Once again the financial planning firms owned by the big five financial institutions (CBA, ANZ, Westpac, NAB and AMP) have let our industry down. Last week ASIC reported the results of another review that found poor standards of advice, and once again the industry suffers reputational damage due to skewed incentives and self-interest.
The big five are all ‘vertically integrated’, that is, they know through their banking arms if their clients are sitting on investable funds, they make financial products (like managed funds and ‘platforms’, which provide administrative services for clients’ accounts) for which they charge a management fee, and they employ financial planners, who are supposed to give objective advice to clients about which financial products are best for them. Blind Freddie can see the potential conflict.
The advisers that work for the big five will typically have what’s called an Approved Products List (APL), which is a menu of managed funds and things they are allowed to recommend to clients. ASIC found on average 79% of the products listed were from external providers, yet in 200 files they examined, 68% of client funds were invested in in-house products.
Why does this happen? Largely because the advisers are incentivized to recommend the in-house products. It’s not as blatant as having someone standing over them telling them what to recommend, but it’s only slightly more subtle: the adviser will get paid more for recommending the in-house product.
There’s an old saying in economics: follow the money. Work out what someone’s incentives are and there’s a good chance you’ll be able to work out how they’ll behave.
It’s far from a victimless crime. Obviously their clients pay the heaviest price: potentially receiving advice that at worst isn’t appropriate to their circumstances or long-term objectives, or at least isn’t as good as it could be. The others who pay a price are financial planners who do prioritize their clients’ interests, but get tarred with the same reputational brush, as well as those potential clients who would genuinely benefit from getting help with their financial planning but are persuaded not to because they feel they can’t trust the industry. In one study it was found that nine out of ten baby boomers that worked with a financial planner have retirement savings and 80% believe they are better prepared for retirement.
There have been two developments over the past five years that will help consumers. First the FOFA reforms, which have stipulated that financial advice has to be in the clients’ best interests and has banned conflicted remuneration, like commissions. Then again, what kind of an adviser has to be told to act in a clients’ best interests?
The second is that over the past few years there’s been a sharp increase in the number of so-called IFA’s, Independent Financial Advisers. These are advisers that either hold their own license or work under a licensee that is not one of the big five and doesn’t make its own financial products, so they can offer un-conflicted advice. Mind you, ASIC doesn’t let them refer to themselves as independent, so instead you’ll see things like ‘privately owned’, ‘unaligned’ or ‘self-licensed’.
Financial planning offers a lot of meaningful, long-term benefits to help people make the most of their financial resources. In choosing the right planner, it pays to be aware if they manufacture their own financial products or are otherwise incentivized to recommend particular products.