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June - july 2010

S TA N D A R D S , E D U C AT I O N A N D P R A C T I C E P R O F I T F O R F EE - B A S E D A D V I S E R S

chris bowen faces the industry

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Co n te n ts

June - July 2010

04 06 07 08 10 12

Opinion and views From the editor Sanders Whiteley Slattery Best of the web Practitioner perspective

Advice forum 2010 16 Authenticity the key to winning client trust Securitor convention 18 Light up the after burners; go for growth

Cover story - page 20

Advice in super 38 Bridging the great planning divide Professionalism 42 The unique distinguishing feature Investor psychology 52 Short-term focus, long-term pain Self-managed super 56 Catch-all and general compliance clauses

Client case study - page 34

Self-managed super 61 What Cooper means for SMSFs Technical 63 Turning insurance inside out

Roundtable: Self-managed super - page 44 and portfolio construction

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SPECIAL REPORT Capital- and incomeprotected products

71 The action here is behind the scenes

Risk

76 Government unleashes a regulatory avalanche Practice management 78 Martin Mulcare 79 Peter Switzer 80 Rod Bertino 81 83

Responsible investment Doing the right thing pays off

Private banking Understanding the front line

Managed funds 84 Sticks and bones: Agribusiness review

Property

86 88

Assessing the true nature of risk

Sharemarket Australia goes it alone in the long run

Philanthrophy

89 Why HNWs like tax time Final word 90 Dribble...fiddle...piddle... is that it?

66 Part 3: Viable and sustainable businesses

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F R O M T HE EDITOR

Avoiding unintended consequences S

ometimes it’s hard to see the forest for the trees. The financial planning industry is facing a lot of change, it’s coming quickly, and it’s difficult to work out exactly what the outcome is likely to be. Whenever there is rapid change – and sometimes even when the change is ostensibly quite simple and well intentioned – there is a very real chance of adverse unintended consequences. There will doubtless be unintended consequences from changes contained in the Government’s blueprint for an overhaul of financial advice. The Future of Financial Advice package is based on the findings of the Parliamentary Joint Committee on Corporations and Financial Services Inquiry into Financial Products and Services in Australia, chaired by Bernie Ripoll. In addition to being much less of a mouthful,

the Future of Financial Advice proposals, released on April 26, extend the PJC report’s recommendations in some areas – for example, ditching the so-called “accountants’ exemption” – and in other areas rejected its recommendations, including the establishment of a professional standards board. Overall, while the proposals have largely been welcomed, valid concerns have been raised about how much thought and consideration the Government has given to the package. But those concerns were allayed by the Minister for Financial Services, Superannuation and Corporate Law, Chris Bowen, at a Professional Planner/Vanguard Investments roundtable on May 5. The roundtable provided an invaluable insight into the Government’s thinking. Bowen freely acknowledged that there was, and

continues to be, some uncertainty on how to proceed, in certain areas. But no one can say the consultation process has not been exhaustive: it was joked during the roundtable that over the past two years, Bowen has spent more time with industry figures than he has with his own family. What the industry can be confident of, however, is that Bowen understands the issues and is committed to finding workable solutions. An appreciation of commercial reality will temper the more outlandish or impractical suggestions that may be thrown up from time to time. Even so, Bowen acknowledged that any significant reform package invariably has unintended consequences, to a greater or lesser degree. There are some areas – such as the issue of commissions on risk products – requiring further consultation, so that unintended consequences

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F R O M T HE E D I T O R

can be minimised. Bowen underlined the fact that there was no chance of an increase in the Superannuation Guarantee, from 9 per cent to 12 per cent (announced in the Government’s response to the Henry review of the tax system), unless and until it could be shown that the planning industry has cleaned up its act. This is consistent with statements made by Bowen’s predecessor as the minister with responsibility for super, Senator Nick Sherry. So the phase-in of the Future of Financial Advice and SG proposals are not closely aligned by accident. It’s worth reiterating the two principles that guided Bowen in framing a response to the PJC inquiry. The first is that financial advice must be in the client’s best interests, and that distortions to remuneration which result in a misalignment of client and planner interests should be minimised. And secondly, any moves to minimise these distortions should be implemented so that financial advice is not priced out of the reach of consumers who would benefit from it. There’s no one working in the industry who could reasonably argue with those objectives; there are plenty who, justifiably, question whether those objectives can be achieved, or whether they are, in fact mutually exclusive.

Reforms to conflicted remunerations structures will, so the argument goes, inevitably lead to a rise in the cost of advice. Product providers have a role to play in helping meet the Government’s objectives. They will clearly be beneficiaries of the increase in the SG; the amount of money they will manage for Australians is set to balloon. So it is absolutely not unreasonable to expect a significant – and clearly articulated – cut in the cost of products. If product manufacturers are no longer paying commissions to planners, then it is only right that the cost of those commission payments be cut, in their entirety, from the cost of products. The legislation effecting the Future of Financial Advice proposals has not yet been drafted. In fact, the process hasn’t even started. Bowen also has to deal with the Opposition and the minor parties to get these proposals into law. One thing the Government won’t stand for is industry self-interest. Having commissioned the PJC report and then framed its response, it’s clearly not in the mood to have its objectives watered down or circumvented. In this context, it will be fascinating to see how the various industry bodies jostle and vie for prominence in putting forward the “industry” view. The incoming chief executive of the Financial Planning Association of Australia, Mark Rantall, is not going to have long to settle in before he’s pushed in at the deep end. Provided politics doesn’t get in the way, there’s a golden opportunity for the industry to get in on the ground floor and influence how the legislation is framed, with the aim of minimising the unintended consequences and ensuring the Government’s twin objectives can be achieved. Simon Hoyle simon.hoyle@conexusfinancial.com.au

June - July 2010 - Issue 24

Editor: Simon Hoyle simon.hoyle@conexusfinancial.com.au Writers: Simon Mumme simon.mumme@conexusfinancial.com.au Head of Design: Saurav Aneja Publisher: Colin Tate Business Development Managers: Laurence Jarvis (Events) Sean Scallan (Advertising) Printing: Sydney Allen Printers Mailhouse: D&D Mailing Subscriptions/Distribution: Debbie Wilkes debbie.wilkes@conexusfinancial.com.au Subscriptions are $79 inc GST per year (6 issues) Cover Image : Matthew Fatches Roundtable Photos: Matthew Fatches www.mattfatches.com.au

Professional Planner is published by: Conexus Financial Pty. Ltd. Level 1, 1 Castlereagh Street, Sydney GPO Box 539 Sydney NSW 2001 Ph: 61 2 9221 1114 Fax: 61 2 9232 0547 Conexus Financial is an independently-owned company.

Executive Directors: Colin Tate, Debbie Wilkes, Greg Bright

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Circulation 9312

C O LU MN

y now you’ve all read the releases from the Government in response to Ripoll (now affectionately being called the “Bowen reforms”). By now you’ve all considered the changes; and even though there are a lot of questions without answers, you’ve no doubt thought through whether you’ll be able to absorb them and how much your business will have to change to fit into the Government’s Future of Financial Advice world view. I won’t sugar coat it: the changes are significant, not just in sheer scale of reform, but also in their application in your business. Even so, I have faith that professional financial planners are in this for the long haul. I am heartened by the fact that FPA members have been on this journey for some time now, and I have met too many people with a deep passion for their clients and their business to believe anything else. However, I also know that some people have considered that it’s time to jump ship; that this is one change too many in a decade of reform that has worn them out. While it’s inevitable that we will lose some people through change, I’m worried that some people are telling me that they’re leaving because they’re simply tired and angry at the way they’ve been treated over the past few years by government(s), media and groups with vested interests. It would be easy to dedicate this space to a deconstruction of the reform proposals and their legal implications, but we will have plenty of time over the next two years to digest those issues and to consider how financial planning businesses and legislation need to change. There’ll be

consultation (probably too little) and legal opinion to consider (probably too much); but my concern at this point in the debate is that we need to keep the focus on encouraging the Government (and media) to reflect on how it also needs to change. and And it needs to consider the role it plays in building a culture that values advice and that encourages Australians to take charge of their financial future, to become a nation of self-empowered, educated participants. To my mind, this is the most significant gap in the Government’s “culture war” on advice. The current Government (just like the previous Government) appears to believe that you can impose as much change and pain on our industry as you like, because in the end you will do the right thing. However, every piece of research on basic change management and good government policy development also tells us that you have to reward positive change when it occurs; but this is the piece of the puzzle that always seems to go missing for the advice community, and neither government has demonstrated much capacity for rewarding good behaviour. I think this is the biggest battle we face - the cultural battle for government respect of professional advice. “Advice” has become a convenient whipping boy for governments of either persuasion. Unfortunately, the self-interest and greed that one or two firms, and a handful of individuals, have demonstrated have given the Government a convenient target to paint on the backs of the entire profession. It’s also unfortunate that the outraged noise that some quarters of our

own community continue to make, as an excuse for considered professional policy, also doesn’t help convince the Government of our seriousness; and it just means the FPA has to work twice as hard to ensure yours is a voice to be taken seriously. I am concerned, though, that this is too important a battle to be drawn on simple political or media convenience. The opportunity for financial security and confidence of all Australians could rest on it, if the industry and Government both play their cards right. We will continue the work of legislative negotiation, cultural building and assisting you in reform, but at the same time we will continue to hold the Government to account for its part of the bargain. Reform should not only come from industry changing, it must also come from Government changing the message it sends to the community. The professional community of financial planners, and FPA members in particular, have already been on a substantial journey of change. They already hold the highest professional standards for financial planners in the world, and our CFP® professionals already hold the highest educational and quality advice expectations in the world. The Australian financial planning profession as a whole is the envy of governments and regulators across the globe and yet the reform program assumes the same old stereotypes of financial planning, tarring everyone with the same brush and in the process frightening more Australians

Continued on page 69

Sanders

Culture shift

Deen

C OLU M N

ver the past few weeks the Government has announced substantial changes to three industries: accounting, financial planning and mining. The response from the three sectors has been a study in contrast. A proposal by the Government to provide taxpayers with the option of a $500 standard tax deduction (rising to $1000 from 2013-14) to replace existing deductions for work-related expenses was announced as an end to workers keeping bills in shoe boxes. It will have a profound effect on the accounting profession, with a proposal that the Government claims could affect 6.4 million Australians. The Institute of Chartered Accountants welcomed the proposal, supporting a Government decision that is in the interests of the general population, rather than a specific industry, its executives or lobby group. The response of the resources sector to the Resource Super Profits Tax (RSPT) is at the other end of the continuum. Mining executives have launched an extraordinary lobbying and public relations assault on the Government. Mining companies are predicting the shelving of major projects, withdrawal of capital and claim the RSPT will “adversely impact the future wealth and standard of living of all Australians”. Deloitte suggested that workers’ super returns could be lower as a result of the tax and that funds may become reluctant to invest in the resources sector if they felt they could

not achieve sufficient risk-adjusted, after-tax returns. As long-term shareholders in the resources sector, industry super funds have a vested interest in its long-term sustainability and profitability. Industry Super Network (ISN) therefore has had a good look at the RSPT and, in particular, the impact of its announcement on fund returns. In the week following the announcement of the RSPT, ISN economists estimate the direct cost of the Resource Super Profits Tax (RSPT) to super fund members is surprisingly low (12 basis points), and within normal volatility generated by equities. For a member with a balance of $50,000 it amounts to a variation of $57 on their fund balance. Further, any direct cost is likely to be more than offset by substantial benefits, though some of these may take time to materialise and be difficult to value. The RSPT will make it more cost-effective for mining companies to undertake risky or high-cost projects. This is because State mining royalties are levied on production, irrespective of profitability, while the RSPT is a profit-based tax. The Federal RSPT will compensate State royalties through a rebate. Further, while taxpayers will enjoy 40 per cent of the super-normal mining profits, they will also be liable for 40 per cent of the mining company losses from failed projects. The Government has announced it will

guarantee 40 per cent of project investment costs. Finally, the RSPT is likely to dampen commodity price inflation, leading to a more predicable inflationary environment for business investment and facilitating a less restrictive monetary policy. Industry super funds are therefore backing the RSPT on economic grounds and investment grounds. So what of the third industry to face profound change? The financial planning industry - after a long public debate - has broadly welcomed the reforms outlined in Minister Bowen’s Future of Financial Advice. Unfairly, the media’s first response was to suggest that financial planners and retail funds would find ways around new regulations and return to “business as usual”. Perhaps this demonstrates the lengths to which the financial planning industry has to go to rebuild confidence. The financial planning industry is on the cusp of transformation into a profession. A threshold to achieving this will be to not only support the Government’s changes publicly, but to avoid entering into a strategy to dilute the effect of the reforms behind closed doors. This will be self-defeating. To comment on this article go to . www.professionalplanner.com.au

