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Personal reflections on the history of CFS

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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.   

In this article I provide some personal reflections on my time working for one of Australia’s funds management success stories.

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 20th 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.


Lucy Brogden on the link between mental and financial health

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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.

Most estate planning for tax is inadequate

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Over the next 20 years, there will be an intergenerational transfer of wealth the like of which has never been seen before. Wealthy baby boomer parents will die leaving their estates, in most cases, to their children. Most will also leave income tax liabilities.

When they receive their inheritance, the children will have two main tax issues to deal with:

  • Minimising tax payable on the benefit (eg. tax payable by the estate) and
  • Finding an investment structure to hold assets that allows for future tax minimisation.

Through the proper management and planning, the ‘after-tax’ value of the inheritance can be greatly improved. Despite this, many wealthy individuals have a will that does not deal with the tax consequences of their death adequately.

What can be done within a will?

A will provides excellent opportunities for tax planning. Generally, under a will, assets can be transferred to a new investment structure without the usual impost of stamp duty or capital gains tax. The ownership of assets can be rearranged to provide a better tax result.

A will also allows for the establishment of a ‘testamentary trust’. In broad terms, assets can be inherited by a beneficiary but held via a trust which they control. The beneficiary can generally then direct income from the trust to pay various family members in a tax-effective way. Family members receiving distributions may include children under the age of 18. Family trusts, set up while a person is alive, cannot distribute to children under 18 without the beneficiary being taxed at the top marginal tax rate.

Management of tax payable by the estate

In most cases, the assets of the deceased are liquidated and the funds distributed to the various beneficiaries. This can result in two major tax consequences:

  • Capital gains tax on the disposal of the deceased’s assets
  • Death benefit tax on superannuation withdrawals.

Proper planning may reduce or eliminate these taxes.

1. Capital gains tax

In basic terms, a testamentary trust can provide flexibility to who receives taxable income resulting from the sale of estate assets.

I recently had a client die while holding two properties. One was his home, which is exempt from capital gains tax. The other was a ‘weekender’ which had grown in value by $400,000 since it was purchased. He had four children, who each had personal taxable income over $100,000, and 12 grandchildren, all under 18-years-old.

Before the property was sold, it was transferred, under the will, to four testamentary trusts, one for each beneficiary. This allowed for the capital gain to be split between the grandchildren. As a result, no tax was paid.

2. Superannuation death benefit tax

A common scenario is where the last parent dies and leaves superannuation to their adult, non-dependant, children.

Adult non-dependant children will be required to withdraw money from superannuation. They have no choice. This will usually result in tax of 17% being payable on the withdrawal of the ‘taxed’ portion of superannuation. If the members balance is large, this can amount to many hundreds of thousands of dollars in tax.

So, what can be done?

The simplest way to avoid death benefits tax is for the superannuation to be withdrawn before death. The assets are then held in the member’s personal name instead of being held in the superannuation fund. A withdrawal by a member, over 65, and in some cases earlier, is not subject to tax.

The obvious problem with this strategy is we don’t know when we are going to die. However, often we have some idea, and if reducing income tax payable is important to the member, then steps can be taken.

In a simple scenario, a member with a terminal illness can withdraw their superannuation themselves. However, individuals are often not able to make such decisions once their health has deteriorated.  An alternative is for the power of attorney to be provided with the authority to make the withdrawal. In my experience using an attorney can work, but only if the following takes place:

  • The member gives clear instructions to the power of attorney before their health deteriorates
  • The process is explained to the other family members.

It always needs to be remembered that the attorney owes a fiduciary duty to act in the best interest of the member.

There are a number of strategies that can be used to make a speedy withdrawal, but these are outside the scope of this article. Suffice to say that, where the tax liability is reasonably high, it may be worth considering as part of a tax effective estate plan.

Strategies to minimise future income tax payable by beneficiaries

In recent years, it has become increasingly difficult to invest in a tax-effective way. Changes to superannuation place limits on the ability to reduce income tax. Labor policy includes additional measures such as the removal of negative gearing and the taxing of trusts at a rate of 30%.

There is every likelihood that future beneficiaries may receive an inheritance in an environment where:

  • Family trusts no longer provide a viable tax planning strategy
  • After-tax superannuation contributions are limited to $100,000 per year or less
  • A person can no longer make after-tax superannuation contributions once their balance reaches $1,600,000.

Two strategies could be considered:

1. Holding investments long term via a testamentary trust

For many years, families have used discretionary trusts (also known as family trusts) to hold investments and distribute income to family members with little or no taxable income. Labor intends to stop this. Their proposed policy can be found in a fact sheet titled “A Fairer Tax System – Discretionary Trust Reform”. On page 10, it states that the policy will not apply to testamentary trusts. If legislation is eventually introduced, and this exemption remains, testamentary trusts may become a useful structure for holding investments for the long term.

2. Lending to adult children so they can make contributions

I expect the following scenario becoming common in the future:

  • Children not having available funds to make superannuation contributions during their working life
  • When they are older, perhaps in their 60’s, receiving a sizable inheritance
  • Only being able to transfer a small portion to superannuation due to contribution restrictions.

In selected circumstances, the following strategy may be useful:

  • The parent lends money to their adult children
  • The child makes a contribution to superannuation
  • The loan is ‘paid back’ out of the estate on the death of the parents.

If implemented correctly, this strategy may result in additional funds ending up in the beneficiaries superannuation accounts. However, there is a lot to consider before implementing a strategy like this and professional advice should be sought.

Conclusion

The purpose of this article is not to provide an exhaustive list of potential strategies or to analyse any particular strategy in depth. Instead it is to alert readers that there are opportunities available and to encourage you to seek advice sooner rather than later. I have found that many people are uncomfortable speaking about estate and death issues. I understand this. However, a well thought out and considered estate plan can not only result in significant tax savings but also provide for greater family harmony.

 

Matthew Collins is a Director of Keystone Advice Pty Ltd and specialises in providing superannuation tax, estate tax and structural advice to high net wealth individuals and their families. This article is general information and does not consider the circumstances of any individual investor. It is based on a current understanding of related legislation which may change in future.

What happens at death of an SMSF member?

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Do you ever wonder what happens to your super after you die? This is particularly important if you have an SMSF. No one wants to burden others with planning a funeral and figuring out what to do with their SMSF, so let’s look at what happens when an SMSF member dies.

Compulsory payment upon death of a member

First, death is a compulsory payment situation. It means the deceased’s super cannot remain in their SMSF. It must be paid either to their dependants or their legal personal representative “as soon as practicable”. The Tax Office will normally allow up to six months for payment. If it takes more than six months, then the SMSF trustee may need to explain the reason for the delay. The Tax Office may accept reasons such as the death benefit nomination being challenged by beneficiaries, or the uncertainty of eligible beneficiaries. But if the trustee just took their time to pay out the death benefit without good reason, then the Tax Office may take compliance action against the SMSF.

Depending on the SMSF’s trust deed, the deceased’s super may be paid either as a pension, a lump sum death benefit or both. However, a pension is only available to the deceased’s dependants such as a spouse, a child under the age of 18, a child up to age 24 who was financially dependent on the deceased, and a child of any age with a disability. Other dependants such as an adult child and the legal personal representative can only receive a lump sum death benefit.

If the deceased was receiving a reversionary retirement pension, then the pension can revert to their nominated beneficiary. If the pension is non-reversionary, then it will cease upon death, and can be paid to the surviving spouse either as a new pension, a lump sum or both. Paying the deceased’s pension to their spouse does satisfy the compulsory payment situation as it is no longer in the deceased’s super account.

The spouse of the deceased

Under current law, a transition to retirement income stream cannot revert to the deceased’s spouse unless the spouse has met a condition of release, such as having reached the age of 65 or reached their preservation age and retired. This does not mean, however, that a new pension cannot commence from the SMSF and be paid to the spouse. In addition, money in the deceased’s accumulation account can be paid as a new pension to the surviving spouse. The surviving spouse needs to ensure that if they have their own retirement pension it does not exceed the current transfer balance cap of $1.6 million when the new pension is added to it.

As the deceased’s transfer balance cap is not transferable to their spouse, the spouse can either reduce their pension by putting money back into their accumulation account, or pay out some of their pension as a lump sum benefit prior to receiving the reversionary pension or the new pension. The spouse cannot put the deceased’s super into their accumulation account.

If the deceased’s pension is reversionary, the amount counted towards the spouse’s transfer balance cap is the amount in the deceased’s retirement pension account on the date of death. It is counted towards the spouse’s transfer balance cap twelve months from the date of death. If the pension is non-reversionary then the amount paid to the spouse will count on the date it is paid.

A lump sum death benefit can be paid using assets. However, a pension cannot be paid using assets. If a pension is either partially or fully commuted, then the commutation amount can be paid as a lump sum death benefit using assets. The pension recipient needs to ensure that the minimum pension payment requirements are met prior to the commutation.

SMSF structure

The structure of the SMSF is important. If an SMSF has an individual trustee structure and it becomes a single member SMSF, it has six months to restructure. If the surviving spouse wants the SMSF to remain under an individual trustee structure, a second trustee will need to be appointed prior to the expiration of the six-month period. The remaining trustee can make decisions for the SMSF during the six-month period, which includes paying out the deceased’s super.

It is important for SMSF members to take an interest in superannuation law. By understanding the law, members can ensure their super is passed onto their loved ones with a minimum of fuss.

 

Monica Rule is the author of The Self Managed Super Handbook – Superannuation Law for SMSFs in plain English. See www.monicarule.com.au for more details. This article is general information and does not consider the circumstances of any individual.

Strategies for avoiding the super ‘death duty’

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Whenever I make a speech to retirees, I talk about the death tax of 15% (or 17% when it includes the Medicare levy), which can apply to superannuation death benefits. Most people have never heard of it, and believe that Australia doesn’t have death duties.

Well, I guess it is not, strictly speaking, a ‘death duty’, but the effect is the same. So take the time to get your head around it, as it’s an easy tax to minimise with a bit of planning.

Value of a re-contribution strategy

The first thing to understand is that it applies only to the taxable portion of your superannuation fund that is given to a non-dependant. A spouse is always a dependant whether they have a separate income or not.

It does not apply to the tax-free portion of your super, so those over 60 and still eligible to contribute to super could take advice about adopting a withdrawal and re-contribution strategy. This involves taking out a chunk of your super tax-free, and then contributing it back as a non-concessional contribution.

There is no cost involved, as there is no entry tax on these contributions, and it effectively converts the amount re-contributed into a tax-free component. But watch the contribution limits as there are big penalties for exceeding the caps.

The next thing to understand is that you cannot elect to withdraw just from the taxable component. If your balance is partly taxable and partly non-taxable, the components of the withdrawal will be in the same ratio as your existing balance.

Taxable components of a tax-free fund

Many retirees are in pension phase, which means the earnings on their fund are tax-free, as are the withdrawals if they are aged 60 or over and eligible to withdraw. However, the tax-free status of the fund does not mean that all the components become tax-free as well. There will almost certainly still be taxable and non-taxable portions of the components, with the death tax applying to the taxable component when paid to a non-dependant.

One reader asked if the death tax could be avoided by leaving the money to a charity. There is no joy here, as a charity is treated in the same way as a non-dependant. A much better option for anybody who wants to leave money to charity would be to withdraw it from superannuation before they die, make an immediate donation and claim a tax deduction.

However, if you are receiving Centrelink benefits, take advice before doing this, because the gift could be regarded as a deprived asset if it is over $10,000.

Strategies for avoiding death taxes

So, if the tax does apply, how is it calculated? It is a maximum of 17%, not a flat 17%, and is deducted by your superannuation fund before paying your beneficiary the death benefit. The tax paid is recorded on a PAYG payment summary (similar to wages). When your beneficiary lodges their personal tax return, the assessable amount received and PAYG withheld must be reported. If they have a high income, or if the sum is large, the tax is rebated so that no more than 17% is payable. If they have a low income, they may receive a refund of the tax paid by your super fund.

