GB: Bernie thanks for talking to us. Could you talk a little bit about your business as a financial planner?
BF: The world of finance and financial products, superannuation, investments and insurance is complex. Our job is to provide advice to consumers who are trying to understand that complexity and work out what is best for them. The approach that we take is much like a financial architect: there is no point designing the house until you understand the client. So we take the time to understand what the client’s goals, objectives and lifestyle issues are. We then look at what they already have; most people will have some super and some insurance and those sorts of things, maybe a mortgage. Then we work out how we can help them achieve their goals from a financial point of view. Advice that is not implemented is a waste so we also then, as part of the business, help people implement the advice we have given them.
GB: So when you talk about understanding your clients, are you trying to increase returns on their investments with other goals that they might have in mind? Is it just about the money?
BF: For our clients, no it is not. It’s about what they want the money for and when do they want it. One of the ways I describe my business is that we are financial planners but we don’t do get rich quick schemes. If you want to do that, we are not the financial planners for you. Our approach is helping clients make the most of what they have and maybe all they have is a house with some debt with some income and no money left over at the end. Our job is to help them make the most of it. So, for example, if they buy insurance, we make sure it is a competitive insurance. If they are going through a phase where cash flow is really tight, maybe we can use their super balance to pay for some of the insurance that they need. Whilst considering the longer term implications of that we must point out that, at some point in the future, you will have to top super back up. That might be utilising salary-sacrifice rules; it might be using the government’s co-contribution benefits that are available for low income earners. It is about having a road map for the future whilst taking care of today as well as possible. We could contrast this sort of approach to living for today and keeping your head in the sand about the future and then dealing with that later.
Proper presentation of risk
GB: Quite a number of problems have emerged in the investment and financial planning fields with the Global Financial Crisis. I imagine a good part of those problems have to do with the balance between returns and risk, so when you say “We are not into get rich quick schemes”, I presume that means the promise of high return at the cost of high risk?
BF: That’s right; we spend a lot of time with our clients explaining the fact that there is no risk-free extra return. If you put your money in a term deposit you will get a certain interest rate. Before the GFC, people probably thought their bank deposits were guaranteed anyway but obviously they have realised that if governments are stepping in to guarantee bank deposits now that means that they weren’t guaranteed before! And there has always been some risk of bank failure. If we assume that putting money in the bank is relatively risk-free, then any return that is higher than what the banks pay must have some risk associated with it.
GB: So are bank deposits your benchmark for where risk begins?
BF: Well that is right, for the average person on the street and now especially with government guarantees on bank deposits then it is a very low risk option.
GB: How do you go about explaining to that client with the modest resources you mentioned before where you draw the line between risk and returns?
BF: One of the advantages of the last few years is that I have good examples of explaining that. So, for example, Australian Capital Reserve used to have some fantastic ads on TV, where they would bowl the opposition out of the way and you can earn 10% guaranteed. It sounds really risk free but the fact is that when you invested with Australian Capital Reserve you invested in property development finance. If those properties continued to sell off the plan, everything went beautifully but if the real estate market started to slow up and there were half finished properties that were not selling off the plan, it would mean that the banks who had provided their money would then say, “Sorry, we are not going to advance any more money.” So those particular developments collapsed. Australian Capital Reserve, WestPoint and Fincorp were three disasters waiting to happen in the lead-up to the GFC where, on the surface they had guaranteed returns that looked as good as banks but higher. They collapsed because the guarantee was only as good as the guarantee against a particular property that was an unfinished development. It is a great example of how what looks like risk-free extra return, actually had a great risk associated with it.
GB: But the measure is still a bit subjective, isn’t it, depending on how wide you throw your net in terms of factors to take into account?
BF: I guess so, but certainly in the world of financial planning, one of the problems was that WestPoint paid 10% commission. Now I am with the licensee AMP Financial Planning and WestPoint was never on our approved list. It was, however, on other financial planners approved lists. And financial planners were recommending the WestPoint investment to clients and earning large commission which potentially is the structural situation which promotes unethical behaviour.
In whose interests?
GB: So this is a conflict of interest that you are describing?
BF: Well yes that is right, and that has been the subject of government enquiries recently. There has been a move in the industry away from commissions which is well founded when you consider these sorts of situations. I am aware of a client, I don’t know them personally, but I have heard of a local financial practice that recommended a client put $700k into WestPoint. That means the planner would have earned $70k commission and then WestPoint subsequently collapsed. Now I don’t know any more details about it but I often ask the question, do you think the planner gave back the $70k? There is a good chance that he didn’t because he may have convinced himself that he was acting in good faith and it was just part of the risk of investing. But the unfortunate client lost $700k, I don’t know if that was the only $700k he or she had, which would often be the case of a retiree, I reckon it was probably bad advice with non-existent diversification to minimise risk. One context is if that was $700k out of someone with $7million who knew the risks then maybe they went in with full knowledge. But the Storm Financial collapse represents a different picture: it took with it many Mum and Dad investors, people who are claiming they were not aware of the risks. I think that there is a case to be made that the structural payment systems in the gearing world possibly do encourage unethical behaviour. By encouraging people to take more risks than they are really comfortable with in the short term, the planners made higher commissions.