David Whiteley is chief executive of Industry Super Network

Whiteley

Miners, accountants and financial planners

DAVID

C O LU MN

hat an extraordinary period for the financial services sector. In the space of a week the Government released its responses to the Ripoll Inquiry and Henry Review, and Cooper’s phase three report on self-managed super solutions. The SelfManaged Super Funds Professionals’ Association of Australia (SPAA) has been actively involved in each of these reviews and agrees with most of the recommendations made and decisions taken. Our focus throughout the consultation process has been to ensure the integrity and viability of the SMSF sector, with a particular focus on lifting professional standards. Our members adopt a fee-for-service approach, so we were pleased to see the Government’s commitment in the Future of Financial Advice reforms to ban commissions paid to advisers by 2012. Similarly, the Government’s decision to remove the accountants’ exemption echoed our submission. The accountants’ exemption prevents accountants from being able to provide “unbiased advice” for their clients about the different types of super funds. We’re advocating for the introduction of a Super Licence based on an enhanced RG146 “superannuation advice” education requirement and SPAA SMSF Specialist Adviser Standards, which are set at undergraduate equivalent competency requirements. Cooper’s recommendations were a great win for professionals advising SMSFs, with a commitment to enhance professional standards and

strengthen regulatory controls to ensure suitability. We recommended minimum education requirements be set for SMSF specialist advisers and that SPAA’s specialist accreditations should be the benchmark. Enhanced professional standards will also ensure suitability concerns are addressed. SPAA recognises an SMSF is not suitable for all investors and so we support Cooper’s recommendation to help would-be trustees evaluate the best super option for their individual circumstances. Measures to enhance controls and systems relating to SMSF rollovers, to help prevent fraud, were also welcome. Evidence suggests bank accounts are the weak link in SMSF identity fraud and so the review’s recommendation to introduce member identity requirements is a positive step forward. SPAA has raised some concerns, however, in regards to proposed measures to strengthen the independence of auditors. While we agree independence for auditors is critical, we believe the panel’s recommendation to legislate full audit independence - so that an individual or firms providing any services to SMSFs, the members or the trustees cannot also provide auditing services is unnecessarily heavy-handed. We have also urged caution on measures that impose restrictions on how fund assets can be invested - in particular, restrictions on exotic assets, which are held by less than 0.1 per cent of SMSFs. The introduction of further transitional measures, and difficulties

associated with what constitutes a collectible or exotic asset, will no doubt lead to further legislative complexities. We question the need for this, given the modest extent of the issue. SPAA is pleased to see the concessions afforded to business real property have been retained by Cooper. These concessions have helped many small business and primary producers prepare for retirement and enabled them to grow their superannuation savings. Finally, we largely supported the Government’s commitment to address adequacy in its response to the Henry Review. However, we believe it missed an important opportunity to address the issue of harsh excess contribution penalties. We believe most excess contributions are unintentional. For example, there have been instances where multiple employers who make compulsory SG contributions on the member’s behalf have caused the member to exceed their contribution cap. Indeed, the announced increase in the SG is likely to exacerbate this problem. We will continue to request Government action on this issue.

To comment on this article go to . www.professionalplanner.com.au

Andrea Slattery is chief executive officer of the Self-Managed Super Funds Professionals’ Association of Australia (SPAA)

Slattery

Reforms another step forward

Andrea

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Why should planners shoulder this burden alone? Simon Hoyle Comments: “How can the planning community be helped to articulate its value proposition to a population used to the idea of “free” advice, or conditioned by advertising to believe financial planning is evil?” - finplan “The government could not get a simple plan like roof insulation right and look how mnay people have now been adversley affected, not only home owners, but also employees and business owners. Another Labor strategy that will have to be corrected in time again at how much cost? ” - Barry Katzenberg “On the one hand, the industry fund group (clearly a cartel fund manager) have heaped abuse on planners and created a public perception that all financial planner are commission driven leaches (except those who are clients of financial planners who understand the value of advice), and on the other hand the fund managers who set up the historical remuneration structure in the first place racing to be excluded from any close checks as to the level of fund fees.” - paulmoran “If now i will be payed by my clients and my main concern is to do the best for my clients (been doing this for 25years) and the products i use come from the product manufacturer ( who gets his product distributed for nothing ) can someone please explain to me why i need a licenced dealer.” - stan nawrocki “The announcement from the Govt was pretty much a no brainer. Anyone who is shocked by this was either out of the country ( cruising de nile) in the past block of time, or just not paying attention. Watch this space, the product providers have done their homework and soon we will hear all. The Risk Providers have won round one just as they did with FSRA so many years ago. Can’t wait to see the legislation and the visits from the creative BDM’s. Bring it on.” - Mel “Interesting. A good start in the change process. I await with interest on how to identify an ungeared product. At what level will the investment be deemed as geared, the underlining stock, the trust itself, or just the clients money that invests.” - Bob “We will come through whatever the changes may be BUT we all should bring some pressure to bear on the Government Departments that feel they are doing the right thing with the proposed changes outlined. Even Governments can make poor choices as we have recently experienced!!” - Ian Burkinshaw “What business are we in? I thought the Advice Development, Client Management, Implementation and Review Business: NOT the product distribution business. Isn’t it about time we truly morphed as a profession? These proposals are the price of trying to maintain the status quo. Whilst I am not immune from criticism for past practice over 21 years, we need to articulate the value we provide in terms the clients understand.”- Paul Tynan

• • •

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MySuper - YourView? Is the Cooper review’s MySuper proposal good, bad or a non-event? Simon Hoyle Comments: “Just what consumers need - another superannuation product!” - Barry Crewther I think Mark Webber put it pretty well when he described Australia as becoming a “nanny state” - D Gareth Hall “My Super is just another low cost, low performance offer that can be used by people that dont care about the performance of their super” - William Mills

Readers’ Survey 2010 Congratulations:

MICHAEL SULIMAN, d.i.b. Financial Group Bankstown NSW Michael has won four nights’ accomodation for two people at the Pinctada Cable Beach Resort

P R A C T I TIO NE R P ERSP ECTIV E

Insurance is not a special case Claire Mackay and Tim Mackay outline why risk products should not be carved out of the Government’s plan to ban product commissions

e do not understand why the proposed ban on commissions by both the FPA and the Federal Government does not also cover life risk products. In our family-owned business, we have successfully implemented a transparent, fixed-fee approach, which our clients support and which encompasses all financial products. Arguments by the industry that insurance commissions are a “special case” appear to consumers to be self-serving, and ultimately undermine the professionalism and creditability of our industry. The main reasons we hear in support of commissions are that a ban would be to consumers’ detriment, would lead to higher premiums and would exacerbate underinsurance. All consumer advocacy groups that we have spoken to, including Choice, support a commission ban across all financial products. Choice describes all commissions as “perverse incentives” and lobbies to have them banned. So despite arguments put forward by industry, consumers themselves do not believe banning commissions would be to their detriment. We have not seen logical arguments or empirical evidence that demonstrate a commission ban would result in higher premiums in the long term. The only credible short-term reason for higher premiums for risk products is due to a potential exodus of commission-based advisers who may be fearful and unwilling to implement the reforms, which will reduce the number of advisers in the short term. However, we believe it is in consumers’ interests to have fewer professional advisers who they trust rather than having more advisers operating under the broken commission model in which consumers no longer have any faith. In the medium to long term, we believe a commission ban

Chart 1: Upfront and ongoing commissions Year 1 commission! 117%!

11.5%!

Aviva!

123.75%!

130%!

115%!

11%!

10.12%!

AXA!

Ongoing commission!

ING!

will lead to increased, transparent competition resulting in a reduction in fees for consumers. Currently the cost of commissions is hidden, wrapped up in the premium paid. Defenders of commissions argue disclosure is adequate. According to a former High Court Chief Justice, Sir Anthony Mason, when it comes to current financial product sales practices, “Detailed and dense disclosure is often the most effective form of concealment”. Those who defend commissions are effectively arguing that it is OK to continue to hide the cost from consumers. To us, this seems like an appalling argument supporting commissions. According to Ric Battellino, deputy governor of the Reserve Bank of Australia: “This reluctance to pay for advice upfront appears to be a form of money illusion, whereby investors may feel that they are somehow paying less for financial advice if the cost is buried.” We believe a ban on all commissions empowers consumers with a clear and transparent understanding of how much they are paying, to

11%!

AMP!

115%!

10%!

Tower!

whom, when, and for what. We believe that commissions reduce competition and drive up premiums. While the insurance industry is competitive, we argue that competition is at the wrong points in the value chain. Rather than competing on premium price, insurers compete on the level of upfront commission they dangle in front of advisers. We show the upfront and ongoing life commissions offered in Chart 1. For example, if a couple was advised into AMP policies with premiums of $4000 in the first year, their adviser could receive $5200 in commission up front (130 per cent from AMP) and $440 (11 per cent from AMP) in following years. Insurers offer advisers subsidised upfront commissions larger than the premium paid as a sweetener to woo their business. We understand why advisers prefer commissions to remain embedded in the premiums - if commissions were banned advisers would struggle to justify to their clients charging such relatively large payments up front.

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P R A C T I TIO NE R P ERSP ECTIV E

Chart 2: Share of premiums paid

Advisor/Dealer!

Insurer!

53%

52%

54%

49%

55%

47%

48%

46%

51%

45%

Aviva

AXA

ING

AMP

Tower

If these policies were held by the couple for three years, we estimate the adviser and their dealer group will receive between 45 per cent and 51 per cent of the total cumulative premiums paid by the client. (This decreases to a 31 per cent to 35 per cent adviser/dealer share if the policies are held for five years.) So the client pays the premium and then the insurer, the dealer and adviser all fight over that pie. It is in no-one’s interest to make that pie smaller but it is in everyone’s interests to negotiate a bigger slice of that pie. Therefore, competition exists at the insurer/dealer/adviser level, but less so at the client level. Now, if we turn this on its head and remove commissions, the adviser must now negotiate advice fees with the client every year. The adviser will have to demonstrate to the client that their advice is value adding and they now will be in effective competition with the insurer for a certain slice of the client’s wallet. We often hear “underinsurance” provided as a defence for life insurance commissions. However, the “underinsurance” problem has arisen entirely under the existing commission- based system. Therefore, to use underinsurance as a key reason to support the continuation of commissions, to us appears nonsensical. We believe banning commissions could actually help address underinsurance. From Chart 2 it is clear that advisers who receive upfront

commissions share 45 per cent to 51 per cent of total cumulative premiums. If commissions were banned and the savings were entirely passed onto consumers in the form of reduced premiums, this could result in premiums immediately falling by between 45 per cent and 51 per cent in price. Price is the key determinant of demand, not the aggressive selling techniques or remuneration structure of the sales force. Significantly decreased prices would lead to significantly increased demand. A ban on commissions could be an effective way for the Government to help address the underinsurance problem. The FPA’s position in its 2009 Remuneration Policy is that commissions on all financial products result in a real or perceived conflict of interest between the adviser and the client. Consumers demand and rightly deserve life risk advice that is free from real or perceived conflict of interest. Our industry deserves a single remuneration regime that helps drive increased professionalism. Life risk products should not be an exception and any real (or perceived) conflict from ongoing commissions can only be to the detriment of consumers. We believe that having multiple charging regimes will be complex and confusing for consumers. We know from 2012 there will be two charging regimes for financial products - the new rules banning commissions will apply to new investment products issued from 2012 and

the old rules allowing commissions will apply to existing investment products. If life insurance commissions are also excluded from the ban, consumers and holistic financial planners will need to operate under three different sets of rules - one for old investment products, one for new investment products and one for existing and new life insurance products. From a consumer perspective, let’s assume they pay a fee for investment advice and receive advice on life risk products at the same time. After 2012, the consumer may believe that advice for both types of product are included in the fee. If they understand that the adviser is remunerated separately by the provider for the life product, this may lead to confusion and it may alter their perception of the value of the fee. There are obvious significant benefits to consumers and advisers in having one, easily understood, uniform remuneration system that applies uniformly and consistently across all financial products. If there is a commission ban on investment products and not life risk products from 2012, advisers providing holistic advice could have a real (or perceived) incentive to focus more on life risk products (where they can get paid up to 130 per cent of the premiums upfront) at the expense of investment products (which do not attract commissions). Sadly, this type of situation could compromise the industry’s drive for professionalism and cause consumers to question the adviser’s real or perceived balance and suitability of advice.

Claire Mackay and Tim Mackay are directors of Quantum Financial Services in Sydney

Our fund managers’ most useful tools No. 4: A shared cup of coffee

Before investing, we spend time with a company’s managers – wherever they are in the world. Aberdeen’s international equity funds At Aberdeen we like to meet every company in person before we invest. Over time, from the thousands we visit every year, we’ve got to know those that will look after shareholders’ interests. With between 40 to 60 holdings, only the highest quality companies meet our strict selection criteria. For us that’s a sensible number. Good diversification consists not in holding a long list of stocks but in fewer ‘best ideas’, where we can know each one well. Our portfolios are strong and concentrated - just like a good espresso.

