Robert Keavney recognises the trend for industry super funds to establish financial advice businesses, like their retail competitors. But he asks the question: Whose money is used to operate this activity?
There has been a flurry of industry funds launching advice offerings. This is a step in the slow process of convergence with retail funds, remembering that the big life offices also began as mutuals and only later acquired shareholders seeking profit.
Those with long memories may wonder how it was to the mutual benefit of policyholders to offer products with outrageous fees, as was the practice for many decades — but this is well outside the topic.
The forces that led retail funds to acquire dealer groups would seem to make it inevitable that many industry funds will also want to provide advice. The question this article will explore is how institutionally owned advice business are funded.
A number of the industry funds, which have announced initiatives to provide full service advice to members, have noted that they will charge less than mainstream financial planners.
One organisation is reported to have claimed it will only charge what it costs to run the business, and it will therefore be able to provide advice for around half the cost of conventional planners.
If dealers generally charge twice their costs, they must operate their business at a 50 per cent profit margin. This will be news to them. In this writer’s view, there is probably no Australian dealer group of significant scale that maintains such a margin. Certainly it is very far indeed from the industry norm.
Nonetheless, it may well be that some industry funds will offer advice at less than current market prices. It seems a reasonable inference that not-for-profit funds will not seek to make a profit from the provision of advice.
As many dealers operate at marginal profitability from the provision of advice alone (ie, excluding rebates from platforms and products), if industry funds provide advice at a lower cost, it seems unlikely that profits would be generated, whether desired or not.
Failing the occasional chance outcome where income exactly equals expenditure and a break even is achieved, most businesses that don’t make a profit will suffer a loss.
Several funds have stated that intra-fund or single-issue advice will be free and only more complex cases charged for, so a loss will inevitably be suffered on the provision of this simple advice.
The question is: who funds the loss?
Lacking any shareholders, it would seem that fund members must carry this loss (and one fund has explicitly stated that the members who seek advice will pay a fee that covers most of the cost of advice, and that the fund will subsidise the shortfall).
There will also be cases where an external or related party provides the advice under a contractual relationship. If members do not pay the cost of their own advice under this arrangement, any payments for this contract would presumably also come from members’ funds.
There will be many instances where this situation does not exist but, where a red bottom line does reduce fund assets, it raises both the sole purpose requirement and a broader question of the appropriate use of members' funds.
Any advice business owned or operated through a super fund would have to be assessed on its investment merit as a fund asset. The complication is that those who are charged with making decisions about the use of members’ funds to operate such a business have a conflict of interest where that advice can be to the benefit of their organisation.
Notwithstanding the undoubted high character of the trustees of Australia’s superannuation funds, self interest sometimes has a way of influencing decisions — irrespective of whether a fund is retail, industry or corporate.
A cynic — and this writer is, of course, of a sunny disposition and completely free of all cynicism — might suspect a trace of self interest in assessing the investment merit of using policyholders’ funds to acquire and operate a business that directs inflows to related platforms or products.
Nonetheless, it is important to acknowledge that there may be certain cases where an investment in a dealer group may be justified on investment grounds.
Complexity
To be fair — and this writer is known for his fairness, at least by those who agree with him — the situation is complex. There are grounds for using members’ funds to pay for widely valued member services (eg, call centres, member reporting, online facilities, etc).
A prima facie case could be made that the provision of advice is justified on these grounds. One factor that would seem relevant in considering this is how widespread the take up of the service is. Member reporting is universal, so all members are paying for their own report.
The use of call centres would be less universal but still widely used. Demand for advice would be much less.
It is a matter of judgment about how widespread the take up of a service must be to justify the use of members’ funds to pay for it.
Moreover, if one objective in providing advice is to retain funds under management, which would surely be an objective in the majority of cases, it seems inappropriate for members to have to pay for a facility to encourage themselves not to leave.
In any case, in a world where transparency about remuneration is required of those who give advice, there should be clear disclosure to all members if their funds are used to pay for advice given to others.
On the profit making side of the fence
Does this situation exist in retail funds? I have heard the claim that one or more retail institutions, whose offerings include both life insurance and financial advice, own their dealer groups through their statutory funds. Enquiries to several institutions have been met with a clear denial — at times accompanied by the suggestion that it is true of competitors.
It is only reasonable to assume that the temptation to use fund assets (ie, other people’s money) to serve one’s business interests will be equally tempting to individuals in industry funds, retail funds and corporate funds. However, to date this writer is not aware of specific retail funds that have used members’ funds to acquire or build advice businesses for their own ends. This is not the same as certainty that it has never happened.
Paying from superannuation
There is a development where members are able to use superannuation funds to pay for advice. This trend will not be confined to any one sector of the superannuation industry.
This will have appeal to those members who otherwise would be unable to pay for advice. It will also appeal to advice providers, who won’t have to ask clients to write out a cheque.
However, using superannuation to pay for advice may be the most expensive way to fund it.
To the extent that superannuation is tax advantaged, it may be unattractive to pay for a service from super rather than ordinary money (assuming the individual has any), as funds retained in superannuation can compound over time more rapidly than money outside superannuation.
Further, if advice includes matters relevant to the earning of taxable income, fees would be at least partly deductible. It will rarely make sense to incur a deductible expense in superannuation rather than against personal income.
It is to be hoped that members are offered the right to pay directly, and advised appropriately — though perhaps the latter would be outside the purview of 'simple’ advice. Of course, some people just won’t have personal funds available.
‘Simple’ financial advice
Many funds offer so called single issue or simple advice. Contribution options have been nominated as an example of such advice. One can take a simple approach to this question, but only if one doesn’t care whether the advice given is the best possible.
Most people are not on track to adequately fund their retirement — defining adequate funding as able to sustain the same standard of living as before retirement. Therefore if the question of whether to contribute more is put to a fund adviser, the simple answer is likely to be yes.
However, in many cases the member will have non-deductible debt. Paying down this debt should be considered as an alternative to increasing contributions.
It may also be more beneficial from the point of view of a family’s overall position if the increased contributions are made for the spouse (eg, depending on age, salary sacrifice potential, etc).
Further, in the view of some advisers, the benefits of negative gearing should be assessed against superannuation contributions.
By confining advice to the single issue of whether to increase contributions or not, and thereby failing to undertake a complete analysis of the member’s situation, the advice given may not be the most appropriate for the individual.
Defining financial planner
‘Single issue’ advisers do not do what a financial planner ought to do, which begins with a complete needs analysis. It would appear they only need to partially ‘know their client’.
This brings us to the call by the Financial Planning Standards Board for a definition of financial planner. When a client seeks advice from a planner, they surely presume that the planner is highly skilled, appropriately qualified, adheres to ethical principles and gives advice focused solely on the client’s interests after fully understanding them.
Those who do not meet these criteria should not be able to call themselves a financial planner. This is a matter of public interest.
Robert Keavney is an industry commentator.