If you are considering a binding nomination, make sure you clearly understand the implications before setting it up. Once a valid binding nomination is in place, the trustee may lose the discretion to distribute the proceeds of the deceased’s superannuation fund in the most tax-effective manner.

The simplest way to avoid the death tax is to make sure you have given a trusted person an enduring power of attorney, with instructions to withdraw your superannuation in full if it appears that death is imminent. There would be no tax on the withdrawal, and the money could then be distributed in accordance with the terms of your will after your death.

 

Noel Whittaker is a leading financial adviser and the author of Making Money Made Simple and numerous other books on personal finance. Noel writes an excellent monthly newsletter and a free subscription is available on this link

How much is really needed in retirement?

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In the UK in 2014, The Independent Review of Retirement Income (IRRI) was commissioned to look at retirement incomes. Two recommendations from IRRI were:

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

“They should be replaced with stochastic projections that take into account important real-world issues, such as sequence-of-returns risk (and) inflation.”

Quite a bit to digest. There is a broader discussion of these issues in a previous article written by David Bell.

What is deterministic forecasting?

In retirement projections, deterministic forecasting is a set of fixed assumptions around investment returns and inflation to produce one scenario to establish whether a retiree has sufficient financial capital.

An example of a deterministic forecast is the superannuation balances required to achieve a comfortable retirement as calculated by The Association of Superannuation Funds of Australia (ASFA). The ASFA Retirement Standard was developed to objectively outline the annual budget needed by the average Australian to fund a lifestyle in their post-work years, providing benchmarks for both a comfortable and modest standard of living.

ASFA details that:

“a comfortable retirement lifestyle enables an older, healthy retiree to be involved in a broad range of leisure and recreational activities and to have a good standard of living through the purchase of such things as: household goods, private health insurance, a reasonable car, good clothes, a range of electronic equipment, and domestic and occasionally international holiday travel”.

As of March 2018, for a retired couple, the budget for a comfortable lifestyle was $60,264 per annum. Based on a rate of return of 6.0% per annum and inflation of 2.75% per annum, ASFA has determined that a sum of $640,000 is required for retirement. This method draws down capital over the period of withdrawal so that nothing is left at the end of an average life expectancy.

Stochastic modelling introduces variability and stress testing

A stochastic model considers different outcomes by allowing for variation in the inputs within the forecast.

For example, the Accurium Retirement Healthcheck is a projection tool that allows the assessment of retirement sustainability. It stress tests a retiree’s plans through 2,000 possible future scenarios. The investment return assumptions are provided by Willis Towers Watson and are generated using their Global Asset Model. This Model produces ‘random’ future sequences of possible investment returns for each asset class. These are generated so that ‘as a whole’ the simulations represent a full distribution for how ‘real world’ markets could perform in the future.

Stochastic modelling assists in making a scientific assessment of sequencing risk, which is the risk of experiencing poor investment returns at the wrong time. Stochastic modelling can’t predict the nature of ‘Black Swan’ events. Is the chance of a significant crash 1% or 10%? These models can’t estimate these odds, so the best that can be said is that these events don’t happen very often.

Modelling a ‘comfortable’ retirement

It is an interesting exercise to model the ASFA example in the Healthcheck software for a two 66-year-olds in a couple couple who are eligible for the age pension.

Let’s assume $640,000 in superannuation in a ‘balanced’ portfolio using the asset allocation constructed to align with the Morningstar Multisector Balanced Market Index (22% Australian shares, 25% international shares, 5% listed property, 33% fixed interest and 15% cash). Fees of 0.9% per annum are assumed. The default long-term asset class return assumptions within the Healthcheck produce a return of 5.3% per annum based on the asset allocation after the deduction of fees. Gross returns of 3.5% for ‘cash’ and 4.5% for fixed interest are assumed, which could be considered optimistic in the current environment. Nevertheless, the 5.3% per annum is lower than the ASFA assumption of 6.0% per annum.

The Healthcheck also allows settings around the lifestyle of a retiree. ASFA produces budgets for those around 65-years-old and 85-years-old. For those around 85-years-old, the comfortable lifestyle budget is $56,295 per annum, which is approximately 7% lower than that for a 65-year-old. So in the Healthcheck, it has been assumed that expenses reduce to this level at age 85. ASFA also produces budgets for singles and the comfortable lifestyle budget is $42,764 for a single, which is approximately 29% lower than for a couple. Again, in the Healthcheck, it is assumed that expenses reduce to this level at the first death. Personal effects of $25,000 have been assumed for age pension calculations.

The chart below illustrates the misleading nature of a deterministic forecast. It shows that the retirees’ money in their account-based pension (the blue bars) should not run out until they are 98-years-old. The dotted line shows where there is a 50% chance that at least one member of the couple will still be alive, and that’s in 26 years’ time.

What if a greater range of outcomes is considered?

However, the stochastic modelling produced via the Healthcheck shows that in 64% of the 2,000 scenarios tested, the retirement lifestyle is sustainable. This means that the couple has a 36% chance of outliving their savings.

I’m not sure what readers think about a 36% failure rate, but I wouldn’t feel comfortable crossing a bridge if it had a 36% chance of collapsing!

The chart below details where variability has been allowed for. There is an 80% chance that the retiree’s future savings will fall within the blue shaded area. The bottom of the blue range represents a ‘worst case’ outcome at each age. There is a 10% chance of running out of money after 22 years. The top of the blue range represents a ‘best case’ outcome at each age. The green line represents the median of 2,000 scenarios.

When presenting the deterministic forecast, I don’t think anyone could reasonably imagine that there was a 10% chance of running of money after 22 years. The deterministic forecast illustrates that the retirees should be fine until they are aged 98, which is 32 years away.

So how much does a retiree need to be ‘safe and comfortable’ with 95% confidence?

Let’s assume that we want 95% confidence that the retiree would not run out of money. I am risk averse, so I still wouldn’t walk across a bridge if it had a 5% chance of collapsing. Nonetheless, it is better than walking across a bridge that has a 36% chance of collapsing.

By reverse engineering within the Healthcheck software, based on the previously detailed assumptions, it is estimated that a retiree couple would need $1,036,000 to have only a 5% chance of running out of money. This is 62% greater than the amount estimated by ASFA. However, it is lower than that implied by some safe withdrawal rate articles that suggest drawdowns of not more than 4% ($1,506,600). This is due to the benefits of the age pension, but if social security laws change significantly in the future, as they have in recent times, then this would impact the results produced by the model.

The chart below is based on $1,036,000 in superannuation at retirement. There is a 10% chance of savings being approximately $40,000 in 29 years’ time and a 10% chance of being roughly $460,000.

There is no doubt that a deterministic forecast is easier to explain, easier to understand and still has its place. However, stochastic modelling, while more complicated, considers a vast range of possible scenarios and estimates the most significant financial risk for retirees, which is the likelihood of running out of money.

As David Bell succinctly notes in his article mentioned earlier:

“Many other industries develop complex products which are explained effectively to consumers … Too hard … cannot be an excuse.”

 

Patrick Malcolm is a Senior Partner and Financial Planner at GFM Wealth Advisory. He has attained the Certified Financial Planner® designation, completed a Master of Applied Finance and is also a SMSF Specialist Advisor™. This article is general information that does not consider the circumstances of any individual.

‘Best interests’ requires walking in their shoes

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As financial advisers, we are subject to a ‘best interests’ duty whereby we must act in the best interests of our clients when providing advice. It seems obvious, doesn’t it, but historically this obligation was being so overlooked by so many advisers that it has been enshrined in legislation and is overseen by ASIC.

Best interests duty is taken seriously these days, and rightly so. Our licensee has provided endless hours of compulsory training and guidance. Their regular audits of our files focus largely on this. If we get best interests wrong, we can end up in a whole world of trouble including losing our licence and in extreme cases, jail time.

The advice is up to me

I like to think that since becoming an adviser, acting in my clients’ best interests is something I have always done on the advice given. The ongoing training and audits is vital to ensuring that the advice is presented and documented correctly and in accordance with the law, but the advice itself, I believe, is up to me.

In our studies, we learn about Modern Portfolio Theory, risk/return trade off and diversification – all important for building an investment portfolio that meets a client’s tolerance for risk. In other words, a portfolio based on how well they can bear to lose money at any given point in time.

In our training, we are given the tools in the form of questionnaires to assess each new client’s tolerance for risk and from there consider time frame and the client’s goals and voila …  build an investment portfolio. Years of brilliant minds have honed this methodology and it has been used for decades in best practice financial advice.

Not something from the textbooks

However, the longer I am an adviser, the clearer it becomes that understanding a client’s ‘best interests’ is not something that can be learned from text books or gleaned from a complex and often misunderstood questionnaire. It comes from experience as an adviser of not only technical knowledge but also knowing how to listen to and interpret what clients are saying through words, body language, nuances and any other signals. It’s about knowing the right questions to ask, recognising when there might be something they are not telling us.

Take the recent client who on the risk profiling questionnaire would tick all the boxes to be classified a ‘defensive’ investor, indicating a 30% allocation to growth investments such as shares and property. He is educated in financial matters, he understands the inflationary consequences of holding only cash over the long term, he understands that without exposure to growth assets, his money will lose value over time.

What the questionnaire doesn’t consider is that this investor is riddled with anxiety, a deep thinker, an avid reader of world news and a natural pessimist. Recommendations to invest a small portion of his substantial wealth – even less than the benchmarked 30% – into growth assets resulted in sleepless nights and mental anguish.

He was consumed by cognitive dissonance and his discomfort was palpable. We abandoned the recommendations and agreed to keep his money in cash. As such, he doesn’t earn us much in fees, but he sleeps well at night, and that’s just fine with me.

Then there’s the couple who came to us already established in their SMSF. It is now invested and performing well, but the trustees both work full time in busy, time-consuming professional jobs. They have teenage children that keep them busy and they both loathe administration and paperwork. The trustee duties and obligations that come with an SMSF drive them crazy. Whoever recommended they go down the SMSF path didn’t understand this aspect for a busy couple.

Not my portfolio, it’s theirs

For each and every client, best interests are a matter of perspective. As an interior designer must leave his or her own tastes at the front door to envisage and interpret their client’s desires, so too a financial adviser must put aside their own biases and knowledge and walk in their client’s shoes.

This skill comes from experience only, and after nine years as an adviser, I’m still honing it, I don’t always nail it. But I’ve seen it done well by very experienced advisers, and the difference it makes to a client’s wellbeing can be remarkable.

I do hope The Financial Adviser Standards and Ethics Authority (FASEA) doesn’t rob our industry of this vital skill.

 

Alex Denham is a Senior Adviser at Focus Wealth Advisers. Prior to becoming an adviser, she spent 20 years in senior technical roles with several financial services companies. This article is general information and does not consider the circumstances of any individual.

The FASEA was established in April 2017 to set the education, training and ethical standards of licensed financial advisers in Australia.

The reality of three phases of retirement

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Planning for how you would like your retirement years to play out can be an exciting proposition. Amid those holidays and time spent with family, however, it is important to also consider the ‘frailty years’. They are the later years of retirement where you might experience physical and cognitive decline. A plan is needed if you want to maintain independence for as long as possible.

The reality is that we are all likely to experience some cognitive decline or lose some of our physical ability as we age. This is a natural process but does not mean we will all develop dementia or lose the ability to live independently.

But at some point, we may need to ask for help with our normal activities of daily living. This might be help we access in our own home, or we might need to move into residential care for a higher level of support.

Funding the increasing costs of care allows greater independence and control, which is key to a happier retirement. Take control while you still have capacity to make these choices yourself.

Rethinking retirement planning

We need to rethink our approach to retirement planning to consider the increasing cost and complexity of aged care.

Recognising and accounting for retirement income needs can reduce the risk of retiring with insufficient savings. This should include the means to deal with the increased cost of care in the later stages of retirement which can influence when we are ‘retirement ready’.

