May you live in interesting times

Confuciusonce said: “May you live in interesting times.” Dealer groups today are doing that but even more so they are facing a crisis and few really understand the ramifications.

The consumer

Consumers are the most important people in the financial planning process because they pay for the other members.

The Australian consumer gets the best deal of any financial planning customer in the world. The financial planning industry in Australia is far in advance of any other in the world, with the possible exception of the US. However, the standard of advice here is still too low and still too product focused.

But this is the least of consumers’ problems. The real problems lie in the following areas:

People are living longer but are unhealthier in their old age. Their money will have to last them longer and they will have higher expenses;

We are heading into a period of lower investment returns, which are also lower in real terms;

When you combine an ageing population and rising health costs with fewer salary earners, the Government will struggle to provide old-age welfare and an up-to-date medical system; and

If you add this to the low average saving rate of Australians, most of us in old age would be better off if medical science weren’t so advanced.

The conundrum is there is currently a shortage of high quality financial planners. In this scenario, price is not the over-riding issue — the quality of advice is. Wealth creation needs to become the major focus.

The manufacturer

We are moving to polarisation of manufacturers. There are those with scale and those that are boutique. For both product manufacturing and investment management, the main game being played is the pursuit of scale. The major game is being played out by the banks, which are fighting to achieve scale across product manufacturing, investment management, and platform administration.

The current standard of administration is not acceptable. Most advisers have become a buffer between incompetent administration and reporting to clients, and are funding back-offices that are choked by these problems. At some stage, the issue of who pays for this incompetence needs to be addressed.

Dealer groups

Dealer groups will change dramatically over the next few years. There will be winners and losers, and as with the manufacturing businesses, there will only be large groups or niched boutique groups left.

There are a plethora of dealer groups out there that are trying to become large enough to be viable. However, we shouldn’t judge a dealer group by the number of its proper authority holders. Turnover and profit are the only reasonable measure of a dealer group. In this area, there is a significant dealer group crisis looming for two reasons:

1. Scale

Australian dealer groups are not big enough. Our American counterparts have greater scale and are able to generate profits commensurate with their business risks.

American Express andMerrill Lynch, for example, have more than 10,000 advisers. The two largest independent dealer groups in the US each have more than 5,000 advisers and US$1 billion in turnover. They have real scale and are able to generate real profits.

Real scale in the Australian marketplace will require turnover greater than $300 million to provide real profitability and, more importantly, solvency. Everybody agrees that dealer groups need to be solvent but nobody seems to want to pay for it.

2. Price

Here is the real core of the issue. Most dealer groups in Australia will cut their own throat to get a new proper authority holder on their books. It is the old law of supply and demand — there are not enough good advisers to go around for all the dealer groups.

From an adviser point of view this is great, because they can get dealer groups to cut their margins to provide them with services. Dealer groups are offering equity as part of their start-up strategy to attract new advisers.

In many cases these new dealers also cut their price to get advisers on board, so they can never achieve the revenue required to build the services to deliver on the promises.

In the meantime, the adviser practice is starved of technology and business support to move forward, so there is a reduction in potential value to the owners.

In other words, while advisers may be getting a good deal on dealer splits, they are short-changing themselves on business development and their future business value. This begs the question — what is a dealer group supposed to do?

A dealer should provide at least the following services to advisers:

Technology (not just financial planning software);

Best practice and business coaching;

Compliance and training;

Technical resources;

Camaraderie; and

A growth environment.

A dealer group should provide other services like a vision for the future, a genuine succession plan and dealer equity, and many good dealer groups do.

There are two forces facing the industry:

1. Professional Indemnity(PI) insurance

It has become apparent we are paying for some of our former practices. PI insurance is difficult to get and there are stories emerging about advisers and dealer groups now unable to get cover. This story will get worse before it gets better.

To survive, your business will need strict systems and precise documentation. If you have a claim and you are negligent in your procedures, how many more claims will your insurer pay before you can’t get cover? Worse still, if you are in a dealer group that can’t afford to provide proper compliance, systems and processes, where are you going to be when they lose their licence?

2. Demand

Most planners attract new clients who have never had a planner before.

Estimates suggest supply will exceed demand in less than five years at the rate of growth of proper authority holders. What does that mean to your business? Most back-offices fail to deliver on the promises made by the adviser. Will that be acceptable in an environment where your next customer will come from another practice?

More importantly, is it an issue you can leave for five years before tackling? Can you afford not to have state-of-the-art technology now to be delivering on promises long before you need to, to develop the customer loyalty to survive?

Forward thinking

Who is going to pay for the development cost required to drive financial planning practices forward?

The latest survey results indicate most clients see advisers as competent and ethical, but all much of a muchness. This screams of commoditisation.

Most industry experts agree we will need to deliver to our clients the entire package of advice, administration and investment management for around 150 basis points. Our current environment delivers that same service at 250 basis points or more, so there clearly needs to be a new game.

This new game will be dealer scale. The size of the dealer will greatly influence how that 150 basis points is broken up. For very large dealers, investment management and administration will be accessible for around 60 basis points, leaving 90 basis points for the dealer and the adviser. For the small dealer group, the story will be different.

The industry habit of paying a small dealer the same as a large dealer with completely different value propositions will end soon. This will cause a major shake-up in dealer groups. A word of warning — many dealer groups have platforms that provide equity to advisers. That is good but not if the client is paying for it.

The price on some platforms has increased on the basis that a captive shareholder (in this case, the adviser) will tolerate a higher priced platform because they have equity. A worse scenario is where the platform price is inflated, so the adviser reduces their dealer splits as they contribute more into the platform. Any scenario where the client is subsidising dealer splits will not survive the new world.

Everybody knows the story of the boiling frog. If you throw a live frog into boiling hot water, the frog will instantly jump out of the pot. If you put a frog into a pot of cold water and slowly heat it, the frog will cook to death. Advisers are going to have to make a decision on whether they stay with dealers who keep delivering vapourware and slowly boil to death or find someone to take them to the next generation.

The consumer will expect a high value proposition delivered with certainty through a professionally run and automated financial advising practice. If you are in a low cost dealer group waiting for the vapourware to be delivered on and your retirement plan extends beyond five years, you might need to re-evaluate where you are.

Ray Miles is the managingdirector of AssociatedPlanners.