nothing inherently inappropriate with these developments, but they erode unity.

The financial advice industry had its opportunity to preserve a unified voice, but sacrificed it.

Time will tell if it will ever be recovered — the history of the accounting industry suggests otherwise — but it is inconceivable that it could occur today.

At this moment the major issue for financial planning is the banning of commissions.

The FPA supports it, and the Association of Financial Advisers opposes it (favouring client choice of payment method). This contradiction can only be unified by one party changing its views.

As the ban is to become law (failing a new government with a contrary attitude) it is easy to see which view is sustainable.

However it is naïve to expect unification in the meantime.

Fixing the problem with philanthropy

Australians are increasingly involved in philanthropy, though not to the level in America where some wealthy individuals (eg, Gates, Buffet) give away large portions of their wealth.

There is a problem inherent in philanthropic gifts, which limits their quantum: the more you give, the less you have left.

However, Chris Cuffe has developed a method by which it is possible to invest for profit while simultaneously supporting charitable activity.

Cuffe made his reputation by transforming a sleepy little state-based asset manager into Australia’s biggest fund manager, Colonial First State, by the end of his tenure.

The latter stage of Cuffe’s career has been devoted primarily to philanthropy, through Social Ventures Australia (SVA).

Many charities are created by what SVA calls social entrepreneurs.

These people have a vision of how they can help a group in need, and the energy and drive to bring it into reality. But most lack commercial expertise (even as simple as budgeting) and access to funding.

SVA supports a ‘portfolio’ of such charitable social enterprises with commercial skills and capital, to increase their impact and sustainability.

Most charities operate with capital equal to only a few months expenditure - a situation most businesses would find intolerable. Lacking recurrent income streams, they function hand to mouth.

Cuffe has used his expertise, contacts and considerable persuasiveness to create the Third Link Growth Fund. Almost everyone who provides a service to this fund does so pro bono.

It is the nearest thing to a cost-free fund manager that is ever likely to exist.

The underlying asset managers rebate most or all of their management fees (close to 1 per cent per annum of the FUM) to Third Link. These are given to SVA.

Thus investors in the fund retain ownership of their capital and the return achieved on it like any other investment, while knowing that the asset management fees on their capital are being directed to charity.

Simultaneously this creates that most rare and valued asset for charities — an annuity income stream.

The idea of contributing to the good of others while making a profit will appeal to many clients of financial advisers.

Planners increasingly include philanthropic advice in their services, so this not for profit fund may be of interest to some clients.

Since inception in 2008 the fund has beaten its benchmark (Morningstar Multi-Sector Growth Index) by 6 per cent per annum. Of course, you should form your own views about the quality and appropriateness of the product.

I mention Third Link because it is gratifying to see the financial services industry, from which so many of us have made so much money, developing creative ways to support the community. (I have no interest in Third Link, other than the provision of pro bono advice.)

Correction

Unfortunately there were errors in the published version of my last article, which I had tried to have corrected before going to print but was defeated by gremlins. The ban on commission in 2012 is to apply prospectively, not retrospectively.

However MySuper proposes to extend it to be retrospective. Readers may have noticed that this typo made nonsense of the point I was making. Some may suggest it’s not the first time I have talked nonsense.

Robert Keavney became a financial planner in 1982, and has played many roles since then. He still believes financial planning can be an honourable profession.