To find out more about Aberdeen’s international equity fund range - the Aberdeen International Equity Fund, Aberdeen Actively Hedged International Equities Fund, and Aberdeen Fully Hedged International Equities Fund - or our global equity investment process, call us on 1800 636 888 or visit www.aberdeenasset.com.au Independently owned financial researcher van Eyk highly rated^ Aberdeen’s international equity funds in its recent review, identifying Aberdeen Asset Management’s strength with regard to experience, teams and process.

Aberdeen Asset Management Limited ABN 59 002 123 364 AFSL No. 240263 (Aberdeen) is the issuer, manager and responsible entity of the Aberdeen International Equity Fund, Aberdeen Actively Hedged International Equities Fund and Aberdeen Fully Hedged International Equities Fund. All offers of units in the Funds are made in the relevant Aberdeen Product Disclosure Statement (PDS) available from Aberdeen as set out above. You should consider the relevant PDS in deciding whether to acquire, or to continue to hold units in a Fund. Aberdeen does not guarantee the repayment of capital, the performance or any distribution from a Fund. Information in this document is based on sources believed to be reliable, is of a general nature only and is not intended to provide investment or personal financial product advice. This document has not been prepared taking into account the particular objectives, financial situation or needs of any investor, so it is important that before acting investors should consider the appropriateness of the information, their own circumstances, objectives and financial situation and consult a financial and/or tax adviser. You must not copy, modify, sell, distribute, adapt, publish, frame, reproduce or otherwise use any of this material without the prior written consent of Aberdeen. ^van Eyk Research Limited (ABN 99 010 664 632 AFSL 237917) (van Eyk) rates investment management capabilities rather than individual products. This rating is valid as at March 2009 but can change or cease at anytime and should not be relied upon without referring to the meaning of the rating, as well as the full manager report, available to subscribers at www.iRate.vaneyk.com.au. Past performance information given in this document is given for illustrative purposes only and should not be relied upon as it is not an indication of future performance. van Eyk has not directed the publication of Aberdeen Asset Management’s rating. The rating is not intended to influence you and your client’s investment decision in relation to any products managed by Aberdeen Asset Management and does not take into account your client’s individual financial situation, needs or objectives. We recommend that you and your client do not rely on this rating in making an investment decision and instead you seek advice from an appropriate investment adviser and read the product disclosure statement before making such a decision.

A D V I CE FOR UM 2010

Authenticity key to winning client trust Success in the year ahead will depend on finding new ways of doing things - but also, really doing what you say you’re going to do. Simon Hoyle reports

istorians will look back on the global financial crisis (GFC) as a painful but ultimately productive step in the development of the financial planning industry as a profession. Perhaps more than any other single event, the GFC will be seen as marking the point at which the financial planning industry shifted from being a transactional, investment-andproduct-focused industry, to one offering principally strategic advice and services - and charging for the provision of those services rather than for the sale of products. Andrew Inwood, the managing director and founder of brandmanagement, told the MLC/ Professional Planner Advice Forum 2010 that his firm’s research shows the demands of clients, particularly high-net-worth clients, have shifted fundamentally since the GFC. Inwood said that pre-GFC, clients’ focus was on being offered the latest and greatest investment opportunities, and on generating superior investment performance. Clients valued a planner’s ability to deliver product, pick stocks and time markets. Post-GFC, however, clients’ priorities have, understandably, shifted. Inwood said the GFC had “disturbed” clients, and planners cannot necessarily rely on old ways of doing business. Those who have focused on product and have based a value proposition on promising investment performance run the risk of becoming redundant. Inwood said the shift presents significant challenges and opportunities. There’s a great opportunity for planners to demonstrate clearly their “utility” - but at the same time, that’s the challenge. It’s not always clear, even in a planner’s own mind, exactly what their utility is. For other things, it’s simple, Inwood said. When you buy a car you know how much

power it has, what its fuel consumption is, and how it makes you feel. Those things are its utility. When you buy a computer, it’s how much RAM it has, the size of its hard drive, its processor speed and screen size. “What is the utility you offer as a planner?” Inwood said. “Unless you can articulate that clearly, there’s a problem. Unless you can articulate that clearly, they have no reason to use you.”  Financial planning, as a service, is clearly not becoming less relevant, Inwood said. In fact, financial planning is arguably a more relevant service today than it has ever been before. “But I do not think it’s the type of relevance you think it is,” he said. Financial planners do two things: they make people wealthier, obviously; but they also make people happier. And happiness is not linked to wealth. “But the idea of control...means people are much more likely to be happy,” Inwood said. Selling a product may satisfy the wealth part of the issue; making people happy requires more. It requires more than making people feel like they are in control. It requires putting them in control. Inwood said planners must be “authentic”, because “authenticity” and trust are “almost perfectly linked”. In other words, to win a client’s trust, a planner must actually be what they say they are; and they must actually do what they say they’re going to do. This is why making investment promises is a value proposition doomed to fail. Kevin Bailey, principal and private client adviser with Shadforth Financial Group, said there are some things a planner can control, some things a planner can influence, and some things a planner can neither influence nor control.

Bailey said planners can control strategy, the advice they deliver and the range and quality of their services. Planners can influence a client’s goals and objectives, and the client’s discipline along the way. But planners can neither influence nor control investment markets, laws and regulations, or inflation.  Holding oneself out as being able to control these things undermines a planner’s authenticity. But that’s precisely the danger any planner faces if their offering is exclusively product-orientated, or if they make investment performance promises (either impliedly or explicitly). Planning is about “problem solving, not product pushing”, Bailey said. Yet research by the consulting firm CEG has found that more than 80 per cent of planners are still investment centred. These planners are “on a hiding to nothing”, Bailey said. Peter Switzer, founder and principal of Switzer Financial Services, said the key to success in the year ahead will be “getting out of your comfort zone, and doing things you haven’t done before”. “That’s what you’re going to have to do this year,” Switzer said. “I think we’re going to have to come up with something to respond to the challenge.” Switzer said that whether it’s welcome or not, change will be forced upon all planners in the year ahead. The old way of doing things may no longer be appropriate. “If you keep doing the things you always did, you’ll get the same outcomes,” Switzer said. “We want a different outcome. So what I say to you is, KO your complacency, you have to get out of your comfort zone, and embrace this year of change.”

Our fund managers’ most useful tools No. 4: A shared cup of coffee

Before investing, we spend time with a company’s managers – wherever they are in the world. Aberdeen’s international equity funds At Aberdeen we have a patient approach to investing. We take our time to find companies that we can understand and value, meeting management face-to-face. Once invested, we often act against the run of play, adding to positions on market weakness and reducing them on market strength. Our firm belief is that if we’ve done our due diligence properly, company fundamentals will drive returns over time. It’s a long-term approach we’ve successfully mastered over many years; and over many cups of coffee.

S E C U R I TOR CO N VENTIO N 201 0

Light up the afterburners and go for growth Securitor planners got a lesson in keeping their eye on the ball from the nation’s Top Guns. Simon Hoyle reports

here are more similarities than it might seem between a successful F18 jet fighter mission and running a financial planning business. Phil Eldridge, a speaker for “Afterburner” - a group of past and present fighter pilots and instructors - told the Securitor 2010 National Convention in Adelaide that in both cases success comes down to a concept called “flawless execution”. Eldridge said flawless execution is aimed at “ending up with as close to zero in the gap between what you set out to do as a team, and what you actually achieve - day in, day out, striving to improve your execution”. “We do it using a discipline. The discipline is called the Flawless Execution Model,” Eldridge said. He said the model has four steps: defining a plan; briefing individuals on specific roles and expectations; executing the plan; and then, critically, a formal debrief - “a post-execution meeting, our review … to hash out what worked and what didn’t, what was done and what wasn’t done out of our plan”. The Flawless Execution Model is how pilots plan missions, and it’s a process that can be used to improve business performance. He said one of the biggest obstacles pilots face in effective execution is called “task saturation” - quite simply, having too much to do all at once. “‘Task overload’ is how you may know it: I’ve gone to work today and I’ve got this much to do, and I’ve only got this much time and resources to get it done,” Eldridge said. “It’s part of modern-day business. “I’m task saturated from the second I step

into my aeroplane, and it can really affect our performance. “Task saturation gets in the way of great performance, and great execution, because it does one very unique thing: when we get overloaded when too many things happen - we become very susceptible to distractions. “We call task saturation a silent killer, because it’s insidious. Most people do not realise when they’re just starting to get distracted.” Eldridge said task saturation presents a significant management challenge, but it can be managed. When task saturation arises, Eldridge says, “we train our pilots to focus on just a small handful of instruments”. “We need to focus on the things that will keep us in control of our aircraft,” he said. “The tool here is to recognise, pre-emptively, that everyone in your team at times gets task saturated. I’m sure you’ve felt it, and I can guarantee you’ve seen it in your employees and your work colleagues. When people get task saturated, it’s insidious and they get easily distracted. When you see periods coming up when you and your team are going to be overloaded, you can preempt it; make [sure] everyone stays focused on what they need to stay focused on during that period. “It might be, stay focused on your clients. You can make it specific for your organisation. It could be making sure you’re valuing your advice correctly and appropriately. You’re an organisation that has heaps of measures.” In a corporate setting, particularly one like financial planning where there is a large amount of change looming, avoiding task saturation, and staying focused on what is important, is critical.

Neil Younger, head of dealer groups and Licensee Select for Securitor, told the convention that “one thing this industry can be assured of is that things change”. “This time, the changes we will see across our businesses will be more significant than ever,” he said. “You’ll not be able to apply, necessarily, old solutions to new problems. You’ll need to innovate.” After the convention, Younger said there were “a few things that resonated really well for us” during the convention. “It’s a growth period again for financial planning businesses,” he says. “You do pick up a mood or a sentiment out of the advisers; a lot of these guys had been bunkered down for six to 12 months with their clients, just telling them to keep the faith. “They felt personally responsible, and it was quite draining. “But now they are past that and into this next phase: we’ve survived a tough time, our clients are still with us…and now is the time to take more confidently our services to the market.” “We’re getting clear air,” Younger says. “The environment is starting to clean up around advice, and there’s an opportunity for the quality of advice that we’ve always delivered to be recognised. “That, coupled together with some key messages about professionalism, and the benefits that come out of being recognised as a profession - all of these are changes that [support] what we have always held out as principles of doing business properly. “Let’s take that enthusiasm and vigour out into growing our businesses again.”

Our fund managers’ most useful tools No. 4: A shared cup of coffee

Before investing, we spend time with a company’s managers – wherever they are in the world. Aberdeen’s international equity funds At Aberdeen we seek to maximise our stock choices for our global portfolios. This can mean travelling to all corners of the globe, and sitting down with local management to assess opportunities first hand. Even the most exotic and unlikely of places can yield surprising opportunities. By ignoring benchmarks, labels and arbitrary investment constructs, we aim to build a truly diversified portfolio, based on company quality, regardless of location. The result is a truly global portfolio of businesses, each bringing unique attributes to the final blend.