Historically, the approach to retirement planning has been to decide what income you need and then calculate how much you need to save to generate this income. Most people assume a flat (or declining) level of income which grows with inflation. However, if you consider the cost of care, the pattern is more likely to follow an upwards curve as shown in the graph below.

 Retirement phases: care-free, quiet, and frailty years

The three phases of retirement

There are three phases of retirement linked to a retiree’s health, including years:

  • without disability
  • with some disability
  • with severe disability.

Retirement planning and projections need to consider the income requirements for each of these phases, including the frailty years when expenditure patterns change.

An average 65-year-old retiree will have a health pattern as shown in the diagram below.

Spending patterns in retirement are likely to vary over the three phases.

Phase 1 is the initial period of retirement with ‘care-free’ years to focus on travel, spending time with family and friends and basically loving life! Health and wellbeing during this time are good, and the income needs of this phase of retirement are generally well accounted for in the planning process.

Phase 2 includes the ‘quiet’ years when health starts to decline. As we experience some disability, the level of activity and therefore spending declines.

Phase 3 is when we experience severe disability, and can be described as the ‘frailty’ years. This can account for 17%-25% of retirement years where help may be needed with daily living activities, and more is likely to be spent on dealing with aged care needs.

Preference for ageing in place

Older Australians strongly prefer to age in place (in their homes) rather than move into residential care. The costs of aged care have been accelerating at a rate higher than inflation. The opportunities for home care (in terms of home adaptations) are also increasing, adding pressure to retiree household budgets.

We might need increasing levels of support over the last 10-12 years of our life, with many people experiencing high levels of care dependency in the last 4-5 years.  This may require income to cover:

  • home care costs
  • home adaptions to make the home suitable, such as widening doorways for wheelchairs and ramps.

Aged care costs can be difficult to predict and can vary from $100 – $5,000 a week ($5,200 p.a. – $260,000 p.a.) depending on care needs and family circumstances. Access to government subsidies helps to drastically reduce the cost payable by the user, but having adequate savings expands the options available and the ability to control the level and type of care received.


Did you know: ASFA Retirement Standard
Modest retirement for a single 85-year-old only allows $31.04 per week for care and cleaning. This is less than half the basic daily fee for a home package and that’s before extras!


Fragility is the third pillar of retirement risks

When planning for retirement and calculating the required level of savings, we usually consider two key retirement risks – longevity and sequencing risk. Longevity risk means savings may run out earlier than anticipated.

There is a third pillar of retirement risk – frailty risk – which if ignored, could also cause savings to run out earlier than anticipated, exacerbating the longevity risk. We need to manage the greater spending in the third phase, and in particular, care costs could be significant. Planning for frailty years should consider independence and control and the ability to stay in your home as long as possible, including:

  • How you expect to fund aged care costs – recognising that legislation has been shifting towards a greater user-pays basis
  • The role of your home in meeting aged care costs – including your willingness to access the equity in your home as against a preference to maintain the equity in your home as an inheritance for your family
  • Ability to rely on family and friends to provide care and financial support
  • If you choose to move to residential care, what options you have for funding the accommodation deposit and ongoing costs

It is important that you discuss these issues with your financial planner to ensure that you plan for a secure and comfortable retirement throughout all phases of your retirement – including the frailty years.

 

Assyat David is a Director of Aged Care Steps.


Incentives at heart of Commission’s findings

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The Financial Services Royal Commission released its much-anticipated Interim Report on 28 September. Volume 1 (of 3 volumes) itself, at over 115,000 words, would fill around 400 pages in a paperback book.

There is a heavy emphasis on how the industry created the wrong incentives. The most illuminating paragraph in a sea of damnation occurs on page 301, Chapter 9 (Entities: Causes of misconduct, sub-heading, ‘Culture, governance and remuneration’):

“All the conduct identified and criticised in this report was conduct that provided a financial benefit to the individuals and entities concerned. If there are exceptions, they are immaterial. For individuals, the conduct resulted in being paid more. For entities, the conduct resulted in greater profit.”

And, further:

“The conduct that is at the heart of the Commission’s work is inextricably connected with remuneration practices, with deficiencies in governance and risk management and with the culture of the entities concerned … And every piece of conduct that has been contrary to law is a case where the existing governance structures and practices of the entity and its risk management practices have not prevented that unlawful conduct.”

The Commissioner states an intersection between psychology and finance thus:

“An employee will treat as important what the employee believes that the employer generally, or the employee’s supervisors and peers, treat as important. When the employee and others in the organisation, including the employee’s supervisors and peers, are remunerated according to how much product they sell, or how much revenue or profit they contribute to the entity, sales or revenue and profit are treated as the goal to pursue. How the goal is pursued is treated as a matter of lesser importance.”

In other words, human beings are hard-wired to respond to incentives.

The wrong incentives can corrupt the most revered of professions

In 2009, economist Steve Levitt teamed up with Stephen Dubner, a journalist, to show that economics is, at root, the study of incentives – how people get what they want or need, especially when other people want or need the same thing. ‘Freakonomics’ (and its successor, ‘Superfreakonomics’) explored, among other things, the inner workings of a crack gang, the truth about sumo wrestling and the secrets of the Ku Klux Klan. Laced with dry humour and fascinating anecdotes, the lessons apply to all areas of life, including and especially commercial ventures.

The essence of the methodology is that data on outcomes reveals actual preferences much better than surveys, which demonstrate only expressed preferences. Even in blind surveys, people hardly respond with “Yes, I will behave dishonestly to gain more for me.”

Levitt’s study of sumo wrestling is a good example of incentives gone wrong. In addition to Freakonomics, he co-authored a paper asserting that corruption existed in sumo, a revered, centuries-old professional sport, steeped in Japanese tradition. Levitt argued that the scoring system incentivised throwing matches at certain points in the tournament.

The Japanese Sumo Association (JSA) was shocked of course. How dare these Americans insinuate that sumo is corrupt? But in 2011, the JSA conceded after conducting its own investigation that match fixing was indeed widespread. It expelled 23 wrestlers and cancelled that year’s Grand Tournament in Osaka, the first time of such occurrence since 1946.

What was the problem with sumo incentives? When Levitt was asked whether he expected tennis players to throw matches the way sumo wrestlers had done, his response was:

“There is something absent from tennis that is present in sumo wrestling: a highly non-linear incentive scheme. The eighth win in a sumo tournament is worth far more than a sixth, a seventh, a ninth, or a tenth win. As such, the sumo wrestlers themselves can see strong gains from trade. In tennis, however, the only apparent incentive at work is bribes related to gambling. The lack of incentive for tennis players to trade wins has to mean that endemic cheating is far less likely.”

Vertical integration under fire

The word ‘remuneration’ occurs over 200 times in the Interim Report. ‘Greed’ only occurs nine times, ‘dishonesty’ only five times, despite what the report calls the recurrence of two themes, being greed and dishonesty. The report correctly forecasts that:

“Eliminating incentive-based payments for front line staff will not necessarily affect the ways in which they are managed if their managers are rewarded by reference to sales or revenue and profit. The behaviour that the manager will applaud and encourage is behaviour that yields sales or revenue and profit. The behaviour that is applauded and encouraged sets the standards to be met and forms the culture that will permeate at least that part of the entity’s business.”

Hayne is setting expectations, but what outcomes should we expect? It’s not difficult to find examples in other industries similar to the vertical integration in financial advice that Hayne criticises.

Suppose we visit a travel agent. Let’s say, the same company that owns the travel agency also owns a specific airline, a large hotel chain, a tour operator, and a travel insurer.

As a consumer, should we expect our experience and outcomes to be different as compared to visiting an agency which receives similar commissions from most airlines, many hotel chains, tour operators, and travel insurers?

The short answer is yes. The former is a vertically-integrated travel conglomerate which no doubt has incentives to use in-house products. The latter has no incentive other than finding the best deal for the client.

The question Hayne asks is whether such vertical integration should be allowed to continue in financial services. It is almost the bedrock on which our system has developed. For example, the Reserve Bank of Australia said this back in 1996 when the trend toward conglomeration in finance accelerated in the nineties:

“Financial conglomerates are becoming an increasingly important feature of the Australian financial system. A conglomerate is essentially a number of financial institutions under common ownership or control and operating in more than one of the main financial sectors of banking, insurance, funds management and securities.

“Over the past decade, technological and regulatory changes have encouraged many institutions to expand their activities beyond traditional areas of operation. Some life offices, for example, now have bank or building society subsidiaries. Banks have responded to competition from funds managers by establishing life office and other funds management subsidiaries which have been increasing their share of the funds management sector.”

This was a worldwide trend. In 1999, the US Congress passed legislation to permit bank affiliations with all sorts of financial enterprises. However, in 2002, Brookings Institution, a high-profile research agency, reported that:

“Investors do not necessarily welcome financial firms’ drive to become conglomerates or financial supermarkets … stock prices of (non-financial) multi-product firms generally sell at some discount relative to firms with more narrowly drawn product or service lines.”

Their report suggested that company performance in financial services is unrelated to size. The answer they receive to the question, “Are economies of scale and scope so compelling that the future must inevitably belong to the largest financial conglomerates?” was a firm ‘no’. Perhaps the breaking up of Australian vertically-integrated businesses will create value rather than destroy it.

And this is even before we factor in the benefits arising from the correct application of fiduciary duties of bankers, trustees, financial planners and financial advisers toward their clients.

Struggle to reconcile fiduciary duty and cross selling 

Perfecting a governance system that adequately addressed fiduciary duties while cross selling wasn’t thought through, and it may well be too hard. With the sale of their wealth arms or their insurance businesses, many Australian conglomerates have already conceded this by their revealed preferences even though the expressed preferences are customer apologies and ‘this time, we will do it right’.

Trimming the entities down won’t solve the problem, but it should make it easier to structure incentives correctly. Kenneth Hayne, however, is on a different path:

“The unstated premise for so much of the debate about remuneration of both bank staff and intermediaries, that staff and intermediaries will not do their job properly and to the best of their ability without incentive payments, must be challenged.”

Hayne is not providing answers in this Interim Report but asking numerous searching questions. Sceptical of more laws solving the problem, he is prepared to throw everything out there for questioning, from added regulatory and legal scrutiny to business structures, and even trying to solve the holy grail of how to ensure financial service employees act in the best interests of the client.

 

Vinay Kolhatkar is Assistant Editor at Cuffelinks.

Don’t allow a BoMaD to ruin your retirement

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This article is the third in a series written for Cuffelinks by leading retirement website YourLifeChoices. It reports on the financial impact on parents who are assisting adult children with loans to buy property or are allowing them to live rent-free at home.

What is a BoMaD and why should you care?

The BoMaD – or Bank of Mum and Dad – is the 10th largest lending institution in Australia, ahead of ING, Suncorp and Bendigo Bank. It is estimated to be lending $65 billion per annum, according to a Mozo survey in September 2017. That’s right, $65 billion a year is being transferred from the pockets of Australian mums and dads to their adult children to assist them in buying a house.

Children staying at home is more difficult to measure

While children are no doubt lovable, they can also be very expensive, particularly when it comes to reducing your retirement income. It’s not just in the headline fact of parents lending grown-up children money to buy property. There is a quieter, more insidious erosion of retirement savings and income, and that occurs when adult children live at home for extended periods without contributing to household expenses. This is a less spectacular, difficult-to-measure version of the BoMaD. And it’s not a loan, but a gift!

YourLifeChoices runs frequent in-depth surveys on all things to do with retirement. In the recent 2018 Retirement Matters survey, we asked our 230,000 55–75-year-old members whether assisting younger family members was eroding their retirement savings.

Here is what we learnt:

  • 17% of respondents still have adult children living at home
  • Of these, only 58% are receiving contributions to the household expenses
  • Of those respondents with adult children at home, 32% believe their retirement income is reduced by this arrangement
  • The median amount respondents projected they were losing per annum was $10,000, within a range of $5000 to $50,000.

So, what does this mean for you and your retirement? This is tricky emotional territory.

