Internet: friend or foe?

The recent flurry of activity among Australia’s online brokers mirrors the price war which hit the US online broking market about three years ago. Stuart Engel examines a recent research report on the US online financial services market looking for clues on what might happen to financial planners here.

The recent flurry of activity among Australia’s online brokers mirrors the price war which hit the US online broking market about three years ago. Stuart Engel examines a recent research report on the US online financial services market looking for clues on what might happen to financial planners here.

Five years ago, financial planners regarded the Internet with suspicion. Stories were filtering through from the US on the boom in online stock broking which left the bro-ker and financial adviser out of the loop. There were fears this Internet-based boom in direct distribution of shares would extend into managed funds and life insurance products — the bread and butter of a financial planner’s revenue stream. Hundreds of millions of dollars in commissions paid to advisers would go down the drain, leaving financial planners as a relic of a by-gone era.

Advisers who had sleepless nights worrying about these threats to their business are probably sleeping a lot easier now. Reports emanating from the US indicate that the Internet has yet to take off as a distribution medium for managed funds. But disturb-ingly for advisers, fund managers may soon be competing with advisers in the provi-sion of financial advice over the Internet.

In its report, The Internet and Financial Product Distribution, US-based research house Cerulli Associates predicts that tools which generate online advice will “prolif-erate rapidly” in the US this year.

“The general trend in the financial services industry has been towards advice and guidance,” the report says.

“Cerulli believes this trend will continue in the Internet age, particularly for individu-als with higher account balances. While the Internet can empower investors, it can also confuse them with information overload — fuelling the demand for advice.”

Cerulli reckons most of the advice tools will be used to service the booming 401 (k) superannuation market in the US which operates similarly to how a choice of fund model would operate in Australia.

One of the characteristics of the 401 (k) market is the need to educate and advise a huge number of superannuation fund members on the right direction for their super-annuation. Many of these members have small account balances. The Internet pro-vides a low cost method of communication and education.

However, Cerulli says adviser services will gradually spread to other parts of the mar-ket, particularly the retirement products market.

“Ultimately, online advice and guidance providers will set their sights on attracting the attention of all investor types—not just retirement plan participants,” Cerulli says.

Most of this advice will be fairly simple and will generally emanate from fund man-agers and specialist Internet financial advice groups such as Financial Engines and DirectAdvice.com. But eventually, Cerulli warns, these groups will be forced to com-pete with financial planners for wealthier clients.

“Third-party advice firms are thus likely to expand into serving the retail market and will seek to leverage their strong brand identity, integration of their technology with trading platforms, and degree of ownership of the customer in the 401(k) arena,” the report says.

“However, once in these channels they will be forced to compete with intermediaries for the same high-net-worth individual investors.

“Over the next year, the majority of leading online brokerages will provide online ad-vice and guidance tools that deliver specific mutual fund (and eventually individual securities) recommendations.”

While planners might feel the heat of competition from fund managers, the Internet will open up a number of opportunities for advisers. Primarily, it will give advisers the opportunity to service clients at both ends of the wealth spectrum.

“The Internet and its inherent capabilities create the opportunity for (dealer groups) to deliver truly scalable advice for the first time,” the Cerulli report says.

The Internet will also accelerate the trend towards fee for service arrangements for financial advisers away from the traditional commission emphasis, Cerulli says.

“Industry wide, more fund flows are coming from intermediaries who provide advice and guidance and charge fee-based expenses. Competing against low-commission Internet intermediaries has pushed (dealers) with more traditional business models to launch their own online fee-based initiatives.”

While fund managers may increasingly compete with financial planners in the provi-sion of advice via the Internet, Cerulli does not see much evidence of fund managers successfully exploiting the opportunities of the Internet for distribution purposes.

In fact, the report says fund managers in the US have been slow to adopt the new technology to business models. A little more than half of the 615 funds management groups in the US have Web sites for their managed funds and most of these have only “limited functionality”, Cerulli says.

However, Cerulli says those fund managers who market products direct to consumers should be able top migrate their businesses on to the Internet.

“Because of their direct distribution model, direct marketing fund companies are in a better position to use the Internet as a medium for conducting the majority of their operations,” the report says.

These fund managers will continue to form strategic partnerships with groups outside of the financial services industry, especially retail groups such as supermarkets. Ce-rulli breaks these alliances up into three categories: alliances of expertise, cross-selling opportunities and market niche partnerships.

The ability to exploit the Internet has spawned a new breed of direct distribution fund managers offering transparent pricing and low cost index funds. However, Cerulli be-lieves these new players will not influence transparency or pricing of the main players in the industry.

The slowest to embrace the Internet have been those who rely on financial planners to distribute product — what are known as “load” companies in the US. These companies make up the vast majority of funds management groups in Australia.

Cerulli argues that the so-called “load” fund managers have been reluctant to exploit the opportunities presented by the Internet because they fear the financial advisers who distribute their products will feel threatened by their actions.

And US consumers have not rushed to buy managed funds off the Internet at the same frenetic pace they have moved to buying shares or doing banking transactions.

“While mutual fund investors are becoming more comfortable making e-commerce transactions and have increased their online banking activity, their willingness to make online mutual fund transactions is not growing at a similar pace,” Cerulli says.

“The number of mutual fund investors making online transactions, such as moving money between accounts, opening new accounts, or redeeming shares on mutual fund Web sites, remains below 10 per cent.”

But the really good news for advisers is that Cerulli does not believe the advent of Internet distribution of managed funds will push clients who would normally seek ad-vice towards direct channels. In fact, quite the opposite.

“Cerulli does not believe that the Internet alone will convert advice-dependent fund investors into direct buyers — primarily because the tremendous amount of informa-tion available online can overwhelm investors and accelerate the tendency to seek human-based advice and guidance,” the report says.

“The greater demand for advice and the proliferation of inexpensive sources of advice and guidance suggests that fund investors will seek a combination of sources — ranging from online tools to human-based advice.”

For those who think Internet financial services is but a flash in the pan, Cerulli has some interesting statistics.

? At the end of 1999, there were 34 million US households with Internet access. This number is expected to grow to about 107 milli