Changing the

face

of financial planning

C O VER S T O RY

ROUNDTABLE PARTICIPANTS Hon. Chris Bowen, MP - Minister for Financial Services, Superannuation and Corporate Law Michael Bailey - editor, Investment magazine Robin Bowerman - principal, head of retail Vanguard Investments Martin Codina - director of policy, Investment and Financial Services Association of Australia Tony Cole - business leader, Asia-Pacific, Mercer Investment Consulting Anne-Marie Corboy - chief executive, HESTA David Graus - general manager policy and

BOWEN: What we’ve announced in the last two weeks, the reform process, is not small, and so there is a lot of work to be done in terms of getting through the Parliament. And there’s a couple of issues that we need to think about. Firstly in relation to, for want of a better word, the Ripoll reforms, the response to Ripoll and the reforms announced [on April 26]. There are a number of elements that I said that there was to be further consultation on. I tried to minimise those, but it was appropriate that there are some that there was further consultation [on], and perhaps most clearly they are the treatment of risk insurance, and the operation of the annual renewal notice and when that should kick in. There’s the separate process of the review of the statutory compensation scheme, which I’ve asked Richard St John to do. And there’s the general drafting of the legislation and consultation on the final detail. Now, the legislation has not yet begun to be drafted, and there’ll be quite a consultation process, which I’ll be saying more about in the not too distant future. But there’ll be a Treasury website just devoted to this consultation process; there’ll be a series of discussion papers on the various elements; and then we’ll need to get the legislation through. In relation to the superannuation guarantee [SG], and the other reforms announced on [May 2], there’s a similar story there. They are part

industry practice, Association of Superannuation Funds of Australia Steve Helmich - director, financial planning, advice and services, AMP Simon Hoyle - editor, Professional Planner John James - managing director, Vanguard Investments Fiona Reynolds - chief executive, Australian Institute of Superannuation Trustees Don Russell - chair, State Super Deen Sanders - deputy chief executive and head of professionalism, Financial Planning Association of Australia

of a broader package, of course, and they are tied to the revenue coming from the Resource Super Profits Tax. And again, the Opposition have indicated that they oppose 12 per cent [super contributions]. They haven’t been quite so explicit on the other measures we announced in relation to superannuation, and clearly they’ll oppose the Super Profits Tax. I think that’s the most likely outcome. So there’s still a deal of work to do, to convince the Parliament that these are worthwhile reforms, particularly going to 12 [per cent SG contributions]. Perhaps the most complex part of the legislative reforms we announced would be, in terms of super, the $500,000 threshold on the over-50s cap. That has a degree of complexity about it, which I need to do some consulting with the industry on, in relation to how to make that work. We did that with our eyes wide open, and [knew] that …we’d need to talk to industry about how it would work, and there’s going to need to be some changes in the way the Government does business in relation to tracking multiple funds, et cetera. I think that’s probably a good thing, in terms of a wider process of tracking down lost money as well. But there’s a degree of conversation that needs to go on about that. WEAVEN: The Government announcements on [the Henry tax review], together with Chris Bowen’s earlier announcements [on financial advice], clearly are the most significant event for

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Andrea Slattery - chief executive, Self-Managed Superannuation Funds Professionals’ Association of Australia Ian Silk - chief executive, AustralianSuper Jim Taggart - president, Association of Financial Advisers; principal, Taggart Group Colin Tate - executive director, Conexus Financial (publisher of Professional Planner and Investment magazine) Steve Tucker - chief executive, MLC Garry Weaven - chair, Industry Funds Management

superannuation, and the system of superannuation, in 20 years. I think it’s a well-thought-out package. I think particularly the Bowen announcements are the result of very careful thought. Not everyone will like them, but - and as you know, I don’t give praise very easily - the set of measures did give to me the appearance that these matters had been thought about very, very carefully, and some of the obvious huge loopholes closed off, at least conceptually, in advance, so that the reforms might actually work. On the SG front, it’s much bolder than I believed that any government would do, because it can be portrayed as a hit to employers, and the small business lobby in particular has always been rabidly opposed to any SG - at least, their organisations have. It is obviously phased, which is clever. It’s exactly what Paul Keating did. It’s the appropriate way to do it, as well. The only other thing I would say is that to some degree, because of the way in which this has been done, and the package nature of it, and the fact that it’s all now related to the continuation of government, so to that extent, it seems to me that a large part of the superannuation industry, at least, are now conscripts in the war with the mining industry. So it is unfortunate, from my point of view, that that circumstance arises. We have no desire,

C O V ER STORY

Steve Tucker, left, and Garry Weaven

from my perspective, to be at war with the mining industry. We’re major investors, very major investors, in particular in the more stable end of the mining industry, and the major Australian companies. So we don’t relish being conscripts and at war. And hopefully, ultimately the more sensible voices and more mature elements of that industry will conduct the debate. COLE: I agree that 12 per cent is appropriate. I originally supported going to 15 per cent but when I look at the replacement incomes that people get, that the lower-income people get, relative to what they get while they’re still working, the very bottom end of the market are working poor; and taking 6 per cent of their remuneration into super rather than 3 per cent just takes it a bit too far. I think to get adequacy, a bit of encouragement is also a good thing. And

we’ve got that, for additional voluntary contributions, even if they are capped. So I think that’s a reasonable position, 12 per cent, and something we should all applaud. TUCKER: We’ve always thought [we need] that [increase in the SG], coupled with a system which people can trust to go and get advice from, and get advice in the form that they want to get it, whether it be simple intra-fund, or sophisticated or complex. The packages together means not only will contributions now create a solution to some of the adequacy issues, but the confidence in advice - and we want Australians to get advice much, much more than they do - will also have a big impact on adequacy over time. You’ve got to look at these things together. A trusted system, quality advice, in the way they want to access it, in a transparent way, linked to contribu-

tions going to 12 [per cent], we’re going to get much better outcomes. TATE: Jim - if I can bring you in - your group is still lobbying quite publicly, I think, the Association of Financial Advisers for - along with Tony Abbott - to not abolish commissions. Would you like to make a few comments? TAGGART: Obviously we’ve never wavered from the point of view that it’s one of choice. And it’s predicated, Steve, on what you’ve said, based on transparency and trust. So philosophically and in a practical sense, we don’t deviate away from that. So it’s not a question that we’re lobbying for commissions. It’s a question of it’s a hybrid. And I think you need to understand what our role is in the advice market. The difficulty I have is that I’m speaking on behalf of over 1500 members, but also [as an individual].

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C O VER S T O RY

So while there’s a nexus, there is also [a need] to look at the new breed of advisers coming through, and different things. And quite clearly, those in university, and GenX, and so on, are different, in the sense of remuneration models and so on. I guess I get taken aback by the view that, personally, I’m tarnished as being a grub, as being someone that rips someone off. And I take that personally as being insulting. And I have to put that on the table. I do not deny that there’s been situations where things have happened. So, the point that I want to make is that while I agree with regards to some of the comments being made, I think it really is about being a trusted adviser. HOYLE: Minister, you said that one of the elements that was going to require further consultation was exactly the issue of commissions in risk products, and whether they should be subject to the same bans. And we’ve heard arguments for, and we know the arguments against. Do you have any inclination one way or the other? BOWEN: Well, rather than inclination, perhaps some of the issues that were on my mind. And as I said, when we put this package together, I tried to land as much as I could, and I tried to keep further consultation to a minimum, not because I’m against consultation, but because I thought the industry needed as much certainty as possible, and there’d already been a long process of discussion and basically, frankly, I knew where everybody stood on everything, and there was very little to gain from further discussion about most things. But on risk insurance, a couple of issues. Firstly, obviously the same principles apply to risk insurance as other financial products. You should try and minimise conflicts, and arguably that principle needs to apply to risk insurance. Against that, I always try when dealing with regulatory reform, to be very clear about the

mischief I’m fixing. What’s the problem that I’m trying to fix? I’ve got enough problems without going and finding new ones. Is there a problem here that I’m trying to fix? And I’m not sure of the answer to that. I think that’s the sort of issue that needs to be on the table. Likewise with risk insurance, there are unintended consequences both ways. One of the things that worries me about Australia generally is under-insurance. I think it’s more an issue in terms of some other parts of insurance, rather than life and risk, but it’s nevertheless an issue. And also, is this, if you don’t touch risk insurance at all, are you opening a loophole for people to put commissions on other types of financial advice by stealth? In other words, yeah, sure, we won’t have commissions on any financial products, but geez, we’re going to have a huge commission on the risk insurance part of our product. And really just get commissions through that process. Now, I thought about those issues deeply, and thought at the end of the day as the time is coming to announce this package, I just simply couldn’t look myself in the mirror and say, ‘I’ve got this bit right, I’ve got the balance exactly right

Supporting low cost and transparent investments.

in this bit.’ And so that was the one bit I carved out for further consultation. So I genuinely don’t have a final landing place. But I do accept it’s not a simple matter, and there are potential unintended consequences whichever way you go on that particular one. HELMICH: We’re in a similar position to MLC. We saw the reviews that were going on as a great opportunity to increase the public confidence in financial planning, and that, I think, is to everyone’s advantage, that if we can have more people out there getting advice, we know the outcomes of that. Our position around commission in the investment and superannuation area was pretty clear. We thought it was much better for the planner to negotiate the advice level and the service level required with the client directly, and set a fee based around that, rather than have a product manufacturer determining what the fee should be. And that’s why we’ve moved that way, and are moving ahead of others in that space. A lot of our planners were operating that way already, so to tell you the truth, with some of them it’s not a journey at all. Others we’ve worked with and will be ready to go on 1 July as

Martin Codina, left, and Fiona Reynolds

C O V ER STORY

Don Rssell, left, Anne-Marie Corboy and Tony Cole

we suggested. Risk is hard, and I’m not sure, to tell you the truth, to answer the question now, where it should be on risk. I think there does need to be some consultation. There’s arguments for and against, and you can mount very good arguments both ways. What you tend not to see in the risk area, I find, is the amount a planner does when a claim’s in process - which you don’t get paid for. So whether it might be insurance companies then put in place some sort of payment for that, as opposed to - you know, if commissions were to go. Planners do often walk clients through that, and I think it’d be very hard to go up to a grieving widow or someone on disability and say, “I now need you to pay me this to process your claim.” That would be an interesting aspect of it. I think we do need to do something about it, and come to a position. I agree with the Minister on that. I’m not sure where it is at the moment. TATE: Minister, at a recent MLC roadshow, Greg Medcraft, ASIC commissioner, was posed with the question, “I’m a National Australia

Bank financial planner. What you’ve just said, Commissioner, suggests that if I know that down the road in Westpac is a better product, my fiduciary duty requires me to tell someone, ‘Well, you should leave my branch now and go down the road and buy the Westpac product’.” There seems to be some very complex distinctions around fiduciary duty. Can you articulate a little? BOWEN: Well, again, I think the majority of people accept the need for a fiduciary duty. It’s how you frame it. And we did look at various options. One of the concerns that was raised at one point in the development of our thinking was, well, if you put a fiduciary duty on to act in the best interest of clients, that means that the adviser then has a fiduciary duty to assess all of the 16,000 products available in Australia for every single client. And clearly, nobody thinks that’s workable. And that’s the reason for the “reasonable steps” defence; that you will need to show that you took reasonable steps. And the courts will interpret what “reasonable steps” is. But it’s a fairly well established and understood

term in jurisprudence. Yes, it does mean that firms will either need to expand their approved product list, or, from time to time, say, “I can’t help you”. I don’t think it means saying, “You need to go and see Westpac” in particular. But it may mean the adviser’s fiduciary duty is to say, “Look, for your needs, I don’t have a product in my approved product list which I think is in your best interest, and you need to see another adviser, or make your own arrangements.” I think advisers will be reluctant to do that, so they will be trying to improve what they’ve got. TATE: If I went to an Industry Fund Services financial planner now, would they ever recommend anything other than an industry fund? WEAVEN: Well, they do, but on rare occasions. Just like the banks. You know, in fairness, they will be affected at the margin by these laws. We’ve always acknowledged that. We’ve always said that’s appropriate. BAILEY: So round the new rules, Anne-Marie or Ian would be expecting more referrals from

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C O VER S T O RY

outside [Industry Funds Financial Planning], or the service you’re using, to the personal sections of your funds? CORBOY: I think you need to look at our membership base. I mean, we’ve been running intra-fund advice at our fund for four years. And it’s a free service to our members and it’s been very successful. And the thing is that not every member needs advice every day; it’s not like they’re all going to ring up on one day and all want comprehensive advice. There’s only a small group of our members that really need that really comprehensive advice. You know, we’re thinking of people on average weekly earnings. I think a lot of people, when we talk about advice, it is really centred on the top end, you know, and those people do need comprehensive advice, and it should be provided, and all of that. But we’ve got a big group of the population that don’t need to spend thousands of dollars on a piece of advice. They just need certain things at given points, you know, in their life cycle, and that can be delivered. JAMES: I’ve been six years out of Australian financial services, and in the last six months we’ve been doing some global work on looking at all the financial services industries around the world. First thing I want to say is that Australia is number one. We look at the US and we look at Australia, [and] as far as transparency and the involvement of the regulator, we are miles in front of what’s happening globally. We’ve looked at all the other countries where we want to be, and there’s probably a handful of countries, but we’re certainly ranking Australia number one. One of the things we saw in Australia is the open architecture [of ] platforms [which] is certainly one way that fiduciary standards can fit in; we’re not seeing that globally. We’re seeing very closed structures, high commissions, a lot of rebates. I’m probably making a comment more coming from the US, that Australia is a long way in front of everyone else.

