As financial services evolve and new opportunities open, the decision becomes even more difficult. Many investment managers once confined themselves to institutions and large adviser ‘dealer groups’. Now, most recognise that a conversation directly with individual investors is an essential part of their marketing range.
The Future of Financial Advice (FoFA) legislation is a critical part of the change. At the time of its development in 2012, it might have seemed like another piece of arcane industry regulation. In fact, it was the foundation of a disruption finally cementing its place due to the findings of the Financial Services Royal Commission. It heralds a new era of transparency which all market professionals must adapt to.
The traditional distribution model for investment managers
Prior to 2012, the dominant retail distribution method relied heavily on the support of financial advisers and their related ‘dealer groups’ (they are the financial planning umbrella groups under which large numbers of financial advisers operate). In fact, many Business Development Managers never met with an end investor. Rather, they hoped that thousands of individuals could be accessed by focussing on a few crucial gatekeepers, such as:
- Ratings agencies such as Zenith, Morningstar and JANA, who are used as consultants to identify investment managers to include on Approved Product Lists (APL).
- Researchers and principals in ‘head office’ dealer groups, who coordinate investment manager selection into discretionary platform choices or mixed in model portfolios.
- Financial advisers, whose clients can be corralled into the portfolios of a manager.
- Platform providers, who decide which investment managers are added to their limited menus.
Investment managers paid commissions to dealer groups (who might also provide the platform) to gain preferential marketing access, and part of these payments would go to financial advisers. Managers also supplied entertainment, financial support for events, shelf space fees (that is, a payment for placement on a platform or APL) and the occasional gift. At one level, the payments were legitimate because most investment managers did not have the resources to service hundreds of smaller investors, and they paid advisers to do the servicing and marketing for them.
A typical retail fee structure at the time might be 1.8% annual cost to the investor with 0.6% retained by the platform, 0.6% paid to the investment manager and 0.6% to the dealer group.
The potential for conflicts of interest are obvious, as dealer groups had an incentive to recommend the services where the commissions and extras were most favourable to the advisers.
The major impact of FoFA
The FoFA legislation of July 2013 banned commissions paid by investment managers to dealer groups and advisers for the distribution of the investment manager’s products. Disclosure measures were introduced to better inform investors. However, there were crucial grandfathering clauses allowing existing trail commissions to remain in place. As the 2018 Royal Commission has revealed, many old arrangements still operate, although most institutions have announced they will soon be cancelled.
Problems between dealer groups and their advisers, especially when part of a vertically-integrated wealth business, led to disagreements about which products should be on APLs. This has led to a surge in advisers obtaining their own licence or moving to more independent dealer groups (sometimes called licensees). The adviser industry is undergoing a profound change.
After years of argy-bargy, countless lobbying trips to Canberra, behind-the-scenes advocacy by industry groups and thousands of hours of management time, the wealth industry has reached a turning point which should have been mandated long ago. Conflicted remunerations which potentially compromise the best interests of investors have been substantially eliminated.
Unable to pay advisers to sell their products, investment managers have been forced to rethink their marketing and methods they use to target clients.
Growth of the independent retail investor
The June 2018 statistics on self-managed super funds (SMSFs) show:
- SMSFs hold $750 billion of the $2.7 trillion in superannuation assets
- 596,000 SMSFs with 1,119,000 members
- Average assets per SMSF $1.2 million, median assets $700,000
- 16% of SMSFs hold assets over $2 million.
Those numbers illustrate the enormous investment firepower of over one million Australians. Each of them has signed a long and detailed legal document, the SMSF trust deed, which includes responsibility for the way the money is invested. Of course, these amounts are a fraction of the investments of retail investors, as even more wealth is held outside superannuation.
There are many estimates of the proportion of Australians that use the services of a financial adviser, but a popular overall estimate is about 20%. About half of people aged 55 and over say they sought financial advice in the last year. It’s likely that with increased compliance and regulation and advisers leaving the industry, the cost of obtaining financial advice will rise, encouraging advisers to focus on the wealthy. There is a massive unmet need for advice, and yet as the following research from Investment Trends shows, the most difficult aspects of running an SMSF are ‘Keeping track of changes to rules and regulation’ and ‘Choosing what to invest in’.
Source: Investment Trends March 2018 SMSF Report
Industry expects direct-to-consumer to dominate
More advisers are developing their own lists of approved investment managers without the assistance of the centralised coordination of a large dealer group. The sale by the banks of their wealth management business will accelerate this move. While advisers remain important for investment managers, far more are focussing on business-to-consumer, or B2C.
In 2017, Calastone and Funds Global Asia surveyed 332 respondents from financial institutions with a range of questions, including the future of funds distribution. They concluded:
“Direct-to-consumer models were anticipated to be the most important channel, followed by fund platforms and in third place, new entrants to the market.”
The biggest decline in importance today versus the forecast for 10 years’ time was in financial advisers, moving from a present-day first or second choice among respondents of 40%, to 25% in future. As shown below, asked whether direct-to-consumer will take over from banks and financial advisers as the main way to raise assets, 60% said they ‘Strongly Agree’ or ‘Agree’. Remember, this is the industry speaking.
The growth of different retail distribution models and methods
A decade ago, investment managers would set up an unlisted managed fund and market to platforms and dealer groups to add the fund to their lists. It was the only destination for retail money. There is now a multitude of options, and some investment managers are opening one of each in an effort to meet whichever option an investor prefers. These include Listed Investment Companies (LICs), Listed Investment Trusts (LITs), Exchange Traded Funds (ETFs), Active ETFs, mFunds … please sir, can I have some more. There are now $80 billion of ETFs and LICs/LITs issued on the Australian Securities Exchange, a dramatic increase in the past five years.
With this ability of retail investors to go directly to the ASX, managers such as Magellan and Wilson have stepped up their direct-to-consumer marketing. Magellan gets over 40,000 visits a month to its website while Wilson claims its newsletter goes to 80,000 SMSF trustees. Both still court brokers and advisers, but they have such a big following that they can raise substantial amounts directly.
These managers are not simply flogging their products. They are educating their investors. The material they produce explains markets and gives opinions to nurture investors’ opinion that they are smart. Research by leading consultants, Tria Partners, concludes:
“… thought leadership is the single most important factor that underpins improvement of buyers’ understanding and perception of external asset managers – i.e. it’s the most value-adding activity marketing can undertake.”
OpenInvest is a new approach. Its online marketplace gives individual investors direct access to a range of investment managers, each of whom offers a series of diversified portfolios. The added benefit is engagement with the managers to enable investors to determine whose results, style and communication most appeals to them. The investment manager also takes on the crucial asset allocation role which often confuses unassisted retail investors.
The need to build trust
In its 2018 Financial Advice Report, Investment Trends records that trust levels for banks and financial advisers have fallen into the ‘distrusted’ range, both below 5 out of 10. The impact of the Royal Commission is clear, and rebuilding trust will take years, based on increasing transparency.
In such a climate, while financial advisers have important roles to play, investment managers will continue to focus on alternative distribution models, continuing the direct-to-consumer trend.
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About the author:
Graham Hand is Managing Editor of the leading financial newsletter, Cuffelinks. OpenInvest is a sponsor of Cuffelinks and Graham is on the Advisory Board of OpenInvest. Cuffelinks will always be free for OpenInvest clients and includes the insights from hundreds of market experts. You can register to receive the newsletter here. This article is general information not personal financial advice.
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