Banksters are generally focused on maximising profits and thus emphasise product over solution. Photo / Thinkstock
Banksters are generally focused on maximising profits and thus emphasise product over solution. Photo / Thinkstock
Opinion by
Despite the rhetoric from the industry it's an open secret that the retail financial advisory sector globally is not delivering on its promises to put clients' interests first. Indeed to anyone with half a brain and a knowledge of how things work in the practice this is a truly ridiculous assertion.
For example proponents of the investment banking model tell companies "deal with us and we will sell your shares/bonds to our clients and maximise your exit price". The retail side of the same firm says "we will design a balanced portfolio for you and advise you when things are cheap". Ridiculous.
Intermediaries can wriggle around as much as they like but you can't reconcile those two objectives. Inevitably one client will be put further first than the other. That's why compliance is such a huge industry and disclaimers often longer than the actual research document.
One of the most egregious examples of the investment banking model that I have witnessed was when a US stockbroking firm with a very well-known name was paid by a major US company to sell its bonds to the broker's clients. One of the broker's clients was aged 75 and was also a client of mine.
All good except that the bonds the stockbroking firm recommended he buy matured in 100 years' time so he would have got into the Guinness Book of Records had he been around to see the bonds mature. Totally inappropriate. Making matters worse within a year to two of the bonds being issued the company got into serious financial strife.
The banksters are generally focused on maximising profits and thus emphasise product over solution. Exacerbating matters in many countries, including NZ, is the fact that there is a disturbing movement of people between the regulator, industry and government leading journalists in the London Financial Times and retired regulators to lament that long term industry problems will never get resolved.
There is now cause for hope that things will get better because the systemic weakness in matters financial is increasingly threatening government finances.
Nevertheless there is now cause for hope that things will get better because the systemic weakness in matters financial is increasingly threatening government finances. The decline of the defined benefit pension and the rise of the defined contribution model means that the liability for failed savings schemes lies increasingly with mum and dad and there are a huge number of people going to retire in the next twenty years.
Therefore governments of the world are becoming vitally interested in ensuring that retirees get value for money because if they get a bad deal it's the Government that has to pick up the pieces.
There are three ways of maximising your lump sum in retirement. The industry, predictably, tells us we have to start saving earlier, keep working for longer or save more. But there is a fourth variable and that is maximising returns which can most reliably be achieved by minimising costs. Funnily enough we rarely, if ever, hear about that alternative from industry.
Things are changing as Treasury officials in major countries have finally noted the threat to the nations finances posed by the dysfunctional finance sector in the wake of continued mis-selling scandals and have begun to address the problem.
In the US the Executive Office of the President of the United States in February 2015 published a major document entitled "The Effects of Conflicted Investment Advice on Retirement Savings" in which it estimated that bad advice was costing Americans a minimum of US$17bn each year, in Australia last year a rash of scandals involving high profile players like National Australia Bank, Macquarie and Commonwealth Bank, amongst others, resulted in a 500 page report entitled "The Financial System Enquiry" which, when commenting on financial advice, quoted an ASIC survey of 2013 which found that 1 per cent of advice was good. Oops!
At a banking summit in Sydney in April one Chief Executive said "trust has disappeared in the financial advice area". Over in Europe the Brussels based Financial Services User group prepared a report on the European asset management industry and was reported in the London Financial Times as saying that "the European asset management industry produced a huge welfare loss for EU investors" as well as failing to win the trust of its customers.
As we know things aren't perfect in NZ and many of the issues highlighted in the overseas reports impact local retail clients so let's have a closer look at developments offshore.
First up in the US the report by the Executive Office of the President notes various ways that consumers can get bad advice and cites the fact that some managed funds pay ongoing commission payments to advisors and concludes that these payments "creates a financial incentive to direct clients to funds with higher revenue sharing payments". This is generally what happens when local financial advisors advise on KiwiSaver. Yet local luminaries promote the idea that this advice is independent.
The US report cites a study by Guercio and Reuter (2014) which found that intermediaries frequently sold actively managed funds and these actively managed funds underperformed passively managed funds with lower fees by between 1.1 per cent and 1.3 per cent pa.
In another study the authors found that where participants in a workplace retirement plan were unable to use conflicted advisors they tended to rely on the plans default investment options. Shock, horror the default investment options outperformed the conflicted advice by about 3 per cent pa and the authors concluded that the advice "significantly increased annual fees, significantly decreased annual returns and slightly increased risk taking". Part of the underperformance was explained by the advisors recommending a high exposure to risky assets just prior to a period of underperformance.
The conflicted investment advice report is full of other revelations but perhaps the major point that local regulators and the government might reflect on is the determination made in a related report by the Department of Labour, recently reported in the Economist magazine, that the disclosure of conflicts of interest doesn't improve decision making very much.
Unfortunately it seems like it suits almost everybody to sacrifice retail advice for institutional profitability so don't expect much material improvement in the current review of the financial advisors act.
This column rehearsed that argument a few years back but it is good to see that the US government has thrown its weight behind the view. The Economist quote the FAO report as saying "disclosure alone has proved ineffective to mitigate conflict in advice" and "even if they understand the scope of the conflicts many consumers are not experts and cannot distinguish good advice from bad". The Brussels based report also concluded that "information disclosure is not effective at tackling information asymmetries between financial institutions/intermediaries and investors".
In contrast NZ's regulatory approach has been captured by industry and thus sees disclosure as the main protection for retail investors from the investment advisory industry. The sooner that we arrive at the US/European view the better.
Unfortunately it seems like it suits almost everybody to sacrifice retail advice for institutional profitability so don't expect much material improvement in the current review of the financial advisors act.
These latest developments haven't been without touches of humour and the Australians showed that they can always be relied upon to make the most inappropriate comments at the worst possible time. The Chief Executive of one of Australia's largest banks was recently quoted as saying that "banks should hire [financial] advisors who are more focused on the customer rather than bonuses and commissions".
Good advice except that the Annual Report of that bank discloses that this same Chief Executive received short term incentives, which most people would think sounds a teeny bit like a bonus, of A$1.48 million in the June 30 2014 year. This was part of his total remuneration of A$8.1million. The old saying about pots, kettles and dark colours comes to mind, again.
Brent Sheather is an Authorised Financial Adviser. A disclosure statement is available upon request. Brent Sheather may have a financial interest in the companies mentioned in this article.
