Financial planners have a hard time gaining the trust of their clients and in this environment of bearish stock markets, they have an even harder time retaining that trust. There is a school of thought that suggests that if advisers were less reliant on commission that they would have a much easier time justifying their existence. Clients have a natural suspicion of financial advisers, because the relationship is so heavily weighted towards the sell side. If advisers were to charge a fee and refused payments from product suppliers, clients would be more inclined to trust their adviser. Or would they?
The issue of how adviser firms derive their income has just become the hot issue for planners in Australia where a report by consumer magazine Choice, carried out in association with the Government’s investment commission ASIC, has attacked the commission culture. Out of 124 financial plans studied, over half were deemed ‘borderline’ or ‘very poor’, with advisers shown to have ignored client needs, recommended higher fee investments, regardless of their suitability, and to have padded client reports with generic information. Commissions were judged to have been an influence on the advice given and the report noted that the quality of advice was significantly worse if the planner was paid only by commission. The report concluded that many financial planners were more like salespeople for the fund managers rather than impartial guides. Not surprisingly, the report has caused a huge rumpus in the Australia financial planning industry.
In New Zealand, broker commissions were at the heart of investment adviser Gareth Morgan’s recent criticisms of the adviser industry. Morgan’s view is that advisers should be in the employ solely of the investor, with the only source of their remuneration being the fees that investor pays for their advice. His shoot-from-the-hip style may not win him many friends in the adviser community, but he has nonetheless highlighted the potential conflict of interest which undermines the reputation of even top quality financial advisers.
The situation that Morgan describes has come about because of the structure of the market. In New Zealand and even more so in Australia, the adviser market is largely owned and controlled by the institutions whose products they are selling. Finding a truly independent adviser is not easy. Advisers are not encouraged to think outside the box. Some argue that it is hard to buck the trend of adviser firms subscribing to wrap programs that offer them access to a not only investment expertise but reporting and back office services. The product providers are saying to the adviser ‘what can we do as a company to get you to sell more of our product’?
In this environment, it is only natural to ask who the adviser is working for. Where an adviser’s relationship with the product provider is so well-entrenched, isn’t it bound to result in the adviser recommending products that are not the most suitable, but which fit within a familiar financial plan and therefore require little or no variation from a plain vanilla offering?
The cynic would suggest, and the Australian survey seems to confirm, that commission-based advisers are not motivated by a desire to do the best for the client, but to do the best for themselves. There are many FPIA members who would strongly disagree with this, of course, because they work hard for their clients and the commission they earn is simply a by-product of that.
FPIA chief executive Philip Matthews says: “The simple answer is that it doesn’t matter how an adviser is remunerated, as long as it is a fair amount for the work and that the nature of the remuneration is fully disclosed to the client. Whether it is a fee-only adviser who rebates all commissions, a commission-based adviser or a combination of the two, the client needs to know how they are being paid.”
New Zealand’s Consumer magazine published its most recent survey of financial advisers in November last year. The magazine found that five of the fifteen advisers surveyed failed to provide requested disclosure documents, despite the fact that they are legally obliged to do this. The current Investment Advisers Act (1996) requires only that the adviser disclose commissions if the client asks for the information. New proposals being considered by the Government will make it compulsory for disclosure to be made at the outset.
Head of the Securities Commission, Jane Diplock, believes that the issue of fees and commissions is central to the debate on adviser regulation. As well as backing the tightening of disclosure rules for financial advisers, Diplock has also persuaded the government to consider following the Australian model for licensing of advisers. It is by no means certain that this will happen, given the different scale of the New Zealand market, but it is clear that the Commission wants to raise the overall quality of advice and to empower consumers with greater knowledge.
Phillip Matthews agrees with the disclosure proposals but questions whether it is necessary to get tough with advisers: “Are there so many bad advisers that we need to regulate the industry further? And is licensing the solution to eradicate bad advice? If licensing is the route the government wants to follow, we want to ensure that it is practicable. What tends to happen in these situations is that you get a regime that involves so much compliance that it makes it very difficult for advisers to operate.”
Blair Dyer, a financial adviser with the Takapuna-based Integrate Financial Services, does not believe that to focus purely on fees is really that important: “Simply declaring your fees and commissions isn’t going to do it. I am working for my clients’ financial well-being and so there are quite a few occasions where the work I am doing is not accounted for in my remuneration.”
