The introduction of the $1.6 million transfer balance cap, effective from July 1 this year, will impact the estate plans of many superannuation members. This article reviews the role of insurance as part of an SMSF’s investment strategy and the changes that people may need to make.

Making insurance part of an SMSF’s investment strategy

Superannuation law requires all SMSF trustees to formulate, regularly review and give effect to an investment strategy relevant to the whole of the fund’s circumstances. The investment strategy must set out the investment objectives of the fund and detail the methods the fund will adopt to achieve these objectives.

When formulating an investment strategy, trustees must consider:

• the risk and likely return of investments
• the diversification of the fund’s investment portfolio
• the liquidity of the fund’s assets
• the fund’s ability to pay benefits and other costs it incurs
• whether the trustee should hold insurance policies for one or more members.

The mandate to consider the insurance needs of members has been law since 2012, but many trustees have not amended their investment strategies to comply with the requirement.

Considering the insurance needs of members generally involves the following steps:

• determining the insurance needs of each SMSF member (including death, total and permanent disability insurance (TPD) and income protection insurance).
• determining whether insurance should be held by the super fund.
• amending the fund’s investment strategy.

Once the insurance needs have been determined, the investment strategy must be updated. Given the personal nature of the assessment of insurance needs, this could be documented by way of a minute, relative to each member.

The notation in the investment strategy can be quite simple and concise, for example:

‘the trustees have considered the insurance needs of members of the fund and have determined that the insurances held by the members within the fund remain appropriate.’

or

‘the trustees have considered the insurance needs of members of the fund and have determined that it remains appropriate for the fund not to hold insurance policies for members.

However, the notation to amend the investment strategy should be supported by more detailed information on the insurance needs and an outline of the reasons the decision were made. This may take the form of a statement of advice (SOA) prepared by an adviser. Trustees need to ensure that the information they retain is sufficient to withstand future scrutiny. For example, the widow of a deceased member who was in an SMSF with his parents may have recourse against the parent trustees if they cannot demonstrate that they considered the insurance needs of all members.

Regular review of investment strategy

Trustees are now required to ensure that the investment strategy is reviewed regularly, to ensure that trustees do not simply ‘set and forget’ their investment goals and insurance needs. Whilst ‘regularly’ is not defined, it is generally considered that at least annually is prudent.

In addition, there are events that should prompt an SMSF trustee to consider a review of the insurance needs of members and the fund’s investment strategy, such as:

• the admittance of a new member
• changes in a member’s personal circumstance (for example, marriage or children)
• a member commencing a pension
• significant changes in financial market conditions.

Insurance and the $1.6 million transfer balance cap

The introduction of the $1.6 million transfer balance cap is likely to prompt a review of holding insurance in super for many SMSF trustees and members of retail superannuation funds.

This is because the transfer balance cap places a limit on the amount of super that can be used to commence a pension that receives tax-free investment returns. On the death of a member, their benefit must be ‘cashed’ and paid to their superannuation dependants (most commonly to a spouse or child). The benefit may be cashed by paying a lump sum benefit, by commencing one or more pensions or a combination of both.

If a death benefit pension is paid, the amount that can be used to start the pension is restricted to the transfer balance cap of $1.6 million. Any amount above the transfer balance cap must leave the superannuation system. Where there are multiple beneficiaries, each beneficiary receives a proportionate share of the transfer balance cap.

If a beneficiary has commenced a pension themselves, their own pension and the death benefit pension they receive counts towards the $1.6 million cap. A member’s own pension may be commuted back to accumulation phase, but a death benefit pension cannot be.

Case study – Margaret

Margaret is a single parent who has two children. She has an accumulation account which holds $400,000 and life insurance of $2 million. She has binding nominations to her two children in equal shares.

If Margaret dies her total superannuation death benefit will be paid 50% to each child ($1.2 million each). Before 1 July 2017, each child could receive $1.2 million as a death benefit pension. However, from 1 July, each child will be limited to a death benefit pension of $800,000 (half of the $1.6 million cap). The remaining $400,000 each must leave the super system as a lump sum payment.

Therefore, it is essential that people with large super balances review their estate plans to ensure any benefits that may be forced out of the super system are directed to structures that can be controlled, such as testamentary trusts established via a will.

The introduction of the super changes is likely to be a catalyst for SMSF trustees to review their insurance needs and for members of other funds to review their own arrangements.

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.

A gripping day at the Royal Commission on 24 April 2018 saw the focus on poor advice shift from the major banks and AMP to a smaller ‘independent’ financial advice business, Henderson Maxwell. Sam Henderson has built a high profile in the independent advice space with regular appearances on Sky Business and The Panel, and columns in the AFR, Sydney Morning Herald and Money magazine. As the successful owner of a boutique advisory firm in Sydney with financial advice awards under his belt, $170 million under management and a recent equity sale to AZ New Generation Advisory, he presented as a role model for aspiring wealth managers across the country.

Safe to say he had his toughest day in the office ever, as an aggrieved client volunteered her advice experience with some startling revelations. The client, Donna McKenna, is a Commissioner with the Fair Work Commission.

The video of the client’s and Sam Henderson’s evidence is here, starting at about 5:00:00 on Day 17.

Focus on the actual advice

There is a lot to go through. The biggest issue was advice to roll out of a rare ‘deferred benefit’ public service scheme, with the consequence of the client missing out on a potential $500,000 deferred retirement benefit two years later. Mr Henderson said this background was not relayed to him by his staff at the time of the advice.

The direction to inject the proceeds into a new ‘Henderson Maxwell Accounting’ originated SMSF and then invest into a ‘Henderson Maxwell Investments’ managed account share portfolio compounded this poor advice. The Commission heard the fees on the managed account were 1.1% to 1.8% depending on the amount, plus 0.525% brokerage. The recommendation included using a third party managed account platform that Mr Henderson was an equity holder in at the time (but has since sold out of). The client advised the Commission that she had repeatedly told Mr Henderson at the initial meeting that she did not have the skills or time to run an SMSF and definitely did not want one, but was told, “We’ll look after it.”

All this for a $4,950 up-front advice fee, plus the client moving from a current annual fee structure of $2,700 to $14,642 per year with setup fees of $6,000.

Exacerbating the whole process, his assistant pretended to be the client at least four times in phone calls to the client’s existing superannuation fund, his non-existent Masters degree was recorded on regulatory client documentation and finally a series of emails with the Financial Planning Association in an investigation was less than complimentary about the client.

It’s difficult to think of anything else that could have gone wrong.

Advice without commissions will come at a cost

I feel for Sam a bit, as public service funds are often confusing and generally have a number of subtle benefits not normally found in other superannuation products that are available to the general public. When a client walks in with significant funds in one of these schemes, the adviser must get the facts straight. The fact that the fund repeatedly told his assistant the deferred benefit would be lost shows some serious lapses in the background research.

In the past, I have found that usually a client is better off to remain where they are for these reasons, and the advice opportunity should be used to find other facets of a client’s financial life that may need attention.

Carelessness on this point aside, the remainder of the advice shows inadequate research and cookie-cutter advice that often plagues the advice industry. Clearly, it’s time is up.

As the Royal Commission moves from discovery to action, and the public demands more client-centric advice that is driven by client best interests, a new dawn approaches for advisers who wish to do the right thing and be successful. The next step will be managing the client expectation that good quality advice, without the commissions and aligned interests, simply cannot come cheap.

Tim Fuller is a Certified Financial Planner and Head of Operations at Nucleus Wealth. This article draws on publicly available information heard at the Royal Commission, with the complete transcript available here. 

Unless the obvious ‘elephant in the room’, the product/advice conflict, is addressed head on, any attempt to respond to the Royal Commission’s exposure of poor behaviour and inappropriate advice with more legislation is likely to continue to prove costly and ineffective.

The ‘best interests’ protections in the current legislation skirt around the issue and have already failed to prevent the selling of inappropriate products by advisers linked to product manufacturers. A fatal flaw is the reliance on ‘reasonableness’ to test various aspects of ‘acting in the best interests of the client’.

‘Reasonableness’ is simply too low a standard when account is taken of the diverse range of skills and knowledge possessed by financial planners. There is no industry consensus on what body of knowledge all planners should subscribe to or what is regarded as best practice on the many aspects of personal finance.

Doctors provide a model for financial advisers

Medicine has had a long history of grappling with issues of professionalism and the separation of product from advice. The AMA’s ‘Position Statement on Doctors’ Relationship with Industry 2010‘ potentially provides a model for the personal finance industry. Replacing ‘doctor’ with ‘financial planner’ (and other appropriate substitutions) in Section 3 of their Position Statement sets a standard for financial advice:

3.1 The major principles guiding [financial planners’] relationships with industry include the following:

• The [financial planner’s] primary obligation is to the [client]. Considerations involving industry are appropriate only insofar as they do not intrude or distort that primary obligation; 

• The primary objective of relationships between [financial planners] and industry should be the advancement of the [financial] health of [clients]; 

• [Financial planners] must maintain their professional autonomy (bold added), [advice] independence and integrity. Relationships between [financial planners] and industry must not compromise [financial planners’] professional judgement or ability to act in their [clients’] best interests 

• The [client’s] [financial] health needs should be the primary consideration when utilising products and services; 

• [Financial planners] should manage potential conflicts of interest appropriately so as to maintain the public’s trust and confidence in the [financial planning] profession. Appropriate management may include, but is not limited to, timely and honest disclosure of relevant relationships with industry to [clients], peers, ethics committees, and others in a transparent and accountable manner as well as eliminating the potential for conflicts of interest to develop.

Adoption of Section 9.2 would require:

[Financial planners] in practice should not ask for or accept a fee, loans, or equivalent consideration from industry in exchange for seeing them in a promotional or similar capacity.

The notion that a doctor could be employed or authorised to practice by a pharmaceutical company, for example, would be regarded as outrageous by both the medical profession and the public (although we know dubious practices still occur, showing it is impossible to remove all rogues from any industry).

Until advice is effectively separated from product, either by legislation or self-regulation, consumers cannot be confident that the requirements of the product manufacturer are not unduly influencing the advice. 

Future directions and practical next steps 

I am not naive enough to believe that separation along the lines that exists between doctors and industry will occur immediately. Although desirable in the long term, in the short term it would be very disruptive for product manufacturers to disband their large distribution networks.

A better alternative is to make a legislative distinction between aligned (to a product manufacturer) and non-aligned advisers. Key aspects of this distinction could include the following:

• Aligned advisers would be required to clearly state and have acknowledged by clients the nature of their alignment and that their advice may conflict with the best interests of the client i.e. no ‘best interests’ duty. They should also be required to inform potential clients of the existence of non-aligned advisers and their ‘best interests’ obligation.

• Aligned advisers would not be able to call themselves ‘financial planners’ or ‘financial advisers’, but something along the lines of ‘financial product sales consultants’ or ‘financial services agents’. The titles ‘financial planner’ and ‘financial adviser’ would be strictly defined.

• Non-aligned advisers would have a general ‘best interests’ duty to clients, that need not be as prescriptive as currently.

• Much of the current compliance, disclosure and reporting requirements would be removed for non-aligned advisers, enabling them to reduce the cost of advice and service a much wider market.

• ‘Assets under management’ fees would be abolished for both aligned and non-aligned advisers. Fees would be charged on an hourly basis or on an agreed retainer basis. These fees should be tax deductible.

• Both aligned and non-aligned advisers would be required to disclose the annual costs in dollar and percentage terms of all charges paid by clients for financial services provided, arranged and managed by the adviser, including advice, administration, fund manager, loan and personal risk insurance costs. Also, standard illustrations of those charges should be provided to potential new clients so valid cost comparisons can be made at the time of choosing an adviser. This requirement would serve to nullify any under-pricing or subsidising of advice by product manufacturers to position themselves to win product-related business.

Non-aligned advisers would meet ASIC’s current definition of independence. Under the existing regime there is little to be gained from complying with this definition. There is no regulatory relief and the potential marketing advantage is drowned out by the noise of the large product manufacturers and their aligned advisers. Our experience is that without education most consumers, to their detriment, are not aware of the difference between an independent and non-independent adviser.

If the distinction is enhanced, along the lines proposed above, it is likely that more Australians will see non-aligned advisers as value for money sources of quality objective financial advice and acting only in clients’ best interests when recommending third party product solutions. Also, it may help to drive change within the advice industry, with more aligned advisers being attracted to the non-aligned space.

Given the proposed level of legislative support, it is possible to see how the fledgling non-aligned advisers could over time potentially evolve into a true profession, developing a relationship with industry not unlike that of doctors. The role of advisers could be restricted to advice with referrals to trusted brokers for product placement, enabling an adviser to look after many more clients at significantly lower cost than currently is the case.

In summary

My views are driven by a belief that financial product manufacturers should have a very limited role (if any) to play in the provision of financial advice to consumers. Their overriding reason for providing financial advice is to facilitate the sale of product, rather than seeing advice as the core business.

The resulting conflict of interest, together with confused consumers, will almost inevitably lead to future misselling disasters. Legislating ‘best interest’ and a focus on financial literacy are band-aid solutions that do not reach the heart of the problem.

As in the provision of medical services, financial advice needs to be separated from product to increase the chances that providers of advice are intrinsically driven by their clients’ welfare.

