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Estate planning: where there’s a will, there’s a way

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Part 1 of this series on estate planning looked at the decision-making process that should be followed to prepare an effective plan. Parts 2 and 3 outline the documentation required to ensure that your strategy is effectively executed, starting with your will. Given you will not be around (or perhaps not have capacity) to ensure your wishes are met, an estate plan and a will must be carefully drafted by a qualified professional to ensure the outcome is implemented as intended.

Focus on the prime objective

In Part 1, we asked to whom, when and how you would like your assets distributed. Many people are advised to plan around tax minimisation or even prepare simple plans in order to save legal costs, without keeping their primary objectives in mind. Prioritising secondary objectives or trying to minimise costs can lead to adverse and even disastrous consequences for those left behind. Tax laws change and poorly-drafted documentation is more easily challenged (and overturned), and your beneficiaries may be left fighting for what was originally intended. It is critical to draft all your documentation around your original objectives.

Many people will go to a solicitor they know, but it may be better to choose an estate planning specialist if your circumstances are complex or your current solicitor is more of a generalist (if he or she looked after your conveyancing, for example). The Law Society in your state will have a list of qualified solicitors and information regarding specialisations, such as the Wills and Estates Law Specialist Accreditation.

What a will can and cannot address

Your will is the legal document that outlines how the assets that comprise your estate are to be distributed, but some primary assets are not included in your estate:

  • any assets you jointly own with another person. Unlike assets that are held as tenants-in-common, these assets automatically revert to the surviving joint owner on your death.
  • your superannuation. Superannuation death benefits can only be paid to specific individuals (see below) and the trustee of your super fund generally has discretion as to how these are distributed, unless you instruct otherwise via a binding nomination.
  • a reversionary income stream. If you have an income stream (such as a superannuation account-based pension or an annuity) with a reversionary beneficiary, it will not form part of your estate, but continue to be paid to that person.
  • life insurance proceeds (including those held in superannuation). These will be paid to the nominated beneficiary on the policy, or according to the discretion of the superannuation trustee.
  • assets held in a fixed or discretionary trust of which you are a trustee or beneficiary, or by a company in which you are a director or shareholder. Any shares or units you hold, however, generally will form part of your estate.

Your will deals with the remainder of your assets – cash, shares, property, personal effects and so on. Your solicitor will give guidance as to how your wishes regarding these assets should be documented. Some people are highly prescriptive about each asset, beneficiary and potential scenario (such as a specific bequest of each item to one person), while others avoid ‘ruling from beyond the grave’ and take a more principle-based approach (such as dividing the proceeds of the estate three ways if there are three primary beneficiaries).

Timing of beneficiary receipt

Timing of the receipt of your estate by young or otherwise vulnerable beneficiaries requires care. Some prefer their children to reach a mature age before accessing an inheritance, while others are comfortable with it being made available when they reach 18. Others provide for their children over time, for example, 10% at age 18, 40% at age 25 and so on, or providing for specific expenses such as university fees or a house deposit. A testamentary trust can assist with delivering to these objectives.

There are pros and cons to both the general and specific approaches. While the specific approach offers certainty, it can also create significant challenges if estate equalisation is an objective, as is common when leaving assets to adult children. How do you ensure each beneficiary receives a bequest of equal financial or emotional value? This is particularly difficult if asset valuations have changed dramatically since the will was drafted, or if other issues such as capital gains tax and sale costs have impacted the final value more than expected.

The downside of the general option is that it may require assets to be sold, with adverse tax and valuation consequences, if there are large assets that are not easily divisible. It may also create conflict if more than one beneficiary wishes to receive a particular asset. This is particularly common in rural families where the family farming property is the sole asset and only one beneficiary wishes to continue working on the land. Specialist succession planning assistance should be sought in this scenario.

Ultimately the decision to be highly specific or general in your will falls to you, however it helps to have a solicitor who is supportive of your strategy or who is willing to help you understand any limitations in your approach. A good solicitor will work through multiple scenarios, to check your wishes are met in different circumstances. These could include you pre-deceasing your spouse, you and your spouse dying simultaneously, your whole family dying simultaneously etc. While such scenarios are tough to contemplate, documenting your wishes in each event ensures that you have provided for those who are left behind.

Keep your will up-to-date

Your will should be checked and may require regular updating, either due to the passage of time, value of assets or a change in your circumstances. For example, a marriage or divorce will render your will invalid, but a marriage separation will not. If you do not update your will following a major relationship change, the entire estate may be awarded to a new spouse and children from the previous marriage may miss out. The period prior to a separation or divorce is crucial, because if you pass away unexpectedly, your previous spouse may inherit your estate against your wishes.

It’s important to take control of your estate to ensure not only that your own wishes are met, but that problems are minimised for your beneficiaries at a difficult time.

In Part 3, we will look at other documentation, including powers of attorney, insurance and superannuation benefits.

 

Gemma Dale is the Head of SMSF Solutions at National Australia Bank. This information is general only and does not take into account the personal circumstances or financial objectives of any reader. Readers should consider consulting an estate planning professional before making any decision.


Do investment principles stand test of time?

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Time travel is a skill that would dramatically transform the world of the investor. Sadly, despite all the technological advances of the past two decades, the ability to go back or forward in time remains the realm of science fiction novels, not a killer app on an investor’s smartphone. While time travel may still be the domain of TV and film producers, the passage of time is a real-world test for investment ideas even if – as we are constantly reminded – history is not a great predictor of future returns.

What has changed over 20 years?

Twenty years ago, Australia was a country of 18 million people with a median age of 37 and the median weekly household income was $637 while the cash rate was set at 7.5%. The fledgling superannuation system had accumulated assets of $262 billion some four years after the super guarantee contribution had been introduced.

In 1996 a new, more modest undertaking was getting started – it was the year Vanguard established its Australian business which was its first outside the US. It seems an appropriate time to look back and see how the underlying investment principles that Vanguard has used in guidance to clients has stood up to the test of two decades.

The market has changed markedly. Of the top 10 companies by market capitalisation on the Australian share market in 1996, half have either dropped out of the top 10 or are no longer on the ASX.

With help from actuarial firm Rice Warner, we decided to look at the past 20 years through the time capsule of three different investors in 1996 – a 40-year-old, a 20-year-old and a newborn baby – and test how our investment principles have stood up to 20 years of significant geo-political shocks, stunning market rises and dramatic declines that included a global financial crisis.

Pic Life stages

All our investment strategies are underpinned by four core principles:

  1. Goals: Create clear and appropriate investment goals
  2. Balance: Develop a suitable asset allocation using broadly diversified funds
  3. Cost: Use low-cost, transparent investment options
  4. Discipline: Keep perspective and long-term discipline

Outcomes for our three investors over two decades

One of the first lessons is that investors have been rewarded for taking extra risk.

An investor who invested $10,000 at the start of 1996 in cash would have seen the nominal value grow to $26,800. Someone who had invested in the Australian sharemarket index would have seen the portfolio value grow to $51,400. The US sharemarket index was just slightly behind at $48,100 while Australian bonds grew to $37,600.

For our three investors, Rice Warner was asked to model the superannuation outcomes. Remember back in 1996, super was really just getting started, so our 40-year-old did not get the benefit of a full career under the super guarantee nor the higher rate we have today.

The growth in the super system has clearly been one of the major developments in the Australian financial landscape in the past 20 years with it now being the second largest financial asset in average Australian households and the system growing into a savings pool of more than $2 trillion.

Our 40-year-old in 1996 is now turning 60 in 2016 and with retirement firmly in sight, Rice Warner project their super balance at retirement (assuming compulsory Superannuation Guarantee only contributions, average wages and a 7.5% gross return on investments) to be $217,000 in today’s dollars. That is projected to last until they are 74-years-old.

For the person turning 20 in 1996, and effectively just starting out in their working life, who is now 40 in 2016, the projected retirement balance is $395,000 when they reach retirement age. This money is expected to last until they are 83-years-old.

For the baby in our investor trio who is now 20, the projected super account balance accumulated during their working life is $456,000 – more than double what the 40-year-old is likely to get. It should last until they are 87.

Source: Rice Warner. Assumes default super with no additional concessional contributions.

Source: Rice Warner. Assumes default super with no additional concessional contributions.

 

Based on the ASFA comfortable retirement standard, the baby of 1996 could reasonably expect her super to last 13 years longer than their older baby boomer counterpart.

Higher contribution rates and a long-time period to allow compounding to work is driving these outcomes but it is interesting to reflect that even after more than 20 years, our super system is not yet at maturity. The challenge remains for those in the older age bracket to be able to contribute enough to fund their retirement lifestyle.

 

Robin Bowerman is Principal, Market Strategy and Communications at Vanguard Australia. This article is general information and does not consider the circumstances of any individual.

Stranded: too old to work, too young for the pension

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After a career spanning business, software analysis and the Arts, and now in my late 50’s, a few years ago I decided to reinvent myself as a financial planner. I studied and started applying for jobs. Over many years, even if I made it to the interview stage, I have been amazed to hear the excuses as to why I am not suitable. My favourite is “too creative”. I believe ageism is the real issue.

Eventually, I secured a one year casual contract with a major dealer group looking after their existing superannuation and insurance customers, which I finished in February 2016.

The plight of the ‘renting transitionals’

In dealing with these customers, it became evident that there is a particular group of people who are being ignored by both our political and financial classes. I call them the ‘renting transitionals’. They are in transition between mature-age (50 years-of-age upwards) and age pension age. Not only are they in transition between jobs, but crucially, they do not own their own homes. Surviving on the age pension as a non-homeowner is a topic for another day.

With the superannuation system still evolving into maturity, when these renting transitionals, especially women, lose a job, they do not have sufficient funds to support themselves to preservation age, let alone pension age. Even when they can access their super, perhaps under the ‘hardship case’ provision of release or a Transition to Retirement pension, it is insufficient to pay for both rent and food. The money won’t last the distance.

For those that qualify, the Newstart Allowance for a single person is only $13,717 per annum, which will not cover basic living expenses, and any income earned reduces the Allowance.

Home ownership is a massive issue

Many financial commentators quote the ASFA Retirement Standard as the benchmark for living standards. Their latest annual budget for a ‘modest’ standard is $23,797 for a single person, and $43,184 per annum for a ‘comfortable’ retirement. The crucial qualification is:

“Both budgets assume that the retirees own their own home outright and are relatively healthy.”

I have a colleague who was made redundant after working for Arts and Heritage organisations for many years. The recent cuts to the Australia Council do not come without personal consequences. The types of jobs she has held mean her income has been low, she has been unable to buy a house, her super balance is accordingly smaller and at age 59, she has not been able to find another job. The loss of manufacturing jobs and the downturn in resources and construction have hit others hard. My colleague is increasingly isolated and losing confidence which in turn affects her chances of employment. It causes profound stress, depression and suicidal thoughts.

Now her TTR pension may also be subject to 15% earnings tax further affecting its longevity.

What do we do? This is not an issue that will go away for older workers. It is not that they do not want to work. Often people employed in the Arts are working extremely long hours that are usually underpaid, and they rely on other jobs to get them through. Income protection policies, while highly desirable, are out of the reach of these low income earners. Newstart (again, if they qualify) is a form of entrenched poverty. If it was maintained until their other earnings reached a liveable wage, it may be useful.

Council of the Ageing SA Chief Executive, Jane Mussared, recently said:

“Home ownership was a bedrock for older Australians. Our pensions are low by OECD standards but were propped up by high ownership levels and low mortgage levels. (Federal MP) Mark Butler talks about home ownership rates being in free fall among older people. Put in a period of unemployment prior to aged pension, low levels of super, low earnings over a lifetime and high levels of caring responsibilities and we have a looming problem.”

What do large institutions say about employing older people?

Nearly every major corporation has a public policy on the need for diversity in the work place. Often, there is a heavy focus on gender balance, pushing other diversity issues such as age, disability and religion into the background.