John James

That’s a perfect segue to what I want to say, which was I think there’s a bit of a [misconception], that an adviser sitting in an MLC business is effectively providing automatic referrals to MLC products. That’s just not the case. If you look at any one of the platforms, the number of products that are available, where the flows go, I think you’ll find the house actually loses rather than gains, in terms of the majority of those flows. So I think it’s an important point to make, and open architecture is exactly how we described it, and how, every time we’re overseas, people describe that system. SANDERS: John makes a really vital point that frankly is so often lost in our dialogue in terms of government reform and regulation: that…we are absolutely the most advanced financial planning profession in the world, the envy of regulators in every other country, the envy of the marketplace in every other country. And that’s part of the debate that we do need to encourage here. Delivering on the promise of fiduciary is where that challenge exists, that there are CODINA:

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complex analyses. We have a common law Westminster history of law that does make it slightly different to the US. But making that work to suit different clients in different environments for different needs is truly challenging. That will require some masterful legislative drafting that we look forward to having a say in, because it’s frankly, I think, very exciting but truly challenging. What we’d certainly like to see, too, is delivering on the other side of that promise; that is a challenge that’s obviously in the hands of Government, that there was a promise in the release a fortnight ago about reviewing the barriers to accessible, affordable advice. We recognise that in intra-fund [advice] for a defined class of individuals. We need to see that broken out to the benefit of more Australians, so they can access professional advice, because they frankly do all need it. What they don’t need is to pay lots of money for it. And I think that’s the great challenge - how do we balance those capacities, to make sure they are getting access to good advice? That’s the real challenge for the legislative program. REYNOLDS: I think the most important thing is we make sure that we get the 12 per cent and that we don’t let the Opposition and the small business lobby shut down the debate. How serious do you think that the Opposition is about not supporting that? BOWEN: I think they’re deadly serious. I think they’re deadly serious, for two reasons. One, I don’t want to be political here, but we could say the sky is blue and they’d find a reason to say it’s a plot. And secondly, I think, in all seriousness, Tony Abbott has an ideological objection to superannuation. Have to read [Abbott’s book] Battle Lines to find it. He says all tax concessions for superannuation should be abolished. And he is a man who will not step away from that easily. So I think they will oppose it down to the last vote in the Parliament, and they will run

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a campaign in the small business community to oppose it, and they will make it one of their key planks. I think it is deadly serious. TATE: Andrea, you also were pretty happy, I would imagine, with your member outcomes, in terms of the policies announced, although I believe art and exotic assets have been excluded, which now [means] wealthy people can’t hold art, but large super funds still can. SLATTERY: I will go to exotic and I might come back to advice in a second, because I’d like to talk about professionalism. But the exotic assets are actually something that are 0.1 of a per cent of the investments of the self-managed super fund market. And the majority of them are held appropriately and they are actually part of a diversification [strategy]. And Jeremy Cooper said that they weren’t going to intervene to actually stop the opportunity of investment. And I think at that point there’s a lot of complexity that will have to come in, a lot of transitional issues that will have to come in. But if I come back to professionalism, I must applaud what the FPA and the AFA and others have done, in relation to try and bring professionalism into [the] financial planning sector; and by bringing in the fiduciary duty requirement, I think that’s actually something that has to go hand in hand with any professional industry sector. And I think the concept that the Cooper Review has come out with is that superannuation will become a specialist professional business proposition for business. And that will sit alongside financial planning as well. And so I think if you don’t have that level of complex advice that’s given by somebody that has the right level of competency - and we’d love to see the level of competency for super raised so that it’s on a level playing field with other professions such as accounting and financial planning, et cetera. And if you have that level of professionalism and you have intra-fund advice, as the lower-level part of advice, I think it’s very

Andrea Slattery

important that that intra-fund advice doesn’t end up with complex issues in there and it is really a genuinely baseline advice capacity. And Deen is quite right in relation to the cost that will actually be applied to that area. But as a profession, you really need an undergraduate equivalent and level of knowledge, have a level playing field across all other professionals, whether medical or legal or other professionals; and so we would love to see that the super and financial planning sectors actually look and feel like professions. And as John said, we are the leaders in the world, we’re recognised by the World Bank in 2002 as being the leaders in super, in particular. And so it would be very good to align our professionalism with that, and have it look and feel appropriate as well. BOWERMAN: Minister, the fiduciary standard from Vanguard’s point of view, could in the long term actually be probably the single biggest reform that comes through, in the way it actually

changes the way [the industry is] structured. I suspect that one of the impacts coming out of it will be quite a generational change. At Vanguard we’ve seen, as Steve was saying, that the industry has been moving this way some faster than others - but for the last two or three years, at Vanguard we’ve seen moves towards low-cost and transparent products like index funds. But I think what your reforms do is absolutely draw a line in the sand to clarify and make the perception of conflict actually disappear. You get this tiered piece, where the intra-fund advice, which is what most people need, and then the complex, more expensive stuff at the top end, will hopefully come together and work. I know in the US, Vanguard have seen a lot of people need advice, and we provide it; but we provide advice on an incidental life stage product, where if something happens and they need advice at that point in time, they don’t need

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Robin Bowerman

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comprehensive advice on an ongoing basis. BOWEN: Sure. I think there’s some truth to that. Firstly, I think there’s going to be structural change in financial planning anyway, regardless of these reforms. The exact figure escapes me at the moment, but the average age of a financial planner I think is 58. So I think it’s ageing slightly more quickly than general society, and there are going to be changes there. But I do think, sure, changes we’ve announced will lead to more structural change, in terms of some people saying, “I’m used to working this way, I’ve worked this way for 30 years, and I don’t want to work under other arrangements, and I’ll leave”. And I accept that. Also, I’ve got to say I’ve been a little surprised - I wouldn’t overstate it - but I received a few emails after the reform saying, “I was thinking of becoming a financial planner and I didn’t want to because there was too much conflict and too much perception of conflict, but now I think I’ll have a good look at it”. So I think it will be a more attractive industry for some people who want to be in a profession, to be seen as a profession, and will come into it in that sense. You touched on - and it’s been touched on before - the possible distinction between sales people and advisers. And I did think very carefully about that. And at one stage I was attracted to putting in a formal distinction and saying it can be one or another, and I actually went to Britain and talked to Lord Turner about it. And they’ve gone more down that road in the United Kingdom. I came to the view, after thinking about it, well, why do that? Why not just professionalise the whole industry? Why have one part of the industry which has high standards, and another part which has a different nomenclature and different standards? Why not just get it right for everybody, was the view I came to. And frankly I think that’s a better outcome. TATE: Minister, my understanding also is that you’ll be abolishing, legislating to abolish, all

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Tony Cole, left, and Deen Sanders

forms of volume rebates and platform fees, shelf space fees and the like? BOWEN: If they are linked to volume. So if there is any incentive in the pay which incentivises the sale of a particular product. So in some instances - and there needs to be some consultation about the finer details of how we frame this in the legislation - but if there are flat payments which don’t in any way incentivise a product, then they would potentially pass the test. But if there is anything which in any way says it’s volume-based on rebate et cetera, then that would not pass the test. It applies across the supply chain, so at any stage if it encourages sales, it would not pass the test. Again, there needs to be a little bit more work about the finer details, but the principle that I’m applying is that if it incentivises sales, then it would not be allowed. RUSSELL: What about individuals working within a company where the incentive is not related to any product, it’s really just a reward for being energetic? It’s a reward for not being

slothful. What’s the thinking behind that? Because a lot of businesses - the act of providing advice, where you actually have to go out and find clients, it does require an energy, so a lot of businesses are based around rewarding energy, in that sense. But the best indicator of energy is just the number of new clients. And as long as that isn’t skewed to any particular product, it’s just the more clients, the bigger your return. What’s the thinking about that? BOWEN: Again, that was a tricky area in terms of just how to deal with that. You couldn’t have a situation where you ban commissions to non-employees, but allow volume-based bonuses for in-house employees. You couldn’t allow that. So it does apply to in-house employees. In terms of other payments, that’s something which I think comes into the realm of the professional advisory committee. That would deal with soft dollars. So soft dollars - I’ve expressed the continuum of soft dollars as a pen with your product written on it, which you give to advisers, ranging to a conference in the Bahamas at the end of the year. Now, they’re the range of soft

dollar activities, which the professional advisory committee will need to work with ASIC in just determining what’s in and what’s out. And in terms of remuneration of in-house employees, I think there’s a good bit of work to be done there, just in terms of seeing that right balance. TUCKER: It’s a very complex area when you’re looking at volume rebates, shelf-space fees, internal incentives. We’ve always had the view that as long as - and you will have employees that are better at generating revenue than others, and they should be able to be rewarded for being better performers. The question is to try and separate that from success being measured by how much product they sell. And reward them for revenue which is generated from a proper fee model, which is generated from the client agreeing to pay a fee for the advice they get. And we believe that by separating those two things, two financial planners sitting next to each other, one happens to be very good at their job, gets a lot of clients that buy their advice and pay for it - they should get paid more than somebody who doesn’t.

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Could I ask, Steve, how do you sell advice and at the same time sell product in the same organisation? TUCKER: There are different types of networks inside our organisation, and many advisers tend to choose the network based on how they want to give advice and how they want to relate to their clients. But if you take the conversation that centres around the bank financial planner, the bank financial planner’s job is to give advice in the interest of the client, which takes into account all of the consequences of that advice, all the different aspects of that advice. Now, what we’ve got to do is make sure that the implementation at the end of it, for a fiduciary obligation, is into a reasonable product. It’s not an outlier in terms of cost or functionality or any of those sorts of things, and competitive forces will force that anyway. But most importantly, 90 per cent of the process is the advice - they’re not overgearing them, they’re understanding their risk profile, they’ve got their cashflow management understood, their insurance needs are met, and that’s really the professional advice process that we want to run. Now, I believe Garry’s right, that some of the obligations will need to be met by opening things up. But don’t make the mistake today of assuming that every time a client walks into a NAB adviser’s office, they tell them to take their money out of an industry fund. That’s not the case. In many cases, they will choose not to necessarily do much more to that client but to say, “You haven’t got enough money to need what I do; stay in the industry fund, pay off your mortgage. See you later. And when you do want to, come back and have a chat”. So there’s a lot of myth around how these things actually play out that we need to be careful about. Is it appropriate to move somebody with a lot of money into an industry fund if they’re happy with an MLC TATE:

product, because it’s cheaper? Don’t know. Is that best advice? I don’t know. You’ve got to take all those things into account. WEAVEN: I think this is a really important issue. Let’s assume all of these changes are made, and after full consultation about the detail. Of course at the end of the day there will remain some grey areas, and of course part of the answer will be in the degree of enforcement - obviously a lot of things now could be cleaned up by enforcement rather than law - so that is true; that none of these things are ever absolute. You never get an absolute solution in any case. But extreme care needs to be taken to get this as clean as it can be, first time. And that’s more than just about public interest in the way you may be thinking about it. When this set of proposals become law, it will, I believe, most likely represent the end of the reform campaign for a large section of the industry. It will be a new model that is being proclaimed, after full debate, as the way it’s going to be. That means that industry funds - they’ll make their own minds up, but this is what I’m seeing as a potential outcome - and public sector funds which [together] could be, say, 40 per cent Jim Taggart, left, and Ian Silk

Supporting low cost and transparent investments.

of the industry, are very likely, it seems to me, to move to that new model, whatever it is, because it will be proclaimed as the new commissionfree, best interest of the public, best interest for the member, best-interest advice model. Whatever weaknesses are in it may well be picked up by the 40 per cent of the industry. You need to get it right. For example, if it is the common thing that to have professional best-interest advisers recommend your product only if you pay a fee to someone to get on the shelf, industry funds will have to look very hard at paying that fee. So the cost per member will go up. So just keep that in mind, because this is a once-in-a-lifetime chance to get this right. And everyone’s going to say, “Well, that’s the rules. They’re the rules, and we’re going to compete by the rules”. CODINA: I think we need to be careful about not assuming there’s only one model that will ever exist or that should ever exist. I’m not sure why - the rules provide a platform for the industry and for the sectors to go and compete, and as with the advice discussion we’ve had over here, sometimes we’ll see the solution as intrafund advice, and others will see it as outsourcing

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to a third party provider, and so on. So I think we set the platform, and we have to be very careful about what that platform is; but competition will arrive at what the landscape will look like. RUSSELL: There’s one tricky issue which we haven’t really focused on, and it’s that [within] the advice stage, there’s the accumulation phase and then there’s the retirement phase. And [at] the retirement phase there’s an overwhelming case that people need advice, and it’s not just advice necessarily about products. There’s 70 to 80 per cent of the population [who] will still have a relationship with Centrelink, and there’s clearly people [who] need advice to make sure that how they structure their retirement income arrangements does have to be done in the context of Centrelink, and most people need advice on that. CORBOY: Remember that a great number of them, Don, won’t have the account balance to need it too. In a mature system, that’s true, but there’s millions of Australians who retire now, take a very small lump sum, and have ... RUSSELL: For people who have a lump up to about $200,000, they’re going to qualify for the full pension, and so in that sense, the Government doesn’t really need to be concerned about annuities or whatever, because these people are going to get the full pension. But there’s another group from about $200,000 up to about $500,000, and that’s our members. And these are people that come out of the system with a lump between $200,000 and $500,000. This is a group of people, the private sector is not that interested in them, but it’s very important that they actually get advice and it’s very important that they get advice in the context of how they structure their arrangements with Centrelink, because most of our members will be in receipt of pension. And we’ve put the system now on track to give intra-fund advice as a major way to do this. And the area which we haven’t really tidied up is in that context of intra-fund advice and the retirement phase; there are going to be a lot of

David Graus

funds which will want to do this, and the advice they’ll give to their members is, “The advice we give to you is that you should put your money back into the fund itself. So we have a very fine allocated pension, and that’s where you should put your money”. And I think we’ve got to think through, at that stage, is it appropriate for the answer to always be, “It goes back into the fund where it’s come from”, or do we need to think of an arrangement where - in most cases it probably will go back into the fund where it came from but should that be contestable in some form or other? REYNOLDS: The intra-fund advice laws are changing to take into consideration Centrelink so that the fund - like for a lot of not-for-profit funds, most people are just going to retire with a small amount, and they’re going to be getting their aged pension; and that was a real gap, I think, that you couldn’t talk to people about the relationship between Centrelink and what you have in your super and how that was going to work. So I think that’s a significant step in the right direction for lots and lots of workers. HELMICH: I think Don was saying, though, it’s got to be affordable.

