The financial planning industry is facing a structural overhaul as parliamentary committees, industry groups and the public debate proposed reforms. Jonathan Barrett asked three Perth financial planners for their opinion on how to improve the industry.
Remuneration
Fund managers spent some time in the 1980s devising plans to encourage financial advisers to recommend their products. Instead of purely focusing on the performance of their products, they decided to slice a small amount out of their own margins and hand it over to planners, in the hope increased flows would more than compensate for the loss. The payments have had many names over the years - servicing fee, trail commission, asset commission and distribution fee - but their purpose remains the same; to attract advisers. A move to change the system to fee-for-service, which can mean hourly billing or the payment of an agreed sum, is gathering pace, however there are many that consider commissions to be a viable form of remuneration, which is used in other industries like real estate.
Leggett: There are two critical issues with respect to commission. Firstly, any remuneration payable to a financial adviser, in whatever form, arising from a product purchase by a client, should not be allowed without the prior express written consent of the client. Secondly, as noble as suggestions to ban commissions on financial products may be, certain products, notably personal (risk) insurance policies and managed investment (agribusiness) products would be problematic to implement in the portfolios of the clients to whom they are appropriate if the planner had to rely on fees charged to the client as the sole source of remuneration.
Ravlich: Our industry stands apart from all others. There is a view held by the media and politicians, which then filters through to the public that financial planners are immoral for having the expectation to be remunerated for the work and responsibility that we do and take on. Product manufacturer commissions can create a conflict of interest for advisers because they may not necessarily serve the best interest of the clients, thus should be phased out. Unlike other professions, a financial planner's role is not finite. We must provide ongoing advice and management of assets and, as such, the adviser needs to be remunerated for this ongoing service. Trailing commissions fees should be replaced by a yearly service fee charged directly to and settled by the client for services rendered.
McCracken: If the cost of advice/product is clearly stated to the consumer and in a form they can understand and compare, I don't personally see any major issues with fees or commissions. For the sake of the industry, however, it would be better to see more progress towards fee-for-service. We just need to be far clearer about defining what exactly we mean when we say fee-for-service. If a fee is agreed with a client for a defined service, I think it is irrelevant whether it gets paid from a platform (is it now a commission?) or the client is invoiced.
Formal QUALIFICATIONS
Just how long does it takes to become a qualified financial planner? Our respondents know the answer, and have some ideas on how to improve the system.
Leggett: From its sales-based origins, the discipline of financial planning is rapidly developing into a profession to the extent that it is entirely appropriate for people to be suitably qualified, such as a university degree or equivalent, before being allowed to advise clients. The dilemma with this is that laws only control the law-abiding. As a result, because clients are unaware of the legal obligations of a financial planner, these requirements do not protect the client from the unscrupulous con-man. While a cultural difference exists between bank planners and most independent financial advisers, different sets of rules for each would be unnecessarily divisive.
Ravlich: For our industry to gain credibility and be recognised as a profession, the level of academic qualification for all advisers needs to be raised. Like accountants, all advisers should hold a tertiary degree as a minimum requirement. Currently, the sole requirement to provide advice is to be PS146 compliant, which can be gained simply by completing a six-day open-entry course. While this is the case, its status as an industry and not a profession will remain. Best practice seems to be that the new breed of advisers has, at a minimum, a university degree and post-graduate qualifications. The complexities of people's financial affairs are demanding a much higher level of expertise in the full area of financial planning.
McCracken: It is important to ensure that minimum requirements are at a level equivalent to other professions, so the bar does need to be raised. However, from my experience most clients are more concerned with the personality fit rather than number of degrees hanging on the wall. Also, qualifications are not going to weed out bad advice. Dealer groups need to take on a lot more responsibility in this regard. There are far too many instances of advisers, rather than being terminated, are asked to leave and then pop up at another dealer group. I am starting to agree with some in the industry that we have come to a stage where we need to differentiate between institutional and non-institutional advice (or independent versus non-independent if you like). I am not suggesting that one is necessarily better than the other, but consumers need to be better informed.