It is common for a policy to state that the company’s employees should reflect the characteristics of its customers. This ensures an empathy with customer problems, leading to greater understanding and hopefully, business retention. For example, the Commonwealth Bank has a microsite devoted to sustainability and the need to ‘reflect community diversity’, stating:

“The Australian community is diverse, dynamic and culturally rich. It is also changing as the population ages and we become more economically and culturally entwined with our Asian neighbours. As one of Australia’s largest employers, with a nationwide branch network, it only makes sense for our workforce to reflect the diversity of the Australian community.”

“Diversity is an essential element of the Commonwealth Bank Group’s new strategic vision: to excel at securing and enhancing the financial wellbeing of people, businesses and communities. A key area of focus over the next 12 months will be further developing our response to the challenge of age diversity.”

A good place to start on age diversity would be employing the number of older people in proportion to the number of older people among CBA’s customers. Now, that would be a big number!

What else can be done?

Luckily, I have sufficient funds and my own home. I will shortly complete my Advanced Diploma in Financial Planning and will continue to look for full-time work. Failing that, I will retire if the government starts taxing my modest transition to retirement pension. The renting transitionals are not so fortunate.

Do we need an education campaign reminding 40-year-olds that they may need to provide for themselves without government assistance from anywhere between the ages of 50 to 70, before the likely age pension kicks in?

We need solutions beyond standard income protection policies. For low paid workers who are aging, many of these favourite insurance solutions do not present themselves. Are there new affordable ‘Living Wage Mutual Income Protection’ insurance policies that could be designed for this demographic?

The alternatives to taking action are mental health issues and homelessness affecting potential workers who do not have the resilience of youth to tide them through. I worry about that my colleague may be among the growing number of older women who experience homelessness for the first time later in life. Older, single women are vulnerable as they may lose their jobs early, lose a spouse or be discriminated against in the housing market. As Jane Mussared said:

“It is your mother, sister or grandmother that is at risk of being forced to sleep rough.”

I would dearly like to hear how we help people get through this period until they can at least qualify for the age pension. Have you survived a similar period? How are advisers helping clients with this potential problem?

 

Barry French has a BA and is currently completing an Advanced Diploma in Financial Planning. He formerly worked as Technical Support Manager for an international software company. His passion is to provide financial services and education to people in the Arts and the 80% of people who receive the least advice and probably need it most.

 

 

Regulator demands robos understand clients

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Quick and simple digital advice makes investing easy, but do the long-term consequences outweigh the short-term benefits? A new report by US market regulator, the Financial Industry Regulatory Authority (FINRA), draws attention to this question by sharing the digital investment advice practices employed across the securities industry. It’s a reminder of the obligations that come with robo advice and the standards FINRA expects to underpin a financial advice service.

FINRA CEO Richard Katchum questions the adequacy of robo risk tolerance practices when he contrasts them with personal advice delivered by a human advisor:

“The same requirements are in place — the same expectations that you understand your customer, both from the standpoint of what their risk appetites are, and also that you have asked enough questions to really understand their financial situation and that they can accept risk and the risk of loss.”

Furthermore, advisors need to be able to explain both to clients and the regulator how their tools and products work. There is no defence in the argument that ‘I’m just following instructions from head office.’ Black-box solutions are not acceptable.

Undergoing a complete investor profile

Many robo advisors do not develop an appropriate investor profile of clients. One of the most fundamental aspects of delivering suitable advice is to ascertain the level of risk that a client is willing to take. This is referenced as ‘risk willingness’ in the FINRA report and is commonly referred to as risk tolerance. The regulator questions whether it’s possible to accurately measure the amount of risk that an investor is willing to take by asking a small number of risk tolerance questions – in some cases just one.

There are no lower standards expected for robo advice compared to human advice. FINRA’s ultimate concern is investor protection, and the importance of accurately assessing risk tolerance cannot be ignored. When investors take more risk than they are comfortable with, they are more likely to bail-out of the market when the going gets tough and then wait too long to get back in. This pattern of buy high and sell low makes it difficult for investors to achieve their financial goals. Furthermore, over-exposed investors suffer adverse behavioural reactions to financial loss such as anxiety, loss of sleep, and relationship problems.

It is common industry practice to treat investment time horizon as a sub-factor of risk tolerance when, in fact, time horizon is an aspect of risk required (the level of risk needed to achieve your goals). Simply put, this requirement is a catalyst for change. Most risk tests used in the market place would be non-compliant according to these principles.

FINRA also makes a distinction between risk tolerance and investors’ capacity for loss, making customer profiling critical because it drives recommendations to customers. The message is clearly aimed at the executives at the top of the enterprise:

“Two other areas of digital investment advice – customer risk tolerance assessment and portfolio analysis – reinforces the need for broker-dealers to establish and implement effective governance and supervision of their digital investment advice tool. Good governance involves understanding if the approach to assessing customer risk tolerance is consistent with the firm’s approach. Firms must apply good practices across all distribution channels, not just robo advice.”

Analysis of seven robo recommendations

FINRA details seven robo advisors’ portfolio recommendations for a young worker. Let’s call him Michael. Of particular concern is the wide range of 60% to 90% in growth asset recommendations and how they match to his risk tolerance. If growth exposures are greater than what is consistent with risk tolerance, then the likelihood increases that the investor will be disturbed by a market correction. If not satisfied by the advice, clients may sell down growth assets at the wrong time, and in the worst cases, seek legal redress. Dissatisfied clients are a blight to all businesses, more so in financial services in the last few years.

Let’s assume that Michael has a FinaMetrica risk tolerance score of 50 (out of 100) and is placed in Risk Group 4. Based on a score of 50, Michael would be comfortable with between 39% to 58% growth asset exposure. Most people in Michael’s Risk Group would typically be discomforted when the value of their entire investment fell by 20%.

If we look at the seven portfolios illustrated in the FINRA report from the standpoint of who would be comfortable based on risk tolerance alone, the riskiest portfolio with a 90% exposure to growth assets matches the risk tolerance score of just the top 5% of the population. This rarefied group generally includes hedge fund managers, bankers, entrepreneurs and high risk tolerant individuals.

When we map the seven recommendations (shown by the vertical bars below) on to Michael comfort zones, none of the portfolios is consistent with Michael’s risk tolerance and all but one are in the ‘Too Much Risk’ red zone.

To test sensitivity, we look at four broadly diversified portfolios with 60%, 70%, 80% and 90% growth assets. These portfolios were back-tested to 1972 using indices rebalanced once a year. Even the 60% equity-exposed portfolio exceeded the 20% drawdown that investors whose risk score is 50 typically tell us they are comfortable with.

158b

We are regularly reminded that the past is not a precursor of the future in terms of investment performance, so we don’t need to be reminded that unhappy investors are a scourge on our industry’s/profession’s successful and profitable future. If we don’t manage the matching of investments to investors’ needs effectively, we can be assured that regulators will continue to do it for us. Risk tolerance is not hard to assess accurately, it just needs a little science and a dash of common sense.

 

Paul Resnik is Co-Founder and Director of Finametrica, a risk profiling system that guides ‘best-fit’ investment decisions.

The Australian regulator, ASIC, recently completed its consultation feedback for its own policies on robo advice.

Will roboadvice exterminate traditional advisers?

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A concise definition of roboadvice is an online wealth management service that provides automated, algorithm-based portfolio management advice without the use of human financial planners. The question is, will this form of advice become dominant, exterminating traditional financial planners (to use a Dalek analogy)?

The answer is yes, of course, but only when robots take over the world. Between now and becoming slaves to the machines, financial advisers will be greatly assisted by changing technology. But not every planner will benefit. Roboadvice will vastly increase the market size through offering inexpensive advice, but some planners will fail, unable to deal with the ever-increasing pace of technological change.

Winners and losers

Many people lack confidence in managing their money and they will want face-to-face advice, but that does not mean technology will not materially disrupt the industry. Winners will be non-aligned financial planners, planning groups in small superannuation funds, and smaller banks. Losers will include major banks and bank-employed and aligned planners.

While always open to debate, my selection for winners and losers is based on:

  • Ability and willingness of organisations to adopt new technology
  • Burden of legacy systems holding back implementing new technology
  • Restrictions from having a valuable brand – companies who are very protective of their brand are often slow to adopt new technology, waiting for all bugs to be removed
  • Degree of ‘creative destruction’ occurring within the industry – those at risk of losing market share are more likely to look to innovation to remain competitive.

Australian banks have large IT budgets but most of it is spent on maintaining legacy systems or meeting changes in regulations and compliance. When banks do turn their hand to system development, it frequently fails, incurs major cost and time over-runs, and becomes prohibitively expensive.

Major banks are unwilling to risk their brand with start-up technology. A Chief Investment Officer of a very large super fund once told me that systems development now either costs less than $2 million or more than $200 million. There is nothing in between. Smaller start-ups are so nimble and inexpensive that new technology from this source is amazingly cost-effective. But a large organisation is unwilling to risk tarnishing its brand with a small start-up. Major banks are more willing to risk their brand from expensive technology failures so long as the developer is a well-known company.

Major bank wealth management groups risk placing too much reliance on building new platforms. The disruptor to platforms is the predicted increase in open APIs (application programming interfaces). Open APIs will mean:

  • Client investment and personal data can be sourced cheaply and safely. The planner, at almost no cost, can see their client’s position, in almost real time, with data presented in a useful manner with recommendations based on previously-agreed financial objectives and constraints.
  • Fund (and SMSF) administration and tax will be commoditised, driving down price.
  • Planners can execute transactions where they like. Planners will no longer be restricted to what the platform offers.

Bank platforms are yesterday’s technology. My winners are selected because they are organisationally smaller and experiencing some ‘creative destruction’ in their industry.

Size is important. If you are not the lion in the jungle, you better wake up running. Smaller organisations will have to be nimble to survive. Those who do survive, and there will be many who do not, will have an ability to make quick decisions with a high degree of management accountability. They are likely to have less to lose by realising that their historical technology spend has little to no residual value. Cheaper more powerful technology means smaller organisations can quickly develop a technological advantage over larger organisations. A smaller technology spend will not mean less capability. It might mean more.

Younger planners are also big winners with technology, not because their minds are youthful but because they need the business. Younger or new financial planners will see technology as a way of growing their list of clients, including those clients which more established planners thought were uneconomic.

Creative destruction refers to the incessant product and process innovation mechanism by which new production units replace out-dated ones.

The reason Australia is slow to adopt financial technology is the absence of creative destruction in many parts of the industry. Traditionally, superannuation funds do not go out of business because members are attracted to another fund with better products and services. But that is no longer the case. Many small and mid-size superfunds are losing members or are under pressure to merge with larger funds.

These smaller funds must adapt or lose their purpose for being in business. They have to adopt ways to improve member engagement and offer higher quality services at an ever-decreasing cost. They will have to engage with emerging technologies, as they don’t have the budget or capabilities to build their own systems. Their size, rather than being a weakness, will actually make them competitive, offering superior products.

Where are the financial planners?

Financial planners must decide where they are as technology emerges. There are warning signs that they are not prepared for the technology changes, including:

  • Their main browser is Internet Explorer or Safari rather than Chrome or Firefox.
  • They have a fax number on their business card.
  • They have just replaced their server in the office.
  • They have not yet tested or had any experience with a roboadvice product.

Technology is moving to a Netflix / Spotify business model. It can be tested for a very small amount of money. If it works, users can increase the subscription and if it doesn’t, they can terminate the service.

Financial planners must at least experiment with roboadvice and related technology, or they are at risk of not developing the management skills to deal with what will be a material change in the industry.

Conclusion

Technology will only get better. Information will become cheaper and more available. A financial planner will spend materially less time collecting and summarising data and more time with clients discussing important issues. Technology will release them from the cost and limitations of large platforms. Those contractually obliged to use platforms will be at a material cost and flexibility disadvantage.