RUSSELL: It’s certainly got to be affordable. The model that we have, and this is at State Super Financial Services, is that our members, or anyone - because we have relationships with other funds - we provide four levels of meeting before that which is free; so it’s not a question of us sizing them up to see whether they’re capable of paying fees to us. It’s actually useful ... advice to them. And then, when they finally invest, then there’s an asset-based fee, which carries them through. And that model works very well. The members value it, and it’s affordable because they don’t actually pay anything up front at all. And they value the advice and they value the wholeof-life relationship. And with the new arrangements, they will have to actually sign off on the advice component and they’ll have to renew it every year, but our members actually value the advice and we’re confident that they will actually do that. BOWERMAN: Well, the remuneration model within the financial planning industry as it was, actually [did] the financial planners no favours at all, because it actually disguised the value of advice. People perceived the advice was the free bit, and the products were the valuables.

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I think the reforms the Minister put up - the idea of separating the idea of anything that can skew the decision towards a product, versus what the advice piece is - is actually the really fundamental piece. And if you get that right, then people should value the advice and be prepared to pay for it. That’s the really critical piece. Advisers need to get to a position where they charge for the advice and it’s valued by the end client. I think Garry’s point is absolutely valid, though, that this is a very creative and competitive industry, and if there’s the slightest opportunity for fees or different payment structures to be developed, it will be developed. The platform piece is really critical, and that’s where people need to understand. It needs to be very, very clear about what it is you’re paying for. COLE: You just said it’s a competitive market, and where there’s something that needs to be developed, it’ll be developed. We haven’t made much progress on the annuities issue. It might be coming but it’s taking a long, long time. WEAVEN: Well, the Government abolished the system. We had a system and the previous government abolished it, only relatively recently. CORBOY: You still need to look at what the average account balance is, Tony. Annuities are not on the radar for the majority in the immediate future. COLE: That’s fair enough. But if you take a country like the UK, where they don’t have compulsory accumulation, there’s no compulsory super in the UK; but at the end, if you are in a retirement scheme you must buy an annuity when you retire. So, whereas we have compulsory at the earlier stage, we don’t compel people to buy an income stream at the end. Now, I take your point, the system is not mature and people haven’t got enough and so on, but there are a band of people who have got enough. TATE: Ian, in the world that Garry’s predicting, do you expect to see AustralianSuper on

the Asgard platform, or the Colonial First State platform? SILK: It’s a good point. It depends on the growth ambitions of the fund. If the fund sees itself attracting members through external planners, the only way that will be able to occur is to pay money to get on platforms. SANDERS: Our vision as a profession for financial planning is that the professional actually has a very different role to play in the context of product-institutional relationships, that we

Steve Helmich

need to find ways of encouraging culturally; that the planner in fact sits in front of the client and protects the client, as well as supports the client, from, frankly, all of you guys. You know, my members’ job is to not be swayed by you people, but in fact to act on behalf of their client. I don’t care where you’re coming from. That’s part of the challenge in this environment, be they MLC employees, be they, frankly, industry fund financial planners who are qualified and certified according to our professional expectations. But we continue to see this debate as though it is institutional, as though it is structural and product-driven. That’s a great

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challenge. We need to find a way to support the culture of the profession, not just ways to deliver institutional models. GRAUS: I’d have thought that it’s difficult with shelf space, if a platform doesn’t have everyone available on it, how can a planner turn to that platform and say, “I know these other investment products which are pretty good aren’t there. How am I fulfilling my fiduciary duty using this platform?” Isn’t that just a conflict? BOWEN: Well, that’s where the “reasonable steps” defence comes in, and it’s also a case, as I say, that we then, it may be an obligation for an adviser to say, “Go and see somebody else”. SLATTERY: But I think if we actually look at the consumer, we often forget in all that we talk about, the consumer goes to somebody for advice and expects that …the adviser will provide them value, and the adviser will put them into an investment or into a product or into an area that is most appropriate for them. And that nexus between the consumer’s interest and the advice is actually something that needs to be separate within every organisation. If there’s going to be a genuine attempt to have a profession in these areas of super and financial planning, then that has to come from within the organisations, no matter which organisations they are. And this will generate a new industry, a new professional industry of advice, that might be outside of organisations, because organisations have to make a call on whether that conflict is too great to have everybody in their organisation, or whether they actually outsource the complex advice, and only keep the internal advice as well. So they’re all issues that need to be addressed. HELMICH: I look at what financial planners do and I think what my financial planner does for me, and it’s about structure, it’s about strategy, it’s about discipline, it’s around that approach. The product selection - and it is an AMP financial planner I use, I put that on record - the

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product selection is almost inconsequential. The platform’s almost inconsequential. And I agree with you. I agree, Garry, the costs should be between the planner and the client. There is at the moment, in all the aspects, whether it be industry funds or whatever, cross-subsidisation occurs. That’s why industry funds can give free advice, that’s why things happen. So where that cross-subsidisation goes, is going to be interesting in the debate, because I’m like Steve, I’m not a fan of shelf space. We get hardly any of it at AMP because we don’t support that approach. But what’s going to happen, if the customer pays more because the cross-subsidisation goes, it’ll be an interesting debate. Because it could actually push more people away from advice. And I think the point you were making is advice needs to stretch right across the spectrum. We need to get people interested in middle Australia because they need advice, just as much as people at the top end do. And it needs to be scaled advice and affordable, and scoped advice to suit their needs. TAGGART: We need to be very clear [about] the difference between information and advice. That’s really critical to the whole debate. And I say that not just from an academic point of view but from [a] very practical point of view. I just say this to you, for all you learned people. Trauma insurance, while it’s not the debate or part of super: which one pays when you get MS, straight away? Which one pays seven years later? But [knowing that is] not important, is it? So the point I’m trying to make is, I’m in the advice market. And I treasure that. And I think I reflect the growing tendency of all members of our associations in increasing their qualifications. I’m just looking at self-managed super funds, and I’ve just finished a doctorate, I’ve got two Master’s degrees, and I’m doing another Master’s, in tax. How much more study do you want me to do at nearly 56? I’m being really honest, because I take that as being responsible.

What is the Government’s vision for what financial planning should look like after these changes have come into effect and are bedded down and are operating? BOWEN: Well, perhaps I could answer it this way. Two announcements in the last week were linked in this regard: I don’t think I could have convinced my colleagues, and I don’t think I could convince the Australian people, that putting more money into superannuation is a good thing unless it was much more transparent and professional. And I think the idea of the financial planning industry, as we’ve all said, and I think we’re all on the same page on this - we might have different nuances to the view - but we want it to be professional and trusted, and that means it needs to be not only free of conflicts of interest but be perceived to be free of conflicts of interest. And there’ll be differing views around this table as to the degree of conflicts of interest. And in some respects we’re similar. I’ve been in politics in some form or another for 20 years or so. And I have never seen once a political donation to either side of politics having impact on public policy. Never. Never seen it. And I’ve been at relatively senior levels at local, State and Federal, and I’ve seen people of both political persuasions, both close up. That’s not the perception in the community, and as a result, we’re going through a whole process of cleaning up perceptions, political donations, that will end with a much different system of funding politics and political campaigns as we do today. Now, I’ve no doubt that there have been some donations which have swayed public policy, but I’ve never personally seen it, I have to say, close up. And that means that we’ve taken the decision to clean up the perception of politics. Similarly in financial planning, there have been some very clear instances of very poor advice being given because of very clearly conflicted remuneration structures. There’s no question HOYLE:

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about that. And they have done two things: firstly they’ve caused the financial ruination for a not small number of people. A not insignificant number of people have had their life savings wiped out. Secondly, it’s given everybody else a bad name. So how do I see financial planning and the financial advice industry working? It’s quite simple. It works on a basis that the advice is given with no view to the remuneration of the financial planner, and it can’t be perceived to have any view to the remuneration of the financial planner. That might sound like it’s a generality, but it’s what it all boils down to at the end of the day.

TATE: I’d like to thank Vanguard for taking part and for agreeing to sponsor today. I approached Vanguard in launching Professional Planner three years ago, when we wanted to take a position on cleaning up conflicts of interest in the financial services industry. I went off to meet with Jack Bogle, the founder of Vanguard. That organisation has never paid a commission in its life, and I wanted to ask him why that was, and how we could create a world free of commissions in the financial services industry. Vanguard has always had a transparent low-cost model and it believes in industry debate, governance, education and transparency. It’s been in Australia for about 13 years. I think they’re an appropriate partner today as we review the three reviews with the Minister: the Cooper Review, which is all about how do we reduce the cost of superannuation to Australians; the Henry review of the Australian tax system; and of course, prior to all that we had the Ripoll review, into the collapse of Storm and other financial service organisations.

Get ahead of the pack

Praemium presents a Nuts and Bolts Solution Roadshow on the expected impact of the Government’s response to the Cooper Review. It’s crucial information for all advisers, explaining the transition from commission to fee-for-service and how Praemium can help position you ahead of the pack.

The Cooper Review – A Nuts & Bolts Solution Roadshow Brisbane 13 July

Melbourne 14 July

Sydney 15 July

Adelaide 19 July

3.30 – 5.30pm (followed by drinks)

For more information and to register visit www.praemium.com.au

Perth 20 July

C L IEN T CASE ST UDY

A Simple plan “When in doubt do nothing” might be a great axiom for crossing the road in busy traffic, but when it comes to financial matters it’s rarely a smart client strategy. Mark Story explains

CL I ENT C A SE S T U DY

ith the family home paid off, a regular income, and two grownup kids off their hands, fifty-something Byron Bay couple Tony and Joy Cunningham (not their real names) should have been living the life of Riley. However, their inability to communicate on financial matters meant that, by default, important decisions integral to their future retirement were being alarmingly overlooked.

As an artist, Joy’s income was at best variable. However, her “old-school” intuition for buying undervalued property - living in it, and then reselling it - had delivered some tidy profits over the years and had seen the value of the couple’s family home progressively climb to more than $3 million. But when it came to money matters, Joy’s other half, Tony, a former executive with a bigcity ad company, had no investment interests beyond ensuring the mortgage was paid on time,

and even less desire to find out. Over the years, “all things financial” had gradually tumbled into the too-hard basket, leaving the Cunninghams with no real fix on their true financial position. There was lingering uncertainty over whether Tony’s unpredicatable income as a selfemployed art director would continue to meet their existing lifestyle - let alone their retirement needs - and this led to mounting anxiety about the future. Having convinced themselves that an

C L IEN T CASE ST UDY

eventual depletion of savings would force them to sell the family home to fund their retirement, in July 2008 Joy finally called on an acquaintance, financial planner Christoph Schnelle, for help. Adding considerably to the Cunninghams’ anxiety was the GFC which, unbeknown to them at the time, had reduced the value of their managed funds by nearly half. “By engaging Christoph as a conduit between Tony and myself, I hoped we would begin to heal the rift in our ability to communicate on financial matters,” Joy says. Beyond a modest sum of $25,000 invested with St George Bank in cash, Tony held Platinum Japan and Platinum Healthcare funds (outside super), plus MLC MasterKey super. Schnelle says: “In addition to not knowing how much money they’d lost, Tony’s indifference towards financial matters made it impossible for them to have a meaningful discussion with each other about finances, let alone a third party.” Clarity and guidance

While their financial position wasn’t as dire as their anxiety levels would have suggested, what the Cunninghams lacked most, Schnelle says, was both clarity and a tangible road map that would deliver on stated retirement goals. “It became clear very quickly that 90 per cent of the Cunninghams’ solution was more about clarity and guidance than hitching their fortunes to any particular product,” says Schnelle. He also knew how important it was for Joy and Tony to keep things simple. Not only did Tony want to keep working, adds Schnelle, but it was the most obvious way of maintaining their required income of around $75,000 annually. “The transparency of knowing where they were financially gave Tony and Joy a new lease of life, and this improved their overall emotional and physical wellbeing,” recalls Schnelle. Minimising exposures