So determining the quality of advice is a bit more fundamental than just focusing on commission. Dyer believes there needs to be more awareness by the public of what a financial adviser does: “Unfortunately, they are not sophisticated enough to appreciate that many of us are professionals. A financial planner should be qualified to advise on
debt, risk and cash management and the good ones will actually carry out these tasks. So people need to seek a financial professional who will organise their affairs, and not just invest their money. Investing is 10% of what I do for my clients. The other 90% is what makes me a good financial adviser.”
New Plymouth adviser Peter Hensley has moved more towards fee-based advice. He says he had been operating on an arrangement where his clients would pay a ‘small membership fee’ to him and he would then be paid a trail from the investment platform he was using. When he decided to move away from this platform, he looked at a number of options and decided on a fee as a percentage of assets under management. The reason he chose the asset based method was because he believes it’s simple to understand: “The client knows what they’re in for and there is nothing hidden.”
Hensley agrees with the FPIA view that it doesn’t matter how the adviser is remunerated, as long as the client is informed: “You can’t link commissions and fees to bad advice. There is a separate issue that the industry has to deal with, and that is identifying the sub-standard advisers.”
Another factor which favours the adviser/product provider relationship more than the adviser/client is trail commission. Trail commissions are an attractive way for an adviser to secure a recurring income on the back of assets invested with a particular firm. The problem for the client is that the trail commission is an inducement for the adviser, encouraging their ‘loyalty’ to leave the money invested in a particular fund or wrap program, even when the product may no longer be appropriate for the client.
So does fee-based advice result in the adviser working more for the client? One adviser who believes in the fees-only approach is Robert Oddy of International Financial Planners in Auckland. Oddy moved to become a fees-only adviser in 1998. He says the move was driven by a realisation that receiving commission didn’t allow him to be seen as truly independent. He also realised that operating on a fees only basis allowed him access to a wider variety of facilities and products that would benefit his clients.
He admits he was roundly criticised for this move and that fellow advisers were openly hostile, because they saw his move as a threat to their continued receipt of commissions. Oddy sees himself as a financial planner, with a holistic approach to advice: “We are not in the business of investment. In fact, because we are driven by the trusted adviser approach, clients are free to go elsewhere to implement their investments if they wish, and we will refer them on to trust planning or property investment specialists if that is their desire.”
He says it was difficult at first to get clients to understand that paying a fee was a good thing, but it is getting easier. Having taken such a firm stance and, for example, not doing business with suppliers who refuse to not pay trail commission, Oddy feels strongly that the industry needs to move more in his direction: “It has been hi-jacked by the institutions and geared towards investment. It angers me that institutions are dictating the way people structure their financial affairs.”
Oddy is happy to declare that he is a director of a sharebroking firm that does take commission on sales, but he sees no problem with this, since the businesses are quite distinct from one another. He would not go as far as to say that fees-only advice is the only solution for advisers, but he says advisers would have a much better reputation if they were seen to be more independent: “Advisers need to make it clear who they are acting for.”
The government has defined its objectives for the future regulation of advisers. Now, the industry itself needs to recognise the concerns of the public and act to create an environment where trust can be established. And it seems this can happen best in an environment where advisers are seen to be acting independently of the product suppliers.
One conclusion we can probably make is that advisers have a role to play in this education process. Everyone seems to agree that transparency of charges is desirable. The Consumer magazine survey highlighted the current situation where fees can vary across a wide range, from several hundred dollars to several thousand, and while some firms illustrate their fees in straightforward terms, others bury them in the small print. This highlights the need for a better of understanding of what you are likely to get for your money and the need for stronger disclosure rules.
The financial planning process can be complex and time-consuming. Advisers have to be willing to invest that time at an early stage, but in order to be fully reimbursed for this investment of time, they should also attempt to educate their clients and prospective clients by demonstrating in simple terms the value that they are trying to add, over and above simply investing clients’ money. Once the client understands this, they will understand the nature of the commission paid to the adviser and will be less likely to question the fact that the adviser makes money even at times like these, when the client is possibly not making any. By emphasising the elements of financial planning that are not directly related to investment, it will also be easier for advisers to develop their businesses in an environment where fees from investment based products are coming under pressure.
Published in ASSET Magazine, September 2003