Size and brand will be a disadvantage. Small flexible organisations will be the winners with more clients, higher margins and providing greater service.

 

Donald Hellyer is the former Global Head of Funds and Insurance at National Australia Bank and Chief Executive of BigFuture.

Diversification in thinking and practice

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In 2015, Brookvine ran a workshop modestly entitled ‘WhiteBoarding 2.0’ where advisors and Chief Investment Officers to High Net Worth (HNW) clients and Family Offices (FO) assessed the role of diversification in their thinking and practice.

The wisdom of diversifying is ancient: Warren Buffett has stated that it’s a hedge against ignorance and a modern version of the biblical instruction to ‘divide investments among many places, for you know not what risks might lie ahead’. A millennium later, the Talmud offered an explicit and not unreasonable uniform diversification, to divide equally across ‘buying and selling things’ (equity), ‘gold coins’ (cash) and ‘land’ (real estate).

Selling diversification to HNWs

Until Modern Portfolio Theory (MPT) came along, diversification was justified by the slogan ‘don’t put all your eggs in one basket’ as opposed to the less common but for some equally valid, ‘put all your eggs in one basket but watch it very carefully.’ By quantifying risk, Nobel Prize winner Harry Markowitz transformed diversification from a slogan to an explanatory and operational tool. Diversification went from theoretical insight to black letter law in a mere 20 years and became an investment truism, the ‘single most important thing’ in portfolio construction. Superannuation funds must ‘have regard to’ diversification and for MySuper funds, it is compulsory. Yet many private wealth portfolios and SMSFs are less than ‘optimally’ diversified … often for sound reasons.

Most wealth is created by HNWs through direct investment in a single business. That makes it hard for wealth creators to appreciate the logic of diversification in their investment portfolios as they transition from getting-rich to staying-rich. Sensitive advocacy is needed to convince HNW families of the efficacy of diversification in preserving capital, especially in explaining the need for unconventional asset classes such as private real estate lending, catastrophe bonds, real assets like agriculture and timber, infrastructure, oil/gas, and collectibles including art that are unfamiliar and hard to access. Advocacy can be re-enforced through ‘diversification’ of a different type in which portfolios are structured around different purposeful ‘themes’ such as income, aspirational/opportunistic, security, legacy/philanthropic, and fun/trading.

Whether diversification is a free lunch led to vigorous discussion among participants at the workshop. Forceful comments were made on the cost and risk of ‘diworseifying’, a consequence of agents minimising business risk, consistent with Berkshire Hathaway’s Charlie Munger’s statement that “diversification is a veil to hide behind”. A more direct cost flows from the added complexity of more asset classes demanding more advisor time, thus making fees an issue. Costs led to an engaging debate around the perceived recent failure of diversification exacerbated by the one-way path in asset prices clients have experienced for almost a generation. Some advisors saw a consequent need for more dynamic approaches to diversification.

Two brothers with different goals

A case study involved two brothers who were distinctly different investor types with different goals and objectives. Because decisions have financial as well as emotional or psychological dimensions, advisors need to appreciate families’ experiences, expectations and idiosyncrasies lest diversification remain an abstract notion. These include:

  • any relevant friction within families
  • what they most worry about
  • the time horizon they think in terms of
  • the level of control they want
  • any roles they want to play in decision-making
  • their biases and strength of their convictions
  • the extent to which unrealised taxable gains are an impediment to change
  • their personality types
  • how they think about and describe risk
  • any comparative advantages the trusts have.

These can be partly expressed in a ‘family governance document’ that can help link investment strategies to financial and emotional well-being.

Klyde, an entrepreneurial businessman who created his wealth by building a narrowly focused business, established a trust for the benefit of his immediate family and future generations. He struggles to relinquish control, making the trust’s implicit purpose somewhat ambiguous and therefore a challenge for an advisor wedded to the tenets of MPT. His brother, Cerry, a delegator with minimal interest in investing, established a perpetual philanthropic trust to support the arts with an explicit objective: spend 5% per annum to maintain its tax-free status.

Klyde had tried to diversify his businesses with disastrous results, an evident source of resistance to portfolio diversification. His trust’s initial configuration, dominated by the idiosyncratic risk of a single business, was seen as dangerously under-diversified, exposed to a meaningful risk of a sizeable capital loss that could be materially reduced through diversification. Advisors favoured slowly but tax-effectively reducing the weight of legacy assets and crafting a portfolio with more calculated bets, and direct ownership of some other assets. They recognised cash as a very active component of the portfolio and favoured a program of sizeable shifts in allocations.

Alternative investment models: entrepreneurial and transitional

The entrepreneurial model favours a concentrated set of investments familiar to Klyde, combined with interests in operating businesses aligned to his experience a bias away from co-mingled funds. This model needs to be managed by an in-house team supplemented by external advisors. The initial lack of diversity may be partly compensated for by its unique deal-flow advantages.

The transitional model reduced the weight of the legacy business and favoured a far higher weight to non-operating assets with a more conventional notion of diversification through a planned transition to a broader array of assets. This model is more accepting of co-mingled funds, and of public markets and alternative assets. Nonetheless, it is avowedly opportunistic and ready to work with Klyde in vetting opportunities originated through his networks. It demands more sophisticated external advice for origination, due diligence and monitoring.

Cerry’s philanthropic trust was less problematic. Its purpose is explicit and tax plays a marginal role, while on the psychological side Cerry is unlikely to argue for greater concentration or control. Advisors saw the initial configuration, dominated by Australian real-estate, as dangerously under-diversified, exposed to a meaningful risk of a sizeable capital loss which could be materially reduced through sales, with the proceeds directed towards diversification. Cerry’s trust also has paintings: legacy assets where he has a strong emotional attachment. Such collectibles can play a powerful diversifying role.

For Cerry, a third outsourced model was preferred where management is primarily delegated to an investment advisor with a portfolio that blends traditional public markets with a heavy mix of alternative assets. Benchmarks and tracking error were, by institutional standards, irrelevant because, being perpetual, the trust should have considerable tolerance for short-term variability and should favour long-duration and particularly real assets such as infrastructure and timber.

Conclusion

WB2.0 re-enforced the view that diversification is an effective way of reducing risk of capital loss and of lowering volatility. It is almost a free lunch. For large institutional funds it should be weakened only under justifiable circumstances. For smaller Australian private wealth funds its full benefits are harder to achieve due to tax, liquidity needs, access to unfamiliar assets and the technical nature of arguments. It is difficult for advisors to convince clients of the need for some diversification given the concentrated approach founders relied on to accumulate wealth and their strong emotional attachment to their businesses.

WB2.0 did show that the nuances of diversification are not fully understood. Its value will be questioned again if the next crisis sees all assets go down together. Nonetheless, thinking and practice have evolved. Advisors are seeking unconventional assets that offer stronger diversification benefits; they are questioning the ‘optimal’ level and type of diversification, thinking about diversifying across risk factors and exploring more dynamic approaches to asset allocation. As one participant wisely observed, “diversification is harder to deliver, but the results are better and you have happier clients.”

 

Jack Gray is a Director and Advisor, and Steve Hall is the Chief Executive Officer of investment manager and advisor Brookvine. Whiteboarding 1.0 and 2.0 are available on request via www.brookvine.com.au. Jack has been voted one of the Top 10 most influential academics in the world for institutional investing.

Estate planning and your wishes after death

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Part 1 of this series on estate planning looked at the decision-making processes involved in preparing an effective plan. Part 2 outlined the documentation required to ensure that your strategy is effectively executed, starting with your will.

In this final part, we look at areas that are easy to overlook in the overall estate-planning process but are vitally important for ensuring that your funds go to those you intended them to and that your house is in order way before that time arrives.

Powers of Attorney

An Enduring Power of Attorney is a legal document where you appoint a person of your choice to manage your assets and financial affairs if you are unable to do so due to illness, accident or absence (such as being overseas). It also applies in the event that you lose mental capacity to make decisions, and may therefore apply for many years in the event of dementia or other cognitive illness.

A medical power of attorney allows you to appoint someone to make decisions about your medical treatment if you become mentally or physically incapable of deciding for yourself.

These two documents give your chosen attorney or attorneys almost limitless power, and therefore require careful consideration and great trust. While the Power of Attorney can be challenged and an alternative Guardian appointed in the event that your attorney is behaving unscrupulously, there is no guarantee of success and a publicly appointed Guardian may be less cognisant of your personal wishes than a close family member or friend.

To guard against unscrupulous behaviour, many solicitors will advise that two or more attorneys be appointed jointly. While this can cause conflict, it creates a system of checks and balances. In the event that you have no preferred loved one or professional to appoint, you can appoint the Public Trustee in your state. Often, however, a close acquaintance will take a more personal interest and therefore be more likely to look after your wishes, and many solicitors will recommend this option.

Superannuation death benefits

Superannuation death benefits are often an individual’s largest asset, particularly if the family home is held in joint names. These are not automatically captured by your estate, and therefore you should take steps to ensure that benefits are distributed according to your wishes.

Firstly, understand how your super fund trustee deals with death benefits. Some automatically pay all death benefits to the deceased’s estate and do not distribute benefits directly. Others distribute according to their discretion, which generally favours a spouse and minor children over other potential beneficiaries such as adult children. Some offer binding (and even non-lapsing) death benefit nominations which allow you to direct to whom your funds are paid.

An SMSF generally allows all of these options, however the trust deed must explicitly provide for binding nominations. Only certain individuals can receive a superannuation death benefit directly, including your spouse (which could be de facto and same sex partners), children (including step, adopted and adult children), any tax dependants and a person who is in an interdependent relationship with you. The tax treatment of your benefit differs depending on these relationships. Others, such as parents or siblings, can only receive your superannuation benefit via your estate.

Once you know what options are available to you, choose your preferred option and document it. Some solicitors will advise to have all proceeds paid to the estate, so the will can deal with distribution. This is often the case where a testamentary trust has been incorporated into the will. In this case, make a binding nomination to your estate if this option is offered by your fund. Other specialists believe the tax benefits and flexibility of paying a death benefit pension (generally only available to a spouse, minor child or disabled child) make this a better option. Again, ensure this is documented in a binding nomination or consider a reversionary pension, while being mindful of social security and other potential considerations.

SMSFs are a particularly important area of estate planning, as the surviving trustees of the fund have full discretion as to how your death benefits are paid in the event that you have not documented your wishes in a valid binding nomination. This has led to some high-profile court cases and adverse outcomes for potential beneficiaries, which cannot be overturned, despite the clearly valid claim (in principle if not in law) of the wronged beneficiary. Ensure your solicitor has experience in this area, and ensure your trust deed and nominations are carefully prepared; inadequate documentation has caused much grief and expense.

Insurance

Non-superannuation insurance policies should have clearly specified, up-to-date beneficiaries nominated. Check these each time you receive your annual statement to ensure nothing has changed. This includes total and permanent disablement and trauma/critical illness policies that may have life cover attached. The proceeds of these policies will be paid directly to the nominated beneficiary and bypass your estate entirely, so can be an effective way of equalising an otherwise unequal distribution or ensuring your loved ones have access to funds that may otherwise take some time to become available.

Insurance policies held inside superannuation are treated as super death benefits as per the above (albeit with different tax treatment, but that’s for another article).

Ultimately, ensuring your wishes will be met after your death or in the event of your illness or incapacity can be expensive and time-consuming. However, it may be the greatest gift you leave your loved ones, making their lives a little easier in a time of grief. The complexity of these issues illustrates why a well-qualified professional is imperative in ensuring the right outcome for you and those you care about.

 

Gemma Dale is the Head of SMSF Solutions at National Australia Bank. This information is general only and does not take into account the personal circumstances or financial objectives of any reader. Readers should consider consulting an estate planning professional before making any decisions.