Value OF ADVICE
You have to sympathise with financial planners who are aware that a huge number of people could be so much better off with a little bit of advice; but they don't think an adviser can help them. Advisers pull their hair out when they hear of people with several superannuation funds - paying fees on all of them - or who don't have an understanding of transition to retirement strategies, which can cost consumers tens of thousands of dollars, if not more. So, how valuable is advice?
Leggett: With any challenge we face in life, we have a choice: work out for ourselves how to proceed, or engage the services of an expert. The key issue is this; is the time commitment required to gain the know-how to tackle the problem worth more or less than the financial commitment to hire the expert? Sometimes, the decision is self-evident, such as when we require surgery. Other issues, such as a leaky tap or a flat tyre, are less straight-forward. Financial advice is, increasingly, becoming a case of the former. This is because you don't know what you don't know.
Ravlich: Issues around superannuation, tax, Centrelink, estate planning, asset allocation, are all extremely complex, which consumers generally need advice on. Constant changes to the investment and legislative landscape can create both opportunities and challenges. If these changes are not addressed and considered appropriately, it can often result in lost opportunities and/or financial losses. In addition, failure to accommodate these changes can also cause breaches or penalties enforced by regulatory bodies.
McCracken: We should distinguish between educational advice and recommendations as such. There are many decisions consumers are quite capable of making with an understanding of some basic principles, such as selecting investment options in their company super fund. When making recommendations, the cost of advice becomes far greater with the legislative requirements and liability advisers take on. These costs unfortunately often make advice inaccessible to a lot of consumers. The financial life-coaching aspect of financial advice is often undervalued by consumers and industry commentators. Often what clients don't do is as important as decisions they proceed with.
Soft DOLLAR ARRANGEMENTS
Soft dollars include everything from a lunch or paid-for visit to the footy to overseas 'learning' tours. Institutions might reward a planner for writing a certain amount of insurance premiums or margin loans, or by being a key supporter of a particular managed fund. Product sales reps also use soft dollars to get in front of a planner, and the common defence is that it is an opportunity to educate advisers on a company's product range over a glass of wine in Hawaii. Industry bodies require most planners and institutions to keep a register of such gifts, however the system is self-regulated, few clients even know they exist and nuisance journalists are the only ones to ever request a look.
Leggett: Like any industry, financial services relies on relationships between product providers (fund managers/life companies) and intermediaries. This will inevitably lead to advisers receiving benefits from the relationship in various forms based on the strength of the relationship. Being taken to lunch or the football, as long as it is recorded for client disclosure, is a far cry from being set a 'sales' target, the reward for which is a 'holiday'. The former is a normal part of the necessary business relationship between adviser and provider. The latter has no place in the realm of what aspires to be a profession.
Ravlich: Soft dollar payments are definitely a conflict of interest. There are several grey areas in this matter making it easier to eliminate them. Like any human-driven system, the system will work if humans are not driven by self-interest.
McCracken: From what I hear, some institutions still provide conferences and the like, of which sales targets are the criteria for being invited. This can create an environment or culture that is not conducive to good advice practice. I think you can differentiate between what might be a reward for being a good client of a product provider or dealer group versus having achieved a particular sales target and qualify for a reward. Having to record a lunch or an invite to the footy is getting a bit over the top however (not that I am getting many invites).
Platform REBATES
These things are confusing, to say the least. Firstly, a platform is a piece of software planners use to distribute their client's money into different investments. Platform providers - namely big institutions - take a cut along the way. Rebates occur when a planner, or a practice, invests large amounts through a particular platform. There are accusations that the rebates influence the flow of client money, and arguments that if rebates were got rid of, the consumer would pay far less in administration-linked charges. Platform rebates are big, big business, and can be worth millions to large adviser groups, and many more millions to the institutions. And few people understand them.
Leggett: It is difficult to envisage a world in which financial planning and product recommendations are not intrinsically linked. That said, volume-based incentive benefits, such as platform rebates, as commercially sensible as they may be to the platform provider, fly in the face of any attempts on the part of the financial planning community to lay claim to the status of 'professional' if, at the same time, advisers are receiving incentives based on volume of product placement. Although it is easy to mount a sound commercial argument for them, such issues really have no future in the realm of a profession.
