A lasting legacy: the financial planning platform industry

As the financial planning platform industry enters a new year that will see big changes, Janine Mace discovers it may not all be plain sailing.

While planners may be hoping for a quiet life after the events of the past few years, 2011 does not look like it is going to provide any relief — particularly when it comes to the platform market.

The impact of the global financial crisis (GFC) is fading when it comes to investment markets, but it has left a legacy that the platform market still hasn’t fully worked through. From regulatory change to growing pressure on costs and efficiency, the platform market will be reshaped from top to bottom.

“The next few years are going to be a really exciting time in the industry,” says Arthur Naomidis, managing director of Praemium, one of the smaller platform providers.

He believes the platform industry is far from settled and expects to see some very significant developments occur this year.

“The GFC is part of a confluence of events that are dramatically changing the industry,” Naomidis says.

“The GFC has led to a willingness to change by financial planners. The broad themes in the platform market are cost, risk and scalability.”

Investment Trends principal Mark Johnston agrees the landscape is shifting. “The industry is going through an unprecedented period of change,” he says.

Ian Knox, managing director of Paragem Dealer Services and a former CEO of Sealcorp and its Asgard platform business, believes reforms such as the Future of Financial Advice (FOFA) are driving a re-examination of many of the old norms in the advice and platform businesses.

“Regulatory change will lead to changes in funding costs for financial planners. This will force down headline costs for platforms,” he says.

The industry is also grappling with slowing inflows. “Platforms are struggling to grow in the current market, because the financial planning market is not growing due to the limited number of new clients and inflows,” Knox says.

Another person who believes the industry has more changes ahead of it is executive general manager of MLC Investment Platforms, Michael Clancy. “Platforms exist to support advisers and take the headache out of their back office, so as advisers’ needs change, the platforms will change,” he says.

Pressure on costs

Johnston believes the key issues in the platform market at the moment are cost and regulatory reform.

He puts this down to the ongoing investor reaction to the GFC (which has created lingering distrust of the financial services industry), growing pressure on fees (which has created strong growth in cheaper alternatives like direct equities and exchange-traded funds) and a plethora of legislative reforms.

“The fee-for-service model and opt-in requirements mean financial planners are under pressure to lower costs to clients and this is driving change. Financial planners are looking to platforms for assistance with the transition to fee-for-service,” Johnston says.

His research indicates this is occurring both through a squeeze on platform fees and advisers seeking to ‘rejig’ where the money goes.

“This is about lowering the cost to the client without reducing the money that goes to the adviser. They want to maintain or reduce the total cost to clients while protecting the adviser’s margin to fund the cost of providing advice,” Johnston says.

Knox agrees there is pressure to re-examine the fee split. “The challenge is to deliver an advice competency that the client is comfortable paying for. If it is done well, advisers will receive the same fees as they have from volume bonuses.”

He believes the cost of platforms is an issue the planning industry needs to think hard about. “The cost base of platforms continues to be inflated to accommodate a return to the dealer base,” Knox says.

“Platforms are a very good structure, but they should be at a commoditised cost in Australia. This is largely due to the relative lack of competition in the market here.”

Unlike many overseas markets where a few big players dominate, Knox argues concentration in the Australian platform market has done little to help lower costs. “The scale benefits in the platform market haven’t really been reinvested to reduce costs,” he says.

Naomidis agrees cost is a big driver in the platform market at the moment. “Previously everyone was very comfortable and no one wanted to change, but the GFC has shaken everyone in the industry — especially financial planners,” he says.

“The GFC showed financial planners the weaknesses in their business model, as previously costs were not an issue when returns were high. This has led to a sharper focus on cost and an increasing willingness by financial planners to look at new ways to do things. The GFC was a big shock to the system.”

Research conducted by Investment Trends analyst Recep Peker for his firms’ Planner Technology Report supports the view cost is central to the current turmoil. “There is a strong demand for lowering costs,” he says.

The report found 35 per cent of planners are looking for platforms that lower the costs to their business, while a significant group are also looking for platforms that lower the cost to clients.

“Post-GFC there is tremendous pressure on fees from clients,” Peker notes. “Cost is a driver of platform churn, with 26 per cent of planners saying they had stopped using a platform due to cost.”

Slicing the margin

The focus on costs is likely to be heightened by forecasts of single digit investment returns over the next few years.

“In the past, buoyant equity markets and high returns made it comfortable to retain clients on-platform, but this will be hard in the future given the subdued investment outlook,” Knox says.

He believes this will be a huge issue at the top end of the market, with high-net-worth clients and self-managed superannuation funds (SMSFs) likely to focus closely on costs in a low-return environment.

Knox points out that many top economists are predicting a 7-8 per cent investment return over the next few years, which will provide an insufficient equity risk premium if low-risk products like term deposits are paying 5-6 per cent. It also makes the cost of a platform difficult to justify.

“The equity risk and administration costs are too high in that sort of low-return environment,” Knox says.

These GFC-induced ripples will further disrupt the market status quo.

“In the platform market, the mid to lower end will remain on-platform, but the higher end is moving away from platforms,” Knox says.

“The platform market is splitting and the challenge for platform providers is how to deal with that. They can either adapt with technology or reduce costs.”