Should much of our financial advice be outlawed?

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Recently, a person named David Blake implied that almost all financial advice given today should be outlawed.

You often hear outlandish claims from people less than fully informed on financial advice, but David Blake does not belong in this category. His views should be respected and his claims taken seriously by advisers, directors and executives of advice firms, and investors in considering how they are advised.

Who is David Blake?

David Blake’s career straddles both academia and industry, and he’s been highly successful in both. Completing his PhD in 1986, Blake is Professor of Pension Economics at Cass Business School, City University London, Director of the Pensions Institute (which he founded in 1996), and Chairman of Square Mile Consultants, a training and research consultancy. He is also: the co-founder with JPMorgan and Towers Watson of the LifeMetrics Indices; Senior Research Associate, Financial Markets Group, London School of Economics; Senior Consultant, UBS Pensions Research Centre, London School of Economics; and Research Associate, Centre for Risk & Insurance Studies, University of Nottingham Business School.

To say that he is well qualified to voice a strong opinion on this topic is an understatement.

What did he say?

Blake led the production of a report by the Independent Review of Retirement Income (IRRI) in the UK, released in March 2016. The report was far reaching, but his recommendations regarding financial advice were especially relevant:

“The use of deterministic projections of the returns on products should be banned.”

(‘Deterministic’ effectively assumes the average outcome will be achieved and it is only this outcome that is communicated).

“They should be replaced with stochastic projections that take into account important real-world issues, such as sequence-of-returns risk, inflation, and transactions costs in dynamic investment strategies.”

In short (on reading the full document), there are two important elements of this recommendation. The first is that advice needs to consider all of the key risks, most of which fall into two main groups: investment and mortality risk. The second is that the analysis of outcomes needs to be stochastic rather than deterministic. This simply means that the range and associated likelihood of outcomes are presented, something that can be quite hard to model in practice.

By suggesting that any advice that doesn’t meet these standards should be outlawed, Blake means that offering a deterministic prognosis represents dangerously misleading information.

How does this apply to the Australian advice industry?

This recommendation is produced in a UK environment and policy setting. However, Blake has shared his views at conferences in Australia and they appear to be universal.

Does the financial advice provided in Australia meet the standards recommended by Blake? The broad answer, unfortunately, is no. Most of it has similar failings to the advice provided in the UK: namely it doesn’t account for the major risks to financial outcomes, particularly mortality risk, and it tends to assume an average outcome such as 7% per annum over a defined period.

This is largely a failing of the advice industry rather than the advisers themselves (though they should push hard for the tools they need to deliver quality advice), and most of the major financial planning software fails to address the issues raised by Blake.

Additionally, the majority of roboadvice offerings appear to fail to meet the standards set by Blake. While many provide stochastic reporting it is largely based on one or two investment risk factors (which are relatively easy to model) while ignoring mortality risk. In this respect, roboadvice appears to be at a crossroads – will it represent high-quality online advice that takes full advantage of systems designed in a clean-sheet-of-paper environment, or will it simply consist of smart graphics wrapped around basic advice tools?

Regulators are not likely to rush to implement Blake’s recommendations in the near term. However, the advice industry has been called out by a universal claim from a highly respected thought leader. It remains to be seen if there’s sufficient motivation out there to significantly raise the bar regarding the standard of financial advice. It’s also unclear if leaders with appropriate skillsets can move the industry in the right direction going forward.

There is no denying that developing tools, and using, interpreting and communicating the output are challenging areas. In my view the primary management challenge is twofold: overseeing the technical issues while successfully communicating complex issues to clients.

Facing the challenge

I’ve been to industry conferences where I sometimes lose confidence that this challenge can be met. One such conference left me aghast, the spirit of the day evolving as follows: ‘Modelling needs to consider all risks and be stochastic’ and ‘It is challenging to communicate more complex modelling to people who are not financially trained’ to ‘This is too complex and we should stop talking about all this stochastic stuff’.

Many other industries develop complex products which are explained effectively to consumers; consider for example the technology in cars and medical treatments. Too hard to explain cannot be an excuse for not innovating.

If you consider the following alternative lines for inclusion in a statement of advice, the motivation for change becomes clearer:

1. In developing your financial plan we assume that you will die with 100% certainty at the age of X and that markets will perform exactly Y% each year.

Or

2. In developing your financial plan we have considered the possibility and likelihood of you dying at different ages and have considered a large range of possible scenarios for investment markets, which we all know are difficult to forecast.

It is obvious to me which approach represents superior advice. Dismiss this article if you like, because regulatory-led changes are unlikely, but you do so at your own risk. The poor quality of advice provided to individuals all around the world, including Australia, is a fundamental challenge to an important service industry. At some point it will become a strategic issue. Some people will see the opportunity to improve an important service currently being delivered at sub-standard quality. Others will see the opportunity to profit by innovating. Whatever the motivation, I look forward to seeing our advice industry meet David Blake’s standards.

 

David Bell is Chief Investment Officer at Mine Wealth + Wellbeing. He is working towards a PhD at University of New South Wales.


Advice is silver bullet on super battlefield

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In the battle to retain super fund members into retirement, advice is the key weapon. And First State Super’s acquisition of financial planning firm StatePlus for about $1 billion is a clarion call to this new super fund battlefield. By buying a well-respected financial planning provider, First State Super signalled that advice is of paramount importance for leading super funds. If leadership means ‘taking a stand and acting on something you believe in’, this move shows advice is critical to serving members and keeping them into retirement phase.

Higher satisfaction levels

Other funds have increasingly stated the importance of advice in their plans. Advised investors, on the whole, benefit from savings, investment and insurance advice through better outcomes, and generally report higher levels of satisfaction.

These efforts seem to be paying off as, anecdotally at least, funds that make strong financial planning efforts appear to have much better member retention rates into retirement and more success particularly with higher- balance members.

But many funds have only a basic financial planning offer, provided more as an add-on service, not a core component. And the numbers from Comparator show just how modest the overall impact is: industry-wide, only 2% of members reportedly receive financial advice from their super fund each year.

Industry, and other profit-for-member funds, were once labelled the ‘sleeping giant’ of the advice business and it’s long been suspected that industry and retail funds would converge through more similar advice offers. Surely, the giant is waking up.

Strategic imperative and strategic decisions

If there’s a clear strategic imperative for fund executives to build advice capabilities, it’s not quite as clear how to do it. Executives face a number of strategic questions and opportunities:

a.  Distribute through independent financial planners? In the post FOFA fee-for-service world, the competitive pricing and performance of profit-for-member funds should place them in a strong position to compete with retail funds in distribution through independent financial planners. This is dependent on them being able to master the arcane requirements of third-party distribution, build a brand, and match the service proposition of retail funds.

b.  Introduce external planners to serve members? A number of funds, such as AustralianSuper and Sunsuper, have headed down this path by developing panels of independent financial advisers to extend the services available to members. The challenge of course is to not lose the member in the process.

c.  Build internal planning capability? Many funds such as Unisuper have ramped up internal capability by hiring a team of planners, with all the licensing, management and business process challenges that involves. Smaller funds may struggle to get the economies of scale and efficiency needed to offer a first-class effort, but larger funds may be able to do it with a significant investment.

d.  Reach the mass of members? This requires adopting a much broader focus than traditional advice approaches. The economics of financial planning delivery means that only high balance members can be served through traditional telephone or face-to-face processes. The costs per statement of advice are too high to provide advice to the mass membership. Retail firms often talk about the costs of advice being $2000-$3000 per client. Even straightforward intra-fund telephone advice can cost hundreds of dollars to deliver. Those economics aren’t supported by the typical balances of industry fund members.

The role of digital advice in reaching a larger audience

Leaders look at trends and what is happening in other industries for a competitive edge, and digital advice has the potential to be the ‘game-changer’. Using the toolkit of digital disruption changes the economics of advice delivery and opens up access to advice for all members at low costs.

Digital advice enables personalised experiences, both financial and behavioural. Digital approaches can engage the client in an ongoing journey, which makes the experience personalised, on demand (24X7), ‘in my living room’ or anywhere else. Digital advice need not be transactional based only on one-time statements of advice. It can guide. It can educate. It can provide motivation and personalised communications as needed.

And it can coexist with traditional human forms of advice. Effective triage is an essential part of strong digital advice offers. At times, people need the validation provided by another human being; at times, advice requirements are just beyond today’s digital solutions.

The US industry has been leading the way. While often referred to as robo advice, that catchy title doesn’t capture the variety of digitally based solutions currently available. Often overlooked in articles about US robo advice is Financial Engines, the ‘granddaddy’ of online retirement advice services companies. This pioneer, founded by Nobel Laureate Bill Sharpe, has for 20 years offered online retirement forecasts, advice and managed accounts to members of US defined contribution (401(k)) plans. Financial Engines currently provides advice to millions of members, with assets under advice exceeding $A1,300 billion, and investments in managed discretionary accounts of more than $A160 billion. It is the largest independent investment adviser in the US.

Others in the US are focusing on hybrid solutions. A major trend is using technology to make human advisers more efficient and allowing the interaction between consumer and adviser to be more interactive and integrated, so the customer can decide when to obtain advice online and when to call a human adviser.

In conclusion, advice will become a key battlefield for funds serving their members into retirement. As most funds don’t have a billion to spare to buy existing capability and need better ways to reach the mass membership with ongoing advice, digital advice is the most promising solution.

 

Jeremy Duffield is Co-Founder of SuperEd. See www.supered.com.au. He was the Managing Director and Founder of Vanguard Investments Australia, and he retired as Chairman in 2010.

Fintechs overcome the trust barrier

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It’s become fashionable post-GFC to label any company disrupting the financial services sector as a ‘fintech’. Small, fast-moving and innovative, these firms are primarily start-ups and offer a new approach to service, product development and ease of doing business in the digital age.

But fintech (an amalgam of financial technology) is just the latest phase of an electronic revolution that began with the advent of NASDAQ, the National Association of Securities Dealers Automated Quotation system, in the US in 1971, and was adopted by global financial markets and their operators from the mid-1980s onwards.

In that regard, fintech has been around for over 40 years and we can see the impact these technological changes have had on the financial services industry and consumers over that period.

The democratisation of financial services

While it has been a constant driver of change, it’s the combination of technology, creative thinking and new business models with the aim of solving customer problems which create the opportunities for true disruption and revolutionary change. What we are witnessing today is the democratisation, or what you might call the ‘retail-isation’, of financial services.

Access to financial markets has never been easier, accompanied by tools that allow people with little or no financial sophistication to trade for lower fees, at faster speeds, and with greater efficiency.

Technology is dramatically changing the way that business is done. But what hasn’t changed and which is absolutely key to how this business is undertaken is the intermediation process: matching providers of financial capital with users of capital.

That process provides for a use, transfer and recycling of capital in exchange for a reasonable return (to the providers) at a cost (to the users) and all undertaken for an acceptable level of risk.

Over the past 300 to 400 years we have had different names for this process; banking, exchanges, pensions and funds management, capital markets, superannuation and financial advisory. The latest form of this is peer-to-peer lending or what is now called marketplace lending.

The crucial role of trust

At the heart of this process lies the business of trust and particularly of financial trust between strangers. The history of disruption has shown us that for any new entrant to succeed they need to acquire this trust. But consequently, by causing disruption, trust is often difficult for new players to attain, primarily because consumers are inherently cautious when it comes to trusting their money with others.

It is little wonder then that people will hand that trust and their money to long-established incumbents, especially in uncertain times, the so-called ‘flight to quality’ that we saw during the GFC.

However, there are signs that this nexus is gradually breaking down. The digital revolution has altered the power dynamic and has placed consumers increasingly in control. As a result, their expectations regarding ease of use, speed, convenience, transparency, personalisation, access, security and design have all changed. To this, we can now add trust.