As reported above, most parents are relaxed about long-term cohabitation with their adult kids. The extended family is a traditional source of strength, support, love and fun. There’s a lot to like about this way of living, and it really is the very basis of community.

But financially, it can be an extremely lopsided arrangement. The great ‘risk shift’ of retirement income, as identified by American academic Jacob Hacker in 2006, suggests that we are all basically on our own when it comes to creating a retirement nest egg and managing it successfully.

Consider the money foregone

What is often overlooked is money foregone, and this is where a BoMaD can kill your future prospects. Retirement is fast becoming a user-pays system, exacerbated by the increasing need for personal income to cover both health and aged care.

So, what can you do if you love having your adult children living at home, but fear this is having a negative impact on your finances?

You could start by recognising that family comes first, and if you are happy to have them at home, then that is where they belong. But make sure everyone is paying their way.

Think back to your early days of share houses and flatmates. There are mutual costs which include:

  • mortgage repayments
  • energy bills
  • communication: internet, movie streaming, subscriptions, etc
  • maintenance
  • cleaning
  • gardening
  • insurances
  • food and groceries.

When you stop and itemise the expenses, you realise that it costs a lot to run a home, even one which is fully owned. So create a spreadsheet with all household expenses listed, total it and divide it equally by all adults aged 21 and over. Set up a new bank account to be managed by the home owner, or whoever’s name is on the lease if you are renting.

Request all ‘guests’ organise an automatic payment from their own bank account into the household expenses account, equalling their share of these expenses, on the first of the month, every month.

When sufficient money is collected, organise for automatic payments of all household bills on their due date, and a payment covering ‘general monies’ (i.e., money for consumables, such as food and other supermarket items) to be made monthly into the homeowner’s account to cover these extra, often unnoticed, expenses.

This will hopefully remove potential arguments and ensure that a fair share of the expenses is paid by all, as painlessly as possible.

It may sound like an overly formal system, but rent-free kids eating you out of house and home is hardly the answer, either. Yes, you love them dearly, but you also have to plan for your next 20 or 30 years of paying bills, perhaps when your health is far less robust than theirs.

YourLifeChoices’ June Retirement Affordability IndexTM reports that it costs a couple on a full or part age pension, living in their own home, about $42,830 per annum to cover all expenses. If these costs are higher because you are accommodating your grown-up kids, it’s up to you to ensure you are not digging into your savings to support them forever.

At the very least, it is worth thinking about.

 

Kaye Fallick is publisher of YourLifeChoices, Australia’s leading retirement website for over-55s. It delivers independent information and resources to 250,000 members across Australia.

Roboadvice 2: Why an early roboadvisor pivoted away

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In Part 1 on roboadvice, we looked at the participants attempting to carve out a role, hoping that the support of startup capital lasts long enough to find a buyer, pivot to something else or show a path to profit.

In Part 2, we focus on an early mover in the consumer market.

Interview with BigFuture

BigFuture launched its ‘cloud-based wealth advice service’ in 2015, driven by three experienced co-founders including Donald Hellyer. It raised capital and promoted itself at trade conventions, and produced an entertaining newsletter and educational videos. It was a runner-up in the 2015 Afiniation Showcase for the Best Robo-Advice service.

Three years later, it issued this advice:

“At the end of May 2018, we intend to close the BigFuture website. We are proud of what we built but regretfully we were unable to commercialise the application …

BigFuture Pty Ltd is still around as an entity. We are working on revenue producing projects.”

This is my interview with Donald Hellyer, CEO of BigFuture.

GH: What was the original vision for BigFuture and how did it change over the years?

DH: It was quite simple. Most people don’t have a good handle on what they own. They often have the ‘spreadsheet from hell’. And a single number on the value of their assets in the future provided by a super fund calculator is bound to be wrong. It is deterministic and life is much more complicated. Nobody really cared enough do a better job, so three of us who had been working in financial services all our lives thought there was an opportunity.

We wanted to link up a person’s entire financial position and give it real time to a financial planner, and it’s something with even greater need now given the Royal Commission revelations on fee-for-no-service. How do you create better interaction between clients and advisers?

Think of three or four possible markets for a product like ours:

  • B2C (business to consumer), a system used directly by investors
  • B2B (business to business) with financial planners as one market, super funds in another, and possibly fund managers

The main lesson we learned along the way in B2C is ‘verbs not nouns’. That is, we can give clients details, but we need to give them an action, something to do.

GH: Do you mean particularly in communications to them?

DH: You got to say, “Here are the results, now you can do something.”

GH: When you first started, you were ambitious about B2C.

DH: Yes, we were, it seemed a logical space to be. Perhaps we were early. There’s a problem that millennials don’t have enough money and don’t feel particularly engaged anyway. Most want to repay their student loans and save for a house. And not enough people with more money want to share their details on a cloud-based system. We did not create the required virtuous circle to keep building more functionality.

GH: What about the difficulties finding an audience, reaching out to people?

DH: It’s chicken and egg. Any development must create something people want, not something that you think they want. Perhaps nobody knows what the ‘market’ wants. Everybody has ideas, and some of them will work among the thousands who try. I would not have thought that Acorns (now Raiz) would work, but it has, with relatively low marketing expenditure.

The age of 65 is never going to occur for a 30-year-old. Raiz has made a fundamental change in the business of super compared with institutions, allowing people to put $1 in super when they buy something. It links spending with long-term savings.

When we started BigFuture, I joined 15 super funds to check the experience, and only two called me after I signed up. If you’re a millennial, you want better communication.

GH: Tell me more about B2C problems.

DH: We tried blogs and animations and social media but we never had a breakthrough. Maybe we should have started with an app not a website. But on an app, you struggle giving enough detail on a small screen. Maybe we just didn’t produce something people wanted in enough numbers. Many people loved the product, but just because I think people ‘should’ know about their financial affairs, doesn’t mean people will. We thought people would pay say $10 a month for the service.

GH: What was the point where you said this B2C is not worth doing?

DH: Well, we really moved in parallel, but we needed to work B2B with people who already had clients. We went to super funds who would pay us to offer the product to their clients.

GH: It seems like a strong proposition to a super fund, to offer your service to their members. You had some success, but why did it not resonate more?

DH: The game’s not over, we’re still working with the big funds, but we’ve ‘pivoted’ the business to make more money elsewhere. We put resources where the revenue is, into software development and coding.

Competition between the industry funds is minimal, they each have their constituent, there’s no ‘creative destruction’. Nobody is going out of business. The average person cannot distinguish between them, just like the top three electricity suppliers. The effort required to differentiate the products is too much. It’s not whether super funds care enough about the technology – it’s about how fundamental it is to their business. The largest super funds will probably supply essentially the same services in five to 10 years’ time as they do now. Smaller funds will be more entrepreneurial, they will want to add more value.

GH: What is your pitch to them? They should want what you’re doing for their members.

DH: We only had good conversations, but they required all the development to occur outside the super funds and be proven outside the super funds. But people like us have the least amount of capital to do the development. Someone will break through but take the example of the listed company Decimal. Latest share price 1.5 cents.

The main business development of a super fund is not with its members, it’s with the employer base that uses it. It’s about becoming the default member fund.

You also have administrators in an oligopoly, Link and Mercer. So if you’re going to do something special in technology as a super fund, how do you get the data? Neither has open APIs.

We have a couple of super fund clients with apps we have developed for them, with enhancements specific to the needs of their clients, rather than using the entire BigFuture picture we started with.

Other pivoting developments in the charity space include our launch of ‘Charity Booster’, an app designed to increase a charity’s donor numbers. For example, donors can give to a conservation charity each time they buy petrol, or a charity like OzHarvest each time they go to the supermarket. We can deliver the whole thing for $30,000.

So instead of wealth aggregation tools, we pivoted into contribution planning through payments systems, plus the charity applications.

Fintech is a game of attrition. When does the business stop burning cash as it is creating something? I’ve got five developers cutting code, but if you’re waiting for someone to make a decision, that’s a major operating cost. Our expenditure goes on developing product and the cost of data. You need to find a toe hold where you can make money.

 

Graham Hand is Managing Editor of Cuffelinks.

The 4Ps of roboadvice: persist, pivot, partner or pack up

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Mainstream media loves to publish articles about how roboadvice is the future of financial advice, especially in the face of the practices exposed by the Financial Services Royal Commission. The stories unveil the exciting new wave, the independent disruption and the better online solution that will revolutionise advice. The effusive articles often feature photographs of robots, proving an enthusiastic graphic designer has missed the point. A decade after the start of roboadvice, we are breathlessly told its time has come.

Roboadvice is a broad field, covering many types of automated investment services. It is supposed to be the antithesis of the traditional financial advice model, which is replete with high fees, poor communication and conflicts of interest. The doubtful qualifications of some advisers adds to an image of an industry ripe for the picking.

In reality, roboadvice is struggling to make a meaningful impact, and market penetration is largely confined to millennials or younger who do not yet hold significant wealth. In any case, most of them would rather own a home than an ETF. Many of the more established players are introducing human advisers to complement the online offer.

At a time when one relatively unknown fund manager can raise half a billion dollars in a month of marketing a Listed Investment Company, it’s doubtful whether the entire Australian roboadvice industry has raised this much in five years.

US robo growth rates heading lower

The great robo success stories are, apparently, in the United States, but leading industry watcher and frequent visitor to Australia, Michael Kitces, wrote this summary in 2016 under the heading, “Robo-Advisor Growth Rates Are Plummeting.”

(Kitces is not referring to long-established businesses such as Charles Schwab or Vanguard which have added roboadvice to their existing capabilities, and it’s uncertain how much is a transfer of money within same business).

In May 2018, Kitces gave another reminder of what has been achieved after a decade of roboadvice marketing and strong brand exposure. While the numbers look fine, they should be read in the context of BlackRock managing over US$6 trillion and Vanguard over US$5 trillion (that’s trillion, or one thousand billion). The great disruptors like Facebook and Google drove a network effect where growth rates rose exponentially for many years.

“The early fear was that robo-advisors were going to replace advisors, at least that’s what the robo-advisors came to market with, saying, “We’re here to replace advisors and do it cheaper.” You know, with frankly very limited growth of robo-advisors, I don’t mean to knock the assets that they built with, you know, companies like Wealthfront and Betterment at $10 billion to $15 billion, but when the total U.S. investable market space is upwards of $35 trillion to $40 trillion, we’re talking about something on the order of 0.06% market share of investable assets. Which means I think we’re past the question of whether robo-advisors are going to replace human advisors in the mainstream. They’re not.” (My emphasis)

I asked Kitces for an updated view for this article, and he replied:

“Through Q2 (latest quarter I can get reasonable data), Betterment was adding about $300M/month, and Wealthfront was at about $170M/month. This is a bit of a lift in total monthly flows than it was in 2016, but on a much larger base. Back then, Betterment adding $150M/month on a roughly $3.5B base, or a monthly growth pace of about 4.3%. Now it’s $300M/month on a $13.5B base, which is only a 2.2% monthly growth rate. Wealthfront is similar; back then, it was as low as $60M/month on a $3B base (2% monthly growth rate), and now it’s $170M on an $11.2B base (growth rate of about 1.5%). So in essence, their growth rates keep grinding lower, although the companies are still about 3X the size they were back in 2016, so the absolute flows have lifted (although both were even higher in 2017, and have actually seen another slowdown in 2018).

In terms of companies that have closed or pivoted, off the top of my head …

  • Hedgeable shut down
  • WorthWM shut down
  • SheCapital shut down
  • Jemstep was sold to Invesco
  • FutureAdvisor was sold to Blackrock
  • Upside Advisor was sold to Envestnet
  • Vanare/Nest Egg pivoted to advisors (now AdvisorEngine and funded by WisdomTree)
  • SigFig is partnering with wirehouses
  • Betterment launched its own advisor channel.”

Hedgeable was not a recent entrant. It started in 2010, and when it closed, it held US$80 million for 1,700 clients at a 0.75% fee. This is a scale business. LearnVest also closed in June 2018 but has since reopened as a provider of financial education material.