Ravlich: The traditional platform fee structure is doomed. Competition on price will see the rebate culture eliminated as consumers demand lower management fees. Many of the large banking and financial institutions own the platform and the fund managers and employ the advisers. Dealer groups are rewarded for volume and this is paid from the platform on which clients' funds are invested through.
McCracken: This is a difficult one as different groups will deal with this issue in different ways. It can be a way to lower the cost of advice for consumers if it is taken into account in the overall revenue a practice receives from the client, and therefore the services they receive in return. Many dealer groups also rely on this type of revenue to keep afloat. Otherwise, proper authority fees will go up and therefore the cost of advice will increase.
As long as they are clearly disclosed, I don't see a major problem. It is common with all industries that larger groups will have greater buying power with suppliers and therefore have some pricing advantages.
Churning & USING SALES TARGETS
Churning refers to the excessive buying and selling of stocks, or switching of insurance products, superannuation and managed funds for the purpose of generating commissions. Sales targets are sometimes used in the same way an advertising agency may track and rewards its workers for selling a certain number of ads. The trouble is, what if the best investment strategy is to sit tight and do nothing?
Leggett: Interestingly, churning is, potentially, at least, a far greater concern in the world of stockbroking than in financial planning. Every business must have revenue targets to remain viable. The inordinate focus in financial planning on funds inflow is one of its major downfalls. If the focus was on fee generation, as it is in almost every other profession, churning would not be such a problem. However, prohibition of product replacement is not the appropriate course of action as replacement of an outmoded product, particularly in the area of personal risk insurance, is often in the best interests of the client.
Ravlich: If advisers work in their clients' best interests and are paid by the clients, churning and manufacturer-induced sales target benefits become superfluous if the manufacturers are forced by the industry body to only offer wholesale priced products. The only grey area in this scenario is the commission attached to risk business. Commission should be available on risk, however, a formula must be found to eliminate the propensity to churn. A re-writing of insurance premiums must be justified either by better cover or lower premiums, and both do need to be justified. It should be noted that most businesses have sales targets and thus it would be unrealistic to expect that financial planning practices should be any different.
McCracken: The industry has had an intense focus on super switching in recent years to a point where you are almost reluctant to recommend another fund despite advantages for the client. There has been, in the past and still is, too much churning of products in our industry, in my opinion. I am not sure excessive regulation is the answer here. I think other factors such as education of clients and advisers, moving to fee-for-advice and dealers taking more responsibility for the ethical standards of their advisers and quality of advice - not just disclosure focussed compliance - will improve industry standards in this regard.
Avoiding THE NEXT DISASTER
Is it possible to legislate against the next Timbercorp or Great Southern collapse? Or, at the very least, can we limit or reduce the number of financial disasters, or is that just part and parcel of investing?
Leggett: The only way to avoid losing money on investing is to avoid investing. Business risk is an inherent part of the process and should be clearly understood by the investor, if the adviser is doing his job.
High commission was not the problem, certainly with respect to Timbercorp and Great Southern, as the level being paid is standard for that sector of the market. While scrutiny is, rightly, being levelled at research houses following the demise of these companies, they cannot be held accountable for business decisions taken by boards of directors years after the original research reports were prepared.
Ravlich: The retail research environment is fundamentally flawed. It is a total conflict of interest when manufacturers are paying research houses to be rated. Research houses need to be paid by the adviser, which complements the culture of clients paying advisers for advice. Consumers do not appreciate the critical role research plays in the advice process. As advisers, we rely on research houses to provide us with information on particular investments from which we then make recommendations to our clients. These investments were regarded highly by many of the research houses and in the case of Timbercorp and Great Southern, the ATO gave an additional endorsement in the form of product rulings, which many investors and advisers interpreted as additional endorsement of the investments.
McCracken: There are many clients and financial planning groups that have successfully avoided these disasters. Clients that are tax obsessed and planners that see an easy product sale and a big upfront commission have not. I am generalising, but if you do look at many of these schemes, and if you have a rigorous research process, and look at the track record (managed investment schemes in particular), you would find it hard to recommend clients invest in most schemes. Consumers themselves also need to take on more responsibility for their actions. In recent times many have got a little greedy and then looked for a scapegoat. A greedy client and adviser make a terrible combination.