However, ownership of most platforms by the big banks may make this development less of an issue. “The mass middle market and below is the target of the banks and they will continue to use platforms,” Knox says.

Johnston argues there are different trends occurring simultaneously and urges caution in making generalisations about the platform market.

“There are lots of different ways to segment the industry and it is not a homogenous market at all,” he says.

“There are a group of financial planners focusing on high-net-worth clients and seeking tools to service them better, while another group is looking for as much efficiency and integration as they can in their operations.”

Johnston believes there are different drivers influencing different segments of the platform market and the planning industry generally.

“The high-net-worth and SMSF markets are the target for SMA and IMA [separately managed account and individually managed account] providers, but planners still put 75 per cent of their inflows through platforms,” he says.

“This has fallen recently to 72 per cent, but this is more about the shift in asset mix to direct equities and using higher cash balances than planners abandoning platforms.”

Changing the rules

The potential for sweeping transformation from legislative reform is seeing advisers and platform providers ask some fundamental questions.

“There is a lot of regulatory change occurring and it is not yet clear where it will end up, but platforms are evolving to support advisers’ changing needs,” Clancy says.

“As the platform business evolves, the question of what is meant by advice will also change. Clients are likely to increasingly dip in and out of advice and seek specific advice for specific issues. There will be tiered advice, so platforms will need to evolve to meet that requirement.”

Naomidis believes the reform process is likely to act as a major market disruptor.

“There is always continuing evolution in the platform market, but now with the kicker of the GFC and regulatory changes, we will see even more change,” Naomidis says.

“Once people become fee-based and become professionals it will be the beginning of them owning the client relationship. It is a total mindset change.”

He believes this will generate more change. “They will own the relationship, so this will lead to them questioning why they are paying all this money to a bank-owned platform provider.”

For Naomidis, the introduction of fiduciary duty will be a game-changer.

“Regulatory change is a major driver and this is a big ‘can opener’ for us,” Naomidis says.

“For some planners it has been easier to stay where they are, but with the introduction of fiduciary duty, they have to put their client’s interests before their own.”

It also makes smaller, cheaper platforms harder to resist, a trend that Naomidis says is already occurring in the UK market after the introduction of its fee-for-service regime.

Direct equities

Another major influence on the future direction of the platform market is the growing client interest in direct equities.

According to Peker, 23 per cent of new client inflows are going into listed investments.

“In three years time advisers expect 36 per cent of inflows to be in listed investments. This growth is coming at the expense of managed funds,” Peker says.

Increased interest in direct equities has spurred the major platforms into action, with both the Commonwealth Bank and BT reportedly spending significant amounts on augmenting their direct equities capabilities.

Clancy acknowledges the growing planner interest in direct equities and the need for platform providers to respond. “We are seeing increasing advances in direct equities offerings and specialist SMSF products in platforms.”

However, he does not believe all planners are keen to move in this direction.

“For the majority of advisers, not every client needs 350 investment choices. And often they have only modest balances, so they need good, solid, professionally managed investment options,” Clancy says.

“This is why we are seeing the increasing popularity of ‘mini-wraps’ that offer professionally managed investment options.”

The result is new generation products that offer model portfolio holding up to 30 investments. Although model portfolios have always been offered to the big dealer groups, they are now being offered further down the market — and providers such as Asgard have signalled their intention to launch similar products.

Peker agrees model portfolios are an important advance. “A lot of development is focusing around model portfolios, since these lower costs to the financial planner and the dealer group by saving time, so they gain efficiencies.

Model portfolios will help planners’ businesses become more efficient,” he explains.

There is also growing interest in various forms of managed accounts, particularly at the top end of the market.

“The left field area is the SMA/IMA and managed account markets. We are seeing increasing interest in this area,” Knox says.

He believes some of this is being generated by advisers and dealer groups who are anticipating a future when volume bonuses are eliminated. “By using an IMA you can reduce your costs enormously and the client will be kept.”

Naomidis agrees this is a future growth area. “It seems everyone is getting or building an SMA,” he says.

“SMAs are evolving from being a unitised managed fund replacement. What are now referred to as ‘strategy SMAs’ have the asset allocation within the SMA, so it is a full solution for the financial planner and it is very scalable, with lower costs. Eventually it will be hard to distinguish wraps from SMAs.”

Innovation is not dead

These developments highlight the importance of ongoing innovation in the platform market.

“In the platform market it is necessary to continually develop new functionality to retain competitiveness,” Johnston explains.

Clancy agrees innovation is vital. “We see lots of competition in the portfolio market in terms of product development, lifting the bar on service standards and in downwards pressure on costs. Everyone in the industry is working very hard to be innovative and improve product quality,” he says.

Planners are demanding end-users and platform providers must work to meet their expectations, Clancy says. “Advisers are quick to point out innovations and expect their platform provider to match it.”

MLC recently launched its new full service wrap platform, MLC Wrap, with this in mind. “It provides a lot of improvements and enhancements to bring together the best of both the Navigator and MasterKey Custom platforms,” Clancy says.

“Every platform has a long list of improvements and enhancements they have made to their product in the past year.”

Naomidis believes the popularity of SMSFs is also influencing innovation in the platform market. “There is a lot of private equity money going into SMSF platform product development,” he says.

“This is the holy grail due to the amount of money involved. There is a lot of untied money around and innovators will always create things to attract it.”