In the UK, UBS announced it would close its SmartWealth roboadvice business, launched in 2016 and intended to be rolled out in many countries. The potential of the business was “limited”.

Kitces’ list illustrates the other great hope of many roboadvisor startups: not that they will independently revolutionise financial advice, but that a large competitor will buy the business and become a strong partner with an existing client base.

Many Australian players, not many assets

This article is not a review of the entire Australian roboadvice industry. Although they do not all call themselves roboadvisors, occupying similar spaces are Stockspot, Clover, Six Park, Spaceship, Zuper, MapMyPlan, SuperEd, Decimal, QuietGrowth, Raiz (formerly Acorns), InvestSMART, Ignition Wealth, Balance Impact, Plenty, Grow Super, Superstash … to name many. It’s a highly competitive space raising millions in startup capital.

The vast majority of these businesses do not reveal the assets they manage. Most are startups burning cash each month, relying on optimistic investors for ongoing support. A few will be rewarded but most must pivot to something else, pack up or find a buyer rather than remain independent. Their valuations are not determined by profit, as there isn’t any. Rather, they must demonstrate blue sky and an exponential growth path. Just don’t mention the terrifying CAC – the Cost of Acquiring a Customer.

In its Annual Review of the superannuation industry in 2016, SuperRatings awarded QSuper’s Money Map the prize for the Best New Product/Innovation. It was an “online financial advice tool” with a single online dashboard allowing members to track their finances. From 1 September 2018, the product was closed.

BigFuture was a runner-up in the 2015 Afiniation Showcase for the Best Robo-Advice service in Australia, but it abandoned its direct offer in May 2018 (see following interview).

In February 2017, Westpac wound up its BT Go-invest roboadvice product launched in 2015 with four model portfolios, after finding it unviable, although BT is pursuing consumers directly with Panorama.

In 2017, Macquarie Bank shuttered its OwnersAdvisory service, following the tragic death of John O’Connell, the executive who was driving the roboadvice initiative.

Decimal is listed on the ASX and has built technology to add digital advice to financial products. It has been adopted by some major super funds. It recently announced:

“At the end of 2017 the Board formed a view that the existing ‘direct to customer’ sales approach was leading to a prohibitively high cost of customer acquisition and moved to develop indirect channels and routes to market, for smaller deals and customer segments, while maintaining direct sales for larger opportunities.

The outcome of these discussions, both comprehensive and broad, is the recent announcement of the Binding Proposal for Sargon Capital Pty Ltd to acquire all of the shares of Decimal for a consideration of 1.41 cents per share.”

Here is the share price movement of Decimal (ASX:DSX) since 2014:

Click to enlarge

Source: Yahoo Finance

For a listed company operating in what is supposed to be a new frontier, profits are elusive. Its shares have traded below 1 cent having been 30 cents less than five years ago.

Australian pioneer in online investing, Stockspot, has enjoyed a high media profile since its launch in 2014, supported by $5 million in funding from backers including ETF Securities’ Graham Tuckwell. Stockspot does not release figures on its funds under management, making it impossible to monitor its progress. CEO Chris Brycki provided this comment:

“The first phase of B2C robo advice (both here and overseas) has been focused on process automation, educating consumers and simplifying the customer experience to reduce frictions and give more people the confidence to grow their wealth by investing.

We see the next stage being centered around mass personalisation. i.e. giving clients a more customised experience based on factors like their experience, engagement level, and personal preferences.”

The exit strategies

So we have the four Ps of choice:

  • Persist in making the business work before the source of capital dries up.
  • Partner with an existing business with a large client base.
  • Pivot into a related business where competitive advantages and skills can be commercialised.
  • Pack up (or if you prefer, pull the plug), because the business cannot find a market or a partner.

Fortunately, for the time being, the venture capital market does not seem overly worried about the fifth P: profit.

But it’s better not to make enemies along the way. After I wrote a review of Spaceship‘s superannuation offer (by the way, they have a significantly improved non-super fund), I received an email from someone working in wealth management. She had been for a job interview at one of the new roboadvice startups. After discussions on positioning the business as fighting the injustices of the superannuation system and its incumbents, she asked about the exit strategy for the business. How would the value of the equity offered in the remuneration package be realised? Without hesitation, the recently-minted CEO said he will sell to a major bank. So much for hating the pernicious ways of the old guard.

As she wrote in her email about the CEO, “He’s developed a bit of an ego about not being part of ‘your industry’ which I had a fight with him about … I told him that the minute he picked this industry, he was also a part of it.”

 

Interview with early roboadvisor, BigFuture

In Part 2 of this look at roboadvice, we interview the CEO of BigFuture, Donald Hellyer, on why his business pivoted away from its ‘direct to consumer’ (B2C) aspirations, and what it has become.

 

Graham Hand is Managing Editor of Cuffelinks. Disclosure: Graham is on the Investment Committee of ethical roboadvisor startup, Balance Impact. 

Roboadvice’s role in financial advice’s future

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A rebuttal to Graham Hand’s The 4Ps of roboadvice: persist, pivot, partner or pack up.

Sometime in 2018, the Australian population reached 25 million. There are almost 20 million mobile phones in use in this country today, and smartphones comprise 88% of them. Australians are among the leading adopters of smartphone technologies and the apps that we increasingly use in our daily lives.

A recent Deloitte survey asked, “What did we ever do before smartphones?”, noting that:

“From the moment our fingertips touched the screen, Australians have enthusiastically embraced the smartphone and its myriad and multiplying uses. This disruptive innovation, which started out as the technological Swiss Army knife, has gone on to enable radical changes in not only the global communications landscape but across almost all facets of life and the economy.”

According to the Productivity Commission’s Inquiry Report into Competition in the Australian Financial System (PC AFS), during 2007, about 3 million Australians received financial advice, or approximately 20% of the adult population at the time. The PC AFS report notes that during 2016, about 2.6 million Australians received financial advice, or only 14.5% of the adult population, nine years later.

Far from expanding and assisting more Australians in the important task of securing their financial futures, the financial planning industry (yes, I said industry) is failing to engage people with a value proposition that resonates. Investment Trends estimates that 48% of adult Australians, or some 9 million people, have unmet advice needs. What gives?

Costly, complicated and untrustworthy

There are three hurdles that the advice industry has to overcome if it is to engage with, and genuinely provide, a value-added service to more Australians.

1. Too costly

From a global context, wealth management (as financial advice or planning is generally known) is a niche service for the wealthy. It’s an industry that was conceived to serve the needs of ‘High Net Worth’ (HNW) clients who could afford the costs involved in the provision of advice.

In the post-FoFA era, the cost of providing advice simply does not square with the fee appetite of the majority of non-HNW clients. The PC AFS report noted that the cost of providing comprehensive advice averaged $2,500, but people are only willing to pay $780 on average to receive such advice.

In a post-FASEA, post-Hayne Royal Commission world, the costs of providing advice will rise, precluding even more Australians from receiving the financial advice they desire and deserve.

2. Too complicated

Many Australians neither want nor need comprehensive (‘holistic’) financial advice. That 50-page Statement of Advice magnum opus incorporating debt, cashflow management, superannuation, retirement planning, insurances and estate planning is of interest to far fewer prospective clients than the advice industry cares to admit.

What people increasingly want is piece-by-piece advice on issues of concern at the point at which they occur. Rather than the all-encompassing comprehensive financial plan, the growing demand is for ‘scaled advice’. It must be suitably qualified, efficiently provided and at a price that reflects the nature of the advice.

3. Too untrustworthy

A recent Investment Trends report indicates that trust in financial planners has fallen to an all-time low, with a survey of over 8,000 respondents revealing that on a scale of 0 – 10 (with 10 being the most trusted) financial planners now sit at 4.8, placing them in the ‘distrusted’ range.

There is little doubt that the revelations at the April 2018 hearings of the Hayne Royal Commission of systemic and persistent failings by some of Australia’s largest advice providers have impacted the public’s perception of the advice industry. Many of the issues raised involved contraventions of the FoFA obligations that I’ve previously opined on. The advice industry has struggled to come to grips with the implementation of these changes years after they came into effect in 2013. These transgressions will likely now accelerate the removal of concessions, especially grandfathering of commission arrangements.

Roboadvice to the rescue?

First, one small gripe. The term ‘roboadvice’ does a disservice to both providers and users of this technology. It’s a pejorative phrase, coined in the US by those threatened by its arrival, thus labeling it with a term suggestive of killer droids from some dystopian future arriving to destroy advisers and take captive their HNW clientele. Nothing could be further from the truth.

In fact, the technology created by Clover.com.au and others like us who manage investments on behalf of clients can best be described as digitally-enabled advice. The technology facilitates user engagement in the advisory process, to produce the necessary disclosure documents in a compliant manner (for digital advisers that provide personal financial advice), to automate the on-boarding of a client (Know Your Client, AML/CTF, bank or broker account opening). Thereafter, it provides an ongoing service incorporating cashflow and market-based rebalancing and regular reporting, depending on the contractual nature of the on-going service.

Digital advice (the term preferred by ASIC) is as much about the automation of the middle and back office functions of a financial practice as it is about the front office interaction with the client. If digital advisers impact anyone in the financial advice industry, it’s more likely to be paraplanners, customer service officers and compliance personnel who won’t be required to the same degree in digitally-enabled offerings.

Future-proofed from birth

So why is digital advice here to stay, and will in time become a key component of future-oriented financial advice dealer groups and practices?

The reasons are simple. Australian digital advice was created from inception for a post-FoFA world where transparency, compelling user engagement, simple investment strategies that are evidence-based and low-cost and unapologetically favour the client’s interests over competing interests are defining features of the digital advice value proposition. As Commissioner Hayne noted in his Interim Report:

“The interests of the client are to obtain the best financial advice reasonably available. More particularly, if the advice is for the client to acquire some financial product, it is in the client’s interests to obtain the best product; best in the sense that it is fit for purpose but best in the sense also that it is the cheapest and (as far as can reasonably be determined) the best performing product available.”

Australians are increasingly turning to digital advisers. Investment Trends, in reporting that 27% of the Australian online investor population has heard of the term ‘roboadvice’, recently opined that “roboadvice will take centre stage as more solutions become available, and as investors themselves begin to engage with these non-traditional advice models.”

Why does CSC matter more than CAC in the long run?

Graham Hand’s piece, quoting the irrepressible US sage of all matters financial advice, Michael Kitces, noted that the Cost of Acquiring a Customer (CAC) is notoriously high in financial advice, and that this marketing cost would be difficult for digital advisers to overcome and lower over time, relative to the low fees charged by digital advisers.

In terms of engaging more people, and particularly people with lower investible assets earlier in life, Kitces is right when he says that

“… the problem is not the lack of a business model to serve the masses effectively; the problem is a marketing model to convey the value of financial planning to the masses effectively, and doing so at a cost-effective price point that doesn’t bury the business model in too-high client acquisition costs.”

True, but we need to acknowledge that CAC is high in financial advice in large part because of the trust deficit that exists. A legislative environment has developed to protect investors from industry participants who seek to put personal financial interest above those of their clients. The lower the trust factor and higher the financial stakes, the higher CAC invariably will be.

In an Australian context, however, it is becoming increasingly apparent that in the future, it is not CAC that will determine the long-term winners in financial advice but the Cost of Servicing a Client (CSC).

The Royal Commission laid bare an inconvenient truth: the financial advice industry that emerged in the 1980s adopted the modus operandi of the insurance industry from which it evolved. It was a transaction-based, sales-oriented business model fueled by an opaque compensation structure in commission payments between product provider and advice giver.

The business model was never designed for the provision of ongoing services, and so CSC was never factored into the equation. Now it is front and centre.

In a post-FoFA world, the CSC will almost certainly rise, and reduce the viability of advice for even more Australians. The risks to the current 14.5% market penetration of traditional financial advice are more to the downside.