John Leske is a Principal of Wealth Foundations. This article is general advice only as it does not take into account the objectives, financial situation or needs of any particular person.

In Round 1 of the Royal Commission mortgage broking interviews, the Commissioner asked why the industry does not operate on a flat administration fee paid by the client. This would address the broker incentive to push the borrower into the largest loan and potentially fudging financial statements. Brokers are paid a commission by the bank based on the size of the loan, normally about 0.6% up front. There is usually no cost to the borrower of using a broker.

The idea immediately gained traction. Westpac CEO Brian Hartzer suggested mortgage brokers should charge clients directly, and Westpac would “tighten up” on its processes and transparency on commissions, fees and costs. The Commission found that CBA CEO, Ian Narev, had noted in February 2017 that broker incentives “lead to poor customer outcomes”.

A ban on commissions paid by banks to brokers (similar to the FOFA ban on product manufacturers to financial advisers) would have an enormous impact on mortgage broking and banking, as brokers originate half of all home and investment loans. The industry is already under stress as the banks tighten their lending criteria, with implications for house and apartment prices across the country.

Across a range of financial services, the Commission will make recommendations on fee calculations, who pays them and what incentives are created. How much further could this extend into wealth management?

Fees for fund administration platforms

What’s the equivalent in financial advice and asset management? There was a revealing moment which the media has overlooked in its excitement about charging fees to dead people.

Linda Elkins (LE) is an Executive General Manager at Colonial First State. She was examined by junior barrister Mark Costello (MC) who asked about platforms and their fees. This is a long extract to show how issues sneak up during questioning. Make a note at the point when Commissioner Kenneth Hayne interrupts.

MC: All right. So all consumers that invest through a Colonial First State platform will pay, as a general rule, an investment fee and an administration fee?

LE: Yes.

MC: And the fund manager’s fee would ordinarily be calculated by reference to funds under management?

LE: Yes.

MC: And is the administration fee calculated in that way?

LE: Yes, it is.

MC: And what’s the relationship between funds under management and the administration expenses that the platform operator might incur?

LE: So the main relationship between those things is the – I guess the risk we carry in relation to the unit pricing function that we carry out, and there can be a relationship, although it will vary, between the amount of service that would be required on the account if  the account balance is higher, there can be additional servicing needs, but I would say it’s predominantly the risk in relation to the higher amount.

MC: All right. So you’ve mentioned risk and servicing. Can I deal with risk first. What’s the risk that you’re exposed to?

LE: If we get – the unit pricing is incorrect, then we would be responsible for the remediation of that.

MC: Does that happen often?

LE: No, it doesn’t. We – we – we are – obviously, there is audit functions that are carried out with our external auditors, and we perform at – or we believe we’re at industry best practice.

MC: And explain to me the other vagaries that create the pricing risk?

LE: If we made an error, if we got it wrong.

MC: In the division?

LE: Or in – you know, things like the withdrawal of the administration fee or in the recouping of expenses, wherever it might be.

THE COMMISSIONER: You charge more against the prospect that you might do something wrong? 

LE: We – the question you asked me was what’s the relationship, so no I wouldn’t – I wouldn’t say that that is the relationship. And I would also agree that it is industry practice that these fees are asset-based.

MC: But you would also agree that you’re pricing in your risk of miscalculation which might result in a requirement for remediation, and that affects the price the consumer pays?

LE: Yes.

MC: And that’s the risk component. And the other component was the serving component?

LE: And, again, that’s not necessarily a direct relationship, but it is a factor that it can be. And I would agree that using asset-based fees is the common method that’s used in the industry.

MC: What type of services are contemplated by the servicing fee?

LE: So the servicing fee covers the administration of the account. So the application process, any redemption process, call centre activity reporting, and so on.

MC: All right. And the administration fee will generally be charged by reference to funds under management?

LE: Yes.

MC: And is there any relationship between the administrative tasks that Colonial would undertake and the amount of funds under management?

LE: As I said, it would – it would vary. I mean, no, this is the standard method that the industry uses.

Are platforms a likely target?

The two reasons given for charging administrative fees – possible costs of remediating the client and to cover the services provided – are not the major reasons for the fees. Remediation is minor, and services provided are generally a fixed cost and do not vary materially according to size. Someone with $10,000 on a platform receives the same reports and service as someone with $100,000, so why should the latter pay 10 times as much?

The main reason is to make money. As account balances grow, so do fees. A person with $500,000 at an administration fee of 0.5% pays $2,500 each year (in addition to the investment and advice fees). It’s a scale business where profits are highest on large balances.

Kenneth Hayne is focussing on how financial advice and funds management can address problems with product sales and commissions. He may argue administration in its many forms across the industry should be charged at a flat rate to remove the incentive to grow the account when it might be preferable, for example, to pay off debt.

Furthermore, there is an incentive for a vertically-integrated model to refer larger clients to a platform with a percentage-based fee than one with a fixed fee or a lower cap. There are wrap platforms available which cap the fees or have a low 0.1% fee above a certain amount. Many independent, fee-for-service financial advisers use these wraps to force down the client cost, but an adviser in a large integrated business would be less likely to offer this option.

Or maybe the Commission missed this target. Mark Costello moved off the subject quickly, did not raise the issue of the availability of cheap alternatives, and did not question the two reasons given for charging asset-based fees.

Although the capped or low-cost platforms are already available, it would be a massive change if commissions and asset-based fees were replaced by fixed fees or low caps. Investors paying hefty platform fees on large amounts should shop around now, not wait for the change.

The argument that the industry has not passed on the benefits of scale is not new in funds management. Fiona Trafford-Walker, director of consulting at Frontier Advisors, has been arguing for changes in fee structures for a decade. For example, in an article called Alignment of Interest, written in 2016, she said:

“As the Australian superannuation industry has grown, there has not been enough capture of that scale through reduced costs. We also know that fund manager margins remain very, very high (and if anything, many have expanded since the GFC), especially when compared to any ‘normal’ industry. This desire to capture the benefit of scale is now a significant focus at many funds.”

The Royal Commission will lead to a greater separation between how financial advisers are paid and their choice of products, and there’s a potential for this to extend into other parts of the value chain.

Graham Hand is Managing Editor of Cuffelinks.

“The point is, ladies and gentleman, that greed, for lack of a better word, is good. Greed is right, greed works. Greed clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed, in all of its forms; greed for life, for money, for love, [for] knowledge has marked the upward surge of mankind.”   Gordon Gekko, Wall Street (1987)

Ever since that ‘greed is good’ speech, in what was termed the ‘decade of greed’ (the eighties), the finance industry has been Hollywood’s, and the public’s, go-to villain. The global financial crisis emboldened that view. Public investigations satisfy a desire to vilify a maligned section of society, but vilification is not a solution.

In August 2016, 70% of respondents to a Cuffelinks survey opposed the setting up of the Royal Commission (see What readers think about a bank royal commission). Two points, ‘There are already enough regulators, inquiries and committees’ and ‘Banks have many stakeholders and can’t keep everyone happy’ had three-quarters of readers agreeing.

I wonder how many have changed their minds about the Royal Commission being a bank-bashing fest and a waste of time and money. I admit I have.

The most high-profile recent backflip came after a strenuously evasive denial on national television. It was a masterful samba, even for a politician, many of whom have earned honorary doctorates in the art of evasion. Minister for Financial Services, Kelly O’Dwyer, dodged Barry Cassidy’s question on ABC’s Insiders eight times on Sunday, 22 April. Five days later, O’Dwyer told an SMSF conference in Melbourne:

“With the benefit of hindsight we should have called it earlier, I am sorry we didn’t, and I regret not saying this when asked earlier this week.”

Sales or advice?

Does anyone go to a Honda car dealer and receive a recommendation to buy a Toyota instead? When was the last time real estate agents recommended a comparable property not in their portfolio? Does that make car dealers and real estate agents morally corrupt by virtue of their profession? We understand they have a duty to their principals, the sellers, and not to potential buyers. More importantly, there is no ambiguity: the agent/dealer has a sales function, not an advisory one.

Even the legal profession has a niche for advocacy. It’s the court’s ambit to find the truth, but advocates are duty-bound to represent their client’s interests.

So how does a financial adviser become a selling agent for someone and an unbiased adviser for a client at the same time without developing a multiple-personality disorder? Watch how this exchange on Day 15 at the Royal Commission traverses toward the obvious. It’s between Rowena Orr, QC, Counsel assisting the Commission (RO) and Michael Wright, Head of Advice at Westpac (MW):

RO: Do you think of yourself, Mr Wright, as a sales professional?

MW: No, I don’t.

RO: I have had a look at your LinkedIn profile which lists various things about what you do, and one of the descriptors that you give of yourself is as a sales professional; is that right?

MW: It could be.

RO: Would you like me to show it to you or – I’m happy to?

MW: No, I’m happy to believe you.

RO: I’m interested in that because I want to understand whether you think of the financial advice industry as a sales industry?

MW: I don’t.

RO: You don’t. And do you think it’s possible for a financial adviser to be both a salesperson and a trusted adviser at the same time?

MW: Well, to me, they’re – they’re connected. To be a trusted adviser means that you understand your customer, you tailor their needs to their needs – sorry, to their desires. Often, to realise that, you need to put strategies in place which, in essence, result in products. So, by default, if you genuinely care in taking action, there will be an element of product to bring that to life. So, yes, you could say that is a sale.

RO: Maybe there won’t, Mr Wright. Maybe the right advice for a person is not to sell them products?

MW: Yes, I agree.

You can see the whole exchange here.

Financial incentives have power, as do desires for professionalism, knowledge, and respect. Can we align financial incentives toward doing the honourable thing? That’s where the Commissioner, Kenneth Hayne, went as well:

“Well, forget beating up on yourself, Mr Wright. Can you offer any way in which that sort of thing – I’m trying to find a neutral expression – could be reflected in management structures, organisation, or anything of that kind?”

Contradictory incentives hurt. Terry McMaster, the head of Dover Financial, collapsed while taking questions at the Royal Commission. The Commission is not falling short on its fact-finding mission, and on drama, it had surpassed Hollywood by Day 19.

Long-run outcomes gravitate toward incentives

The big players lobbied during the development of the Future of Financial Advice (FOFA) legislation for keeping the commissions not just because they had bought businesses based on cash flow models that assumed the commissions were there to stay. They wanted to create even more products to sell. What they bought was a sales model dressed up as an advisory service, and it compromised the professionalism of advisers.

The industry knows this. We saw it in Michael Wright’s and Jack Regan’s (AMP) testimony. Executives are themselves now pleading for a law that will bind everyone to a fee-for-service model, addressing the first-mover disadvantages. Consider this exchange between Michael Hodge (MH) for the Commission and Jack Regan (JR):

MH: Do you, as the head of advice – I’m sorry, as the group executive in charge of advice, have a view about whether the taking or continued taking of commissions is compatible with the purported professionalisation of financial planners?

JR: Well, as I said before, my preference would be for fee arrangements expressly.

MH: And is that because you don’t think that it is compatible with the idea of financial planners being a profession that they continue to receive commissions?

JR: I think fees are much more consistent with a professional environment, yes.

In the earlier Round 1 interviews on mortgage broking, CBA admitted there was a conflict of interest created by the commission payments, and that brokers were likely to burden customers with debt they could not repay. In 2011, KPMG and Westpoint directors paid $67 million to ASIC, acting on behalf of Westpoint investors. In that case, it was alleged that financial planners were receiving around a 10% commission to sell clients into mezzanine finance for property construction.

Baring Brothers, a merchant bank that stood proud for 223 years, was brought down by a perverse incentive structure. Nick Lesson was an accident waiting to happen. Give someone $10,000 to play at the casino all night, every night. They keep 20% of the winnings, none of the losses. Will they play every night? You bet.

Incentives matter a great deal in both directions. Fund managers and equity analysts must look deep into incentive structures in the companies they put a valuation on. Perverse incentives will eventually create perverse outcomes.

Vinay Kolhatkar is Assistant Editor at Cuffelinks.

The Royal Commission has highlighted some appalling financial advice practices.  Transparency, greater professionalism and higher standards are required. Corruption, cronyism and incompetence must be weeded out.  A torrent of new regulations is a racing certainty, although how that will look is still to play out.

Hopefully, we will look back in a few years and say the Royal Commission was the best thing that happened to the financial planning profession. Financial planning matters. It matters because quality advice has the power to transform lives. It matters because poor, unethical advice has the power to destroy lives.

Start with two quick checks

How do you find a good financial adviser from more than 24,000 licensed Australian advisers? In November of 2017, I wrote this article for Cuffelinks on the 25 questions you should ask your financial adviser. This is an updated version in a post-Royal Commission world.

First, as before, start with the pamphlet, entitled Questions To Ask A Financial Adviser compiled by our industry regulator, ASIC.

Second, conduct a search of your adviser on the ASIC register. This provides a list of their qualifications and records any banning orders or disqualifications made against them in the past.

Then, insist on getting answers to the following questions in writing. They won’t guarantee you a good adviser, but they will reduce the odds of a dud or a crook.

The questions to ask

1. Who owns your business?

Most advice firms are owned by a handful of individuals. Be wary of those with institutional ownership, especially when those institutions also manufacture financial products, encouraging massive conflicts of interest.

