Dealer groups and advisers create barriers to market access for funds

Advisers and dealer group approved product lists (APLs) can create barriers to entry in the market for fund managers, according to a report from the Australian Securities Investments Commission (ASIC) and Deloitte.

The ‘Competition in funds management’ report said the use of APLs was good for screening but affected the ability for fund managers to compete.

“A financial adviser typically offers advice regarding managed investment products with the use of an APL, which contains a list of products approved by the licensee (typically the dealer group) to be recommended to clients,” the report said.

“The APL process undertaken by advisers can be effective at screening funds and ensuring that they are appropriate for investors but can also affect the ability of fund managers to compete by restricting access to investors.

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“The products placed on APLs will strongly influence the pool of funds available to advised retail investors.

“Managed investment products that are not listed on a given APL are less likely to be considered by advisers who are using that APL.”

However, it said if overly influenced by business development managers (BDMs) when making recommendations, advisers may not act in the best interests of investors, creating a principal-agent problem.

“Fund managers in consultation indicated that smaller financial advice groups have greater flexibility around how they select managed funds and are more likely to recommend funds that are not on the APL,” the report said.

“Responses from the industry on this particular section of the interim report contested claims about the influence of BDMs as well as the height of the barrier presented by the APL.

“Submissions stated that the concerns presented above are adequately accounted for by the introduction of best interest duties introduced under FOFA [Future of Financial Advice reforms] and also stated that advisory groups have “off-APL” practices to approve the use of financial products not on the APL.”

Managed Accounts

The report found the structure of managed accounts presented an opportunity for conflicts of interest

“In principle, the management fee paid to advisers for managed accounts can represent a conflict of interest resulting from vertical integration,” it said.

“Conflicts could potentially emerge where MDA [managed discretionary account] providers put clients into their own investment model portfolio rather than external products, as advisers receive a management fee for doing so.

“This reflects a principal-agent problem related to information asymmetry, with the adviser acting in their own best interests rather than in the interests of the investor.

“Consultees indicated that conflicts of interest are potentially evident in the growth of small advice businesses that emerged from big bank divestments after the Hayne Royal Commission.”

Research Houses

The report found research houses could create barriers to market access for funds as it was difficult to distribute a product without a rating and that research houses did not use their power to lesson competition.

“Due to the number of funds, the difficulty of differentiating between them, and the need to protect consumers, platforms and dealer groups will typically not list a fund without that fund acquiring a rating from one of the small number of research houses,” the report said.

“The impact of ratings on distribution means that fund managers largely cannot access investors without receiving a rating.

“Receiving a rating can also be a time and resource intensive process. Some consultees said that research houses are supportive, and the process of obtaining a rating is not too difficult or onerous, while others noted that processes can be very long (sometimes more than three years).

“Research houses have finite resources to provide comprehensive analysis on funds and may rate only 800 to 1,000 funds — leaving at least as many unrated.”

Platforms

Platform providers had similar issues to research houses, as they had finite resources and did not use their power to lessen competition.

“Lengthy and onerous approval processes can prevent emerging fund managers from reaching market as they start up, making it harder to grow and break even,” the report said.

“Platform operators have relatively substantial market power when dealing with fund managers. This is because there are fewer platforms than funds, platform providers will not select every fund for their platforms and, most of the time, there is a range of funds competing to meet a given investor demand.

“This imbalance means that platforms have the ability to decide whether or not to list a particular fund and are not obliged to list any fund.

“Dealer groups and advisers tend to only purchase funds that are available on platforms that they use. As a result, platforms can limit advisers’ and investors’ ability to access and invest in a fund of their choosing.”

Other findings

The report also found:

• Retail investors were a small fraction of funds under management at 5%, but the managed funds industry affected a much larger number of Australians through superannuation;
• The managed funds industry was competitive, as evidenced by new market entrants, innovation and low fees by global standards;
• There was no single source of truth that allows for direct comparison between funds;
• Retail investors were not highly engaged with funds management.
• There was competition between fund managers on fees and discounts. However, retail investors may not receive the full benefits of competition due to principal-agent issues and issues around transparency; and
• Some participants in the managed funds industry have conflicts of interest, and this could affect outcomes for retail investors.