In fact, as the following chart from the PC AFS shows, for nine deposit-taking institutions dominated by the Big Four banks, financial advice is primarily a distribution strategy for asset management and platforms, and makes little money in its own right. Except for Westpac, the three others are exiting advice as it’s simply not worth the problems.

A hybrid model will prevail for most people

It need not be so. The real future of financial advice may be neither purely digital or purely human, but a hybrid of advisers doing what they do best: engaging in honest conversations, determining financial needs, goals and objectives. Then they will use digital advice technologies to deliver investment solutions, investor education, client on-boarding, portfolio implementation and ongoing monitoring, reporting and compliance requirements.

As ASIC opined in its submission to the PC AFS report:

“An effective advice market should accommodate the diverse needs and different financial circumstances of consumers, deliver advice in a cost-efficient manner and be accessible through a variety of channels.”

Digitally-enabled advice offers the best hope for such a future to emerge, to the advantage of all Australians, not the shrinking minority who will be able to engage financial advice in a post-FoFA, post-FASEA, post-Royal Commission world.

 

Harry Chemay is a Co-Founder of the digital advice provider Clover.com.au.

Royal Commission must remove aged care anomalies

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The Royal Commission into Aged Care will resolve once and for all the debate about staffing ratios. It is imperative that the Commission identifies appropriate minimum standards of care. It is equally imperative to broaden their scope to identify who pays what for care now, and who should pay what in the future.

Resident contributions system is broken

The current means testing arrangements use a complex formula combining an income and asset test to determine the resident’s liability to contribute to the cost of their accommodation and care. While on the surface this seems fair, the reality is that the current means test protects the very poor and the very wealthy, leaving those in the middle to pay the most.

The formula used to calculate someone’s liability to contribute towards their cost of accommodation and care involves a combination of an income test and an asset test:

  • 50c per dollar of income above $26,985 (single) $26,465 (couple), plus
  • 5% of assets between $49,000 – $166,707, plus
  • 1% of assets between $166,707 – $402,122, plus
  • 2% of assets above $402,122

A few important aspects of the means test are:

  • The former home is exempt if a protected person is living there.
  • When the former home is assessed, it is assessed up to a capped value of $166,707.
  • Any amount the resident pays as a lump sum accommodation payment is included in the asset test.
  • The resident cannot pay more than their cost of care.
  • There is an indexed Annual Cap of $27,232 and a Lifetime Cap of $65,357 (which includes any amount paid as an Income Tested Care Fee in a Home Care Package).

How the means test works

Every resident can pay the basic daily fee, set at 85% of the age pension, currently $51/day. In addition to the cost of care, residents still have personal expenses including telephone, medications, clothing and travel, as well as any extra or additional services provided by the facility.

At the fully subsidised end is Tom, a full pensioner with $40,000 of assets. Tom pays the Basic Daily Fee and the government pays the facility an accommodation supplement up to $57/day to cover the cost of his care.

Three examples of means testing

1. At the low means end, Shirley is a full pensioner with $90,000 in the bank and $5,000 of personal assets.

Based on Shirley’s assets, her Daily Accommodation Contribution (DAC) is $22.11/day. The lump sum equivalent (Refundable Accommodation Contribution or RAC) is $135,067. The RAC is calculated at the government-set interest rate, currently 5.96%/year. With $95,000 of assets, Shirley cannot afford to pay by RAC alone but she can pay by combination. If she pays $40,000 towards her RAC, her DAC will reduce to $15/day. After meeting her cost of care, she has less than $2/day for personal expenses or will need to dip into her $50,000 of remaining capital.

2. Don is a part pensioner. He has $190,000 of investments and $10,000 of personal assets. Because his assets exceed $166,707, his accommodation payment is based on the market price set by the aged care facility. If Don lives in a capital city, the Refundable Accommodation Deposit (RAD) could easily be $500,000 or more.

If Don moves to a facility with a RAD of $500,000, paying $100,000 towards his RAD, his daily accommodation payment (DAP) will be $65.31/day. Combined with the basic daily fee, his cost of care will be over $42,000/year. Don’s income is just $26,000/year so he will either dip into his remaining investments to meet his cash flow or deduct his DAP from his RAD (an option available to all residents). If Don chooses this option, which would ease the pressure on his cash flow, his DAP will increase each month as his RAD reduces and in less than 5 years his RAD will be exhausted.

3. At the other end of the spectrum is Dot, a self-funded retiree with a home worth $1 million, $1.5 million of investments and $50,000 of personal assets. She is also moving to a facility where the RAD is $500,000. She pays her RAD in full, from her investments.

If Dot keeps her home, it will be assessed at the capped value of $166,707 and she will pay a means tested care fee of $85/day. After 320 days, she will reach her annual cap and stop paying this fee for the remainder of the year and in 2.5 years she will reach her lifetime limit of $65,000.

By keeping her home Dot’s Means Tested Care Fee is around $90/day less than if she sold it.

Inequitable outcomes

If all three retirees live out their lives in aged care, Shirley, as a low means resident, will have just $2/day to cover her living expenses or will need to dip into her limited capital. Dot will keep her $1 million home, $1 million of investments and $50,000 of assets, and her $500,000 RAD will be refunded after she leaves care. She will pay the lifetime limit of $65,000 toward her cost of care. Don, meanwhile, will have lost the entire $100,000 of his RAD within five years. He may still have some investments left, but like Shirley he has needed to draw on his assets to meet his cost of care.

The outcome of the Royal Commission will undoubtedly recommend changes to the cost of providing aged care. The next step will be to ensure that the means testing arrangements share that cost in a way that is equitable.

 

Rachel Lane is the Principal of Aged Care Gurus and has co-authored a number of books including ‘Aged Care, Who Cares?’ with Noel Whittaker. This article is for general information only.

Do you know the fees you’re paying?

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Most investors don’t have a clue how much they pay across all the different types of fees they are charged. There are fees for advice, administration, investment management, tax planning, and more. The examples below are intended to help you better understand these fees and roughly calculate how much you pay in total. Many investors who do this calculation are shocked at how much it comes to.

An example will demonstrate the importance of minimising investment fees. Imagine that over your 40 years in the work force, you put 10% of your annual income into superannuation each year. Let’s assume that your income starts at $50,000 per year and then grows at 4% per year above inflation of 2.5%, and your investments deliver an annual, after-tax return of 5% per year above inflation, but before fees.

If the total annual fees you paid were 2% (200 basis points) of your accumulated super, then after 40 years you have $1.9 million in super. If instead, your fees were 1% (100 bps), then you have $2.3 million. Cutting fees by 1% leads to a 21% increase in the amount of money retirement in this realistic example.

Calculating fees

The first step towards ensuring that you are not paying too much is to understand how much you are paying today. The following examples are intended to help you calculate the total percentage (and dollar) amounts you are currently paying.

Total fees for different types of investment and advice

Calculating fees

Example 1: Financial advisor and retail super fund

Evi and Karl’s investible savings (other than the family home) are $580,000 of super. The couple’s financial advisor, Steve, has put their $580,000 of combined super into one of the big retail super funds (MLC, CFS, BT and AMP are the largest).

They pay: 1.00% (for advice) + 0.65% (for administration) + 0.75% (for management) = 2.40% of $580,000 = $13,900 a year.

There are three levels here. Financial advice from their advisor. Administration from a retail super fund. Investment management from various fund managers.

Advice: Evi and Karl meet with their advisor once a year to discuss:

  • their financial goals
  • how much they need to save to meet those goals
  • what they should invest in (asset allocation) and in which managed investment funds
  • whether they should borrow to invest in property
  • how much insurance they need
  • how to minimise tax
  • how they should structure their investments (do they need an accountant to set up an SMSF, a family trust, etc.)

Steve charges 1% (100 bps) of their super balance for this advice.

Administration: The retail super fund charges the couple 0.65% (65 basis points) for administration of the super fund, which involves:

  • the creation and governance of the super fund
  • access to a large number of different managed funds (for investing in Australian shares, global shares, fixed income, commercial real estate, infrastructure, etc.)
  • buying power to access those managed funds at low cost
  • calculation of the couple’s share of value in the super fund (which has many thousands of members)
  • preparation of reports for Steve, and some smaller things

Management: Steve chooses which retail super fund to put the couple’s $580,000 into. Then he looks at all the different managed funds that the retail super fund gives access to and chooses a managed fund for Australian shares, global shares, commercial real estate, etc. On average these funds are charging 0.75% (75 basis points) for the effort they put into researching and choosing the shares or properties that they invest in. The 75 bps would be more if not for the buying power of the retail super fund (which many billions are invested through).

Tax and structuring: Evi and Karl’s taxes are simple. They file their taxes online using ‘intelligent’ online software that takes them through the process and costs a small amount (negligible compared with their advice, administration and investment fees).

Example 2: No advisor and industry fund

Faiz and Mary’s investible assets are $620,000 in super plus a negatively geared investment property (for which they pay the rental agent 8.5% of the rent, which I will ignore here). They both have their super in the ‘balanced’ option of their industry super fund (the biggest industry funds are AustralianSuper, Hostplus, HESTA, REST, and Unisuper)

They pay 0% (for advice) + 0.12% (for administration) + 0.76% (for management) = 0.88% of $620,000 = $5,500.

Advice: Faiz and Mary have never spoken to a financial advisor. They wonder whether they might benefit from advice but have put that off until their situation becomes more complex.

Administration: Their industry super fund charges an administration fee of 0.12% which covers the costs of collecting members’ super payments, calculating account balances, providing annual statements and answering members’ inquiries.

Management: Faiz and Mary’s industry fund manages some of its members’ money in-house and pays external managers fees to manage the remainder. The 0.76% fee covers all of the costs of this investment management. The couple chose the ‘balanced’ investment option and the industry fund makes decisions on asset allocation and choice of investment managers on their behalf.

Tax and structuring: Faiz and Mary pay a tax agent about $300 to complete their income taxes, but only because of the tax rules around their rental property, so I have ignored the tax expense above.

Example 3: Brokerage firm and SMSF

Axil and Wei have considerable investible assets: $2.4 million in an SMSF and $1.8 million in their family trust, which continue to grow quickly. This is in addition to the ownership of their family home and the business created and run by Wei. Their investible assets are managed by an advisor of a brokerage firm (some large brokerage firms are JBWere, Morgans, Ord Minnett and Evans).

They pay 0.95% on $4.2 million (for advice, administration and management of their Australian shares) plus 0.50% extra (for management of global shares and some commercial property trust investments – see below) = 1.45% of $4.2 million = $60,900. Their accountant’s fees (structuring and taxes) are $6,800, which is 0.16% of their investible wealth. They have paid 0.95% since they started with the brokerage firm but are considering asking for a reduction to 0.85% now that their investible assets are larger.

Advice: Axil and Wei speak with their advisor three or four times a year. There is a scheduled annual meeting when their advisor takes them through the changes to their investments and performance of their portfolio over the year. But there are also ad hoc telephone conversations when their advisor is considering large changes to their investments or their advisor wants to offer them a particular investment opportunity. These include investments in property trusts, initial public offerings of shares and even investments in some start-up companies.

Administration: Advice, administration and management of the Australian share portfolio are bundled together in the 0.95% fee charged by the brokerage firm.

Management: The brokerage firm manages Axil and Wei’s portfolio of Australian shares in a ‘separately managed account’ that is not pooled with the shares of their other clients. However, their investment in global shares is through a managed fund that charges 1.50% per annum, and their investment in private commercial property trusts has a fee of 1% per year. In total these extra fees are equivalent to 0.50% of their $4.2 million of investible assets.

Tax and structuring: Axil and Wei’s accountant provides tax advice and prepares their personal tax forms, as well as the financial reporting, taxes and audit of their SMSF and family trust. The same accountant is used by their business, but those fees are charged to the company.