2. Who provides your licence (AFSL) to operate?

You might prefer firms who have their own licence, but there are plenty of shoddy independent operators (as the RC showed), and there are plenty of excellent advice firms who are licensed by a major financial institution. You want to learn about potential conflicts of interest that might compromise your best interests. The one key advantage of being self-licensed is that these firms are free to recommend a broader universe of funds and insurance products.

3. What percentage of my portfolio is invested in funds owned by your licence provider?

It should be close to zero.

4. How many insurance providers are on your Approved Products List?

It should be a lot more than one. This gives sufficient diversity and an ability for an adviser to add value through choosing the most competitive policy.

5. Is there any connection between the investment platform you have chosen and your licence provider?

There might be. This may be ok, but it’s a potential conflict as this may be the only platform offered to you as a client. Ask why they selected that particular platform for you.

6. May I see your last Compliance Audit please?

Every adviser is audited annually by an independent team. Ask to see the last three audits as they could be quite revealing.

7. How do you charge your clients?

Fees should vary depending on the job you want done. For specific project work, an adviser might bill by the hour, but not for ongoing advice. Hourly charging encourages inefficiency. Nearly all advisers will increase their fees in line with the assets to manage, but the relationship should not be linear. Managing $2 million is not twice as involved or complex as managing $1 million. Charging clients a fee-for-service is becoming more popular and, in our opinion, will eventually replace percentage-based fees.

8. Are your fees negotiable?

We believe fees should not be negotiable. Clients should be charged by the same methodology. Existing clients should not subsidise new clients (unlike certain cable TV providers we could mention), nor should those with superior negotiating skills receive favourable terms.

9. Do you receive an annual bonus?

Most advisers are paid an annual bonus for a job well done. Nothing controversial about this, but ensure that the bonus is not solely driven by introducing new clients to the firm. It should reflect exemplary client service, a spotless compliance track record, a team ethic and a commitment to ongoing education and training.

10. Can you tell me about your conflicts of interest, orally and in writing?

These must be disclosed orally and in writing. Ask to see their Conflicts Register. Some conflicts of interest are inevitable and may not be a problem, provided they are disclosed.

11. Do you pay referral fees to generate new clients?

Many advisers pay referral fees to lawyers and accountants to refer new clients. Provided this is fully disclosed, there is no conflict. It’s more an issue for the referrer than the adviser.

12. What are your professional qualifications?

The Certified Financial Planner (CFP) is the gold standard in the US and Australia, but there is difference between those CFPs that were ‘grandfathered’ and those that were earned by hundreds of hours of hard slog. The CFP is now a difficult examination to pass. It doesn’t guarantee great advice, but it reduces the odds of engaging a dud. Make sure to ask for the qualifications of the Investment Committee too. The Chartered Financial Analyst (CFA) is the certificate of excellence for portfolio analysis.

13. Who manages my money?

Financial advisers are not money managers. They are not trained to do this. Look for a professional Investment Committee run by an experienced CFA.

14. How do I exit this relationship if I don’t like it?

There should be no lock-ins. Financial advice firms are not mobile phone companies. Account portability is essential.

15. Can you provide me with testimonials of clients in a similar situation?

Always ask for this. We would recommend checking out a website called Adviser Ratings. It contains testimonials from the adviser’s clients and a rating.

Choosing your financial adviser is a significant decision

We suggest asking people in your life whose financial opinions you respect. These might be your accountant or an educated friend. And meet plenty of advisers during your due diligence. A good adviser adds value. We hope this list will help you in your search.

Jonathan Hoyle is Chief Executive Officer at Stanford Brown. This article is general information and does not address the circumstances of any individual.

There is no greater accolade for a social commentator than having an idea enter the national lexicon. So it was with due pride that demographer Bernard Salt showed his unmitigated delight at the way his ‘smashed avocado’ reference now sums up an entire generation of Millennials and their spending habits. Salt was speaking at a Colonial First State Global Asset Management Forum on 1 May 2018, and he explained how media companies from all over the world have contacted him to discuss his smashed avos.

Salt’s reference to $22 avocado on toast for breakfast in the original article in The Australian has become a touchpoint on housing affordability and even intergenerational conflict. He said of young people:

“Shouldn’t they be economising by eating at home? How often are they eating out? Twenty-two dollars several times a week could go towards a deposit on a house.”

However, at the panel discussion, he said the real purpose of the column was misunderstood, as he subsequently wrote:

“It was intended not as a criticism of youth but as a parody of middle-aged moralisers, using the setting of a hipster cafe to showcase the conservatism of middle-aged thinking.”

The mistaken message has more merit

Notwithstanding most people mistaking the original interpretation, the incorrect meaning surely carries more gravitas. This struck me while attending a concert at the ICC Sydney Theatre a few days after hearing him speak. It was the highlights from the BBC series, Planet Earth II, ‘live in concert’ with the Sydney Symphony Orchestra playing an original score to match the action. The theatre holds about 9,000 people, and the only empty seats were the cheap ‘bronze’ sections at the side.

Now here’s the thing. The audience was overwhelmingly young people, say under 30, and most of the tickets were in the ‘platinum’ and ‘gold’ categories. The ticket tiers are shown in the extract. With mediocre wine in a plastic cup at $10 a pop, many young couples were up for $400, and the ‘BBC Earth Lounge’ was full at $1,000 a couple. People queued impatiently to buy drinks and chips while the free water sat unloved.

For what? It was a great show, but BBC nature documentaries and David Attenborough are at saturation levels on free-to-air and pay television. They can be watched for free online 24/7. Most people have big flat screens and good sound systems, and could watch the animals with great sound any night of the week. This was not a once-in-a-lifetime chance to see a music legend. It was a good night out watching something readily available, acknowledging that the SSO made it extra special.

Smashing Pumpkins 30^th anniversary tour

In a couple of months, the legendary band Smashing Pumpkins will start a 30^th anniversary reunion tour in the United States, the first time most of the band has toured together in almost 20 years. The band has a big Australian following, and if the tour makes it here, they will sell out at an average of $200 a ticket.

In 2013, Pink sold out 46 concerts for over 600,000 fans, with the cheapest seats at $150 and the ‘True Love’ package of meaningless stuff at $400. Justin Bieber’s recent VIP experience was over $500. Adele sold 200,000 tickets for two open-air Sydney concerts in 2017 with D Reserve, up in the heavens at the ANZ Stadium, costing over $100, and A Reserve nearer the stage at over $300. Ed Sheeran’s 2018 Australian tour sold over 1 million tickets with 225,000 in three shows in Sydney, slightly more than AC/DC in 2010.

The list is endless, week after week, worth billions a year, and Australia can’t get enough of it.

What do some young people earn?

Clearly, many young people are well-paid and $400 is the cost of a decent night out, but it is common to read young journalists bemoan their inability to ever buy a house in Sydney or Melbourne. The gig economy is making more jobs part-time and removing job security and benefits. Many struggle to make rental payments, never mind borrowing half a million.

Writing in The Sydney Morning Herald on 7 May 2018, a Fairfax contributor, 27-year-old Joshua Dabelstein said he does not know anybody who has ever considered buying property. He said his generation is more concerned with paying the rent.

“A friend of mine’s boss convinced her that paying $17 per hour at a café was a great deal because she wouldn’t have to pay tax on it … In the past 48 hours, two close friends have been fired. One has spent seven months working for a restaurant that paid him a flat rate of $19 an hour.”

So without entering the debate on what’s fair and whether small business can afford to pay penalty rates, there are vast numbers of young people earning less than $20 an hour. Perhaps these are not the people going to many concerts, but when Ed Sheeran sells one million tickets and Pink and Adele sell 600,000, there are a lot of gig economy and casual workers among the audience.

What do banks now require for a home loan?

In the last year, qualifying for a home loan has changed dramatically. Lenders want to know far more details than they did at the start of the residential property boom that has now ended. The Financial Services Royal Commission produced much evidence in Round 1 on how easy it was to obtain finance. Now, lenders want to know about day-to-day living expenses, down to details such as how much is spent on fuel, eating out and, yes, going to movies and concerts. There is more checking of bank statements by line item, and reports of lenders asking why borrowers needed luxury items like gym memberships. The Royal Commission’s honing in on responsible lending obligations has changed mortgage industry procedures. ANZ Bank CEO Shayne Elliott said the more risk-averse mood would make it harder for some consumers to borrow for a home.

The investment bank UBS has done an estimate of how borrowing conditions have changed, as shown below, with a decline in loan size for given levels of household income, and lower loan-to-income ratios based on new lending scenarios.

Following the Royal Commission, much larger deposits will be required, and most people will only achieve this by reducing their spending or going to the Bank of Mum and Dad.

What could be achieved by smashing the concert desire?

Life is for living and café breakfasts and concerts are fun and part of the joy of an Australian way of life. I get that. But for the sake of the exercise, let’s see what could be achieved by salary sacrificing into superannuation instead of buying a $200 concert ticket (or finding some other saving) each month.

These calculations are made using ASIC’s MoneySmart Superannuation Calculator where anyone can experiment with the numbers. Check the website for the underlying assumptions but this example uses the following:

• Age at start, 20
• Annual income before tax and super, $40,000
• Desired retirement age, 67
• Employer contributions, 9.5%
• Low-Medium fund with fee of 0.9% pa plus $50 pa admin fee
• Growth fund with investment return of 5% pa.

The estimated fund balance at age 67 is $221,546. Of course, investments markets do not deliver smooth, predictable results as this chart implies, but it’s an ASIC-approved picture of long-term potential.

Now let’s change only one assumption, with the saver making additional salary sacrifice contributions to superannuation of $200 a month. All numbers are adjusted for inflation.

The balance at age 67 is now $370,657, an increase of about $150,000 or nearly 70%.

Sacrifices are needed

It doesn’t matter whether the $200 a month comes from missing a concert or avocado on toast, the numbers show the remarkable impact of disciplined saving and a relatively modest amount extra each month. Of course, many people would struggle to find $50 a week, but missing a coffee a day would go half way there. It’s a matter of lifestyle and future financial security at the cost of current consumption and enjoyment.

Seeing Smashing Pumpkins, Pink, Justin Bieber and animals on a big screen are all fun to somebody, but having financial security at age 67 is fun for everybody. Bernard Salt was right when he wrote that saving all the little extras for many years could go towards a home deposit or a decent retirement.

If his original article was a “parody of middle-aged moralisers”, the queue starts here.

Graham Hand is Managing Editor of Cuffelinks.

Australians are ball-tampering convicts to many people in London, from where I’ve viewed the Royal Commission. Unfortunately, the evidence seems to support that opinion.

No-one is surprised by the details, because Australia’s got Bradman-like form in bad financial advice. Previously, I’ve needed to explain how scandals like Storm Financial, Opes Prime, Westpoint, Trio, Fincorp and Bridgecorp happened under our regulators watchful eyes.

To be fair, I explain that it’s not just a regulatory failure: the problem is the far deeper issue of ‘unsuitable advice’. Even when all rules and regulations are 100% complied with, institutions are still capable of giving unsuitable advice that damages the financial lives of their clients.

You know unsuitable advice when you see it

It is a 75-year-old pensioner advised to mortgage her home to invest in high-risk leveraged funds. It is a ‘low-risk’ investor being sold high equity exposure. It is every client walking away with the same portfolios and products regardless of their circumstances. It is when the conflicted products are given precedence over the most suitable products.

We’ve known about the unsuitable advice problem for a long, long time. Consumer group Choice identified it in a shadow shopping programme in 1990 and again in 1995. And again in 1998. And again in 2003. The Storm Financial scandal laid bare a step-by-step guide on how to put the interests of the customer last. Low income, vulnerable investors lost $880 million in 2009 while the Storm founders were, just last month, fined $70,000 each and banned from running a business for seven years.

But the ‘quality of advice’ is a problem that this Royal Commission does not have time to explore.

The Commission has hit the areas tantamount to street-crime, where the Corporations Act was flagrantly breached, or a fee was charged for a service that was never delivered. This is deserving work that has provoked outrage from the public.

Royal Commission is missing the main problem

The Commission is not going deep enough to see the main game. The real money-for-jam is made by pushing customers through advice systems that ignore who they are, so that the sale of a standardised product can be closed quickly and cheaply. No thought is attached to what impact that product might have on the client’s life.

So what does ‘suitable’ advice look like? To be suitable, the advice must properly take into account their goals, current financial situation and financial risk tolerance. Investors need financial advice and products that suit their circumstances, needs and personalities.

Put another way, the question is this: ‘Where are you now, where do you want to get to and how do you feel about the financial risk you’ll need to take on to possibly get you there?’ These are tough questions that can take time to answer. Unfortunately, to institutions, that time is a cost to their bottom line, so these critical questions are frequently dealt with superficially, or not at all.

I’ve spent almost five decades in financial services, with the past 25 years helping advisers and institutions to give better financial advice, based around suitability, particularly the risk tolerance part. I have clients in more than 20 countries, with our tools used in over one million financial plans.

But, in Australia, when I would say, ‘I can help you give advice that is tailored to the client sitting in front of you’ the responses would often range from blank stares through to explanations that ‘clients wouldn’t want that and it would take too long’. For most, the passion was around quickly closing more sales, rather than giving good advice that would suit the customer’s needs, situation and personality.