This hasn’t happened because of the banks and financial services companies but rather as a result of technology-driven companies such as Apple, Google, Uber, AirBNB, Facebook and Alibaba. You can see a pattern here when it comes to the transfer and exchange of money: they have in effect taken over the process of intermediation.

Their rise, together with digital disruptors in the financial services market, is due to four primary drivers of change, according to Rachel Botsman, a global thought leader on the collaborative economy who recently looked at 750 disruptors across more than 32 countries.

These drivers are:

  • complex experiences (time-consuming and frustrating processes)
  • redundant intermediaries (layers of people and processes that don’t add value)
  • limited access (to goods and services)
  • broken trust (where trust in an institution has fractured).

Each of these factors is present in the Australian financial sector, which is why banks, insurance companies and wealth management groups with their sizeable profits and high ROEs are being targeted in ever-increasing numbers by new, more customer-centric and innovative players backed by serious capital.

Not all of these operators will survive. But there are signs that companies such as SocietyOne with $100 million of personal loans and 5,000 customers, Click Loans in mortgages and Prospa, OnDeck and ThinCats in small business lending are making headway against their respective incumbents.

These Australian pioneers are part of a global trend which investment bank UBS said pose a ‘real and growing risk’ to banks and their traditional services, in a July 2016 report. UBS interviewed executives at 61 banks and nearly 28,000 customers of 210 banks in 24 countries and predicted that the take-up of new applications such as transfers, payments and peer-to-peer lending could surge by between 47% and 150% over the next 12 months alone.

That suggests consumers – borrowers and wholesale investors – are increasingly prepared to place their trust in the new financial intermediaries and lending market places precisely because they are creating a direct bond and connection between the providers of financial capital and the users of that capital.

 

Danny John is Director of Communications at SocietyOne and a former Business Editor of The Sydney Morning Herald. SocietyOne is a sponsor of Cuffelinks.

Court defends super death benefits from bankruptcy

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Protection from creditors is an unsung benefit of superannuation. Life does not always go according to Plan A.

I keep hammering it into my small business clients in particular that, while they may be passionate about their business and absolutely certain that it will succeed, they need to have a Plan B. Things can go wrong no matter how hard they work.

Superannuation is that Plan B in many cases. By putting a portion of profits away each year into super, they can minimise their tax obligations, save for retirement and protect some of their hard-earned wealth from unforeseen circumstances like a business collapse.

I always give the example of a client who had a successful software business who listened to me and put funds away in super yearly despite not wholly trusting the system. A dodgy overseas firm copied and made minor changes to his software and sold it for 10% of his price, thereby decimating his profits. He could lose everything, as the ensuing defence of his patents in court cases is wiping out his personal finances and those of his company. Even if he wins, they could just keep their assets overseas and he has no chance of recovering costs and damages. If he loses, they could chase his assets to recover their costs. The one thing protected is his superannuation, which will provide a decent, if slightly less comfortable, retirement.

The recent case of Trustees of the Property of Morris (Bankrupt) v Morris (Bankrupt) [2016] FCA 846 shows what happens when superannuation, bankruptcy and the payment of death benefits intersect.

Background

Ms Morris became bankrupt 3-4 months after her husband, Mr Foreman, died. Mr Foreman held two policies with two different superannuation funds: AustSafe Super and Plum Super.

After becoming bankrupt, Ms Morris received three separate payments. Plum Super made a life insurance payment of $311,865.95, which is not controversial, as section 116(2)(d)(ii) of the Act provides that divisible property does not extend to life assurance policy proceeds of a bankrupt, or their spouse, received on or after the date of bankruptcy.

What was ‘controversial’ was AustSafe Super’s payment of $45,392.48 and Plum Super’s payment of $67,240.27. Both funds made these payments to the bankrupt under discretionary powers, as Mr Foreman had not nominated any dependents or beneficiaries.

Ms Morris’s bankruptcy trustees applied to court in respect of these payments, arguing that the superannuation monies received by the bankrupt were after-acquired property that vested in them (as bankruptcy trustees) and was therefore divisible among the bankrupt estate’s creditors.

I am not a lawyer so I will not go into details of the argument but there is a good blog on the subject by Bryce Figot of DBA Lawyers – see more here and the actual case decision here.

In summary

Justice Logan held that prior to the superannuation fund trustees’ exercising their discretion in favour of Ms Morris, she had no interest in either fund. However, on this favourable decision, an interest was then created in the superannuation funds, and therefore these payments (totalling $112,632.75) made to Ms Morris (after bankruptcy) were held to be captured by s116(2)(d)(iii) and s116(2)(d)(iv) of the Act. Consequently, the bankruptcy trustees were unsuccessful with their application and Ms Morris retained the money.

So superannuation death benefits received by the bankrupt were protected from bankruptcy trustees.

I have not seen any previous guidance or authorities about the meaning and effect of the above sections of the Act. The decision seems to be consistent with the intention of legislation to protect and preserve benefits in respect of retirement for both members of funds as well as their spouses and dependants.

If you or your spouse are in business, or in a highly litigious profession, or high-risk investors, then talk to an advisor about your Plan B.

 

Liam Shorte is a specialist SMSF advisor and Director of Verante Financial Planning. This article contains general information only and does not address the circumstances of any individual. You should seek professional personal financial advice before acting.

Banks team up with their FinTech competitors

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These are challenging times for the incumbent heavyweights of the financial services sector. Beset by regulatory, governance, technological, capital, and investment issues, they are increasingly facing competition for business from a whole host of new players, primarily from ‘FinTechs’.

Growth of marketplace lending

In the case of online lenders, this trend began in the UK in the mid-2000s when Zopa, the world’s first digital and now Europe’s largest peer-to-peer (now called marketplace) provider, launched, quickly followed by the likes of Prosper, Lending Club, and OnDeck in the US.

Eleven years on, Zopa has lent around 1.8 billion pounds to more than 150,000 borrowers funded by 63,000 investors of whom 53,000 are said to be active participants into its lending marketplace.

The US players have had a similar impact on the US home market by exploiting a sector of the financial system not previously well-served by the banks. Prosper, for example, has originated $US7 billion of funded loans while Lending Club, now the world’s largest marketplace lender, has provided in excess of $US20 billion in finance for personal and business loans.

This growth hasn’t been without problems. Lending Club has been hit by internal governance and management troubles over the past few months, while Prosper and OnDeck have had to curtail their operations amid concerns about the state of the US consumer credit market.

But what all of these new-style lenders have shown over time is that there is a demand from consumers, previously wedded to their banks as their primary financial provider, for the new generation products they offer.

These companies have enjoyed relative success by targeting particular segments of the consumer finance market where the speed of their digital service, offers of better customer experiences and, in the majority of cases, lower interest rates have left traditional lenders unable to keep pace. And just last week, Lending Club announced it was moving into re-financing car loans to exploit that sector.

Developments such as these have prompted different responses from established players and led to questions from boards, analysts, and investors as to whether banks should compete head-on or collaborate with these upstarts to protect their existing markets.

Fighting digital entrants on their own turf

A competitive response requires legacy companies to fight on the terms that gave rise to the FinTechs in the first place. Take, for example, the launch last month of Marcus, an online small consumer loans platform from Goldman Sachs in the US designed to take advantage of a market grown by Lending Club and Prosper.

Collaboration between the old institutions and the FinTechs varies, from taking part as shareholders or providers of seed capital to becoming loan funders and referrers of customers who the banks, for instance, can’t or won’t serve.

But until the new players get scale in terms of total business and customers, it’s not surprising that the banks, particularly the major ones with their dominant market shares, have tended to be slow to react.

Big Four understand benefits of digital collaborations

This appears to describe the current trend in Australia, where the entry of marketplace lenders like SocietyOne from 2012 onwards added new competitive pressure to the Big Four banks and other traditional lenders in areas such as personal loans, car finance and SME lending.

That pressure, while low level at the moment, is real, according to Ernst & Young’s 2016 Global Consumer Banking Survey released a couple of weeks ago.

Ernst & Young surveyed 55,000 people globally of whom 40% indicated they were becoming less dependent on a bank as their primary financial services provider and were increasingly excited about what alternative finance companies could provide.

While initially slow to respond, banks certainly understand the threat posed by the digital era. In the latest annual results announced by NAB on 27 October 2016, management devoted several slides in their investor presentation pack to improvements to their digital banking services to help compete with those offered by new players.

What has been interesting, though, is the increasingly two-pronged approach taken by the big banks in Australia to collaborate with start-ups and their investors as part of an ‘if you can’t beat them, join them’ strategy.

Westpac kicked that off in a significant way when it created the first retail bank-owned venture capital fund, Reinventure, in 2014 with the aim of backing and learning from digital disruptors, primarily in the financial services sector. It made available an initial $50 million and has since topped that up by the same amount.

From its first investment, in SocietyOne, Reinventure now owns stakes in 13 start-ups including payments platform PromisePay, secure bitcoin platform CoinBase, and SME lending marketplace provider Valiant.

Westpac has since taken a direct stake in new online mortgage lender Uno and also refers customers to the digital SME lender Prospa (not to be confused with US Prosper). The Commonwealth Bank has the same arrangement with small business loan provider OnDeck in Australia.

As for NAB, it recently set up its own venture capital fund NAB Ventures with $50 million to invest in start-ups while the bank teamed up with Telstra in June this year to launch a new SME-dedicated platform called Proquo.

Small business has been the target too for ANZ, which at the start of 2016 partnered with technology-led Honcho which helps new SMEs to set themselves up through the registration process. ANZ also has a tie-up with a Melbourne start-up incubator called York Butter Factory.

Mutually beneficial arrangements

But it’s not just the major banks who see benefits in co-operating with FinTechs. Mutual banks and credit unions, who have seen the proportion of their total lending book made up by personal loans slide over the past 20 years from 52% to just 8% now, are teaming up with new companies to tap back into this market as a new growing asset class.

Customer-owned groups like G&C Mutual Bank, Beyond Bank Australia, Regional Australia Bank and the Maritime, Mining & Power Credit Union are doing that in two ways: as equity shareholders and as direct investor funders (with other credit unions) of borrower loans where the returns are currently averaging 10%.

This sort of collaboration shows how digital disruption can benefit incumbents and create value, despite understandable investor concerns that the opposite is likely to occur.

 

Danny John is Director of Communications at SocietyOne and a former Business Editor of The Sydney Morning Herald. SocietyOne is a sponsor of Cuffelinks.

Asset test changes create questionable advice

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From 1 January 2017 the asset test taper rate for the aged pension will increase from $1.50 to $3.00 per fortnight for every $1,000 in assets held above the threshold. This has led to some rather dubious analysis and advice suggesting that clients may be better off getting rid of their assets to maximise their age pension entitlement.

The reasoning goes along the following lines:

  • if a retiree’s assets exceed the new threshold by $100,000, their age pension will be reduced by $300 per fortnight or by $7,800 per annum
  • so for a retiree to be better off, they need a return of at least 7.8% on the $100,000
  • if they can’t achieve a return of 7.8%+, then they are better off placing that $100,000 outside of the asset test. They can do this by spending it on renovating the family home, a holiday, pre-paying funeral expenses or gifting the money to children and grandchildren (within the permitted limits).

The ability to draw from capital

This analysis, and the advice flowing from it, is questionable as it ignores the impact on the retiree’s annual ‘income’ from drawing down their capital. The goal of a retirement income strategy should be to maximise the retiree’s sources of cashflow over time. This can be achieved by drawing down savings in combination with a part pension rather than exhausting savings to be eligible for the full pension.

We can compare two scenarios. The first scenario is where a retiree spends the $100,000 (such as on a house) to reduce their assets and be eligible for the full age pension. In the second scenario, they keep the $100,000 invested, drawing down $15,000 each year until the amount is exhausted. For simplicity, this example ignores any drawdown of assets held below the asset test threshold levels.

