Financial planners shift to passive investments

Financial planners are increasingly recommending passive investments to their clients, but there is debate about the reasons behind the move away from active strategies. 

Wealth Insights managing director Vanessa McMahon said there had been a marked shift away from active to passive over the past four years.

"As an indication of the move to index funds, twice as many advisers now place business with Vanguard than in 2007 ... Likewise, many advisers have begun using passive [exchange-traded funds]," McMahon said.

For Morningstar co-head of fund research Tim Murphy, the market downturn heralded by the global financial crisis (GFC) only partly explains the move by advisers towards passive investments.

He pointed to recent Morningstar research conducted in the US that looked into the outflows from equities funds beginning in mid-2008, coupled with inflows into big fixed interest and bond funds like PIMCO. The research concluded that the "dramatic change in the way advisers were compensated (commissions versus fee-based) [was] driving the switch to passive".

Murphy said the ban on commissions and subsequent move towards fee-for-service in Australia would see passive investments continue to be favoured by advisers.

But 'Boutique Financial Planning Principals Group president Claude Santucci rejected the notion that fee-for-service was having a significant effect on planner attitudes.

"I don't think it's got anything to do with fees, commissions and all that - I think that's a complete furphy. It's simply a reaction to the concerns people have about the GFC, which is still ongoing," Santucci said.

One planner who has moved over to a fee-for-service business model is Affinity Private principal Catherine Robson, who says she uses an index approach as the core of her investment offering.

"It's illusory to pretend that you can consistently predict short-term movements in markets, or that there are many fund managers that can consistently outperform the index," Robson said.

Robson said the most important thing for her was her value proposition. She said it made sense for her clients to have a large amount of their portfolios exposed to the index at a very low cost, because then she could focus on her clients' long-term financial goals without either party having to worry about short-term market gyrations.

She also said the introduction of a fiduciary duty would give planners an extra incentive to conduct thorough due diligence before they "engaged in something a little bit outside the norm".

FinaMetrica director Paul Resnik said, in his conversations with planners, there was recognition that in any business model that relies on recurring customers, the biggest challenge was managing client expectations. The best way to remove that risk was to offer clients passive investments, he said.

"Generally it's the brighter [planners] that have put all this together, and they've figured out that markets are really unpredictable, and some managers are even more unpredictable," Resnik said.

McMahon agreed that unpredictable fund managers were a risk for planners. Clients were telling planners that market risk was acceptable, but that product risk was not, she said.