I want to believe that the Royal Commission will change things, but I’m far from convinced.

It is worth recalling that almost everything that came out in evidence was self-reported by the institutions. But can we really have confidence that they would own up to giving unsuitable advice, when they are so reluctant to even cop to blatant breaches of the law?

The pushback against the Royal Commission has already begun. Submissions are arguing over the semantics of their breaches. For example, AMP admits it lied to ASIC seven times, but takes offence that it is alleged to have lied 20 times. Westpac admits that one of its advisers engaged in misconduct when he advised a couple to sell their family home to establish an SMSF, accepting he may have breached the Corporations Act. But the bank submits to the Commission that:

“While the advice was plainly inadequate, there is no basis to conclude that it involved either deliberate misconduct or dishonest conduct.”

That, in a nutshell, is the problem. The advice was inadequate so, by definition, the client has suffered. To the public whether that suffering stems from incompetence, dishonesty or failure to follow process is irrelevant. A bank did someone harm and seems tone-deaf to that harm.

Regulation not only inevitable but necessary

It’s not surprising that people don’t trust the industry because it is unworthy of being trusted. It gives bad advice. It refuses to accept responsibility for its actions. Left alone it will sacrifice clients to its own self-interests.

So the answer is not to leave it alone. Tie up its hands in regulations that force it to act responsibly. Give the job of oversight and prosecution to a regulator who is not afraid to do it. And impose harsh financial penalties at both the corporate and personal levels.

That’s what the UK did. For decades the Brits were doing just as bad as us, or even worse. When these mis-selling scandals finally blew up, justice was delivered to customers who got tens of billions of pounds in compensation. Some industry players did not survive to endure tough new rules that mandate that only ‘suitable’ financial products can be sold. The suitability criteria are specific and strict. Non-compliance can see a UK business fined 10% of its turnover, while individuals can be fined up to 5 million euros.

It’s not just advisers who are on the hook. Fund managers and financial product providers are to be held equally culpable for mis-selling. Product providers must now design products for specific market segments, know who is buying the product and have methods to ensure it is, indeed, suitable for that specific buyer. This can’t be done by proxy through an adviser. The product issuer and customer must now have direct, independent relationships.

And this could all soon be coming to Australia!

The Australian Treasury circulated a draft of regulations similar to the UK’s, which are modelled from the European Union rules. If the political will was there (always a questionable assumption) these new rules could be in place quickly, hopefully enforced by an inspired regulator.

Paul Resnik is the founder of a number of financial services business, and has created tools to help give better financial advice in more than 20 countries and to one million financial advice clients. Find out more on risk profiling here.

Most of us know that buying a lottery ticket is a waste of money. The chances of winning are so remote as to be unachievable, yet most of us have probably bought a lottery ticket at some point in our lives.

Prospect theory can explain this behaviour. Prospect theory is useful for investors, particularly those who are approaching, or in, retirement. Understanding how people make decisions in the real world is the best starting point for constructing investment portfolios that allow investors to stay the course.

The term ‘prospect theory’ describes how people choose between different options (or prospects) and how they estimate the perceived likelihood of each of these options. Human nature being what it is, estimates are often biased or incorrect.

Prospect theory was developed as a pragmatic model for explaining real-world choices and why people do not make the optimal, logical decision.

Prospect theory in contrast to utility theory

The theory was a dramatic departure from previous models (e.g. utility theory), where decision making was assumed by academics to be perfectly rational. Utility theory claimed that probability-weighted outcomes served as the basis for determining risk on the final wealth outcome (i.e. the probability-weighted return) and rely on this as a key consideration in decision making.

In contrast, prospect theory claims that investors are more likely to prioritise gains or losses from a current reference point and treat these gains or losses differently from a value perspective.

In other words, the path of investment returns is more important than the final wealth destination.

A critical consideration in assessing this path is the concept of loss aversion. Put simply, the pain felt from losing $100 is sharper than the joy of making $100. If the path of investment returns encounters losses – more probable in a volatile asset class like equities – then investors will focus on the ‘journey down’ and sensation of loss, rather than the longer-term probability weighted return of the asset class. It is exactly at this point that adverse investment decisions are often made.

Insurance is the mirror image of buying lottery tickets, and is a good example of how prospect theory works. Even though the likelihood of a costly event may be miniscule, most of us would rather agree to a smaller, certain loss (the premium paid) than risking a large expense. The perceived likelihood of a major health problem is greater than the actual probability of that event occurring. There’s a reason insurance companies are some of the oldest on the planet.

There are numerous examples of people underestimating common risks. For example, a recent study of Australian hospital data reported that nearly 40% of all injury-related hospital admissions in Australia were due to falls, versus 13% for transport-related accidents. For Australians aged over 65, the rate for falls increases to more than three-quarters of all hospital admissions. And yet most of us perceive driving to be a riskier activity than the daily event of taking a shower.

Another consideration in prospect theory is mental accounting, which describes the process whereby people have different ‘mental bank accounts’ for different expenditures. For example, people tend to have a greater willingness to pay for goods using a credit card than cash, even though they draw upon the same resource. People are unable to focus on the final wealth outcome, instead they assess the individual transactions differently.

Utility theory and prospect theory do overlap in that as wealth or gains increase, the marginal value or utility progressively declines. In other words, the joy felt from a $1000 investment moving up to $1010 is less than the joy felt from a $100 investment moving up to $110. The absolute gain is the same, but we value relative gains differently to absolute gains.

Retirement planning with prospect theory in mind

So what does this mean for retirement planning? If a financial strategy is going to deliver the benefits and outcomes it was designed for, it is important that investors ‘stay the course’ and remain invested with a consistent long-term strategy.

However, at certain points along the investment journey, investors are likely to experience powerful emotional forces that can derail their longer-term investment objectives. Armed with an understanding of prospect theory, investors can recognise the pull of their emotional magnets and incorporate these into a comprehensive investment plan, making it more likely they will stick to their plans.

Based on this, it makes sense for investor portfolios to address three key issues:

1. Losses are felt more acutely than gains

As the GFC proved, retirees are more likely to disinvest during market stresses at precisely the wrong time than other age groups. This behavioural bias during drawdowns is compounded by the separate concept of sequencing risk, which can also serve to materially impair outcomes for retirees.

As such, capital protection is vital during periods of market weakness. This usually only comes at some cost of foregone investment returns. Capital protection cannot be considered in isolation (without some risk there can be no return). As a result, some approaches to capital protection such as a high allocation to cash can perversely increase risk as they simply increase the certainty of investment returns not delivering a portfolio’s objective.

The key is to improve the shape of returns to minimise drawdowns, delivering a growth profile with capital protection.

2. Investors value more certain returns above more ambiguous returns

In equity markets, this helps explain the typical Australian retail investor’s focus on distributions, where regular bank account deposits can unfortunately be prized more highly than the accompanying capital fluctuations in the unit price. While there may be some comfort for retirees from regular payments, the more important metric is ‘total return’, which includes movements in the unit or share price alongside distributions.

Within this total return focus, income can play a critical role by providing:

• greater certainty, especially in low growth environments when real returns are difficult to generate, and
• increased predictability, as the range of possible investment outcomes can be narrowed.

3. Investors’ sense of value diminishes as gains increase

Underperformance in a strong positive market is less important to an investor’s sense of value, especially in relation to stronger performance in a lower growth or negative market.

To help manage these issues, it makes sense to build retirement portfolios that are designed to deliver growth, but with a return profile that mirrors our humanistic biases and include elements of loss aversion and income certainty.

For investors, this can assist in dialling down the pull of our emotional magnets, and result in an increased likelihood of adhering to long-term plans and thus achieving better outcomes.

Alastair MacLeod is Managing Director of Wheelhouse Partners, a boutique asset manager partner of Bennelong Funds Management. This article is in the nature of general information only.

Although recent ASIC enforcement action and the Royal Commission have predominantly focused on the financial advice and lending practices of AMP and the major banks, emerging patterns teach us that non-bank lenders and financial advice firms are the next targets.

How do we know this?

ASIC’s approach

ASIC’s modus operandi is to first investigate potential regulatory issues within big targets, where misconduct is widespread and evidence is easy to find. This serves as a learning exercise, helping ASIC to ascertain the nature and scale of misconduct, and what to look for.

Investigation complete, ASIC generally releases a report on its findings and concerns. You’d expect that diligent compliance teams would read those reports, look within for similar problems, notify ASIC of any breaches and start a clean-up.

That’s what ASIC hopes for too. But, if no one falls on their sword – and the past few years have demonstrated how reluctant financial advice licensees are to do so – ASIC brings out the big guns of enforcement.

Naturally, they’ll start with the banks and big targets, who’ve proven easy to make examples of. But here’s the rub. By the time that work is nearing completion, ASIC has a template for investigating smaller players. They know what to look for, where to find it, what questions to ask, with a standard methodology.

ASIC’s methodology

It goes like this:

• Require from financial advisers a list of clients and information about the advice (s912C notice) and from credit providers, a list of borrowers and information about the loans from the lender (s266 notice).

• At the same time, require production of policies and procedures dealing with the area of concern (s33/s267 notice for AFSLs/credit providers) and production of policies and procedures dealing with the area of concern of past files or loans.

• If their concerns are borne out, some recent files may be requisitioned to see if any improvements have occurred, hoping that by now the firm’s compliance team will have acted on the report (s33/267 notice).

• An optional next step is for ASIC to bring the CEO or other senior managers in for questioning (s19/253 examination).

• If ASIC finds breaches which have not been voluntarily reported, enforcement action will follow.

So reading the tea leaves to be found in ASIC’s Corporate Plan for 2017/18 to 2020/21, its Enforcement Outcomes report for July-December 2017 and the carnage emerging from the Royal Commission, here’s a snapshot of what advisers and non-bank lenders should be looking for in their businesses. If they don’t, ASIC will!

Concerns with non-bank advisers

1. Charging fees for no advice – Over 27,000 customers have received a refund of fees charged for ongoing services that weren’t provided. ASIC estimates at least 150,000 more refunds will be required, and the problem is not limited to the banks. Selling grandfathered investment trail commission books must be in jeopardy, even if the government doesn’t legislate to end grandfathering.

2. Life insurance churning and inappropriately recommending super money be used to pay for life premiums – ASIC now receives regular exception reports on high lapse rates from insurers, from which they’ve become highly adept at detecting bad practices.

3. Failing to consider whether clients’ existing products will meet their objectives before recommending replacement – The minimum standard requires financial modelling of both options and a clear case for change, all of which is clearly explained in the Statement of Advice.

4. Inappropriately recommending SMSFs – It’s not just low balances that ASIC is concerned about, as client financial literacy and willingness to manage the responsibilities inherent in an SMSF are just as important.

5. Recommending services that clients don’t need or don’t value – These could include platforms or simply high ongoing service levels.

6. Recommending in-house financial products to generate extra revenue when there’s no additional benefit for the client – Vertical integration is not limited to banks. Advisers who operate Managed Discretionary Accounts (MDAs) or Separately Managed Accounts (SMAs) run the same risks.

Concerns with non-bank lenders

1. ASIC wants to make sure consumers have not been put into loans they can’t afford, don’t understand, or don’t meet their needs. As part of its focus on credit, ASIC will be looking at brokers who do not arrange loans responsibly and lenders who do not lend responsibly.

2. Brokers are expected to assist consumers to decide whether they can afford a loan, and if they can’t, help them to find a realistic method of achieving their goals. And lenders must not lend to customers if they cannot afford to repay. It’s not sufficient to use the Household Expenditure Measure as a proxy for actual expenditure. Verified evidence of actual revenue and expenses must be analysed.

3. Interest only, vehicle finance, and high-risk products are a priority. Although home loans and personal loans are not immune, ASIC is especially concerned about interest-only home loans, car finance, and high-risk lending products such as payday loans and consumer leases.

4. Brokers and lenders must ensure that reverse mortgage borrowers – who are typically older people at or near retirement – understand the costs and implications of taking out these products. The minimum requirement is for these borrowers to be given a Reverse Mortgage Information Statement, and taken through the Reverse Mortgage Calculator in person.

5. ASIC is preparing to get tough on lenders and lease providers using unfair contracts. It has recently warned lenders to ‘fix up’ unfair contracts immediately or face legal action. Some lenders have already paid heavy fines, refunded repayments, written off debts, or contributed to community programs. Others have lost their credit licence.

6. Lenders are now expected to have systems in place to identify and reduce the risk of loan fraud. This follows some egregious fraud cases where brokers either ignored forged or false documentation, or worse, falsified information for clients to increase the likelihood of their application being accepted.

7. The jury is out on mortgage broker remuneration. Commissions and other financially-based incentive schemes have a propensity to incentivise brokers to recommend loans.

8. Frustrated with its lack of progress in encouraging responsible lending practices through enforcement action, ASIC has taken the radical step of recommending that the industry move away from incentives that create conflicts of interest. This will be echoed by the Royal Commission.

9. Credit repair, where ASIC will take action against companies that charge consumers exorbitant fees to clean up their credit history or who put them into insolvency rather than negotiate hardship arrangements.