Concluding remarks

Fees, taxes and transaction costs are, in one sense, all the same thing for investors. They are all money out, and that needs to be minimised. But ‘minimised’ doesn’t mean ‘set to zero’, because everyone needs some level of help, especially with tax planning and structuring (SMSFs, family trusts, etc.). The advice you receive might lead you to save more, take the right amount of risk, manage your taxes effectively, etc. which will lead to better outcomes. Minimising fees just means getting value for the fees that are paid.

How much do you pay annually in fees, with total fees broken down into advice / administration / management / structuring and tax? Try to work it out yourself. But if you have a financial advisor then ask them. If you don’t get a clear and direct answer, then that is a problem. There is obviously a great deal more to discuss on this topic, but this can start your conversations.

 

Dr. Sam Wylie is a Principal Fellow of the Melbourne Business School and a Director of Windlestone Education. Please seek professional advice on structuring and tax planning from a qualified accountant or financial planner. This article is for general information only and does not consider the circumstances of any individual. A longer discussion of fees and managing your relationship with advisors is part of my Finance Education for Investors course. Go to Windlestone.com.au/melbourne or Windlestone.com.au/perth for more information.


Royal Commission report nails adviser conflicts of interest

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The Financial Services Royal Commission asked Professor Sunita Sah for a report on how to mitigate the negative effects of conflicts of interests that influence financial advisers. Professor Sah focusses her research on how professionals who give advice alter their behaviour due to conflicts of interest. Cornell University, where she is a professor of management, describes her interests as including institutional corruption, ethical decision-making, bias, and transparency.

The outcomes of conflicts of interest on advisers

Academic literature on the effects of conflicts of interest on advisers suggests:

1. Conflicts of interest lead to biased advice. Often, advisers are unaware of the bias, and the effects are consistently large.

2. Self-regulatory mechanisms that govern moral standards do not operate unless they are activated. The advisers may not view the conflict of interest as a moral dilemma: “many psychological processes can be used to selectively disengage from moral self-sanctions. Collectively, these processes are known as moral disengagement.”

3. Moral disengagement is not sudden. It creeps up on the person and gradually erodes self-imposed sanctions.

4. When the biased advice causes harm, advisers absolve themselves by attributing the activities as ‘ordered by others’. This is more prominent if the practice is widespread, and advisers thereby observe other advisers doing the same thing.

5. Moral disengagement can also happen at an institutional level.

6. If the most corrupted are rewarded, moral disengagement accelerates.

7. Over time, private opinion alters as well. Advisers giving biased advice begin to believe their own advice (as being in the best interests of the client).

8. Advisers routinely deny an influence of incentives to a bias even after its demonstration. The bias shifts to the subconscious. Subsequently, ethical issues (in relation to the advice) are pushed aside by the conscious mind.

9. Such psychological processes, including rationalisations at a conscious level, are well established in academia. If there are incentives to not act in the best interests of the client, biased behaviour will not be limited to ‘bad apples’ but will include many who genuinely consider themselves to be upstanding people and good moral agents. As the report says, humans “are fantastically adept at rationalising and believing what we want to believe.”

Thus, “it is relatively easy for advisers to, for example, persuade themselves that the products that they receive commissions for really are the best and the clients they recommend investments for really will benefit from those investments.”

10. A sense of invulnerability to misaligned incentives increases the likelihood of accepting such incentives, and paradoxically, succumbing to them subconsciously.

Is disclosure the remedy?

Reliance on professionalism is grossly insufficient. Sah’s report reminds us that CEOs and managing partners of the large accounting firms, including Arthur Anderson and PwC, testified before the US SEC that their ‘professionalism’ would protect them from being influenced by conflicts of interest.

Sah says that “the most frequently recommended and implemented policy across industries and professions is disclosure,” but warns us that disclosure can have unintended consequences. The psychological principle in play here is that people think it is less morally reprehensible to give biased advice intentionally once a conflict of interest has been disclosed. Advisers may even increase the bias in their advice to counteract anticipated discounting of their advice by their audience.

On the positive side, Sah says that her research indicates that “mandatory and voluntary conflict of interest disclosure can deter advisers from accepting conflicts of interest so that they have nothing to disclose except the absence of conflicts.”

In other words, the ability to disclose an absence of conflict is a marketing plus point. We do see that exploited in the marketplace. Corporations become incentivised to remove conflicts of interest. Perhaps regulators could use this source of competitive advantage by making disclosure mandatory.

Secondly, says Sah, if conflicts are unavoidable, as long as industry norms to place the clients first are actually in place (as against just a lip service to such a norm), disclosure will cause more norm-abiding behaviour. Further, real experts with long periods of training in their profession tend to decrease bias with disclosure.

The paradox of disclosure from the client side

As advisers feel more empowered to give biased advice with disclosure, clients may also suffer subconscious biases that unwittingly lead them toward the biased advice. Firstly, clients may feel they are insinuating distrust by not accepting advice where a conflict has been disclosed, and the relationship is good. Indeed, clients may even want to favour their advisers who disclose they receive a higher fee if the client chooses X rather than Y. The client’s trust in their adviser increases with disclosure. Advisers will also likely to emphasise situations where they are recommending a product which has a lesser incentive for them.

Such effects are mitigated if clients need not communicate their choices to their advisers. But this is difficult in financial planning as execution of strategy is often part of the service.

Disclosure works better if it’s up-front, temporally prior to the advice, or at least at the top of the page (or at the start of the conversation) that sets the advice out.

So disclosure isn’t enough. What else works? Or doesn’t?

Sah says that educating advisers about self-serving biases does not reduce their bias. It only makes them better at detecting other advisers’ biases. Human beings are terrific at pushing ethical concerns into the background when it serves them well. Sah asserts that “Enron’s 64-page Code of Ethics booklet did not prevent the ethical failures of many employees within that institution.”

Sanctions, Sah recognises, would be hard to implement when outcomes of investment decisions are known much after the fact, and culpability as to a deliberately unsound advice hard to determine.

Fines may encourage institutions to undertake a cost-benefit analysis. Thus, Sah contends that insufficient fines would not provide a significant enough disincentive.

However, I note that the report, despite having a US perspective, does not delve into the class-action litigious culture of the US, where impacts are much bigger and more public than regulatory fines. We may start seeing some of that in Australia with several class actions, using evidence uncovered by the Royal Commission, already announced.

Institutional norms are perceived in a variety of ways, including the actions of leaders, not just the Code of Ethics document. Sah asserts that norms strongly affect individuals. Those in authority should pay attention to the myriad ways in which norms, including of what other advisers actually do, are perceived.

Getting second opinions, cautions Sah, is mostly not feasible due to cost and time. Indeed, we know that a second financial planner may in fact have the same biased incentive.

Realigning incentives is superior to disclosure. Removing incentives that create conflicts is the best way, says Sah – “policies that restricted interactions between the pharmaceutical industry and physicians led physicians to prescribe less (expensive) branded drugs and more (cheaper) generic drugs.”

Sah also recommends that “advisees need to be personalised and the harm they have suffered publicised. This decreases the psychological distance between advisers and advisees.”

Well, that’s certainly happening with the Royal Commission.

Professor Sah’s research paper can be found here.

 

Vinay Kolhatkar is Assistant Editor at Cuffelinks.

Grandfathered commissions: what’s it about?

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Investment Trends recently released its 2018 Financial Advice Report, an in-depth survey of the appetite and use of financial advice among Australian adults. The Financial Services Royal Commission has profoundly affected perceptions of the financial planning industry and trust in financial planners and banks is at all-time lows.

Among the major issues at the Commission, fees for no service, charging fees to dead people and dud insurance policies are easy concepts to grasp. However, grandfathered commission is more difficult for most people to get their head around. Various groups have been vocally calling for blanket bans, and banks have been backing away from commitments made to financial planning groups in order to placate an angry population.

How did it all start?

The dictionary definition of grandfathering is to exempt someone or something from a new law or regulation. In the financial advice context, grandfathering concerns investment commissions, superannuation commissions and insurance policies linked to super accounts.

Let’s step back. In the 1980s, financial institutions started marketing managed investments, where investors could access the share market by pooling their money with other like-minded people in a managed fund. The investment managers did not have a means to sell the concept: no sales force, no client service departments and no real way to communicate with potential end-investors. They enlisted the support of intermediaries. They charged the investor entry fees into the managed fund which they passed to the intermediaries as upfront commission. Since July 2013, these commissions have been banned.

The intermediaries were also paid ongoing (trailing) commission, usually 0.3% or 0.4% per annum on the value of an investor’s account balance. It is these commissions which most of the fuss is about. The payments were intended to subsidise the cost of providing ongoing service to people who bought the managed funds.

Who pays it and who gets it?

Two important factors to note.

First, the trail commissions were paid by the investment manager out of their management fee. It was not an added fee that was deducted from the investor’s account. Consequently, it did not (and still doesn’t) show up specifically as a debit on investor statements. If an investor didn’t invest via a financial adviser, the fund manager invariably retained the money and didn’t rebate it to the investor. These managers didn’t really want a direct relationship with investors, and they certainly didn’t want to jeopardise their adviser distribution arrangements. At the time, any fund manager who ‘went direct’ or discounted fees risked being blacklisted by angry advisers.

Second, these commissions were not paid directly to financial advisers, and still aren’t. The vast majority of financial advisers are authorised representatives of a ‘licensee’ (sometimes referred to as a ‘dealer group’) rather than take on the responsibilities and risks involved with having their own licence. This spawned the creation of a group of independent licensees, some of which attracted large numbers of financial advisers. Investment managers paid commissions to the licensees who passed them on to financial advisers after deducting a percentage to cover the costs and profit margins of the licensee.

Along came vertical integration

In the late 1990s, banks recognised the profit opportunities that vertical integration could deliver, and retail banks bought fund managers, administration platforms and licensees. They derived profits from the management fees created by fund managers, admin fees from the platform and a share of the commissions created by financial advisers. Furthermore, their profits were bolstered by the mushrooming size of the superannuation market which grew from virtually nothing in 1992 to more than $2.7 trillion today.

Over time, the legal and compliance demands on financial planners grew to such an extent that trail commission was nowhere near enough money to cover the costs of financial advice. Consequently, many advisers tacked on an adviser service fee to the client’s account. This fee had to be agreed with the client in writing, via a signed copy of the application form, and was directly deducted from the client’s account and was specifically itemised on the client statement.

Some adviser groups rebated the entire trail commission and covered their costs by charging adviser service fees. Others used a combination of trail and adviser service fee.

The ban on commissions

Rumblings about commissions had been growing for a while but really blew up when the industry funds started spending big money on advertising. These ‘compare the pair’ advertisements graphically revealed how much money could be ‘lost’ by ordinary Australians over the course of a lifetime. The Labor Government introduced a package of measures designed to eliminate commissions and increase transparency, including:

  • A ban on upfront and trail commissions on all new investments.
  • Super funds had to invest all new super contributions into new low-cost investment options which didn’t pay commissions.
  • All existing super accounts would have to be transferred to the new low-cost investment option unless the member had actively selected a non-default option, or the fund received notification from the member saying they wanted to remain where they were.
  • Advisers had to provide Fee Disclosure Statements every year.
  • Clients had to sign an Ongoing Service Agreement every two years which clearly stated the services that were to be provided and what they were being charged.

The key date was 1 July 2013 but many of the measures had grace periods and different implementation dates. This confusion was amplified when the Coalition won power and announced they would roll back some of the changes, but the cross benchers objected.

Grandfathering of commissions

The measures that were eventually introduced contained some sweeteners, omissions or mistakes, depending on your view. The major concession was that trail commissions on existing investments were grandfathered. In other words, if an investor remained in an investment, trail would continue to be paid until the investment was redeemed, in theory forever.

Due to the forcible transfer of commission-based superannuation accounts to commission-free accounts, grandfathered commission was expected to die out relatively quickly. However, they are an important part of the revenue structure of many advice groups, although certainly not all.

What isn’t generally recognised is that many superannuation members are actually better off in commission-paying investment options.