The following chart compares both scenarios. The first scenario (spending the $100,000 immediately) is shown by the straight black line on the chart. This is the full age pension for a couple of approximately $34,000 per annum (there may also be energy supplements which boost this amount). This is in current dollar terms so the amount does not change over time with inflation.

The second scenario (drawing down the $100,000 over time) is shown by the columns on the chart. The blue section of the column is the part pension that the retirees receive after the reductions for the asset test (note for couple home-owners the income test will only have a greater impact on the pension once assets above the threshold level fall below about $27,000). The red section of the column is the additional income the couple receive each year by drawing down $15,000 from their savings. Assuming an investment return of inflation + 4% per annum, the $100,000 capital not spent on the house provides an income stream of $15,000 per annum for seven years and in year eight the couple can draw down about $13,500.

annual-retirement-income-021216

Not spending on the family home provides higher income

Drawing down their $100,000 as an ‘income’ stream of $15,000 per annum will, in combination with a part pension, provide a materially higher annual income and standard of living compared with spending their $100,000 in year 1 to maximise their entitlement to the age pension. Of course, the family home has not benefitted from the $100,000 capital spent on it, but nobody knows how much that will improve its value (which may well go to the beneficiaries of the estate in any case).

The faulty reasoning involved in spending the $100,000 in year 1 is a classic example of mental accounting bias. This bias places a different value on a dollar of income and a dollar of accumulated capital in being able to support a retirees’ lifestyle. In this example the retirees have placed a greater value on the ability to access an additional $7,800 in aged pension in year 1, over the $15,000 in additional ‘income’ from drawing down their accumulated savings.

 

Gordon Thompson CFA is Senior Manager, Platforms, at Perpetual. This article is general information and does not consider the needs of any individual.

SAFs can provide powerful estate planning solutions

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A small APRA fund (SAF), which is essentially an SMSF with a professional trustee, can provide valuable estate planning solutions for families with particular needs. In this article, we outline two strategies where an SAF may assist families in second (or subsequent) marriages and those caring for intellectually disabled children.

The SAF blended family strategy

With one in three marriages ending in divorce (according to the ABS in 2013), it’s no surprise that the number of blended families in Australia is rising. Those who remarry are often keen to ensure their new spouse will be well looked after if they die. However, there is also often a strong desire to leave assets to children from previous marriages. This can be particularly important when people remarry later in life and do not have any subsequent children.

Using the SAF blended family strategy, a super death benefit can be paid as a pension to a second (or third) spouse (known as the pension beneficiary) throughout that spouse’s life. Then, when that spouse dies, any remaining capital is returned to the original deceased super member’s estate and the capital is distributed to their children or other superannuation death benefit dependants (the remainder beneficiaries).

The strategy requires a special purpose superannuation trust deed that supports the death benefit design to be included as part of the super fund.

Members make a written binding determination to the trustee confirming the identity of the pension beneficiary and the remainder beneficiaries. The binding determination also includes the calculation method of the maximum pension benefit to be paid to the pension beneficiary.

Calculating the pension

The pension is calculated as a multiple of average weekly ordinary time earnings (AWOTE), which is currently $1,516 (as at November 2016) or $78,832 per annum. The use of AWOTE provides a strong indicator of purchasing power and provides members with a sound basis for determining their spouse’s future income needs.

For example, if a member wanted their spouse to receive an annual pension of $100,000 they would currently select an annual pension of 66 times AWOTE ($1,516 x 66 = $100,056 per annum).

The annual pension payment will be adjusted as at 1 July each year to reflect the updated AWOTE figure. The multiple of AWOTE will not change. The only other determination in calculating the annual pension amount is that the minimum pension required by superannuation law must always be paid. If the multiple of AWOTE chosen by the member was less than the minimum annual pension required by law, the higher minimum would be paid.

The pension beneficiary can vary the annual pension payment between the superannuation minimum pension amount and the amount previously determined by the member. However, the pension beneficiary cannot elect an annual pension payment above the amount pre-determined by the member.

The pension beneficiary cannot commute or roll over the pension payment, however they can forfeit their benefit and have it passed to the remainder of the beneficiaries at any time.

On the death of the pension beneficiary

Following the pension beneficiary’s death, any remaining balance is paid to the remainder beneficiaries. The payments can be made directly to the beneficiaries or may be paid to the original member’s estate and distributed via testamentary trusts.

In a SAF, the professional licensed trustee is an unrelated, independent and unbiased party.

While the blended family strategy outlined in this article is available in a SMSF, the concern for many people is that if there is friction between the second spouse (often also a member of the SMSF) and the children from previous marriages, things may not go to plan.

With cheque book in hand, the second spouse could disappear with the money. While the children would have recourse for breach of the trust deed provisions, locating the spouse and commencing legal proceedings could be a lengthy and expensive process.

Intellectually disabled adult children

SAFs can also provide members caring for intellectually disabled children with effective solutions for asset protection and financial care after both parents die. Often this involves planning for the care of an intellectually disabled adult child in their 50s or 60s.

Superannuation funds can provide tax-effective death benefit pension payments to intellectually disabled adult children, who, unlike non-disabled children, are not compelled to commute their death benefit pensions at age 25. The impediment of the disabled person (or their legal personal representative) needing to be a trustee is removed when using a SAF because, unlike an SMSF, a SAF has a professional trustee.

Following the death of the parents, the superannuation in the SAF can be paid as a tax-effective income stream to the intellectually disabled adult child.

The strategy works the same as the blended family strategy, however, rather than pre-determining a pension amount for the disabled person, the income is determined in consultation with family and carers and based on the person’s individual needs.

The existence of the professional trustee can also ensure that the disabled person continues to receive ongoing needs (medical, lifestyle, housing and financial) once the parents have died. Further payments can also be made from the pension to meet additional medical and lifestyle requirements.

Conclusion

A SAF can provide an effective estate planning tool for blended families who wish to provide for a second spouse during their lifetime and also wish to leave assets to children from former relationships. They can also provide peace of mind for families caring for disabled children.

Costs associated with managing a SAF are summarised in the Cuffelinks article, The other self-managed super funds.

 

Julie Steed is Senior Technical Services Manager at Australian Executor Trustees. This article is general information and does not consider the circumstances of any individual.

Five questions after Super Scott’s Santa surprise

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alice1Contrariwise,” continued Tweedledee, “if it was so, it might be; and if it were so, it would be; but as it isn’t, it ain’t. That’s logic.”

 

Treasurer Scott Morrison has delivered the Christmas present to the financial planning industry that it had glimpsed six months ago but was too excited to actually believe – massive new complexity to the superannuation system. The body of Simpler Super has been incinerated, buried and interred. RIP Simple Super. In its place is a labyrinth of new rules that would make Alice wish she had never gone down the rabbit hole. Long live complexity, bureaucracy and tinkering governments.

Quite what we have done to deserve this exhilarating Christmas present is a mystery, but we’ll take it. The need for superannuation and wealth planning advice just became essential. Whatever next? Taxpayer subsidised advice (as the system is now utterly incomprehensible to all)? We are now prepared, like the White Queen, to believe six impossible things before breakfast.

The lucky folk who have had their superannuation retirement savings subject to hot debate recently have some big decisions to make over the next six months. We highlight five questions of critical importance.

1. Pension, accumulation or outside super due to the Transfer Balance Cap?

The recent passing of the legislation represents the biggest change to our superannuation system in a decade, with a limit imposed on how much you can save in superannuation and how much you place into a tax-free pension. At least you aren’t hit with massive taxes if you withdraw the amount above the Transfer Balance Cap from super.

From 1 July 2017, if you have less than $1.6 million then you will still be able to save for your retirement and make additional personal after-tax contributions much like the current system. However, once you reach the $1.6 million balance (per member), whether it be from capital growth or additional contributions, you will no longer be able to make your non-concessional contributions from after-tax monies.

There are no grandfathering arrangements for those who already have more than $1.6 million in super. If you are a pension member, then the most you can have in the tax-exempt pension environment is $1.6 million. If your pension balance exceeds the Transfer Balance Cap, you will need to transfer the excess back into an accumulation account or remove it from the superannuation environment (for example, if your personal marginal tax rate is zero versus 15% in the super accumulation phase).

The alternative method applies a proportioning approach where the tax-exempt percentage of the fund is determined by an actuary based on the balance of pension interests to accumulation interests. If you have substantial income-generating assets outside of super, then it may be worth keeping your surplus super assets in the accumulation phase. This is your first major decision.

2. Can I still make a large contribution into super?

This depends on when you plan to contribute and how much you already have in super. The non-concessional limits are set to reduce from $180,000 a year to $100,000 a year from 1 July 2017, which means the three year bring-forward cap will be limited to $300,000. To add to the confusion, transitional bring-forward caps will apply if you have already triggered the bring-forward caps in the last two financial years but have yet to utilise the entire cap. Got that?

If you have the capital to consider a large non-concessional contribution, you may wish to act before the end of this 2016/2017 financial year, irrespective of your total superannuation balance. With the upcoming Transfer Balance Cap, individuals under 65 still have the capability to make a non-concessional contribution up to $540,000 within the next seven months (provided you haven’t already triggered your bring-forward arrangements). Even if it pushes your balance over $1.6 million, lock it into super now and deal with the pension transfer issue later. This will be one of the most significant decisions for higher net worth individuals to make over the next six months. You may even decide to borrow the funds to make one last significant contribution to super. Don’t ask us for a unique answer, as it depends on your circumstances and, frankly, like the Mad Hatter, ‘we haven’t the slightest idea’.

3. Is segregation of assets still possible?

Yes and no. Curiouser and curiouser! Today, most SMSFs operate under a segregated approach where members could cherry-pick the assets used to support their pension account. This is a useful tax-planning tool where the pension assets have a tax-exempt status and therefore do not pay tax on the investment earnings or realised capital gains. The alternative method applies a proportioning approach taking into consideration the percentage of the fund that is tax-exempt based on the balance of pension interests to accumulation interests.

From 1 July 2017, SMSFs will no longer be able to use the segregation approach for tax planning purposes if a member’s balance exceeds $1.6 million in the sum of any superannuation structure, be it the SMSF, retail or industry funds. This essentially prevents SMSF members cycling assets between accumulation and pension phase in order to maximise tax concessions available when a Capital Gains Tax (CGT) event arises.

On that note, there is the need for careful planning when transferring the excess amount from pension to accumulation before the end of the financial year as CGT relief may be available.

For the impacted members who have assets supporting pensions before 9 November 2016, you may wish to review the underlying assets and ‘reset’ the CGT cost base before 30 June 2017 to receive tax concessions on the capital gains that would otherwise apply if you had sold the pension asset. You don’t have to sell the asset to reset the cost base and apply the CGT relief.

The CGT relief should not be applied to all assets as those currently on unrealised capital losses may be better off to continue carrying the original cost base whilst the assets on large gains, (particularly bulk assets such as property) may benefit from revaluing the cost base before 30 June 2017. If you have an asset sitting on a large gain, it may be worth considering the CGT relief but it is an irrevocable election which means there may be some tax liability when you sell the asset in the future.

4. What happened to Transitioning to Retirement (TTR)?

Remember the days where you could access your super at 55 (or older), continue to work, pay less taxes but keep the same cashflow? Well, the government has caught up to all the smart people employing the TTR and salary sacrifice strategy, meaning there is no longer any tax arbitrage from transferring your super balance to a TTR pension as opposed to retaining the funds in accumulation phase. This is because the 15% tax on investment earnings will continue to apply up until the age of 65 (the magic age where everything becomes unrestricted). If you have a TTR pension, you will need to decide whether to roll into an account-based pension or to roll back into an accumulation account. You’ll also need to determine whether you have met the SIS definition of ‘retired’ (it’s not a definition you might expect).