ASIC’s track record is impressive

The criticism that ASIC is receiving in the Royal Commission and the media for being a soft cop on the beat isn’t borne out when you look at the statistics. In the second half of 2017 alone, ASIC’s enforcement actions banned 54 people and companies from providing financial services or credit and instituted 232 summary prosecutions for liability offences and a further 17 sets of criminal proceedings. It raised $21.7 million in civil penalties and $94.4 million in compensation and remediation for investors and consumers.

If you’re not sure whether your business is at risk, or if you receive an ASIC notice, it’s best to get on the front foot.

Claire Wivell Plater of The Fold Legal is a leading financial services and credit lawyer. She actively advises both digital and ‘analogue’ businesses on commercial and regulatory issues and is a member of the Federal Treasurer’s Digital Advisory Group. This article is general information and does not consider any entity’s circumstances. 

Parents are often uncomfortable talking to their adult children about personal matters, but there are many benefits in having such a conversation. It should include our investments and more generally, our goals and plans.

My wife and I first did this some years ago, when I decided to graduate from full-time work. Most retirees find, after time passes, that it’s useful to repeat the exercise, as circumstances change and nothing ever works out quite how you projected. It then could become the year’s most important focal point.

I realise that some families, particularly in generations past, have found it difficult to discuss personal details at this phase of life with their adult children. Neither my wife nor I ever had such a conversation with our parents.

Our first talk

Our first effort with our own children has gone down in family history as ‘Dad’s Decumulation Talk’. Yes, as you might guess, I did most of the talking. Just before we started, my wife placed a cartoon in front of me. In it, there’s a family sitting around a kitchen table. The youngest one’s head barely comes above the table. And Dad is saying: “Before we begin this family meeting, how about we go around and say our names and a little something about ourselves.”

I got the message: “Remember you’re their father, not a businessman.” I’m told I conducted myself appropriately. It became a bonding experience in the family, and we’ve been able to discuss financial matters with our children, our matters and theirs, ever since.

At the time I gave them a document entitled “Goals and Plans,” which we prepared to give them enough background that, if and when the need arose, they could be confident about making decisions for us.

I’m including an outline of what our document contained as an appendix, as some people asked for it when I mentioned it in a talk.

The following is not meant to be a comprehensive list or a substitute for talking to your legal and financial advisers. When I refer to your adult children or other close family members, that’s a generic way of saying ‘whoever it is that you’d like to have take charge of your affairs, during or after your lifetime’. That might be a professional or a financial institution.

I’ve found it helpful to think of three dimensions regarding the information to be shared.

1. Where the important documents are

The first is a list of important documents and where they are to be found, preferably in one place, known to your children. This includes government-issued documents relating to your identity (birth, marriage, citizenship etc.) Include in this information regarding assets and liabilities, such as home ownership, cars, bank accounts, savings bonds, credit cards, life insurance, savings plans related to work or retirement, other invested assets, and other miscellaneous things you own.

There are also important legal documents under this heading, such as your will, powers of attorney, and advance directives, like a living will, medical power of attorney, end-of-life instructions, and so on. And contact details of important people, not just professionals like your doctor, your lawyer, your financial professional, but also close friends and relatives.

It’s often said that many people die without a will. My father-in-law, who was in the insurance business, told me that everybody already has a will. A will is a document that says what will happen to your estate after you’re gone. The law says what will happen, if you haven’t written your own document. So think of the law as your will. You do have a will, no matter what you think – it just may be that somebody else wrote it for you. Better to override it with your own wishes!

2. Sharing goals and plans

The second dimension relates to levels of involvement. (I found this at Anderson Elder Law, in an article in their Resources section dated 24 March 2015.)

The least involved level is where your children know where to find the information mentioned above. Next, you may want to share some of the actual information with them, such as your finances and your will. Once you start doing this, you will probably want to repeat the exercise periodically, as we now plan to do. At this stage you’re still in full control. It may later become necessary for them to assist you, or to share responsibility for your affairs, or to take over that responsibility completely.

A friend who is going through her own parents’ late phase of life reminds me that, in that phase, the relationship between parents and children can change completely. The parents need the children, rather than the other way around. The parents can become fragile and susceptible, and easy to be taken advantage of. The children worry about the parents and have to soothe them. My friend adds, feelingly: “I don’t know what I’d do if I couldn’t trust someone to take care of me …”

No doubt, therefore, you will have consulted your children before making the required arrangements and got their agreement to whatever goes into the relevant documents. And you’ll have given them a list of the medications you take and ensured that your professionals know they should consult your children and where to find them. It can provide great peace of mind to know that all of this has been discussed before the need for the arrangements to be carried out ever arises, even if one day you may not remember ever having done this.

It’s peace of mind not only for you but also for your children, who may be worried about whether they’ll have to support you financially at the end. For your children’s sake, don’t leave this conversation so late that your mental capacity is declining.

3. The ‘estate event’ (otherwise known as death)

The third dimension involves saving trouble for your executor after your estate event. (I was amused to discover that American insurance agents don’t like talking about death. Instead, they refer euphemistically to your ‘estate event’.)

Some wills are hotly contested by family members who can’t stand one another. You may not be able to solve this conflict while you’re alive. The angst that it may be possible for you to spare your executor arises from dividing up your personal possessions or leaving clear instructions about how to divide. Paul Sullivan (in his Wealth Matters column in The New York Times on 15 April 2016) wrote:

“… just think for a second what it would be like on Christmas morning if your children ran downstairs and there were all of these presents, bright and shining, big and small, but with no name tags on them. Can you imagine the free-for-all that would ensue?”

Don Ezra has an extensive background in investing and consulting and is also a widely-published author. His blog posts at www.donezra.com focus on helping people prepare for a happy, financially secure life after they finish full-time work.

In 2000, when CBA bought Colonial State Bank and its wealth manager, Colonial First State (CFS), CBA hired me as a consultant on the deal. One of my roles was to determine how much funding CBA could source from CFS portfolios. CBA expected CFS fund managers to invest more into CBA deposits.

It showed a fundamental misunderstanding of the responsibility of a fund manager to act in the best interest of its investors, not the bank’s shareholders. The CFS fundies explained their fiduciary duty and told me where to stick my bank balance sheet. Ouch!

The confusion arises because a banker is not a fiduciary in its customer relationships. A bank is entitled to prefer its own interests above those of its customers, and the bank generally has no duty to advise customers of a more advantageous deal. Banks offer lower deposit rates and higher lending rates to existing customers than new customers without any compunction.

There is therefore inherent conflict when banks own wealth management businesses. To some extent, it can be managed by strict rules about conflicts of interest, but there are cultural differences. In 2011 when CBA paid $373 million for Count Financial, it was driven by the assumption that Count clients would go into CFS funds and platforms. It never happened, and now CBA has run up the white flag and given up on wealth management. CEO Matt Comyn explained:

“(CFS Group) will benefit from independence and the capacity to focus on new growth options without the constraints of being part of a large banking group … It also responds to continuing shifts in the external environment and community expectations, and addresses the concerns regarding banks owning wealth management businesses.”

In fact, it does not address the main vertical integration concerns about funds management, platforms and advice in the same corporate structure, and it passes that problem to the next management team. In commenting on the word ‘independent’, ASIC said that under s923A of the Corporations Act, a licensee can only describe itself as independent if it is operating without any conflicts of interest.

Following the FOFA legislation, advice scandals and the Royal Commission, CFS staff who manage the FirstChoice platform must go through a more arduous process to include in-house funds than those of external managers. Internal compliance demands evidence that funds from Colonial First State Global Asset Managers, and alliances such as Realindex, Aspect Capital and Generation, are both cost and performance competitive. It’s a way of managing the vertical integration conflicts, but it does increase the compliance, legal and administrative work on selecting funds for the platform.

CBA had a harder decision than ANZ and NAB, as its wealth business is more substantial and successful. As the following chart shows, CBA entities not only have a much larger market share of funds, but they are doing well on new flows. The chart also shows why Hub24, netwealth, OneVue and Praemium are sharemarket darlings, gaining more flows than their market share.

Matt Comyn wants to go back to banking basics, and he threw Aussie Home Loans and Mortgage Choice into the demerged entity to avoid further Royal Commission fallout. But nobody is asking why he kept broker CommSec in CBA. Probably because he once ran CommSec and feels he understands it, but it barely qualifies in the “focus on its core banking businesses”. The separation ends the ‘bancassurance’ and ‘allfinanz’ models that bankers loved in the 1990s.

Graham Hand is Managing Editor of Cuffelinks.

Do you or your parents have a cleaner or a carer? Don’t get us wrong, we think that properly-paid cleaners are a good thing and properly-paid carers deserve their place in heaven.

However, just as these people can be underpaid, sometimes they arguably get much more than a family might think appropriate.

A recent case of a carer inheriting an estate

In Carr v Homersham, Ms Cynthia Carr (the Carer) said that she commenced cleaning for a Mrs Beryl Hordern (the deceased) in the eastern suburbs of Sydney. The deceased suffered from Alzheimer’s disease for more than 10 years before her death in 2014. A friendship developed between the two women and they met frequently on a social basis. Ms Carr also performed many chores for the deceased.

When the deceased died, she left 100% of her estate to the Carer. We make no suggestion that the Carer acted with a view to benefitting from the estate of her client.

The deceased executed a will kit in 2001 leaving everything to Ann Richardson, her niece. She subsequently made a new will in 2004 under the belief that her niece complained about having to care for the deceased’s late sister, who passed away when the deceased’s niece was in her twenties. The niece was left out of the estate and so she challenged the 2004 will.

The Court at first instance found: “I am not satisfied that [the Carer] has satisfied the onus of proof that the 2004 will is the will of a free and capable testator so found in favour of the 2001 will kit which left her entire estate to her niece.” The niece won Round 1.

The Carer appealed to the Court of Appeal, where three judges reviewed the evidence. A geriatrician from St Vincent’s Hospital had concerns about the deceased’s capacity but the Court seemed unsure whether he saw her in her then-normal state. He said that she had a whisky during the consultation and that she said she had already had a drink before he arrived! We note the irony of the geriatrician’s name being ‘Dr Beveridge’!

While there was evidence of advanced dementia and difficulty remembering names, the number of the property in which she lived and managing money, the evidence of the two lawyers who witnessed the will was persuasive of her capacity at the time she executed it.

The testator’s solicitor, Mr Noel Bracks, gave evidence that he had questioned her about being sure that she wished to leave everything to Ms Carr. She said she was sure, describing Ms Carr as “my only real friend.” Mr Bracks pressed, noting that she had a niece overseas. The testator responded:

“Yes, and a nephew, but I don’t want to leave anything to them. I have a will leaving it to Ann [the niece] but she has disgraced herself with comments about my sister (her mother) and the nephew doesn’t deserve anything.”

The other evidence came from Ms Carr, who was present when the solicitors came to the testator’s apartment to witness her execution of the 2004 will. Her affidavit stated:

“I said ‘What about Ann [sic], I thought she was to get everything.’ She said ‘No, Ann has paid no attention to me since I spoke to her about the way she had spoken about her mother ruining her life …. When did she last visit me or even inquire as to my well-being? No, you deserve everything. You have been a very good friend to me and anyway Ann has got plenty, she doesn’t need this.’”

The 2004 will stood. Round 2 (the final round as at the date of this article) to the Carer. The Court even found that the deceased was mistaken in her belief that her niece had spoken ill of the deceased’s sister. Crucially, however, there was no evidence that the deceased was irrationally holding on to this belief.

Judicial comments

MacFarlan JA in the Court of Appeal stated:

“The authorities to which I turn below in my view establish that a false belief, even one that is material to the making of the will in question, is not of itself sufficient for this purpose. More is required: the nature of the deceased’s false belief and the circumstances in which it was adopted and adhered to must point to a lack of capacity of the deceased “to comprehend and appreciate the claims to which he [or she] ought to give effect” (Banks v Goodfellow).”

“It is only if there are repeated attempts to correct the view and they are rebuffed that it may get to the point of irrationality and ordinarily evidence will be required that there has been an attempt to reason the deceased out of the belief, such that the deceased’s adherence to it suggests that the deceased has a mental disorder or deficiency precluding the deceased from comprehending and appreciating ‘the claims to which he [or she] ought to give effect’ (Banks v Goodfellow). He found the trial judge erred in thinking the talking out of the understanding was immaterial.”

“To adopt the language of Gleeson CJ in Re Estate of Griffith, whilst the deceased’s approach may have been ‘harsh’ and ‘unreasonable’, it would not have reflected a ‘morbid aberration’ which [so affected the deceased’s judgment of Ms Richardson] as to warrant the conclusion that she lacked the capacity to make a valid will.”

Basten JA stated:

“There was, in effect, an absence of persuasive evidence linking the antipathy for her niece with unsoundness of mind. A court must be vigilant against drawing such a link on the basis of its view that the judgment exercised by the testator, founded upon a false recollection of the reason for her antipathy, was quite unreasonable. Accepting that it raised a relevant doubt, a careful analysis of the whole of the evidence showed that there was no proper evidential basis to conclude that an irrationally based antipathy towards her adult niece warranted a finding of testamentary incapacity. The doubt should be rejected as insubstantial.”