First, low cost super funds often underperform other investment options, even after fees. Second, when MySuper and FoFA were introduced, many retail super funds found other ways to earn revenue, ostensibly because of the additional legal and risk costs. While they deducted the trail from the management fee, some increased their administration fees, inserted an adviser service fee or added a regulatory reform fee to cover the costs of compliance. Overall, management fees went down but perhaps not as much as expected.

Some workplace super funds also changed their fee structure so that management fee discounts were lower on the new MySuper products. These discounts often started when the workplace super fund reached $1 million but following the introduction of MySuper, the starting point for the discounts on some new low-cost options moved $5 million. This sometimes wiped out any cost savings accruing from MySuper. Also, many financial advisers were rebating some or all of their trail commission, and this benefit was lost to MySuper members under the new fee regime.

Grandfathering rights were also extended to allow advisers job flexibility and retirement options:

  • If a financial adviser leaves his current licensee and joins another licensee, the trail continues to be grandfathered and the new licensee receives the commissions instead.
  • If the adviser retires and sells his business to another financial adviser, the new financial adviser can inherit the commissions.
  • If the adviser’s licensee buys his business the licensee inherits the trail commission.

In my opinion, these allowances are reasonable otherwise it creates a restriction on advisers to practice, dramatically limits their employment options, decreases the value of their business and reduces their retirement choices. Grandfathering is an expected concession when changes are made to legislation (and listen to the howls of complaint when it is denied!) so why should financial advisers be treated any different?

Bigger FoFA mistakes

I believe the biggest mistake the government made when introducing FoFA was that Fee Disclosure Statements and Ongoing Service Agreements did not have to disclose trail commissions. This gave advisers the opportunity to be economical with the truth, and it is probable that many investors remain completely unaware of exactly how much money advisers are making on their investment. Many advisers did not disclose trail commissions. In their view, commissions are payments made by the super fund from their management fees and not a direct cost to the client.

While history is on their side, the future is not.

Before retiring in June 2018, I spent 26 years in the investment and financial planning industry including with two fund managers, two banks and three financial planning organisations. Even with this background, I may have overlooked an important aspect of commissions so please feel free to chime in!

 

Prior to retirement, Rick Cosier was a financial adviser for 26 years and Principal of Healthy Finances Ltd. This article is for general information only and does not consider the circumstances of any individual.

Senior Australians’ changing relationship with financial advisers

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This article is the fourth in a series written by leading retirement website YourLifeChoices. It draws on surveys that show the level of satisfaction with the financial services sector.

YourLifeChoices’ members say that they are less likely to seek advice from financial advisers in the aftermath of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry. Tellingly, for those who have sought financial advice, satisfaction with the quality of the guidance has fallen sharply from 75% to 50% in the past two years. Our members are aged from 55 to 75 years and have a focus on maximising their retirement income.

Reasons for not visiting a financial adviser

Two years ago, the YourLifeChoices 2016 Insights Survey showed that of 4,155 respondents, 57% had visited a professional to discuss finances in the previous year.

The main reasons given for not visiting a planner were:

  • Perceived high costs
  • Insufficient assets or funds
  • Ability to satisfactorily manage their own financial affairs
  • Lack of trust in the profession.

Many responses complained of financial planners pushing their own products. Another sizeable group said they did not understand how to assess the quality or independence of the guidance. Still others claimed they had received bad advice that had hampered their returns, which had put them off seeking financial advice again.

Royal Commission will affect use of advisers

Early this year, the 2018 Insights Survey found the proportion of members that had sought financial advice had grown from 57% in 2016 to 63%. However, by July 2018, after the Royal Commission had been in hearings for a few months, members started to lose faith in the financial services sector. The percentage of those who had or would consider consulting a financial adviser about their retirement had fallen to 53%.

The vast majority of members, 86%, say they manage their own finances, although some may also see a financial adviser. In the YourLifeChoices Boomer Consumer Survey undertaken in October 2018, 37% said they would be willing to take an average risk in order to receive average returns. Almost 9% said they would take substantial risk with investments and less than a third said they were not willing to take financial risks.

Asked where they had sought advice, of 1,719 respondents, about 500 had reached out to their superannuation fund and approximately 500 to their own financial planner. The next highest category was banks (about 200 respondents), an accountant (158) and Centrelink (140).

The recent Interim Report on the Royal Commission’s findings continued to highlight failures in the financial planning sector, leaving many Australians wondering if they should pay for advice. Commissioner Kenneth Hayne said about those providing advice.

“Whether the conduct is said to have been motivated by ‘greed’, ‘avarice’ or ‘the pursuit of profit’, it is conduct that ignored the most basic standards of honesty.”

Winning back client confidence

On World Financial Planning Day in October 2018, the Financial Planning Association of Australia outlined six steps to help people locate a reputable adviser. We outlined those steps in an article, Who can you trust with your money?.

Judging from the responses to that article, it will take more than a how-to guide to restore confidence in this profession. Here is a sample of what retirees said:

  • “Why is it taking so long to bring in education/regulations for new and existing advisers? This should be immediate. Why should it take five years for current advisers to meet the required standard? Either they meet it now through ‘recognition of prior learning’, which allows for experience to be accepted, or they should be suspended from working until they can.”
  • “Massive internal changes and changes in ethos are required now to restore any faith or trust in financial institutions.”
  • “Financial advisers want profit, and they will always put their own income ahead of client interests. (Now) they will make noises. They will change the technicalities in a few rules, but nothing will change for the client.”

Other survey respondents blamed the regulators – the Australian Securities and Investments Commission (ASIC) and the Australian Prudential Regulatory Authority (APRA). They are, after all, entrusted to ensure misconduct in the financial services sector is minimised.

 

Olga Galacho is a writer at YourLifeChoices, Australia’s leading retirement website for over-55s. It delivers independent information and resources to 230,000 members across Australia.

Conexus sees conflict in fund manager awards

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Editor’s introduction

Colin Tate is CEO of Conexus Financial, publisher of several trade titles. We admire that he has taken a stance against fund manager awards where conflicts arise. As he says, the awards encourage short termism and the outcome may be influenced by contributions to the revenues of various agencies.

Cuffelinks recently discussed with a major research house the possibility of a new award for the best Listed Investment Company (LIC) and/or Exchange Traded Fund (ETF). We soon realised the dilemma this would create. Any event needs sponsorship, and obviously, LIC and ETF providers would be prime candidates to support the event. But they are unlikely to sponsor an award to one of their competitors, placing the organisers in a compromised position. Some of these award nights have so many prizes, it feels like there’s something for everyone.

We reproduce Colin’s letter to his subscribers below.  

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Professional standards in the advice and wealth management industry are shifting quickly. As a publisher and a thought leader, it’s important to be ahead of the curve at all times, which is why we’ve made the decision to discontinue our successful Professional Planner/Zenith Fund Awards.

This decision is in no way intended to take away from the efforts and successes of the winners and finalists.

In recent years, I’ve been struggling to see how sell-side awards ceremonies add any value to the client, not to mention what this backslapping looks like to people outside the industry. By people outside the industry, I mean those paying a percentage of their savings for returns to afford a better lifestyle and a dignified retirement.

The Hayne Royal Commission hearings and interim findings have already called out many conflicts of interests, but many more will be called out in coming months and the industry needs to make some of these calls itself to move forward. I think the fund ratings process is one of the areas that needs to change, which is why – despite the revenue opportunity for our company – we are walking away from the awards.

Conexus Financial, the privately-owned publisher of Professional Planner, holds 20 events across its three titles, which also include Investment Magazine and Top1000funds.com

The fund awards are the only sell-side event in our stable. The event is inconsistent with our mission to push the industry to lift professional standards and, ultimately, further the interests of the member and the end investor.

By promoting the awards, we are inadvertently promoting short-term behaviour, which is not what investment or super should be about. Firstly, from a portfolio construction point of view, there’s plenty of evidence to suggest that it’s asset allocation, not fund manager selection, that makes the difference to investor returns over the long term.

Further, the role of fund ratings and research houses in the ecosystem is heavily conflicted and, indeed, is hampering the progress of the industry towards professionalism. Requiring fund managers to pay for ratings makes the system favour larger managers with multiple funds because they contribute more to the revenues of the ratings agencies. It’s these types of arrangements that end up creating worse – not better – outcomes for clients.

There are too many agents in this industry already. We need to do much better for the end customer in this regard.

Following the Royal Commission’s final report in February, serious reform will be on the way and there will be no appetite for the financial industry to be congratulating itself, so we are moving now to set the right tone.

Conexus Financial, through Professional Planner and its other mastheads, has core values of making a quantifiable difference, promoting inclusion for women and minorities, and championing diversity in general. Our goal is to encourage growth within the industry, while also promoting more participation in clear and sustainable investment outcomes for individuals and society. In every venture, and in every area, our efforts must reflect these values to remain current, contemporary and relevant.

We thank S&P and subsequently Zenith, along with all our partners, for their past support.

Colin Tate
Chief Executive
Conexus Financial

6 quick answers on appointing an enduring Power of Attorney

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There may be times when, perhaps due to family illness or incapacity or if someone is working abroad, someone else needs to hold an enduring power of attorney (POA) over a person’s financial and legal affairs.

A POA is essentially a document that will legally appoint someone to act on another’s behalf. This arrangement can be useful as people age and struggle to manage their financial affairs, particularly if they start to lose their mental capacity.

What is mental capacity?

To be mentally capable is to be able to fully understand any decisions that need to be made, which includes the reason you are making a decision and the outcome of that decision. It also means having the ability to communicate or to make decisions at the time they need to be made. This may include the sale of property or shares in order to pay for medical bills, or aftercare service in case of illness.

What are the differences between general and enduring POA?

A general POA gives another person control of your financial matters but only for a certain period of time such as an extended overseas visit or stay in hospital. If during this time you become incapacitated, then the general POA documentation becomes invalid.

On the other hand, an enduring POA gives someone such as a financial adviser control of your financial matters for an indefinite period if you are not able to make the right decisions due to mental or physical incapacity. Therefore, if there were changes, for example, to government policy that affected your superannuation and you had not nominated a POA with relevant financial wealth management expertise to manage your affairs, then it could affect your savings, income and potentially your wellbeing.

Who can be nominated as a POA?

The person appointed must be over 18 years-of-age and should not have an interest or stake in the financial affairs of the individual who appoints them. Having a family member is difficult as there may be a conflict of interest when it comes to financial matters. It needs to be someone in whom you have total trust and confidence, and also someone who is financially literate.

If you choose a close friend to undertake this role, it will be important they meet with your financial adviser to ensure they have a full understanding of the state of your financial affairs in case they take over decisions on your behalf.

What financial decisions can a POA make?

Enduring POA for financial matters allows the attorney to make decisions that are related to financial or property matters. This could include day-to-day decisions regarding personal finances and investment portfolios, payment of bills, management of property or completion of tax returns. This is why it is important they understand your financial needs, now and in the future.

Who can draw up enduring POA documentation?

It is always best to ask a solicitor to complete any form of legal documentation. There have been cases highlighted by Alzheimer’s Australia in which enduring POA agreements were used to the detriment of vulnerable adults.

Financial institutions are also looking carefully at POA agreements and will usually require some form of validation, so avoid the DIY POA kits from the internet.

Should the attorney receive payment for this role?

Expenses incurred by those acting as an enduring POA or other fees can be agreed, and you can authorise the attorney to pay themselves a reasonable amount for undertaking this role. Again, bearing in mind if there could be questions or disputes raised at a later date by family members, the attorney must keep records and account for all they spend.

It may be worthwhile appointing a professional organisation or individual to act on your behalf. This will likely incur fees but may cause less hassles in the long run.

Whether you are planning ahead for yourself or managing the affairs of elderly parents or relatives, it is always best to talk to a financial adviser and share any concerns. We have seen many instances of complications when clients have not appointed a POA prior to their circumstances changing.

 

Phillip Richards is the Director and Financial Adviser at Endorphin Wealth Management. This article is general information and does not consider the circumstances of any individual.





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