Before the fall comes pride

In my last article I talked about how the financial services industry remains inefficient because of its success. I discussed this inefficiency in terms of automation and technology and what impact that will have on the industry. In this article, I would like to continue on the success theme, in terms of inefficiencies, complacency and hubris. And, what would happen to all this success if commissions were banned.

In both the US and UK, funds inflow has plummeted. In the US, investors added less money to stock mutual funds in January this year than in any January since 1991. Only US$3.1 billion was added, compared to US$25 billion in January last year. Inflows in the UK are down 30 to 40 per cent. But ours are holding up — why?

Is it because our fund managers are superior, or because our financial planners are superior? Is it because Australians are very keen on managed funds? We all know the real answer. It is the Superannuation Guarantee (SG) and our complicated superannuation system. The SG almost guarantees 12 per cent growth a year, and the complicated superannuation system almost guarantees a steady stream of clients to the financial planners.

This ‘artificial’ success of the industry has led to inefficiency, complacency and hubris. Inefficient work practices have developed, pricing bears no relation to effort or value and the number of snouts in the distribution chain are growing.

Complacency has led to form over substance as advisers and others look for ways to maximise the values of their businesses, rather than looking for ways to add value for their clients. Hubris most obviously expresses itself in the way we believe we can tell the rest of the world, especially the English, how to run a financial services industry.

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As I have said many times, the financial planning process is over-engineered and overpriced. This is because demand exceeds supply. Many advisers pick and choose the clients they want to serve. There is no pressure on advisers to run more efficient businesses. Their businesses are not even valued on profitability, let alone efficiency. They are valued on funds under management, and even then the ratio varies on the ‘stickiness’ of the money. Least valued is new business income, then trails on retail products. Most valued are the trails out of wraps and master trusts.

There are many advisers in this industry who have been around for 10 to 15 years. They are earning very generous incomes, some more than $500,000 per annum from trails alone. Life is beautiful. What would happen to these businesses, their revenue stream, and their capital value if commissions were banned?

How could that happen? Why would it happen? It wouldn’t work! We have full disclosure here — with full disclosure you don’t need to ban commissions. Some clients prefer to pay a commission. Commissions have always been paid.

Registered investment advisers (RIAs) in the US cannot earn commissions and the UK is considering banning ‘independent advisers’ from receiving commissions. To date in Australia, we have followed the disclosure route rather than the banning or limiting of commissions. However, many people suspect that disclosure is not really working.

What would it mean to the industry if commissions were banned? It would change quite dramatically. There would be fewer advisers, as a number could not make the transition. However, it would become a more efficient industry, as advisers would have to relate their value to the fee they would be charging.

The concern is that even with disclosure, advisers do not give independent advice. It is argued that they will not recommend products that do not pay commissions. Many superannuation funds, not just the industry funds, are vocal about this. Even some fund managers. Recently, there was a very successful fund manager whose inflows only picked up once it started paying a trail commission.

Of further concern to some people are the soft dollar and volume equity arrangements that are proliferating. A number of these seem to escape the disclosure net, as do the products and services that are not covered by the Financial Services Reform Act. Who discloses that they get their financial planning software free because they have achieved the requisite funds under advice in the master trust operated by a related supplier?

To me, banning commissions would not resolve the real issue — it would just add to the regulatory overload. The real issue is to ensure that consumers receive advice that suits their particular needs, that has not been tainted by any usury needs of the adviser. How do you define any payment, benefit, consideration and so forth, that may impact on any adviser’s advice? What is a commission?

What do you do with salaried advisers, whose employer is also a fund manager? Bonuses, promotions and so on could all be tied to favouring in-house product, but none are thought of, or described, as commissions. What about the fees from wraps and master trusts? If you can dial down, what if you can dial up? Are both commissions? Most would argue that the dial up is not a commission, as it is adviser and not product provider initiated.

However, you could equally argue that dial up is allowing for a fee to be taken from the product. An adviser could use an industry, government or corporate fund that has no dial up facility, and bill the client directly. Where’s the difference? There are probably two differences. One is what I call bulk billing — which the dial up facility provides. The other is the mindset.

Unfortunately, many advisers do not believe they are providing value unless something happens. They do not believe that the client will pay them for their advice if the advice is to do nothing — stay in the superannuation fund you’re in and take the post-retirement pension.

But if commissions were to be banned, would this ensure better and more independent advice? No, I would argue. My concern would be that if commissions were banned, ‘incentives’ would be driven further underground. Personally, I strongly advocate the breaking of the nexus between advice and implementation but this does not mean I’m against commissions.

How do I link hubris and the possible banning of commissions? The industry has an arrogance about it now, that it is the best in the world, that it is now professional, and that it deserves the rich rewards it receives. We know what’s best for our clients, the industry, the country, the world.

Ah me — aren’t we ready for a fall!