The decisive factor

If the deceased could have been reasoned out of the mistaken view, it would not have been regarded as incapacity. If there had been a statutory declaration by the deceased explaining her thought process, the case could have been decided differently.

We will never know if the deceased was deliberately compromising the assessment of the geriatrician by drinking. You could not make this stuff up.

In all seriousness, the case demonstrates the care that the Court takes to establish the facts and to honour the real testamentary wishes of a person. Unfortunately for the parties, the dirty laundry is closely examined and washed publicly. Without evidence, it is hard to win.

As the experienced consultant psychiatrist said in this case, “[misunderstanding of the family dynamics is] common enough in families”. What family is immune from that?

Postscript

If you like this type of drama, there is more to come when the Supreme Court of NSW delivers its decision in the case of the author of The Thorn Birds, Colleen McCullough. Senior Counsel for the winner in the Carer case, David Murr SC, also appeared in the Thorn Birds case, acting for the author’s husband. [Editor’s update: the day after this article was published, the Court found in favour of Ms McCullough’s former husband).

To set the scene for that decision, we quote from Traveller magazine which published a puff piece on Ms McCullough’s house on Norfolk Island, without knowing the drama that was to follow after her death:

“From the outside, Australian novelist Colleen McCullough’s home on Norfolk Island is prim and picket-fence perfect, a long tree-lined driveway leading to a white two-storey colonial house in a leafy garden. Inside, it’s a different story …”.

Isn’t it the same in many houses?

Donal Griffin is a Principal of Legacy Law, a legal firm specialising in protecting family assets. The firm is not licensed to give financial advice. This article does not consider any individual circumstances and Cuffelinks does not know the merits or otherwise of the case.

The flight to ‘independence’ from major institutions by financial advisers has been a developing theme over recent years and it is set to continue. The findings of the Financial Services Royal Commission increase the importance of demonstrating greater independence between products and advice, but the reasons for the move are as varied as the types of clients and communities advisers serve.

Not just a product off a shelf

What are independent advisers looking for when partnering with technology and service providers? When I asked this question of our clients, the advisers, a strong theme in the responses was that they want to build trusted relationships and partnerships as opposed to buying a product off a shelf or a ‘user licence’. They want open architecture and an Approved Product List (APL) that does not restrict them from delivering what is in the best interest of their clients. They want compliance with a delivery mechanism that is flexible, allowing their own culture and brand in communications. Ultimately, they also need easy to use services and platforms that allow them to spend more time with clients without being bogged down in administration and compliance tasks.

Jayne Graving of Arch Financial Planning summarised the drive for independence as:

“I would say the benefits of being independent and what we value are the ability to partner with best of breed and like-minded firms with resources including research, technology providers, platforms etc. We have complete flexibility and are not locked into any system, methodology or product. Every layer of the advice process is independent of the others, and everyone retains the integrity of their service delivery. There are no impeding constraints like limited APL’s or conflicts, just teams of professionals working together by choice to achieve the best outcomes.”

What about the client perspective?

Some of the themes in the adviser feedback on what their clients are looking for, and hence what the adviser needs to deliver, include:

• Transparency and confidence in the safety of the assets
• Access to appropriate investment options at reasonable cost
• Cost effective and demonstrative value of advice
• Honesty and integrity in the way that services are priced, and fees are levied, with no hidden charges (such as in the form of no interest on cash)
• Online portal for viewing portfolios and ease in communication paths for updates from the adviser.

Not only are these advisers looking for great services and products for themselves, the outcomes and the experience for their clients was paramount.

Features of the platform that assist the advice process

Advisers say they are looking for a provider to deliver these outcomes for their clients:

• Remove the layers of fees built up over the years of institutional management
• A cost-effective solution to assist with best interest duties
• Support and automation of compliance through audit trails, controls, alerts and monitoring, as well as accuracy through reconciliations
• Flexible and reliable reporting systems that can integrate into financial planning software
• Open architecture giving the ability to choose from a landscape of financial products and services based on what is best suited to achieving the clients’ goals: “We don’t want to be beholden to one major, vertically-integrated financial company.”
• Next-generation thinking: “Gone is the old ‘hidden fee’, ‘shelf space’ and ‘lock in’ approach.”
• Branding by the adviser to keep the marketing and messaging consistent and assist in a retention of culture
• Technologically advanced so that it reduces administrative staff time, lowering cost, reducing human error and increasing the efficiency of managing models. “Time spent on back office and administration is time that could be better spent working with our clients.”
• Scalability to grow the business
• A single solution that can be tailored for different types of clients, including retail, wholesale, families, individuals and not-for-profits

The efficiency of model portfolios and managed accounts

Operational efficiency and best interest responsibilities are also assisted by the use of model portfolios and managed accounts.

Firstly, advisers can easily change a model portfolio and it flows through to all clients’ portfolios with that model, and a bulk rebalance can occur smoothly and quickly.

Secondly, a good investment committee or investment manager can make a decision and make the change within a day, allowing them to be responsive to market conditions in best interest of clients’ returns and outcomes. Intraday ‘trading’ is no longer dependent on a stockbroker’s ability but execution is transferred into advice through segregated accounts with their own Holder Identification Numbers (HIN).

Liza Janakievski, CEO of Giles Wade, expresses what many advisers view as the emerging approach to the relationship between the technology (platform provider) and the adviser:

“As a firm with bespoke family group clients, we want to ensure that our future requirements for client tailoring are heard and not just put on a ‘wish list’.”

Even though technology plays a bigger role in the life of advisers and their clients, it does so in subtle ways. Interactions with technology are becoming more seamless within the advice process and systems are becoming easier to use. The goal at WealthO2 is to deliver elegant and intuitive software solutions for advisers that are efficient and compliant. Advisers want to spend more time with clients and develop relationships and let the software implement the adviser’s best interest advice in a scalable and efficient manner.

Now is the opportunity for advisers to cleanse the public perception of poor behaviour raised in the Royal Commission and deliver better outcomes that are clear of conflict and give the best results for both the client and the business alike.

Shannon Bernasconi is Managing Director of WealthO2, a wealth management software solution provider for financial advisers. This article does not consider the financial circumstances of any individual.

Since 2004, when ASIC promulgated the Managed Discretionary Accounts (MDA) Class Order, managed accounts were set to be the next big thing.

Over the past three or four years that promise has started to come to fruition. Approximately $60 billion is now invested in various forms of separately managed accounts (SMAs) and MDAs. These two forms of managed accounts have developed in tandem and represent differing perspectives on the benefits which managed accounts offer, and who will be best placed to take advantage of those benefits.

What are SMAs and MDAs?

Think of managed accounts as ‘Implemented Advice’ – the service an investor client would receive from an adviser if they were the adviser’s only client, and the adviser had the skills of an experienced investment manager across all asset classes.

SMAs generally have a legal structure of registered managed investment schemes. They have been developed by the platform industry as a way of assisting advice firms to deliver the promise of implemented advice. They offer the benefit that the platform takes charge of technology and operations, and often provides a menu of investment managers, just like the traditional managed fund menu. But they suffer from the disadvantage that they are platform-specific and are fundamentally a financial product.

MDAs are set up under their own set of regulations. They are much more commonly provided directly by advisory firms. There are over 200 AFSLs with MDA Provider authorisations. But the issue is that the MDA Provider is responsible for providing or outsourcing all facets of the service from administration and operations to investment management.

Growth in managed accounts of both types has been running at around 40% per year. However, a number of commentators are questioning whether this can continue in a post-Royal-Commission world.

Four drivers of growth in SMAs and MDAs

Growth in SMAs and MDAs has been driven by several factors, including:

1. An attempt to achieve greater practice efficiency among advisers.
2. A desire by advisers to deliver better, more precise client outcomes.
3. Technology developments that have enabled the systematic, model-based management of many portfolios.
4. A strategic trend for advice businesses to move towards wealth management, with different pricing models.

If the last of these clashes with regulatory change, will the other three drivers be derailed?

All forms of managed accounts are subject to the existing FOFA regulations relating to conflicted remuneration, just like any other financial product. Indeed, as mentioned above, SMAs are generally registered managed investment schemes and are subject to identical restrictions to those which apply to unit trusts.

How might a tighter regulatory regime impact the key drivers of growth described above?

1. Practice efficiency

Whether an advice business (AFSL holder) obtains revenue from their managed account service or not, the efficiency gains are substantial. Advisers will seek improvement in their office efficiency, and, if anything, this drive will accelerate as advice firms look to control costs more firmly than in the past.

2. Better client outcomes

Managed account structures, particularly multi-asset class models, recognise that client outcomes will be improved in several ways:

• Efficient implementation of tactical changes.
• Client portfolios receive continuous review, rather than annual ad hoc review. This makes advice fees easier to validate.
• Use of listed investments that was previously seen as impractical by many advisers. Generally, this has meant a lower cost of investment.
• Establishment of central investment teams, with an increase in the level of experience and skill applied to portfolios.
• Other cost reductions, particularly in fund manager MERs and often platform costs. The benefit of this flows directly to the client.

Taken in aggregate, these factors lead to better client investment outcomes. None of these issues is likely to be reduced in their impact by regulatory change.

3. Technology advancements

One of the impediments to the adoption of managed accounts was the inability to implement them on major platforms. Every one of the large platforms is now well advanced in implementing this capability and a number of fintechs are offering implementation which makes it feasible to manage many portfolios concurrently. Again, no likely regulatory change will cause these developments to be withdrawn.

4. Charging for portfolio management services

The development of more rigorous portfolio management capability either with internal investment capability or through the use of external consultants or directly contracted investment managers, comes at a cost. Advice groups either absorb this cost or legitimately levy a portfolio management fee on clients to cover it.

For the groups who absorb it as a cost of achieving the benefits outlined above, any regulation change will likely be a matter of indifference. For groups that recover these costs, there are well established client consent processes they can apply.

So, without wishing to seem like a Pollyanna, we don’t think there will be a material negative impact on the trend to migrate significant existing advised assets into managed account structures.

Toby Potter is Chair of IMAP (the Institute of Managed Account Professionals), an organisation whose mission is education, information and representation of managed account professionals.

Behavioural economics has revealed the vast gulf between what people say they want and how they behave. It makes life challenging for financial planners, superannuation funds and financial institutions attempting to deliver the right products and services.

However, new approaches built on data, analysis and algorithms can help solve the paradox of advising people who are effectively strangers to themselves.

The difference between stated and revealed preferences

Financial planning questionnaires typically ask clients for stated preferences such as how they believe they will react in different circumstances, but decision theory and behavioural economics explain why people’s actions regularly deviate from their intentions.

For example, the second-highest financial priority cited by seniors in a recent ASIC survey was “having enough money to enjoy life and do what they want to do” (69%). Yet a significant proportion of retirees spend less than the age pension according to the Milliman Retirement Expectations and Spending Profiles (Retirement ESP).

Meanwhile, the industry has long known that the stated preference for reliable retirement income doesn’t translate into sales of products such as annuities.

These inconsistencies suggest retirees are prone to stronger opposing forces that change their behaviour in ways they don’t realise. It makes setting personal goals a complex task because people don’t know themselves, let alone how to balance competing desires.

Comprehensive data helps. The Retirement ESP has revealed several surprises about the behaviour of retirees which differs from industry assumptions.

Shachar Kariv, Professor of Economics at UCBerkeley, recently pointed to gamification, or the process of melding game-like actions with everyday tasks, as a more accurate methodology than questionnaires. It can show how clients will actually behave (their revealed preferences) rather than how they think they will behave (their stated preferences).

“People will enjoy it because it will be a game,” Kariv said at a recent Milliman breakfast event. “It’s going to be fun and fast. You can do it from your phone or tablet and in different periods of time.”

For example, a coin flipping gambling game can reveal players’ risk-return trade-offs and preferences in a mathematically-sound approach. Various studies are now showing, with statistical certainty, just how certain segments of the population behave by using these techniques.

The problem with risk

Understanding the risk that hides behind investment returns is complex.

Individuals may think of risk in terms of the possibility of investment losses or in terms of not achieving their financial goals. The asset management industry on the other hand typically defines risk in terms of the distribution of returns (volatility). This disconnect between everyday Australians and investment professionals can lead to poor outcomes.

The problem is exacerbated by the fact that individuals make poor predictions (stated preferences) about their level of risk tolerance. Many investors withdraw or switch their portfolios to cash when equity markets decline. The following chart is now dated but fund managers confirm similar patterns of flows recently where performance varies against a benchmark.

S&P 500 Index performance vs. 12-month equity mutual fund flows

A secondary issue is the way the industry gauges investors’ risk tolerance with standard risk and return questionnaires. As Kariv, who is also Chief Risk Scientist at risk profiling firm Capital Preferences, said:

“I would claim there is no scientific basis whatsoever for this method. A survey is like designing a bridge without writing any mathematical equations. You will not drive on a bridge that the engineer has designed without writing any mathematical equations.”

Accurately measuring risk capacity, not just risk tolerance, is essential if investors want to achieve their goals. Risk capacity is the level of risk an investor can withstand while still meeting their objectives with a reasonable level of certainty.

For example, many older investors have higher levels of loss aversion, which leads to lower risk tolerance levels. However, wealthier investors with high levels of cash to fund their day-to-day lifestyle can have higher levels of risk capacity.

