People are demanding greater accountability for their investments, increased transparency in relation to fees, and more control over their investments. David Rowe
When two listed investment companies, the $5.3 billion Argo Investments and the $415 million WAM Leaders, released their latest financial results it provided a stark reminder of why the integrated advice model of the major banks cannot survive.
Argo and WAM Leaders stand for the sorts of things banks struggle to offer through their integrated advice models – transparency, accountability, low costs and hands-on control of investments.
Under the integrated financial advice model there are layers of different fees including adviser fees, platform fees and investment management fees adding up to 2.5 per cent to 3.5 per cent.
The fees are usually as follows: an adviser charge of 0.8 per cent to 1.1 per cent, a platform fee of between 0.4 per cent and 0.8 per cent, and managed fund fees of between 0.7 per cent and 2.1 per cent.
These fees are not only opaque, they are sufficiently high to handicap the ability of the client to quickly earn real rates of return.
A client seeking advice from a bank-controlled financial planner is likely to find themselves with a bunch of proprietary managed funds sitting on a bank-owned investment platform.
It is hard to believe that in 2017 the banks can keep a straight face and say this outcome can abide by the fiduciary duty for advisers to act absolutely in the best interests of a client.
The future of financial advice legislation changed many aspects of financial advice in Australia, but the grandfathering of certain legacy fee arrangements means advisers with big portfolios of trail commissions are still able to command a high price.
Layers of fees baked into the business model used by the banks means there is not necessarily an incentive for the financial advice arm to make a profit. The profits can be made in the upstream parts of the supply chain.
But that business model cannot survive in a world where people are demanding greater accountability for their investments, increased transparency in relation to fees and more control over their investments.
Looking across the financial services landscape it is apparent the future of advice will be in the provision of separately managed accounts. The banks will have to move down this path in a serious way if they are to maintain any shred of credibility.
But to do so will threaten the $1 trillion in assets tied up in managed funds. This staggering amount in managed funds is a legacy of the high up-front commissions and trail fees that fed the financial planning scandals between 2000 and 2009.
Managed funds, which use a unit trust legal structure, have a number of flaws, the most obvious being the lack of liquidity during times of stress. About $5 billion was “frozen” in mortgage funds during 2008. Many were still frozen six years later.
Other flaws in managed funds include the problems associated with the timing of investments. Investors need to be careful about buying a fund before the end of the financial year as the units could be carrying a tax liability.
Unit trusts must distribute all income even if it is realised capital gains and that means taxation can be incurred without warning.
It is noteworthy the truly independent financial advisory firms in Australia offering separately managed accounts have done everything in their power to avoid using managed funds.
They have made exceptions for international share investments, but that is changing as platform providers are increasingly offering direct international share investment.
It is in this context, listed investment companies (LICs) and exchange traded funds (ETFs) have emerged as favoured investment vehicles for those transitioning to separately managed accounts.
The surge in interest in LICs and ETFs is a reflection of the desire of Australians to maximise the real rates of return on their savings while achieving greater transparency and lower fees.
It is instructive to examine the share registers of the two LICs which released results on Monday to show how they are riding the boom in SMSFs, which is a function of the desire by Australians to have greater control over their investments.
Jason Beddow, chief executive of Argo, says about 38,000 of the 80,000 shareholders on the Argo register are believed to be self managed super funds.
He believes the interest in LICs shown by SMSFs is a function of the lower costs involved compared to other forms of collective investment and the ready access to fully franked dividends.
The management expense ratio of Argo is 0.16 per cent compared to the average MER for a managed fund run by the banks of 0.40 per cent.
There is a much higher percentage of SMSF investors on the WAM Leaders share register. Chief executive Chris Stott says about 60 per cent of the share register is SMSFs.
There are about one million Australians with SMSFs, according to the latest data from the Australian Prudential Regulation Authority. These 580,000 funds had $623.7 billion in assets at June last year with an average member balance of $571,000.
Stott expects his SMSF shareholders to back the conversion of the WAM Leaders options, which expire in November. As an incentive for investors to exercise their options early in the year, the company says its 1¢ a share interim dividend will be paid to shareholders who exercise their options before April 10 at $1.10 a share.
In the past, options issued by LICs managed by Wilson Asset Management have had a 95 per cent take-up by investors when they have been in-the-money. That suggests WAM Leaders will raise another $400 million, taking the total funds under management in the Wilson stable of companies to about $2.5 billion.
The LIC industry has been on a roll in recent years. In calendar year 2015, LICs raised about $1.6 billion in initial public offerings, rights issues and placements.
It was a similar story in calendar year 2016 when there was $1.2 billion in initial public offerings, rights issues and placements.
The banks have refused to admit their integrated approach to advice is fatally flawed. When Chanticleer approached the Financial Services Council for a defence of the layered fee arrangements, a spokesman said the situation was different for each individual client and no generalisations could be made.
This says a lot about the banks failing to realise the financial advice world is changing rapidly. The banks do have one big advantage over others in the financial system and that is their ability to invest heavily in new technology to improve their offering.
This can be seen most clearly with the new platform at Westpac Banking Corp called Panorama. It is being launched to advisers with a very aggressive pricing model.
While that might help to expand Westpac’s market share in platforms and wraps, it won’t do anything to change the fundamental flaws in the advice model.
Originally published in the AFR on Tuesday 7th February 2017, by Tony Boyd.