5. Is it time to switch to an OPP?

If you don’t currently have a financial planner and you are in the group of the so-called ‘1% of impacted pension members’ (we believe Mr. Turnbull would refer to this as a ‘post-truth’), then it may be time remove yourself from the DIY nature of managing your SMSF and switch to an OPP (Other People’s Problem).

An OPP is a complex structure that involves the stimulatory process of removing and spending all your excess super balance to take you just above the new age pension assets test threshold of $250,000 and so entitle yourself to the maximum age pension (this strategy sometimes goes by the less familiar term of PQE – the People’s Quantitative Easing). This kills two regulatory birds with one stone, as the assets test taper rate will double on 1 January 2017 to $3 per fortnight per $1,000 of assets (that is, if you exceed the threshold by $100,000, your pension drops by $300 a fortnight or $7,800 a year). Unless you can find a risk-free way to beat a return of 7.8%, an OPP is worth considering.

Merry Christmas, Mr Morrison

Whilst it’s fair to say that Scott Morrison has cut short the Christmas holidays for financial advisers and accountants, his poster hangs on all our bedroom walls.

alice2It may be worth pointing out that the childcare industry is a warning not an instruction manual. If you make a service so expensive and complex by regulating it to within an inch of its life, and you then have to offer taxpayer subsidies just so that these same taxpayers can afford to use it, you are officially on the road to hell. Or, as Alice remarked, “if you drink much from a bottle marked ‘poison’ it is certain to disagree with you sooner or later.”

“If I had a world of my own, everything would be nonsense. Nothing would be what it is, because everything would be what it isn’t. And contrary wise, what is, it wouldn’t be. And what it wouldn’t be, it would. You see?”

We do, Alice. It would be so nice if something made sense for a change.

 

Diana Chan is Head of Compliance and Jonathan Hoyle is Chief Executive Officer at Stanford Brown. This article is general information and does not consider the specific circumstances of any individual, and is based on a current understanding of the legislation.


Careless estate planning: how artists can lose their legal voice

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When a famous person dies, particularly if they were involved in producing art of any type, the legal implications are like any death, but on steroids (or stronger). Soon after George Michael was found dead on Christmas Day 2016, different players involved in his affairs clashed. A boyfriend allegedly released some of his music on the internet.

After a musician or actor dies there is often huge demand for their work. It is estimated that the value of George Michael’s estate increased by 10% or more than $10 million after his death. Whether copyright material is released to satisfy sentimental demand or financial motives, there are winners and losers financially. This creates conflict. While the conflict is in the public eye it increases the tension, but we suggest that this conflict is there even if the person is not famous.

Enforceability of legal contracts

When someone dies, they obviously can no longer enter into legal contracts. Contracts executed by them prior to their death or pursuant to appropriate agency agreements, if properly drafted, can bind their legal estate. In order to cash in on the commercial opportunity of artistic deaths, it is important that a trusted person is able to bind the estate. That person is usually the person the appropriate court declares is their lawful executor or administrator. The word ‘lawful’ is key here because there can be competing applications to be the deceased’s legal personal representative.

There may be allegations that the person was not of sound mind when they named an executor in a will or that such an appointment was later revoked or that the person is disqualified from acting in that capacity. If the deceased does not have a will, in NSW the person with the largest interest in an estate will usually be their legal personal representative. This means that the dispute comes down to who was the deceased’s de facto spouse or which brother or sister first makes an application to the court.

There is often a perception that being the legal personal representative gives a person an advantage. It is certainly true that they can deal with the deceased’s assets but they may also have to account for same.

Sort it out in a valid will

All of this would be simpler if the deceased named people who they wanted to be their executor, and who agreed to play that role, in a valid will. David Bowie apparently named his business manager and his lawyer as his executors. However, it is understood that his lawyer has renounced so will not be the executor. We can only guess at whether this is to manage a conflict of interest.

In our experience, clients select their executor carefully to ensure that the people who step into their vacated shoes are able to work well together and are disappointed if one of those people decides not to act. It may be that the ‘check and balance’ in that case is no longer present if there is only one executor. How sure are you that you have got the combination of executors who will act for you?

Some professionals charge large fees for acting as executor. It is reported that Michael Hutchence’s estate’s legal fees were more than $670,000, leaving an insubstantial amount for the beneficiaries.

Usually, being an executor of an estate in which you are not a beneficiary is a thankless task. We currently act for two executors for a deceased alcoholic. One of their motives for acting is that the residuary beneficiary of the estate is a charity which they support. They have had to organise a funeral, pay for it (so they are owed money) and sign countless forms and submit certified copies of identification documents to banks and super funds.

The cases can be even more complicated if there are tangible and intangible assets such as copyright and contractual rights. Closer to home, Max Dupain’s Sunbaker photograph was caught up in a 1992 dispute about the distribution of his photographs and negatives between his widow and his collaborator.

Properly representing the deceased

A risk for an artist is that their executor will collude with the beneficiaries to deal with their art in a way that is contrary to the wishes of the deceased. If there is no-one acting as the conscience of the deceased, who will have a right to call ‘foul’?

The solution in many cases may be to have a ‘literary executor’ who has clear authority, for an agreed fee, to manage commercial and artistic matters for the deceased. Pending a grant of representation, this person could issue strong warnings to those misusing the deceased’s copyright and, on becoming the legal personal representative, call in the assets of the estate and manage the estate for the benefit of all of the beneficiaries. The literary executor can be answerable to third parties with the result that the wishes of the deceased, their public and their beneficiaries are best managed.

 

Donal Griffin is a Principal of Legacy Law, a legal firm specialising in protecting family assets. This article is educational and not personal advice, and does not consider any individual circumstances.

A robo response: digital wealth advice will engage at all levels

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Graham’s Centrelink/robo analogy raises a valuable point that if the fact-find has deficiencies, then the outcome is likely sub-optimal. I think the analogy is a bit too harsh in that the Centrelink issue was a ‘behind the screen’ data matching problem. That is, it didn’t ask the end client for any input about their current circumstances. However, there is no reason why a computer interface can’t ask the relevant questions, it simply relies on the smart minds coding the programme to be given the right instructions. The first versions of digital wealth managers (robo 1.0 if you like) do have online fact-finds that engage the client (albeit there is a range of depth to these).

Robo 1.0 as a ‘fund of funds’

The robo 1.0 advisers are a ‘fund of funds’ approach via an online interface. Fund of funds investment models have been around for decades (in human form) and the robo 1.0’s that I have seen are simply a better – that is, rigorous, lower cost, and convenient – approach to what was previously done via pencil and calculator. Think of it as applying statistics to what was previously predominated by ‘gut feel’, much like the Oakland A’s Billy Beane’s approach to using statistics in the selection of baseball players to drive the A’s to the top of the league (popularised in the Michael Lewis book, Moneyball). This approach of statistics and rigour to selection is now widespread across professional sports because it worked.

Robo 1.0 sits as a viable alternative to consider alongside any other fund manager choice. At its core, it uses the power of passive indexing and academic research that shows up to 90% of portfolio volatility is explained by asset class selection. It concentrates on diversification across asset classes, and within an asset class, via the index fund (or more likely Exchange Traded Funds or ETFs) selection. It is relatively safe and dependable for those who take a ‘set and forget’ long-term approach to their portfolio.

One of the drawbacks of this approach is the fact that you need to liquidate your current portfolio, and send the money to the robo to invest into the underlying basket of ETFs (a fund of funds structure). This liquidation means incurring any relevant capital gains taxes. This is perhaps why the client skew is heavily toward millennials. They are early in their investment journey where this capital gains hurdle isn’t such a barrier to adoption.

Robo evolution, technology and humans

You shouldn’t think this is the end of the robo technology story. Consumers of all services are increasingly comfortable with the benefits technology can bring. It is perhaps better to view the ‘robo’ industry through the lens of the mobile phone industry. Robos are probably past brick phones and are up to at least flip phones, not yet at, but rapidly heading toward, smart phones (remember even before the iPhone 7 came six generations of iPhones!). Technology moves forward and looks to solve consumer pain points.

The digital wealth advice (robo) industry is evolving as well. It is rapidly moving more to ‘human augmented advice’ rather than resting on its laurels at fund of funds via ETFs. This means it is moving to a process-automation approach, and this approach is best delivered through a hybrid model – human assisted digital wealth advice rigour if you like. This model is exemplified by Vanguard in the US where they have had overwhelming success. The client numbers and funds onto their platform via their human assisted approach is testament to this.

Others such as Schwab, Merrill, UBS, Raymond James and even Wealthfront and Betterment have either launched or announced plans to launch human adviser assisted ‘robo’ offerings into the US market. Yes, human augmented is most likely where it all starts to really impact the industry. The Vanguard Personal Advisor Services model is delivered via a call centre approach rather than traditional face to face meetings. Smart phone video call technology is accelerating this trend. It includes the cost efficiencies of an ETF approach, but coupled with the ability to interact with a human for that ‘sounding board’, confidence and discussion regarding specific personal nuances.

The Vanguard approach still has the limitation of being a fund of funds model, so the liquidation on entry issue isn’t solved. The best of breed will be those that can handle legacy assets, in other words, look at a current portfolio as it stands and give advice about how to ‘fix it up’ whilst minimising costs. Think of it as the mass customisation of portfolio advice, or individually-advised accounts at scale. Computers are excellent at this sort of problem solving, especially when boundaries are set by a human operator.

In my opinion, the reason for the human-augmented model success is the blending of a lower cost with the ability for the human adviser to perform the role of investment and planning coach. Often this is as much about psychology of the investor, which the industry is now calling ‘gamma’ (ie beta = market risk, alpha = selection risk, gamma = emotive risks, or the behavioural biases that affect your investing. Computers are methodical, they don’t do gamma well (except in sci-fi movies).

Where do I think the industry will get to?

Like everything in business, the winning approach is the one that produces the most convenient customer experience of the desired quality at the lowest price point. The ‘experience’ a consumer wants in advice varies over time depending upon the advice needs. Sometimes it is just portfolio rebalancing, at other times it is more strategic around estate planning, tax strategies or establishing investment vehicles.

I expect to find the professional practice of the future to include all three levels of engagement under one roof. Online 24/7 self-serve for simple matters I can do myself, video call for when I feel comfortable but want a sounding board, and face-to-face for when I have a complex issue and I want to talk through scenarios.

At all three levels the core will be an ‘advice engine’ (the robo) that does the donkey work (hat tip Chris Cuffe for that term) of number crunching cost effectively.

Digital wealth advisers (the politically correct name for ‘robos’) will be an integral part of the future – just like smart phones – but that future is also most likely to be embedded into a human assisted overlay. People engage best with people.

 

John O’Connell is Chief Investment Officer at Macquarie BFS and Founder, OwnersAdvisory by Macquarie, a digital wealth adviser and a sponsor of Cuffelinks.

Lessons for roboadvice in Centrelink debacle

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‘Robo’ has rapidly become the prefix of choice for anything to do with automation or robotics. The biggest local political story of the Australian summer was the use of Centrelink’s computers to chase overpayments to welfare recipients. It was a ‘robo-debt’ campaign, featuring ‘robo-assistants’ to answer questions. An estimated 169,000 robo-debt letters had been sent by January 2017, with over a million more expected in coming years. It was a political fire-storm with thousands of the least wealthy Australians receiving debt notices in the days around Christmas.

The problem was not the attempt to curtail the burgeoning welfare budget. That is a necessary step at a time when 11% of the population draws a full or part age pension, and increasing numbers will continue to do so for decades to come. The problem was the method. The Centrelink computers were sending out 20,000 debt letters a week, the same number previously sent out each year.

Computers replaced humans

Centrelink usually relies on self-reporting for welfare claims, with clients maintaining their own records on the MyGov website with checks at personal meetings in Centrelink offices. If a client found some temporary part-time or casual work, then nothing for a few months, this could be explained across the desk and adjustments made accordingly. By taking account of the wider set of circumstances, verified personally by humans, there were fewer reported breaches.