Risk capacity is also relevant for younger investors. The ASX Australian Investor Study 2017, which surveyed 4,000 Australian residents, suggests that young investors may be more risk averse than previously thought. It found that 81% of investors aged under 35 were seeking guaranteed or stable investment returns.

However, young investors have a higher risk capacity when it comes to their retirement savings, given that they will have decades in the workforce and can withstand market gyrations.

Analysis can discern the difference between risk preferences and risk capacity and help advisers balance the tension to find a solution that works for their clients.

Most people do not know their spending or lifestyle habits

People are bad at estimating how much they spend, which makes it difficult to choose the optimal investment strategy to lift retirees’ standards of living.

The evidence is the Household Income and Labour Dynamics in Australia (HILDA) data, which surveys more than 9,500 households. It provides information and insight into everyday Australians. However, spending surveys of this nature have shortcomings when applied to the context of financial planning.

For example, an industry analysis estimated that the median expenditure for households aged 65-69 was $24,640 a year while the average was $33,944. The Retirement ESP, which uses bank transaction data from more than 300,000 retirees, shows that the median couple aged 65-69 spends $34,858 while the average expenditure was $43,675. This is a significant difference even when accounting for the different time periods of the underlying data (2015 versus 2017).

Other differences are also revealed when people qualitatively assess their own lifestyle compared to a quantitative assessment of data. For example, 2,527 people surveyed in the 2015 HILDA survey said they smoke at least one cigarette a week. However, 38% of these respondents reported spending no money each week on cigarettes.

These discrepancies in spending survey data are not material when taken in the appropriate context. However, they do highlight the potential risks of relying on spending survey data to form views about the spending needs of future retirees.

Financial advisers, and increasingly, super funds, develop an understanding of clients’ and members’ qualitative information and life experiences because they spend time with them. However, a mix of tools powered by data, analysis, and algorithms can help them bridge the gap between the things people say they want and how they actually behave.

This type of quantitative information is a key component of this approach and can provide a clearer view of retirement expectations and what people need to do to achieve their goals.

Jeff Gebler is a Senior Consultant at actuarial firm, Milliman. Read more about the Milliman Retirement ESP here.

This article is the first in a series written by leading retirement website, YourLifeChoices. It reports on the major healthcare burden of many retirees and governments.

Every 1 April, retirees with private health insurance hear one piece of news that they wish really was an April Fool’s Day joke – the announcement of a big increase in premiums.

In 2018, the hike was, on average, 3.9%, which, when grouped with medical services, was the biggest contributor to June quarter inflation. Australian Bureau of Statistics figures show that the Consumer Price Index (CPI) rose 0.4% in the quarter. The category that increased inflation the most was health, rising 1.9%.

Retirees want to keep private health insurance

Retired Australians are among the biggest group with private health insurance. In YourLifeChoices’ Retirement Income and Financial Literacy Survey 2018, 71% of respondents said they had private health cover. While they said the rising cost of insurance was a major burden on their budgets, they were still anxious to retain their cover.

Older Australians are heavy users of the health system. Those aged 65 and older comprise just 14% of the population, according to the 2016 Census, but account for 28% of the 123 million claims for GP visits in 2014–15.

In addition, of the 12.5 million specialist visits claimed through Medicare in 2014–15, 43% were lodged by those aged 65 and over.

The Australian Council of Social Service (ACOSS) believes that affordable health and aged care are just as important in retirement as a decent income. ACOSS Senior Adviser Peter Davidson says:

“It’s vital that we avoid a two-tier healthcare system – one for the top half of the population and another for the bottom half, of the kind that has long existed in the United States and still exists in dental care in Australia.”

He says the challenge for governments is how to pay for the inevitable increases in the cost of existing healthcare programs given increasing longevity, while closing the worst gaps in services, such as dental and mental health services and the National Disability Insurance Scheme (NDIS).

“The Parliamentary Budget Office estimates that to maintain existing commitments in health, aged care and the NDIS, governments will need to spend an extra $21 billion a year by 2027,” he says.

Lower-income households cut back on health insurance

The Australia Institute Senior Economist Matt Grudnoff says that low-income households traditionally spend a larger proportion of their income on essential goods, but that this principle breaks down when it comes to healthcare. Healthcare can easily be regarded as a necessity, he says, but lower-income households view it as a non-essential category that they can cut back on because their budgets won’t stretch that far. As a result, a greater burden is placed on those who can afford to pay.

Mr Grudnoff says that in the past 30 years, the CPI has doubled whereas healthcare costs are 3.7 times higher. He also warns of the dangers of a two-tiered system and questions the Government’s strategy.

“In recent decades, Australia has reduced its emphasis on direct government spending on specialised healthcare and has increased indirect funding by subsidising private health insurance. It might be time for the Government to consider if it is getting a big enough benefit from this strategy or if the $6.4 billion it will spend on subsidies to private health insurers next year might be better put directly into the healthcare system.”

Aged Care Steps Director Louise Biti recommends that senior Australians consult a financial adviser to help them plan for the potential high cost of healthcare later in life. She says:

“Having adequate savings opens up your choices and your ability to control the level and type of care you receive. While we don’t know what your future holds, with some planning, we can help make your retirement a comfortable one. For example, we could ensure you have a safe and secure income in place for life. This might be pension income, lifetime income streams or drawdown strategies from other investments.”

Founder of MyLongevity.com.au, David Williams, says that while we can’t predict how long we will live or what health issues may crop up later in life, it is possible to make informed calculations. He has developed a free tool called SHAPE, which analyses your personal factors, current health and daily habits to give an indication of your life expectancy. He says:

“There is no plan without a timeframe and the best timeframe is the one that you develop for yourself. You can then have a constructive conversation with your financial adviser, just as you will have had with your medical adviser. Understanding more about the chapters in your longevity is a step towards taking more control of your life and achieving a more fulfilling future.”

Olga Galacho is a Writer with YourLifeChoices, Australia’s leading retirement website for over-55s. It delivers independent information and resources to 250,000 members across Australia.

Cuffelinks continues to receive emails from readers asking about Labor’s franking credits policy. Rather than respond in detail individually, we have collected 15 articles into one resource for people to consider. This issue will not go away and will become a major part of the next Federal election. We have had an unprecedented number of comments on this subject.

In addition, we reproduce a ‘sample letter’ which shows the intensity of reaction from a retiree who will lose $6,250 from his modest retirement income.

On 13 March 2018, the Labor Party announced its intent to deny cash refunds for excess imputation credits from 1 July 2019, if elected to power. Bill Shorten called it a ‘tax loophole’ in a speech laden with class warfare, and the public outcry was swift. Two weeks later, Labor capitulated and decided to exempt pensioners, thus sparing over 300,000 full and part-pensioners, people on government allowances, and about 13,000 SMSFs.

Cuffelinks has run a series of opinion pieces on the policy, some of which were published before the ‘pensioner exemption’ was declared. The op-eds dissect the policy’s motives, effects and equity.

The reader response has been considerable, garnering (as at 12 August) 579 comments. The list below links to each of the 15 articles, with a summary of the key message.

1. On 14 March, Ashley Owen calculated the impact of franking credits as 1.5% of a total dividend yield on Australian shares of 5.7%, or 25%. Owen saw one upside:

“If franking credit refunds are removed, it may lessen the myopic ‘home bias’ that many Australians suffer from and encourage them to increase their interest in other opportunities in global markets.”

‘Impact on returns from loss of excess franking’ had 15 comments.

2. On the same day, Nicholas Stotz calculated the impact on the after-tax income of a pension or super fund holding only shares paying fully franked dividends at various tax rates, and discussed whether dividend payout ratios and SMSF allocations would be affected.

‘Impact on pensions and super from loss of excess franking’ had 95 comments.

3. On 21 March, Warren Bird spoke to the underlying principles of equitable taxation:

Tax is paid only once by those who are obliged to pay it. In this case, it’s the owners, or shareholders. The collection of a 30% tax from the company is a prepayment of tax by the shareholders at a sort of a mid-rate. Shareholders who have a lesser tax obligation must receive a refund that places them in the same position had the company paid no tax and all dividends been taxed fully in the hands of the shareholders at their marginal rate.

‘Back to basics shows franking credit refunds are fair’ had 71 comments.

4. On the same day, Brad Newcombe analysed the impact of Labor’s policy on hybrids. He concluded that the pool of potential fully franked hybrid investors will diminish, but there may be an increase in margins attached to new hybrids. For those who can use the franking credits, that is good news. Newcombe said the impact was already visible as he put the case of NAB’s hybrid (ASX:NABHA) under focus.

Impact on hybrids of Labor’s franking policy has received two comments.

5. On 29 March, by which time the pensioner exemption had been floated, Jon Kalkman, a former Director and VP of the Australian Investors Association, called out Labor’s bluff:

“For all taxpayers on low marginal tax rates (especially retirees), the tax paid on dividends from Australian shares will be higher than other sources of income. As this increased tax will lower their income, this will distort investment decisions.”

In other words, Labor’s policy, even when amended, was not directed at the rich on highest marginal tax rates. Further, Kalkman argued that the policy will backfire in the worst possible way, putting pressure on the age pension system.

‘Tax-free super drives the politics of envy’ had 21 comments.

6. On the same day, Geoff Walker cautioned that logic will not win the day. Extrapolating from ABC’s Leigh Sales’ interview of John Daley (Grattan Institute CEO), Walker spelt out a hypothetical Q&A by which those ideologically aligned with the ALP could obfuscate the issue enough for radio shock jocks to carry on with ‘the rich getting concessions’ alarmism that feeds public fears.

‘Franking: never mind the logic, let’s obfuscate’ had 55 comments.

7. On 5 April, Howard Badger took on the case of why the policy was unfair to LICs.

Badger compared the tax levied on an accumulation super fund invested in LICs with it being invested in a trust or direct shares and with a HNWI trust. He concluded that, given a large percentage of investors in LICs are super funds and that many investors in LICs are not wealthy, the result is inequitable.

‘Labor’s new franking policy is unfair to LICs’ received five comments.

8. On 17 May, Michael Hutton spoke to the investment strategies that SMSF members and self-funded retirees could implement to minimise their losses if the imputation rules changed. Hutton explored choices around asset allocation, asset test thresholds, age pension eligibility, transferring the Australian shares part of the SMSF to a wrap account, and the inclusion of younger family members.

‘Four SMSF strategies if imputation credits rules change’ had 49 comments.

9. On 23 May, Matthew Collins looked at the various options available to SMSFs to reduce the impact of the new franking policy (if it became law), including changing the asset allocation, having one’s children included in an SMSF, not hastening from the accumulation to the pension phase, plus closing the SMSF and joining an industry or retail fund in order to avail of the member-directed investments feature.

‘SMSFs, member-direct and Labor’s franking’ had 29 comments.

10. On 30 May, Noel Whittaker argued that Labor’s policy discriminates against widows and widowers and that the wealthy are largely unaffected. Whittaker also took to task Bill Shorten’s rhetoric that the “high-priced medico on $500,000 is able to split income and pay less tax than the nurse on $50,000 a year” — alerting us that it cannot happen except by the ‘medico’ deliberately (or foolishly) investing in numerous loss-making investments. According to Whittaker, the rich already pay more than their ‘fair share’ of tax.

‘Labor, let’s face the facts on fairness, women and franking’ had 46 comments.

11. On 6 June, Tom Garcia articulated the distinction between direct-investment options and a wrap, how direct options work, who offers it, and importantly, showed how the impact from the loss of franking credits can be minimised under direct-investment options.

‘How do ‘direct investment options’ deal with franking credits?’ had 29 comments.

12. On the same day, at the request of a Cuffelinks reader (Trustee X), Graham Hand published an email sent by Trustee X to Shadow Treasurer Chris Bowen, Bowen’s response email, and the reader’s subsequent email to Cuffelinks.

Bowen refused to accept that the very wealthy whom the plan is supposedly targeting will not be affected. However, he did accept that the low-level SMSF of middle class Australians will be. Yet, Bowen shows no intent of changing the policy.

‘Shadow Treasurer Chris Bowen responds on franking policy’ had 68 responses.

13. Jon Kalkman returned on 21 June in response to a reader query, by laying out the legal foundations of imputation, being the avoidance of double taxation since franking credits are prepaid taxes.

‘What is Labor’s franking impact outside of super and pensions?’ had 47 comments.

14. On 26 July, Graham Hand revived the email trail between Chris Bowen and Trustee X, adding clarifying remarks and the entire set of emails between him and Trustee X.

‘Labor franking policy creates incentive to close SMSFs’ drew 33 comments.

15. On the same day, Ian Henschke established how the oft repeated ‘tax the rich’ phrase, fit for the ALP hyperbole, did not align with the facts. He advised of the formation of the ‘Alliance for a Fairer Retirement System’.

‘Tax on so-called ‘super rich’ could prove costly’ had 14 comments.

Call to arms

Wilson Asset Management has proposed that adversely-affected parties write a letter to their local member. A ‘sample letter’ provided by Wilson is published below, although it is specific to someone’s circumstances.