I would hope that the vast majority of planners resist that temptation and actually work in the best interest of the client at all times.
Fee for service: a less ethically risky but more expensive structure
GB: But as you say there is a structure there that would pressure planners to not work in the best interest of the client? There is pressure on the integrity of planners?
BF: That is right, some advisors reject all of that and only charge a fee for service.
GB: How does that work?
BF: One of the difficulties with fee-for-service is how much then does the advisor need to charge and does that exclude the average Australian from more impartial advice. Going back to the architect analogy I made earlier, it is a bit like you are not allowed to buy a house from a real estate agent because the agent is going to sell it to you and make a commission. Now is his advice that this is the best house for you actually impartial advice? No, it is not. He will try and sell you the limited number of houses he has on his books, and he will sell that hard. That might mean that people end up with a house that, you know, doesn’t quite suit their needs. Maybe we should make it compulsory that the only person who can offer advice be an architect: surely they are the only people qualified enough to evaluate if a house suits a particular family. But who will pay the architect? The client should pay the architect so to ensure that the architect works in the client’s best interest. But most clients can’t afford an architect, most clients would go to Homeworld, look at all the houses and then a salesman will sell them a house.
A market place with mixed and confusing signals
GB: But here we are in a world where both things are happening: The client is paying the financial advisor as well as the advisor earning a commission; doesn’t that send a mixed signal?
BF: That’s right. We do have financial products and financial products are different to other consumer products, they are different to houses. People can understand the house more than they can understand the financial product. Part of the reason for that is financial products are so complex, which means to get someone that truly does have the expertise to provide the advice is going to cost more and more. So there is no doubt there are some fundamental conflicts in the whole structure of things.
One of the other analogies I use is that of mobile phones. If you want to buy a new mobile phone and choose a carrier –there are some retailers I believe who would represent multiple carriers– it is likely that you would get advice from the salesman about which one to go for. But the fact is the salespeople would also be paid commissions and also get paid trail commissions from ongoing phone contracts. So Crazy John wasn’t crazy, he became a very wealthy man by selling phones, providing great service, giving good advice at the point of sale and then locking the clients into a contract, of which he then got a percentage. It happens in the telecommunications world and in fact the commissions being paid may be a much higher proportion of the dollars in the telecommunications world than those being paid in the financial planning world.
GB: It’s also an industry with a high degree of complaint level and to the extent that it has its own special ombudsman.
BF: Part of that surely would be the whole commission structure again: people are happy to close the deal hard even if it doesn’t suit the client. The salesperson is happy to lock them into a contract because they know they are going to get some good commission from it.
GB: Is this an argument for saying, we shouldn’t have mixed funding models? That it should be either based on commissions or fee for service but never a mixture of the two and it should be quite clear what is happening?
BF: Maybe, but very hard to achieve. For example, you might attempt to achieve that with a law that said it would be illegal to pay any third party any payment whether you call it a commission or some sort of fee, it would be illegal to sell or provide a product and pay some intermediary for that service. Then people like AMP, MLC, AXA, Challenger, all sorts of product providers, would simply have to distribute their product in some other way, they would have to employ more people rather than pay agents commissions they would just have to employ staff.
BF: That’s right. If that happened, it would still be a sales process with sales techniques and slick advertising and gifts for the consumer, Frequent Flyer Points or buy this and get something else free. They would still have to try hard to sell their product. That would mean that the consumer could only get information either from people trying to sell something or pay the sort of money you would have to pay an architect or a solicitor to get an expert to evaluate all the products and then recommend one; that would come to thousands of dollars.
I also use the analogy of you know there are buyers agents in real estate but there is not many of them are there? Why has that not taken off?
GB: Because they are too costly?
BF: Maybe, that when you want to sell something you are happy to pay a price to sell it. You are happy to pay a commission to an agent to sell it. When you are buying something there is a whole cultural pressure which says, “Well hang on, I don’t want to pay extra to buy something. I am the consumer here you guys should be selling to me.”
Do you “get what you pay for”?
GB: So if you want good advice you need to pay for it, this is basically what you are saying?
BF: In a way, but one of the problems is that you do not necessarily get what you pay for. I reckon the people at Storm paid a hell of a lot of money for advice and what did they get?
GB: They got an extremely risky business model.
BF: That’s right. In the WestPoint case, a 10% commission would have been disclosed because fees have to be disclosed. But there are doubts that it was fully clear to those Mum and Dad investors that if you make this investment of $700k with WestPoint, the “advisor” will get paid $70k. Is the “advisor” getting paid $70k here because the investors were getting $70k worth of advice? That is not true either. This flawed model may mean that clients did not get what they paid for.
Looking for fixes to the structural problems
GB: If I were the CEO of a professional association for financial advisors, what would be a change or a good first step to create a structure that would encourage greater ethical behaviour?
