The fundamental structure of the advice industry in Australia has been flawed, pretty much since its inception. The dishonest advice practices that are being uncovered daily by the Royal Commission are entirely the product of a deeply flawed industry structure.
Over half of financial planners today are employed or licensed by major banks or insurance companies. For these mega corporations, their advice arms have been used as distribution engines for their inhouse financial products.
Whilst the advice divisions of banks have been among their least profitable, they have been tolerated because of the product sales they generate.
To understand the true impact these big corporations have had on the industry, it is important to understand the “value chain” that exists in personal financial advice. This chain begins with the cost of personal advice itself, then increases with the cost of all the associated financial products that are required to affect a person’s financial plan. These products can include super funds, managed funds, life insurance policies, investment platforms and other products like annuities, loans and structured investments.
Through vertical integration the banks have been able to control and distort the value chain so that the biggest profit margins are loaded at the “product level” (rather than the “advice level”).
Incentive structures for advisers within the banks have been geared toward product sales. Consequently, relationships between bank adviser and client have tended to be transactional, revolving around financial products and/or the investment portfolio – with relatively less focus on other “non-product” financial issues in clients lives -cash flow management, retirement planning, tax planning, succession, estate planning, small business planning, careers, etc.
This structure has manifested in a lack of trust between client and bank adviser and has prevented the necessary rapport being developed to effectively advise and guide clients.
So naturally consumer confidence in the financial planning industry is low (surveys suggest its akin to used car sales) and about to get lower as further misdemeanours are revealed through the Royal Commission.
And so the problem goes on. If “advice” is just glorified product selling, then the kind of people you need in the industry aren’t attracted to the career in the first place.
Fund managers (often owned by banks) have compounded the problem. The average active equity fund costs around 1% per annum. Some of these funds run billions of dollars with relatively small teams of people. For example, one fund manager we considered runs > $3bn with a team of 19 and an estimated average annual fee of around 0.6%, so revenues around $16M! Profit margins are extraordinary by any measure. And most of these managed funds don’t even achieve the benchmark return after fees. Indeed, research by Standard & Poors shows that in the five years to 31 December 2017 over 65% of Australian share funds and 90% of international share funds delivered returns that were lower than the markets they operate in after fees were taken into account.
The traditional ownership structures in the industry have contributed to the problem. Whereas accountants and lawyers have formed professional partnerships, virtually all the major financial planning businesses in Australia are majority owned by external third-party shareholders. These shareholders have a relentless thirst for returns. This in turn makes leadership in the industry more mercenary. M & A has been driven by financial engineers looking to squeeze ever higher margins out of financial products through amalgamation and scale. Rarely has the quality of “personal advice” and client relationships featured.
High product costs and the needs of shareholders inflate the cost of the advice value chain, putting pressure on the fees that can be charged for the part of the chain that really matters –the personal advice bit.
Financial planners need to invest time in getting to know each client’s situation. Understanding their needs, goals and aspirations. They need to build long term strategies to help their clients realise their objectives and they need to work with other advisers in their clients’ lives (accountants and lawyers) to ensure the plans are put into place. This is time consuming, clunky work. It isn’t scalable like the product side of the industry is. Yet, most clients pay more in product costs than they do in advice fees.
Leading financial planners earn substantially less than their leading peers in the accounting and legal professions earn. Yet, like accounting and the law, financial planning is complex profession that requires years of training. To be effective, financial planners need to be competent in the ever-changing fields of tax, superannuation, global markets, investments, cash flow analysis, and perhaps most importantly of all – behavioural finance.
A financial planner’s job is to enrich their clients lives through effecting long term strategies, which bring greater affluence, confidence and certainty. This is complex stuff requiring planners to have far reaching knowledge, strong numeracy and high emotional intelligence. People with these skill sets can often get higher paying, better respected work in other industries.
Yet Australians today are still hopelessly under advised. The data shows the DIY-ers are doing a miserable job themselves. You wouldn’t attempt knee surgery on yourself, a mistake would be catastrophic – so to is a financial misstep with your retirement nest egg. Yet so many decide to navigate the labyrinth of personal investing and planning themselves. People need help, but they are sceptical of financial planners and don’t know to whom to turn.
So what have the regulators and politicians done to fix this mess? Well… a lot. Too much in fact. There is new legislation and red tape everywhere. Operating in advice has never been more complex. They’ve even made it law that planners “have to act in their client’s best interests”. Who would have thought you would need to legislate such requirements?
Whilst these waves of regulation have been well intended, they’ve overwhelmingly missed the mark.
All this band aid stuff wouldn’t be required if they would just go to the heart of the problem: ban commissions and force industry participants to decide whether they want to be in advice or product manufacturing – but not both.
A significant problem is that many financial planners are under qualified and don’t have genuine experience with personal advice (as opposed to product sales). Many customers aren’t prepared to pay these planners for advice as a standalone item and to address this, these planners are forced to dressed up their “product sales” as “advice” in order to get around the compliance red tape and ensure they can make a living.
Remove these conflicts and virtually all the bad practices will disappear overnight, without the need for all the red tape. Sales people could hold themselves out as sales people and advisers could hold themselves out as advisers.
Advisers are like the rest of us; overwhelmingly they’re good people. They care about their clients and want to do the right thing. But the carrots and sticks are misguiding and confusing them – distracting them from the job of becoming better advisers.
The solutions are obvious, but politicians have been too beholden to vested interest groups and the bank lobby. They’ve chosen the path of least resistance – mass regulation.
All is not lost however. Financial planners are drifting away from the big banks in droves and there is a burgeoning Independent Advice Industry emerging. These are financial planners who don’t sell products and don’t receive benefits and commissions from product providers. They generally own their own practises and sell just one thing – unconflicted advice.
The relationship the independent adviser has with their client is different. Their client isn’t looking for a transaction, they’re looking for help with the literally thousands of financial decisions they need to make along life’s journey. They want someone who will be there along the way. Someone they can use as a sounding board as they grapple with the puzzling questions – when can I retire, how much will I need, how much should we spend on our daughter’s wedding, how can we ensure our assets are kept within our family when we’re gone?
Savvy clients want their questions answered by somebody they don’t have to second guess, somebody they can trust, and somebody who is prepared to put the time into the advice and get it right – without trying to push a product. These clients want to know that nobody is paying their adviser in relation to their affairs other than themselves.
Once a cottage industry, Independent Advisers are gaining scale fast, driven by increasing understanding amongst consumers. The Independents are correcting the wrongs of the past, putting price pressure on product manufacturers and grabbing some of the best human talent from the banks.
In Australia over 33% of our stock market is made up of financial companies (the number is 16% in the US) and this sector employs more people than any other in Australia. We are over represented in this field and it’s costing our economy. We simply don’t need so many people financial engineering stuff. They’d be better employed in education, health, construction and other more value adding industries.
Financial product manufacturing needs to shrink and become more price competitive. Meanwhile the independent advice sector needs to grow in order to rekindle the trust of the consumer and ensure more of us lead affluent lives free of financial stress. One could even say that Independence is the antidote to everything that is wrong with financial advice in this country.
Mark Minchin is Managing Partner of Minchin Moore Private Wealth Advisers