Brent Sheather: The Financial Plan from Hell

Occasionally the personal finance sections of newspapers report on how best to invest your money.

They ring around agreeable financial planners and stockbrokers asking them for their best ideas which, more often than not, focus on what's hot right now.

For instance this week it would be great if one could say his/her clients were long on gold, emerging markets and Australian resource stocks. All have produced great gains recently, thus the implication is that the adviser in question got his/her clients into these areas ages ago and they are laughing all the way to the bank. Today, however, we change strategy and report on what not to do. And where do we look for inspiration on what not to do - the Financial Plan from Hell, of course.

The FPfH crossed my desk as a consequence of one of the trustees wondering whether the annual custodial and advisory fee of $2625 on total capital invested of $112,000 was reasonable.

The story as it unfolds is an almost perfect template of what not to do with your money. Sadly it did happen and it is indicative of what transpires in the real world when times are tough, volumes are low and commissions hard to come by.

But first some background. The victim in this case is Aunt Daisy who is in her 90s, in a rest home and comfortable in the knowledge her best interests are being represented by her financial planner. Some years ago, at the urging of the said adviser, her portfolio of blue-chip NZ shares and A-rated bonds were sold and the proceeds reinvested a la the FPfH.

The core part of any financial plan is the asset allocation profile - how the funds are split between bonds, property and shares. How much goes into higher growth, higher risk assets like shares as opposed to a lower risk asset class like bonds depends on the risk profile of the client.

As one might expect Aunt Daisy, in her mid-90s and with no children, prefers low risk to high and simply wants to have enough to pay for her rest-home expenses and luxuries like the odd icecream.

The FPfH has an asset allocation profile as follows:

* Bonds 68 per cent.

* Property 22 per cent.

* Shares 10 per cent.

Relative to the average pension fund the asset allocation is conservative, as one might expect for a 90-year-old requiring income. So far so good. The obvious question, however, is: how can a portfolio with such a conservative asset allocation sustain annual custodial and advisory fees of 2.3 per cent a year? Remember these fees are payable to the financial planner and are in addition to fund management fees. The expected total return from the portfolio before tax and fees is barely 8 per cent a year so a 2.3 per cent monitoring/custodial fee consumes more than a quarter of returns. How they do it is clear when one looks at the fixed interest portfolio: this ostensibly low risk component of Aunt Daisy's savings is actually stuffed full of high risk finance company debentures. No government bonds, no SOE bonds, not even any corporate bonds. Aunt Daisy, with total investment assets of $112,000, is funding the property developers who the banks won't touch. That this 100 per cent focus on finance companies is reckless can be seen in the context of the strategy of the average pension fund or balanced unit trust which typically has little (or more often no) exposure to finance company debentures. But when you are stuck with a 2.3 per cent a year fee overhead junk bonds are your only option. The focus on junk debt is all the more incongruous with Aunt Daisy's risk profile which the planner has determined as being defensive. And what if Aunt Daisy becomes ill and needs cash for hospital fees? You can't sell these debentures as there is no secondary market. Methinks this planner's professional indemnity insurance is money well spent.

Fortunately the FPfH's overweighting in debentures is not representative of all managed portfolios but there is no denying that finance company debentures are now a key part of the financial planning sector's product range. With international shares off the menu for many retail investors after the disastrous period between February 2000 and February 2003 more and more advisers are focusing on fixed interest products.

Unfortunately financial advisers' views of just what constitutes low-risk bonds is about as variable as an index of technology stocks. Indeed, while we once could state with some certainty that shares were more risky than property which was in turn more risky than bonds, in today's market some bonds clearly have a higher default risk than some equities.

The growth component of Aunt Daisy's portfolio isn't much better - she has a range of unit trusts, each boasting annual fees of about 2 per cent a year from which trailing fees are apparently paid.

Aunt Daisy must be a financially savvy nonagenarian - she has exposure to hedge funds, a specialist Japanese stock fund and an Australian small companies fund but virtually no exposure to the mainstream, blue chip stockmarkets which should form the core of any overseas equity portfolio. A grand total of $8750 is split over six funds.

You can't charge a 2.3 per cent a year monitoring and custodial fee for managing one or two low-cost index funds - unnecessary complexity is a given with high fee structures. All up fees payable on those managed funds is a record 4 per cent plus a year. Inexplicably, there is no exposure to NZ shares which offer the highest dividends in the world.

The financial planning community complains bitterly when Consumer magazine highlights sharp practice. The FPfH suggests bad advice is alive and well and caveat emptor still rules.

* Brent Sheather is a Whakatane-based investment adviser