BF: I think they have already done it in the last few months. Almost all of the professional bodies and many of the licensees, –for example the Financial Planning Association and the licensee AMP Financial Planning– have said we need to move towards no commissions on investments and superannuation. So from first of July 2010, AMP Financial Planning Advisors will not accept any commissions for any investment or superannuation product. The licensee has gone to all its product providers and said, “You need to provide zero commission products and if you don’t you will be off AMP Financial Planning approved lists.”
Personally this is not a big step because I have been selling our advice and our implementation and fully disclosing whatever payments we get whether they were planner service fees or whether they were called commissions. We have sold them as if they were planner service fees. What we now will be required to do, even though we are already doing it, is let our clients know this is how much it is going to cost for us to provide our advice. Once a client has engaged us I’m not hung up whether people take my advice or not because they have agreed to pay for my advice. Some people stop at that step, I lose clients right up front because they don’t want to pay for my advice.
In the past, someone in my position might want to sell a product, but I’m not in that space. I’m an advisor and I need to get paid for the advice. But that means that straight away we are excluding some part of the community who can’t afford to pay for advice. We need to work out how do we make sure that they are well looked after as well.
GB: So, how might that happen?
BF: One scenario would be if you can afford to pay for advice you will get it. If you can’t afford to pay for advice you are at the mercy of the salesman again and you will have to do your own shopping around.
GB: Is there a third way? I can see two alternatives to those two options; one is that you have something like the difference between buying a tailor-made suit and one off the rack.
BF: Same as buying a project home or paying an architect to design one for you.
GB: That’s right, so you have off the rack products that cover different profiles. You have different sizes and so on and a smaller fee. Is that correct?
BF: Or no fee, just a commission or salary for the person selling it to you. Like you were saying earlier it is clear to the consumer I am being sold to here.
GB: Or the advisor saying I have made the best packages around this is my track record. You can shop with me. The other one is that bodies sell their service to members rather the way Choice does. You know if you are a subscriber to Choice you get access to the full product comparisons of all 4WD cars there are.
BF: I have been an R&D manager at Sunbeam Victa, for example and I know the quality of our testing in-house versus the testing and report put out by Choice at the time. I’m talking about 15 years ago, but in the financial services industry, the quality of advisors and tailor-made advice in a good advisors case would probably be better than could be ever documented and spread out into the general community through a publication like Choice. Maybe Money magazine already provides this type of service. But the dilemma is; now everyone deserves a tailor made solution but not everyone can afford it.
GB: Can you sell tailor made suits as well as off the rack ones?
GB: There is nothing inherently impossible about that is there?
BF: Where I am standing, if on the ground floor of my office block, there was an AMP walk-in transaction centre where people will help you buy an AMP product, if that is what you want. Then upstairs there’s Tactical Solutions, financial planning where advice starts at $1000 a pop, people would pretty clearly get the sense of what the difference is. As long as when you pay the $1000 you get objective expert advice, the difficulty at the moment is the financial services world is so complex that independence means that you can access any product in the market place but there are too many to research. So you need scale to have a research team that do it for you to then tell 100 planners that this is what is on our list and this is what is not.
Complexity itself as a serious problem
GB: Is the complexity itself perhaps an indicator of risk?
BF: Not in itself, but if there are 100 products on the market and now all of a sudden there are 100 more, the second 100 might all be terrible products. But you need to research them to find out if there is a good one among them. So the complexity is self-propagating, I guess. We are suffering this in all areas of life not just in financial products. We could be talking about the compliance requirements in hospitals, for example, of documentation or the OH&S requirements and legislation.
GB: Bernie, is there a case for saying either a professional association or the government or somebody else producing some guidelines about good and bad business models, high and low risk and how to make those judgements. Some sort of guidelines that are produced independently that people can check their advice against perhaps. Is there a case for that?
BF: Well again I think that exists, you know the Financial Planning Association has released numerous papers on this recently and endorsed the move to no commissions.
GB: If I was shopping around for somewhere to invest my money, and I looked at the FPA’s publications, would I then have been able to cross Storm off my list?
BF: No, because their model would be different in the world of no commissions and what they might do if they were a slick sales operation is say:
“Our advice is $10k and you get what you pay for. Don’t go down the road where they are only charging $2k, because we are better than they are and we are charging you $10k. Why, because we are worth it! Also, we will charge you $10k every year as well.”
Some consumers would still get involved because they would believe that sales story. There would be several groups of Storm clients, some of them we should feel very sorry for, who trusted the advisor and were given bad advice. So they are not personally empowered or responsible and then the others that thought this is too good to be true. Or they believed the illusion that we are going to get rich out of this. So when I talk about the GFC being partly created by greed it is not just greedy Wall St bankers, it is greedy consumers as well. So the greed is not just at the top or just at the bottom it was all the way in between. How do we legislate against greed?
GB: Do we need to legislate for some degree of mediocrity?
BF: Well possibly and then we start to look at some of the socialist models again don’t we. So there we go, we have got to the point where we have acknowledged there is no answer maybe.
GB: Well thanks very much Bernie, I think we might leave it there.