Centrelink offices are crowded places at the best of times, with long waiting lines where clients take a number as if they are buying bacon pieces from Woolworths. They wait an hour or two to be called, even if they have an appointment, and sit in front of an officer who is obliged to ask a wide range of questions. What have you done to find full-time employment? Have you looked for voluntary work? How many hours of part-time work have you done? Let’s update your assets and liabilities, and have you gifted any money to anyone? The client then signs the form as a legal document, verifying everything is accurate.

It is much like a financial adviser collecting data for a Statement of Advice.

The downside of this personal, more equitable approach is the massive cost of Centrelink officers sitting across a desk chatting to each person. Instead, in the robo-debt campaign, Centrelink trawled through the income records of its clients at the Australian Taxation Office (ATO). The government argues it is the only way to claw back overpayments in the age pension, budgeted at $1.1 billion. Amid the claims and counterclaims, it’s likely that a minority of the letter recipients owe a debt.

The relevance to roboadvice

Roboadvice comes in many shapes and sizes, and we already have robo 1.0, 2.0 and 3.0 as new developments occur every week.

In the enhanced versions, call them 2.0 and 3.0, robo is an adjunct to a full-service offering, a more efficient way to collect data and record preferences as part of a complete face-to-face relationship. Elsewhere, digital services advise clients on a range of investments available to meet their risk tolerance and goals in a more cost-effective way, offering market commentary and delivering alternatives to a wider audience than traditional advice affords. A human is available for a chat.

In the US, the leading robo-advice providers have recognised this need as they move beyond the basic robo. According to FinancialAdviserIQ (a Financial Times service):

“New York-based Betterment, an early pioneer in online investment advice, says it’s joining a growing number of fund providers and independent wealth managers who are turning to ‘real-life’ advisors to help manage client accounts.

On Tuesday Betterment launched two new services. Its ‘plus’ offering charges 0.4% and lets clients of its basic ‘digital’ platform make one call a year with a human advisor. The all-robo option’s fees are being streamlined to 0.25% a year.

Betterment also says it’s now going to provide a ‘premium’ service for 0.5% where clients can call human advisors on an unlimited basis during weekdays. To boot, the company says each advisor will be fully licensed and expected to hold CFP designations.”

What about robo 1.0?

However, the version most people identify as ‘roboadvice’, the fully ‘automated or robotic’, remains robo 1.0, a relatively simple end-to-end investment sales platform. These basic robo models ask a few questions about risk, income and assets, and recommend a simple, ETF-based portfolio.

This simple robo approach is most exposed to the Centrelink comparison. They use an algorithm to select a suitable portfolio, but it’s based on a cursory glance at the overall circumstances of the investor. The process leads to a product sale without knowing if it is suitable for the long-term goals of the client which comes from a detailed discussion of personal circumstances.

In the Centrelink analogy, the algorithms look at a small part of the overall picture, creating a potential for incorrect assessment. The automation delivers snapshot ‘advice’ to the masses who cannot afford to see a full-service planner.

As Wade Matterson of leading consultants, Milliman, said in late 2016:

“Many automated advice providers are simply replicating the increasingly outdated traditional advice process, which places an investor’s risk tolerance at its apex and delivers product-led solutions … a more nuanced approach to risk profiling will include different components such as risk aversion (the flip side of risk tolerance), risk capacity (the financial ability to endure losses) and risk need (the amount of risk needed to likely achieve goals).”

Examples of potential robo shortcomings

Consider some examples of the shortcomings of many roboadvice processes:

1. Mortgage versus super

The basic robo models do not deliver financial planning, but rather online investment selection. Most cannot answer basic ‘advice’ questions. Advice does not start with which ETF to invest in, but questions such as:

“Can you tell me whether I should pay off my mortgage or invest the money into super?”

2. Coverage of the full picture

Imagine you meet a financial adviser and ask how you should invest $20,000. You tell her that you have total investible assets of $2 million, you own your home, you expect to retire in five years and you are reasonably risk tolerant. What type of portfolio should be assigned to the $20,000?

Based only on this information, it does not matter. Without knowing how the other $1.98 million is invested, or more about long-term goals and income needs, who cares how $0.02 million is allocated? The human adviser should address the preferred outcome for the entire portfolio.

Most of the robo 1.0 models only ask a few questions about risk tolerance to determine how much of the $20,000 to allocate to riskier assets (equities, property) versus defensives (term deposits, bonds), and then recommend a portfolio. There is no recognition that it might be allocating even more to an asset class that is already overweight in the rest of the portfolio.

4. Imbalance in Australian indexes

A major selling point of most online investment products is the low cost (although this often disguises all the expenses). To meet a price point, the portfolios usually consist of index ETFs. But there is a problem in Australian indexes.

The local market is heavily weighted to a few companies, mainly banks. In fact, the Financials Index excluding property trusts (ASX:XXJ) comprises over half of the S&P/ASX200, with the big four banks making up 30%. Some ‘value’ or ‘dividend’ ETFs have 75% allocated to financials. Not only does performance depends on one highly leveraged sector, but it’s likely that investors already hold the major banks directly in the rest of their portfolio.

A warning not a failing

In time, improvements in technologies such as artificial intelligence and data mining will take roboadvice to another level. The robo 3.0 models already provide human planners with tools which show clients the outcomes of various choices, and the human element remains important.

Often, the adviser is as much a coach and educator as a financial planner. It will be a while before the online roboadviser shows that level of empathy, as Centrelink is finding as it rolls out its robo-debt and robo-assistants.

 

Graham Hand is Managing Editor of Cuffelinks.

Graham will be speaking at the Australian Shareholders’ Association’s 2017 Securing Your Investing Future Conference in Melbourne on 15 May with his session: Is there an Uber awaiting wealth management?

Trust alternatives after 1 July super changes

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Given the impending superannuation changes, it’s worth taking a fresh look at estate and superannuation succession planning arrangements.

Background

From 1 July 2017, individuals will be able to have a maximum of $1.6 million in the tax-free pension stage of superannuation. Amounts surplus to the $1.6 million need to either be rolled back to the accumulation stage of superannuation (tax rate of 15% applies to income and 10% to capital gains) or withdrawn from superannuation where earnings may be taxed at personal marginal tax rates.

To illustrate the changes and new opportunities, consider the following example:

  • High net worth retired couple, Simon and Danielle, both age 65 with an SMSF total balance of $3.5 million ($1.6 million for Simon and $1.9 million for Danielle). The SMSF is entirely in pension phase so no tax applies.
  • Simon also has an investment portfolio valued at $2 million outside super.
  • Simon passes away in June 2017.
  • They have two minors as grandchildren who do not have any other income.
  • SMSF succession arrangements are such that Danielle can take Simon’s balance as a reversionary pension, lump-sum payment directed to the estate or Danielle, or a combination of the above (the precise mechanics of this will be discussed in another article).
  • For simplicity, assume an earnings rate of 5% (all income, no franking credits) on investments regardless of entity holding assets.

Pre-1 July 2017 consequences

a) Before Simon’s death

In a pre-1 July 2017 world, there is no tax on earnings within the SMSF as it is all in pension stage. Simon pays tax at his marginal rate on his $2 million personal investment portfolio.

b) After Simon’s death

Danielle continues Simon’s pension as reversionary and inherits the $2 million personal portfolio directly. The tax position is the same as when Simon was alive.

Post-1 July 2017 consequences after Simon’s death

Option 1 – Super roll back

Danielle can hold a maximum of $1.6 million in the pension phase. In this example, we assume that the balance above this amount is rolled back to the accumulation stage. Danielle inherits the $2 million share portfolio and pays tax at her marginal rate.

Option 2 – Withdraw excess from superannuation

As a superannuation tax dependant, Danielle is paid a tax-free lump sum death benefit of $1.6 million of Simon’s benefit, withdraws $300,000 of her benefit, and retains a total of $1.6 million in pension stage. The funds withdrawn from the SMSF are invested in Danielle’s name alongside the inherited $2 million portfolio and taxed at her marginal rate.

Option 3 – Super roll-back and share portfolio directed to a testamentary trust

[Note: A testamentary trust is a trust which arises upon the death of the testator, and which is specified in his or her will].

This strategy is a combination of the above two with a twist!

  • $1.6 million stays in pension stage
  • The excess over $1.6 million in the SMSF is rolled back to accumulation stage
  • The $2 million investment portfolio is directed to a testamentary trust with flexibility to distribute income to Danielle and potentially two minor grandchildren who have no other income.

Conclusion

In a pre-1 July 2017 world, it was often best to continue a reversionary pension to the surviving spouse given that all earnings would continue to be 100% tax-free. In these circumstances, testamentary trusts may have had limited appeal.

However, from 1 July 2017, given that high superannuation balances will be excluded from the zero-tax pension environment, an individual’s overall tax position may be optimised by using testamentary trusts for estate assets. This, when combined with careful superannuation succession planning, can lead to significantly better outcomes.

 

Reuben Zelwer is the Principal of Adapt Wealth Management Pty Ltd. Reuben is a CERTIFIED FINANCIAL PLANNER® practitioner and an SMSF Specialist Advisor™. This article is for education purposes and does not consider the circumstances of any person, and is based on an understanding of the legislation at the time of writing.

HNW asset allocation and advice trends

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In an advanced look at the results, the 2016 Investment Trends High Net Worth (HNW) Investor Report updates research on the use of advisers and the latest asset allocations.

The study is based on 2,500 responses from HNWs with investible assets (excluding super in public funds but including SMSF balances) of over $1 million, net of debt. This group is estimated to control about $9 billion of the $1.5 trillion held by all HNWs in Australia.

Some highlights include:

1. The number of HNWs in Australia fell to 425,000 in 2016 from 440,000 in 2015, partly due to market conditions and partly because of using debt to invest in property. The number with $2.5 million and above is growing.

2. The main investment problem identified by half the respondents is they are seeking growth in their portfolios but don’t expect it will come from Australian shares in 2017 (their return expectations have recovered somewhat since bottoming in September 2016, but they are still bearish). They know they should not allocate significantly to cash.

3. As expected in such uncertain times, there is an increasing unmet need for advice. Says Recep III Peker, Research Director at Investment Trends, “Over half of HNWs have large unmet needs for advice. In spite of this, they are increasingly reticent to seek advice, and the use of advisers is falling. Financial planners and full service stock brokers are losing ground, especially for investment advice.”

The changes for full service stockbrokers are particularly challenging. Those who have retained clients have a more holistic relationship, including in asset classes other than equities. But only 40% will actually call themselves a stockbroker, with most preferring names such as ‘wealth managers’, signifying a more diversified offering. They have not become ‘financial planners’, but their businesses are changing. For example, they commonly sell global ETFs to give their clients an international equity exposure.

4. Asset allocation has not changed significantly in last few years. The top-level asset distribution is 32% direct shares, 32% property, 16% cash and TDs and the rest in listed or unlisted managed funds and alternatives. Geographically, the proportion of assets overseas averages only 5%, although for the wealthy with assets $10m+, it is a much higher 10%.

Uncertain times and stretched market values seem to have paralysed reallocation. The amount in cash and TDs has fallen slightly by 1% to 16% in the last two years, despite uncertainty in the share market, due to low rates. HNWs in Australia are estimated to be holding $240 billion in cash, with $100 billion temporarily waiting for better market conditions.

The proportion of HNWs planning to invest in managed funds remained at 20% in 2016. About half of these HNWs want actively managed international equity funds, and two in five seek active Australian equity funds. Says Peker, “It’s been a bit of a missed opportunity that the industry has not grown its share of the HNW pie, but there is still good appetite for managed funds.”

The number of HNWs who have direct property has increased but average holding size has come down, perhaps indicating property is held in an SMSF.

 

Graham Hand is Managing Editor of Cuffelinks and this preliminary release is courtesy of Investment Trends.

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