In July 2008, Schnelle recommended rolling over Tony’s two Platinum funds and his MasterKey super balance into a new BT SuperWrap pension account - giving it a combined value of

around $500,000. As an Australian couple still only in their late 50s, Schnelle regarded their over-exposure to Japan and health care as far too imbalanced. And while Schnelle rates MLC MasterKey highly, he says lower fees and an expectation of higher long-term returns made the combination of Dimensional and Vanguard a preferred option. But with the timing clearly against them, it was decided that the best short-term solution was to hold around $420,000 of the fund proceeds in bonds and cash, in a Dimensional bond fund, and $80,000 in cash, within the pension account. “Given that the global economy had just gone to ‘hell in a hand-basket’, we figured that the smartest thing we could do was protect assets from further downside risk,” Schnelle says. “Much to our delight, the Dimensional fixed interest funds sailed through the GFC without a hitch.” In February 2009, with markets looking close to bottom, Schnelle recommended placing 75 per cent of their funds into a Dimensional Australia Core Equity BT Wrap, and 25 per cent into Dimensional Five Year Fixed Interest. Franking credits, together with a share buyback, added an extra 2.4 per cent to what was already an attractive return. While at the time things looked bad worldwide, Schnelle took the view that Australia’s future looked significantly brighter. “You can benefit from diversification, but not if you diversify into assets that you feel will perform significantly worse,” Schnelle recalls. “While it was a decision for the moment, today a more balanced approach could be better.” Low hanging fruit

With markets looking significantly undervalued early in 2009, Schnelle says going back into shares appeared to be a smart move. By rolling over an additional $115,000 that Joy had accumulated within her MasterKey personal super fund - previously undisclosed to Schnelle - into an allocated pension, Schnelle also managed to provide her with an additional $375 in monthly income.

The Planner Christoph Schnelle Director - In Your Interest Financial Planning Authorised Representative of FYG Planners Pty Ltd Brisbane QLD and Burringbar NSW Schnelle is an authorised representative of licensed dealer group, FYG Planners Pty Ltd. Prior to moving north, he resided in Sydney where he founded and ran a multi-million-dollar publishing and technology company. A financial planner since 2005, Schnelle has an Advanced Diploma in Financial Planning. Advice structure With clients straddling all walks of life, spread right across the country, Schnelle offers a full fee-based financial planning service for everyone from high-net-worth investors through to those with little or nothing to invest. Based on the level of complexity, clients pay between $1000 and $6000 for a financial plan, plus an annual fee based on 0.75 per cent of assets under advice. History Byron Bay couple Tony and Joy Cunningham gravitated from being casual acquaintances of Schnelle’s within the same social circle in 2005 to clients of Schnelle’s two years later. Given the communication impasse they had reached when it came to discussing financial matters, the Cunninghams looked to Schnelle for a reality check on their overall financial wellbeing. Having convinced themselves that they would eventually run out of money, the Cunninghams’ key concern was when they’d have to sell the family home and start living off the proceeds. Strategy Given their yen for the simple life, much of Schnelle’s brief from the Cunninghams focused on a “back to basics” insight into their true financial position. Whatever issues needed addressing as a result of Schnelle’s fact-finding, his next brief was to recommend solutions that were easy to comprehend, and hassle-free to both implement and maintain. “The value provided by me as a financial planner was more about acting as a channel through which Tony and Joy could re-establish common ground on financial matters, rather than simply pushing them into different and potentially complex products,” says Schnelle.

Meanwhile, with Tony’s pension portfolio now worth around $590,000, the allocated pen-

CL I ENT C A SE S T U DY

Fees paid to Schnelle: $2800 Family Home: $3.5 million Value of funds under advice Pre-Schnelle $500,000 Post-Schnelle $710,000 Change in value: 42.96 per cent

Tony’s assets $650,000 ($588,000 in pension plus car, household items etc)

Joy’s assets $160,000 ($114,000 in pension plus other items)

‘It’s quite confronting to be told ... that you can’t talk to each other about money’

Income from allocated pension $28,100 per year Tony: $23,600 per year Joy: $375 per month

Any other investments NIL

Insurances Nil

Death cover Nil

sion he’s receiving from these funds is supplementing his earnings with an additional $23,600 in annual income. “We based this income on the broad premise that through their investments the Cunninghams would be able spend around 4 per cent of their net worth indefinitely while maintaining the value of their funds under management,” Schnelle says. While Tony, now 64, has no immediate plans to retire any time soon, Schnelle’s next plan is to further supplement his pension by salary sacrificing everything he earns over $35,000 - to reduce his marginal tax rate from 31.5 per cent to 15 per cent. Ideally, he says, Tony would like to increase his contributions to super by around $24,000 and then consolidate these funds within the allocated pension at some future date. Keeping it simple

Looking back, Joy says the peace of mind they gained from discovering they didn’t have to sell the family home gave them a new lease of life. And they didn’t feel compelled to buy a rental property as a supplementary income stream.

Meanwhile, the allocated pension means that, as the family’s primary breadwinner, Tony no longer feels under as much pressure. While there were many other options available to the Cunninghams, Schnelle says the option to rollover into allocated pensions was by far the simplest one. And while a self-managed super fund (SMSF) was mooted as a possible option, he concluded that it simply wasn’t necessary, especially while plans for an investment property are off the table. What was critical to delivering a positive outcome for the Cunninghams, adds Schnelle, was that they literally didn’t have to do anything demonstrably different. Yet at the time, they were fearful of losing their home and angry with themselves for not knowing who to turn to for help. “Their overall performance is up around 42 per cent, which isn’t bad, given the timing,” says Schnelle. Self empowerment

While Schnelle was arguably instrumental in making recommendations, he impressed upon the Cunninghams that any final decisions were theirs to make. And given Joy’s experience buying and selling homes, Schnelle concluded that there was nobody better qualified to decide whether to accept an attractive offer on the family home than Joy herself. In hindsight, Joy says the conscious act of deciding not to sell was extremely empowering, and it made them realise how adept they could be at making major financial decisions with the necessary guidance.

“While we do plan to eventually downsize from our six-acre block, it will be based on opportunity rather than fear,” says Joy. In some curative way, by having to make these decisions themselves, Schnelle says the Cunninghams regained a lost sense of mutual direction - while filling the void created by their inability to communicate on financial matters. “It’s quite confronting to be told by an outsider that you can’t talk to each other about money,” admits Schnelle. “But it was equally empowering to realise that within Joy they had an absolute expert on property investment right within their home.” Given the lack of detail associated with the solution suggested by Schnelle, Tony says that the real value-add was in the broad advice provided, and less about specific product recommendations. “The most important thing for us was Christoph’s personal touch, especially when compared with the financial institutions we used to frequent that were hell-bent on ‘death by pie-chart’ analysis,” says Tony. While they didn’t recognise it at the time, Schnelle says the best solution for the Cunninghams was always going to be the status quo - albeit on a sounder financial footing. “Simple it might be, but the plan allows the Cunninghams to stay ‘masterful in action’ for as long as possible,” Schnelle says. “Joy continues her painting, while Tony continues working, but with a much healthier outlook.”

A D V I CE IN S U PER

Bridging the great planning divide One not-for-profit super fund is actively seeking to improve its relationships with financial planners, as Simon Hoyle reports

o say there is a level of mistrust between industry, or not-for-profit, super funds and the financial planning community might be regarded as an understatement. To financial planners, industry funds are clearly and unambiguously anti-advice (when in fact, industry funds are really only anti-commission). And to industry funds, financial planners are only interested in churning members into expensive, commission-paying retail super funds (when, in fact, planners are only trying to find the most suitable funds for clients). But First State Super, the $18 billion, 530,000-member fund that started out as a NSW public sector super fund, is trying to tread a different path. The fund wants to know if there’s a way it can effectively and efficiently interact with financial planners broadly, without reinforcing the prejudices and misconceptions that have plagued the industry fund/financial planner relationship for years. First State Super’s chief executive, Michael Dwyer, has already overseen the establishment of a fee-for-service, in-house financial planning division: FSS Financial Planning. In the 18 months or so that the service has been running properly, several thousand First State Super members have availed themselves of one or more of the three tiers of advice the fund provides. The lowest tier is very simple, limited advice, generally delivered over the phone, costing $75. The second tier is the provision of transition to retirement (TTR) advice, for $450. And the third tier is a full-service, comprehensive financial planning service, costing $2000. (And if a member wants ongoing advice, with regular reviews and so on, the fee is $1200 a year.)

‘Do they all think the same...or do 16,000 planners all have different requirements?’ In each case, members can pay for the advice from their super fund - provided the advice is “largely focused on superannuation” - or from other sources, if they prefer. Understanding how financial planning works for First State Super members, Dwyer is confident he can get over the barrier that has traditionally existed between not-for-profit funds and the broad planning community. “In terms of going forward and understanding the community we’re becoming a part of, media reports often say that planners don’t recommend not-for-profits or industry funds,” Dwyer says. “We’d like to understand that a little more. “We believe we’ve got a fund that would be very attractive to a large proportion of the working population: Low cost; good returns; significant choice; we’ve been around for a long time; we’re solid, safe and secure; we’re a liquid fund, we have enormous allocations to liquid investments; and we came through the GFC very well. We have a philosophy of protecting members on the downside and giving them competitive, but not shoot-the-lights-out, performance on the upside, because that’s not our game. And we’re the lowest-cost fund in the country.

“So with all of that, we’d be fascinated to find out…would [planners] like to recommend a product like ours to their clients? “Once we…understand what drives their business, and whether a not-for-profit like ours is interesting to them; once we have that information and perhaps a dialogue, we can better understand if there’s any options and avenues we can go down to make our product available to them. “If a group of accountants or planners wanted to know more about what we do, we’d be only too happy to provide that information, either electronically…or in written form. “We’re talking to a community of people who have, perhaps, the same drive as us, which is acting in the best interests of their clients. But of course, professionally, the only way they could recommend us is if they have a full knowledge and understanding and have conducted some research about us and know what this fund stands for.” Dwyer says that traditionally, funds like First State Super simply have not interacted with financial planners, nor with the organisations and individuals responsible for defining and maintaining dealer group approved product lists (APLs). But with 530,000 members, there’s a good chance that some members already have a relationship with financial planners, in some shape or form. “We believe that [fund] members, community members and working people are best served by being a member of a fund like ours, for a whole range of reasons,” Dwyer says. “There are key influencers out there, professional people who are financial planners or accountants or others, and the more they know about us the better.

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A D V I CE IN S U PER

“We were not as open and as transparent to that community as we could have been. I think now, we’re saying, we want to spread our message far and wide. “How we interact on an ongoing basis, we’ll actually be able to determine that when we find out if there’s any interest there.” Common criticisms of industry, or notfor-profit, funds is that they’re actively hostile towards financial planners. And, even if a planner can convince a fund that they’re not, in fact, the enemy, the fund can’t always provide the information that planner needs, in a form that fits easily with the planner’s existing administration or reporting systems, or sometimes even in a timely manner. “Part of our dialogue is to find out, do they all think the same in terms of what they want, or do 16,000 financial planners all have different requirements in terms of what they want?” Dwyer says. “We’re very good at what we provide, which is largely a plain vanilla, high-quality, low-cost superannuation and retirement product, and providing information to third party people is fine as long as we know what they want and whether or not it’s cost-effective for us to provide that information. “I think we’re the right fund for a lot of people. We’re not the right fund for everybody. I think for those that want 300 investment choices, for example, I’m sure there are some very good retail providers around that can provide them with 300 choices. We’d argue that 300 might be too many, but nonetheless, if there are people looking for that, we haven’t got that. For those people who want very, very exotic investment options, again, we’re not the right vehicle for them. We will be right for a certain proportion of the population; we will not be right for others.” Dwyer says that “having read some of the criticism that you’ve talked about - about people not finding that not-for-profits or industry funds are that easy to deal with - we’d like to explore it more and understand it more”. “And if we can’t meet the need in any way,

Michael Dwyer

then that’s fine too. But if we can, let’s have the dialogue and let’s work out what can be done about it.” While there’s a presumption in some quarters of the industry fund community that planners only want to deal with funds so that they can entice members to leave, Dwyer says there is a growing proportion of the planning community - largely, he says, Professional Planner readers - that does not operate that way at all. “That creates in me an interest to know more about how they run their business, and what they’re looking for, in terms of being able to recommend a not-for-profit. All I’m saying at this point in time is, we are open and transparent, we’re regarded as open and transparent, we certainly have the trust and support of our members, and in this environment it would be inappropriate to be looking for anything other than ambassadors for the fund. “I am sure there will be someone, somewhere, who will be able to demonstrate that they want to interact with us only to lure members away, but I have to say I think by far the majority of people who go down the fee-for-service path will really be trying to act in their clients’ best interest, and find the best product for them. “We’re mature enough and old enough and

wise enough to recognise that there is always the option of people being lured away from the fund, but in our history - and we’ve been around since 1992 - by and large, once people become a member of ours, they stay. “Until I get proven otherwise, I’ll go out there in good faith and have a dialogue, and talk to people and see what can be done, and be honest enough to say, no we can’t do business because we’re not what you’re looking for; but honest enough to find that if people want to interact with us, we have to work out ways of communicating with them. How do we get information to them? “We want to be easy to deal with. That’s our philosophy going forward.” Dwyer says the planners that First State has dealt with “we have found to be very professional, and people of integrity”. “These are fee-for-service planners, and what I’d call ‘true’ fee-for-service. And in the same way we’d treat them professionally, we’d expect to be treated professionally.”