Sample letter to the local member

I recently received in my post box a brochure from you saying that you stood for a “fair go”. I was a ten-year-old when my grandfather told me why he was a Labor man and it was because the Labor party stood for a fair go for everyone. Clearly this is not the case in regard to the Labor parties proposed policy on franking credits. This proposed policy will severely damage the quality of life my wife and I may expect in retirement. Apart from supporting Jo Vallentine in the Senate during the 80’s I have voted Labor up until this point in time. No more.

The current franking credit rules make sure that taxpayers receiving company profits are taxed at their marginal tax rate on this income. This is a fair result under our tax system and it offends me to hear it described as a “loophole” or a “rort”.

The refunding of excess franking credits has been a long-standing feature of the Australian tax system, having been introduced with bipartisan support in 2000. This has seen people saving for retirement factor in having franking credit refunds as part of their retirement income.

Retirement planning does not happen overnight. It takes decades, and is not easily turned around. I planned and saved diligently according to the rules of the day. There is much I would have done differently had I known of Labor’s intent to change the treatment of franking credits. I am horrified by your unfair shifting of the goal posts for vulnerable older Australians who have no like capacity to shift their retirement strategy or increase their income stream in the final years of their lives.

Labor’s announced Pensioner Guarantee does nothing to protect SMSF members, like me, who are self-sufficient and are not eligible for the Aged Pension. This reduces the incentive for people to save for retirement as I did, and in fact punishes me for saving in order not to rely on the Age Pension. It also creates an unequitable two-tiered approach for SMSFs; with an SMSF becoming less competitive, tax wise, than an Industry fund. This is unfair.

My wife and I have worked hard, paid considerable tax, and played by the rules. Now, your changes will result in a considerable loss to our comfortable, yet modest retirement income. We will lose $6250 and I can’t see any practical way to replace it. To see your rhetoric about these changes being aimed “at the rich” offends me greatly.

I have spoken with a Financial Planner who tells me that if we withdrew capital from our fund and purchased a more expensive home and spent some of our capital that we would qualify for a part-pension and retain our franking credits. I find this advice personally offensive to my values. Interestingly I hear of a number of people I know planning on this strategy. It seems I would be cutting off my nose to spite my face if I do not follow. Albeit at a cost to the Australian taxpayer.

I am in your electorate and voted for you at the last election. Fremantle is a safe labor seat so my changing my vote will not have any effect. However at the next Federal Election for the first time I will be assiduously numbering my Senate Ballot paper and placing the labor candidates at the end. I’ve an email distribution list of 197 people within Australia with whom I share articles of interest. I’ll be putting out on that my proposed Senate voting strategy for 2019. I already know from conversations with friends that they plan to adopt this strategy. There will be a multiplier effect in all of this.

I wish you well in the coming by-election as I know that you’ve been an assiduous local member. I will not be casting my vote in your direction.

Reader response

Readers are advised that the ‘sample letter’ will not apply to their own circumstances, and that they should consider their own situation.

Vinay Kolhatkar is an Assistant Editor at Cuffelinks. Cuffelinks does not warrant the accuracy of all the material in the articles above.

Editor’s note: On 22 August 1988, an accountant named Chris Cuffe joined First State Fund Managers (FSFM) at the age of 28, shortly after it had commenced managing $300 million of internal State Bank deposit funds and staff super. He was CEO within 18 months and by the time he left 14 years later, it had become Colonial First State and it was managing over $70 billion. This week marks the 30 year anniversary of that joining date. After Chris left in 2002, Colonial First State was split into its funds management side and platform/retail distribution side. Going full circle, the Commonwealth Bank plans to put these businesses back together in the float of Colonial First State next year.   

Over 20 years ago, I became Head of Fixed Interest at a small investment firm that many people thought was about to be gobbled up by another. The FSFM business had been assigned zero value in the acquisition of the State Bank of NSW by the Colonial Mutual Group a couple of years earlier. Colonial at the time expected that all funds management activities would be taken up by its Melbourne-based Colonial Investment Management.

Was I crazy to join this tiny business?

Nevertheless, I left a senior role at the firm that was at the time widely regarded as the best fixed income house in Australia to join this little business that had about $1 billion in cash and $28 million (sic – million, not billion) in its bond fund. While some in the industry who knew FSFM well were encouraging about my move, many thought I was crazy.

FSFM had commenced in 1988 as mostly a cash and fixed income investor, to manage the approved deposit funds of employees and ex-employees of the State Bank of NSW. With interest rates well into double digits at the time, the vast majority was in cash.

However, FSFM’s equity business grew rapidly with Greg Perry at the helm. With all due respect to the many other fine equity managers I’ve worked or invested with since, Greg is the best stock picker I’ve known. Through the mid-1990s his ability was widely recognised by the independent financial planning community. By the time I joined at the start of 1997, the equity funds had become the growth engine of the business, which had just surpassed a total of $3 billion under management [Managing Editor’s note: I remember the $1 billion party in 1991, when I was Deputy Treasurer at State Bank of NSW and FSFM was an almost inconsequential section in Treasury].

Growth had been so rapid that a large proportion of the staff were contractors, brought in to manage investor applications. Strategic discussions at the time had a base case that the coming year would be “a year of consolidation”. However, that year didn’t come. The business kept growing – rapidly.

Fixed income was part of that, with our funds under management reaching $60 billion around 10 years later. The Colonial Melbourne business that had been expected to take over FSFM was itself taken over in May 1998 and the name of Colonial’s funds management arm instead became Colonial First State (CFS).

What were the reasons for CFS’s success? Certainly, we benefitted from the fortuitous timing of being set up just as the rapid growth in Australia’s superannuation industry was getting underway, but there was a lot more to it than that.

Strategic team building

By 1996, Chris Cuffe knew that, if FSFM was to enjoy sustainable success, it needed to have more than a great equities team. Balanced funds were still popular in superannuation at the time. These funds invest across asset classes with the same manager. So Chris began hiring managers to head up other asset classes. Sandy Calder was hired for listed property, Dave Whitten for global resources and I was brought in to the fixed income piece of the equation. There were some setbacks, especially in global shares, where the guy that had been hired to establish those funds went back to his previous employer the day they were due to launch, just before Christmas in 1996. But overall, the team Chris put together was effective and coherent, embracing complementary investment styles that could be blended well.

Strong performance

We delivered strong fund performance, which has to be a key plank for any business. Greg and his team delivered superb results in the equity funds from around 1994 onwards, in both large and small cap portfolios. Other asset classes then kicked in. In my first year heading up the fixed income team (1997) we had the best performing Australian Bond Fund, and listed property and global resources also did well.

End-to-end business

The industry was changing rapidly in the later years of the 20^th century and CFS was able to change with it thanks to the leadership team having control of all aspects of the business. This included IT, which was a flexible and creative team led by a business-savvy guru, Derek Ngoh, who kept us ahead of the game. One of the drawbacks of becoming owned by the CBA a few years later was the loss of this end-to-end capability and the enforcement of ‘shared services’ on many parts of the business.

An excellent culture

At CFS we lived and breathed a positive, high performance culture. This came from the top, with the way Chris dealt with his team, modelling how all leaders within the firm were to deal with theirs. Good cultures empower their staff and equip them to do their jobs to the best of their ability. I have not personally felt as empowered to run the funds and make decisions as I was during the earlier years at CFS.

Focussed customer base and quality service

During its rapid growth period, CFS focussed exclusively on servicing independent financial planners. We had no ambition to deal directly with retail investors or to have in-house advisers, seeing the independent planners as the experts in looking after the end-investor’s needs. To this target market we provided high quality, personalised service. I fondly remember walk-throughs, when Rob Adams or one of his team would bring around a group of advisers to show them the investment teams at work.

What they saw was the culture being lived out. They picked up a positive vibe from all of the teams, often remarking that they could see people working at CFS who were energised and clearly enjoying one another’s company.

As a result of all of these factors, the CFS brand became very strong. Also, by early 1998 Colonial’s CEO Peter Smedley became convinced that Chris knew how to run a business and deliver results. So Smedley ditched the plans for the Melbourne funds management business to be the driver of a combined entity and instead the First State team dominated the in-house merger.

CFS then took over the Australian operations of Legal and General (June 1998) and Prudential (August 1998) in quick succession as Smedley (nicknamed ‘Pac Man’ at this time) built Colonial into a diversified financial services company. That in turn made the business a takeover prospect, an opportunity the CBA grabbed in 2000, in what was then the largest corporate takeover in Australian history.

That created another situation where the CFS team was in competition with the new owner’s in-house fund manager. That turned out quite differently. Suffice to say for now that my team merged with the Commonwealth Investment Management fixed income and credit team in 2003, and we enjoyed some great success over the next few years with Tony Fitzgerald’s team.

I’ve been gone from CFS for five years. I often think back on those exciting times when I joined Chris and Greg and the rest of the team with a dream of becoming the biggest and the best. Some dreams do come true.

Warren Bird is Executive Director of Uniting Financial Services, a division of the Uniting Church (NSW & ACT). He has 30 years’ experience in fixed income investing. He also serves as an Independent Member of the GESB Investment Committee.

How can financial institutions care for customers in a way that goes beyond the balance sheet?

If you were to ask financial services executives what role the sector plays in our society, some might talk about its impact on the economy. Financial planners or superannuation executives might talk about how the sector contributes to retirement incomes and outcomes. A portfolio manager might point out how the sector efficiently allocates capital to the highest returning or prospective sectors. Australia’s National Mental Health Commissioner, Lucy Brogden, offers another perspective:

“There is no doubt that a connection exists between mental health and financial wellbeing.”

Rethinking risk: why we need to consider the social impact

This is why, Lucy Brogden suggests, it may be time for a rethink of how the industry looks at the way it interacts with clients:

“With industry practices in the spotlight, it’s clear that while something might look good in the spreadsheet, when you consider all of the possible social impacts, is it good risk management to put clients in a situation which has the potential to cause financial stress?”

Indeed, the impact of financial stress on Australians was highlighted in a 2015 survey by the Australian Psychological Society which found that financial issues are rated as the top cause of stress, with 35% of Australians reporting having a significant level of distress.

Women: three pay cheques away from homelessness

In Australia, women are for the most part among the most disadvantaged when it comes to financial stress. Lucy states:

“A study by Women in Super and the Sydney Women’s Fund found that only 15% of women living in Sydney earned in excess of $100,000 and 48% earned less than $34,000. While some of this is can be explained by women not being the primary earner, we know that divorce rates mean that women are the most impacted financially when there is a separation. Most women are a mere three pay cheques away from homelessness and women over 55 are the fastest growing cohort of homeless. This is why it’s so important for us to help women develop a sense of financial independence.”

The challenge is that while working women can experience workplace stress from gender discrimination and pregnancy, men are more likely to feel the burden of being the main bread winner. Women, however are more likely to seek help than men.

KYC: Why stress points matter

Getting the best advice for clients is about instilling a culture that takes a deeper approach to traditional ‘know your client’ policies:

“We need to ask, what does ‘know your client’ really mean? You could argue that having better insight into a client’s mental wellbeing is good risk management. It makes good business sense to go a bit deeper into the human aspect of the advice we are offering clients. But many financial planners and advisors aren’t trained to have that conversation.”

Making sure disclosure helps not harms

The challenge is where to draw the line and how to ensure clients are not disadvantaged by disclosing some of the challenges they are facing.

“Although there is a business imperative to know more about the client, at the same time we don’t want to disadvantage those clients who are transparent about the issues they are dealing with. For example, we know that the minute a client seeks a mental health plan this action is notifiable under most insurance policies and can impact on a policy-holder’s ability to make a claim.”

Industry collaboration: finding a TPD middle ground

The good news is, unlike 10 years ago, the industry is now looking at ways to collaborate with the Mental Health Commission to tackle some of these issues:

“We have been trying to work with insurers to design products that offer a solution to mental illness claims which sits somewhere between no payment and TPD (Total and Permanent Disability). At the end of the day, neither the insurer nor the claimant really wants a TPD outcome – and we also know from a mental health perspective, getting people through recovery and back to work delivers the best outcome in most cases for patients. So there has to be a middle ground and we are working on that with the insurance industry.”

Bank regulation: Aspirational target or baseline?

It seems the banks are also stepping up on this front. Lucy says:

“Most of the major banks are also looking at this and it makes sense when you consider the impact mortgage stress has at both a business and societal level. In banking and finance we need to ask the question, is regulation an aspirational target or the baseline? How can we help financial institutions link values to the way we care for customers in a way that goes beyond the balance sheet? Intuitively it would seem that the ability to identify client problems early will help these institutions better monitor and manage risks.”

Finding peace of mind in retirement

While for many the aim of super in retirement is to minimise financial stress, increasingly we are realising that with longer life expectancy, compulsory superannuation is insufficient to ensure a vast proportion of the Australian population have the financial peace of mind they had planned in retirement.

“Here the conversation needs to be about models of tenancy and home ownership that can provide the certainty that retirees will have a roof over their heads.”

Lucy reminds us that relevancy is the ultimate test of social license and that financial stress is a pain point that innovation will eventually address. “The ability to help solve a problem, to fill a need is the ultimate test of the sector.”

Jeannene O’Day is a Business Development Manager at Colonial First State Global Asset Management, a sponsor of Cuffelinks.

For more articles and papers from CFSGAM, please click here.