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P R O F ES SIO NALISM

The distinguishing feature

Whether you believe that it’s a “socialist attack on the freedom of small business” or justifiable reform, the changes can’t be ignored. Robert MC Brown explains

ike most Government announcements, the Federal Government’s recent proposals, principally involving the remuneration of financial planners, include political compromises that offer either “wriggle room” for those who would like to get around the basic message, or the opportunity to build a true profession. So what’s the basic message? Essentially, it’s that conflicts of interest which drive the industry must be removed in the interests of consumers. That will be done, from July 1, 2012, by introducing (inter alia) a statutory fiduciary obligation, banning commissions (except on risk insurance), banning percentage-based asset fees (but only on geared arrangements), and requiring clients to “opt-in” annually. The opt-in initiative may well prove to be a much more important initiative than many people realise because it will require clients to assess and decide annually on the worth of a planner’s services, and to make that decision based on dollars, rather than an innocuous and small percentage of funds under management (more about this below). The wriggle room is obvious. It lies in the ability of planners to continue to adopt percentage-based asset fees in lieu of commissions (“the commission you have when you’re not having a commission”), and the ability to receive commissions on risk insurance. However, given that these concessions are essentially political, and that the Government went to the trouble of making the point that it reserves the right to monitor progress and tighten the rules at a later date, it seems to this commentator that the proposed rules are unlikely to be the end game. Therefore, the industry must either take one more step to achieve comprehensive reform and true professionalism (by removing percentagebased asset fees and commissions on risk insur-

Robert MC Brown

ance), or have that step imposed on it at a later date. This is not a case of taking away the basic democratic right of financial planners to run their own businesses in the way they choose; rather, it’s a case of transforming an industry into a true profession - a task that imposes certain ethical obligations on the profession’s participants, including the removal (not just disclosure) of remuneration-driven conflicts of interest. An important practical consequence of this comprehensive reform is that financial planners (whatever their form or place of employment) will be presented with the opportunity to gain increased or complete control of their professional destinies. No longer will they be controlled by the vagaries of investment markets, by the commercial necessities of dealer groups or funds managers, or by the need to sell products and accumulate “funds under advice”. As a result, financial planners will gain the freedom to build professional practices for them-

selves (or for their employers) based on legitimate fee-for-service remuneration models. Many planners will be unable to make the transition due to a lack of professional qualifications and skills; others will not be able to make it due to their inability to operate a professional practice (as distinct from a product sales business); and others will be unwilling to make the transition because of their established and comfortable income streams flowing from product trails. Those financial planners who are willing and able to make the transition will gain a level of professional satisfaction and independence that they have never experienced before, mainly because they will no longer be required to advise clients in the knowledge that a product must be sold (whether or not the client actually needs one). Many planners expect that their book of trailing revenue, be it in the form of commissions or percentage-based asset fees (trails), will be a valuable asset on retirement. Multiples of two to four times (gross) trail revenues are often mentioned, which is considerably more than the expectation of most accountants and lawyers (who would be fortunate to achieve a multiple of one). There are a number of reasons for this substantial difference. The principal one is that, unlike regular accounting fees, there is a perception on the part of buyers that little work is required to justify and increase the income derived from a “book of trails”. This is one of the biggest mental hurdles for many financial planners to leap in making the transition to a truly professional practice. It’s one thing to transform a book of trailing commissions into a book of (surrogate) percentagebased fees, but it’s quite another (at least in their minds) to move to where the industry needs to be if it is to be treated as a true profession.

P R O FES S I ON A L I S M

This point is best illustrated by an example of a fictitious financial planner with a book of trails deriving an income of $500,000 per annum, represented by 100 clients, with an average funds under management (FUM) of $1 million each, from which is earned 0.5 per cent in percentage-based asset fees (previously trail commissions). This “book” provides a comfortable income that increases (or decreases) with movements in financial markets. On average, each client is paying the planner $5000 per annum (at least). In many cases, little professional and administrative work is required to collect the percentage-based asset fees, and most of the clients would be relatively unaware that the payments are being made automatically out of their funds. In a true professional environment, the fee of $5000 per annum would need to be justified annually to each client by way of an accounting of actual professional services rendered, backed up with regular invoices or a formally agreed retainer arrangement, in much the same way as any other professional services provider is required to do. While the professional fee of $5000 need not be directly calculated by reference to time, it is understandable that when clients are confronted (as they will be after the introduction of the annual “opt-in”) with a decision about whether the financial planner is worth that much, they will think about time spent and the value of services rendered. This means that where a planner has spent 15 to 20 hours per annum of value-added consulting time with a client, transforming a percentage-based asset fee of $5000 per annum into, say, a quarterly retainer fee of $1250 (unrelated to FUM), there should be no significant problems. It is only where little or no time is spent, or a planner has inadequate professional expertise, that clients should quite reasonably baulk at paying for a planner’s services. Put simply, where the remuneration to the planner cannot be justified, it should not be paid in any form (and never should have been paid). For some (older) planners, particularly those

‘The consequences will not be as difficult as many people might fear and anticipate’ with high financial expectations on retirement, this analysis and transformation of their book of trails to an annually justified retainer, flat fee or hourly rate will prove to be an impenetrable barrier to transition; but, for others (who understand that the current situation is inherently unstable), initiating a program of transforming percentage-based trails into genuine fees for service will prove to be a liberating process, undertaken in the interests of longer-term viability, independence, sustainability and professional recognition. The change may have a detrimental impact in the short term on businesses that are based on product sales. In the longer term, however, the viability and value of financial planning practices will be justified and sustainable because they will be viewed as legitimate professional firms in which the participants are earning a fair day’s pay for a fair day’s work. Some dealer groups and institutions that own, partly own, or have significant financial arrangements with distribution networks may find the transition very challenging. This is because their cultures, expectations and structures are designed around the sale and distribution of products, rather than the provision of advisory services. Inherent in these structures is a strong control mechanism that exercises considerable power and influence over the decisions and recommendations of financial planners. In the restructured environment, this power and influence will be considerably reduced or removed. Therefore, it is understandable that

a fundamental change of this nature will be resisted, although it is likely that some product manufacturers will view the change as an opportunity to achieve some direct access and influence over financial planners who might otherwise be inaccessible. It is beyond the scope of this article to analyse the multitude of financial and employment arrangements that exist in the industry. Suffice to say that in any restructuring of the nature proposed herein, there will be winners and losers. The losers will be those organisations and individuals that do not accept the seriously detrimental consequences of maintaining the status quo or who seek to exploit the wriggle room to which I referred above. The winners will be those who understand the depth of the problem, and realise that it must be solved once and for all, without resorting to “workarounds”. More than anything else, reform and transition of financial planning into a profession requires visionary leadership. Without it, the industry is consigned to a future of unworkable workarounds and an increasingly complex and costly compliance regime. A satisfactory outcome will never be reached until the industry’s leaders openly and unreservedly recognise the unacceptable consequences of remuneration-based conflicts of interest and then enthusiastically commit to remove the problem once and for all. The consequences of taking this position will not be as difficult as many people might fear and anticipate. This is because financial planners will become respected as true professionals; their practices will gain legitimacy, sustainability and longevity; and institutions and dealer groups will enjoy an improved image and reputation. Most of all, the public interest will be served unambiguously. This is the unique distinguishing feature of a true profession.

Robert MC Brown is a chartered accountant with more than 30 years’ experience in accounting, superannuation and financial planning. In 2007 he authored the landmark industry paper Reinventing Financial Planning.

R O UN D TAB LE: S EL F-MA NAG E D SUP E R AN D P O RT F OL I O C ONS T R U C T I ON

A question of self-control There are 416,000 self-managed super funds in Australia, with assets approaching about $360 billion, yet there is little hard data on SMSF asset allocation or investment performance. A Professional Planner/Russell Investments roundtable examined how trustees make investment decisions, who they rely on, and the latest developments in portfolio construction - including the growing role of exchange-traded funds

Hogan: It’s clearly a big market. It, in the ROUNDTABLE PARTICIPANTS Graeme Colley - national technical manager, ING Investment Management Patricia Curtin - managing director, retail, Australasia, Russell Investments Alan Dixon - managing director, Dixon Advisory Peter Hogan - financial planner, Avenue Capital Management Simon Hoyle - editor, Professional Planner Tom Keenan - director, iShares Australia Ian Knox - managing director, Paragem Partners Trevor Satill - financial planner, Picadilly Financial Amanda Skelly - director, product development (ETFs), Australasia, Russell Investments Sally Wells - founder and managing director, endgame communications

last five years, has gone from being, in dollar terms, probably smaller than the managed fund area, the public offer area, to a position where it’s now the largest in terms of dollars under management, funds under management. It’s now the largest way that people actually pay for their retirement. There are an average of two members per fund, and [an] average account size of $450,000, so the average fund is just under a million bucks. Dixon: There are about 416,000 funds, with about $360 billion in them. Curtin: It’s interesting to note that the growth of SMSFs has been 20 per cent, until the past couple of years, whereas within APRA

funds it’s about 8 per cent. So you can see the momentum that’s behind SMSFs. Wells: According to the Investment Trends research, there’s two reasons why I set up an SMSF. It’s either an active choice because I want control, or I think I can do a better job myself; or it’s a more passive choice where my accountant or my adviser has recommended that I do it. So if you think about the former, where control is such a driver, even those who have advisers and accountants, control is still a driver. And I’d love to hear from those of you who deal with the clients, whether you’re different in terms of how much control they want, to other clients that you work with. But given that that’s such a driver, and they’re very generous about their own

R O UN DTAB LE : S EL F-MAN A G ED SU P ER AN D P O RT F OL I O C ONS T R U C T I ON

assessment of their own performance, perhaps, you know, they’re not seeking advice as much as, indeed, perhaps they should. Colley: It depends what you call control, because I did a bit of a survey amongst our clients, and I said, ‘Well, why did you set up a self-managed fund?’ And one guy told me it was, ‘Because the other funds wouldn’t do it for me’. And in one case, they wouldn’t roll over something in 2007, and so [the client] got some technical benefit out of it, and he reckoned that he saved about $100,000 in just that one action that he did, that he could do in his self-managed fund that they wouldn’t let him do elsewhere. And another one was being offered some bonus shares from his overseas company, which is a public company. And he couldn’t have put that anywhere else but a self-managed fund. So that was how he saw control; that is that if I get offered something, then I can put it into this thing that will allow me to do that, which just happens to be a self-managed fund. Other people want that control over the investments, and they’re getting quite heavily into investment strategies with their funds. And they do quite a good job. Sometimes they do it well by themselves, other times they need financial planners to help them. Satill: I’ve found that over the years, being an accountant in my previous life, and also now a financial planner, that a lot of people like this idea of “control”, but they don’t actually really know what control means. They want to be masters of their own destiny, but again they don’t really know what that means. Because they still defer to advice the whole time. I’ve got a client at the moment, and he doesn’t want to go into the sharemarket. And all he wants is real estate. So yeah, we go with a property instalment, and you can do that. But when it comes down to what the client is looking for, often the clients don’t know what they’re looking for. Skelly: I think that’s a common trap for self-managed super funds. Bricks and mortar, direct [Australian] shares and cash - that’s what they hold. And there are risks with that, as we know.

Graeme Colley

‘Sometimes they do it well by themselves, other times they need financial planners’ Colley: Big funds hold the same things. So where’s the difference in the risk? Skelly: But as you know, Australia makes up a relatively small market capital of the world. So is that the most sensible place to have all your assets, in Australia? Knox: The SMSF sector appears to confuse corporate Australia because its growth, I would suggest, has occurred because of disillusion with what’s in the market today [and] they’ve, for whatever reason, tried to take control. Whether that’s investment-driven, or personality-driven, or whatever, it seems to me no-one controls the sector, which is an interesting start point. But I would put to you that the cost structure of the [managed funds] industry has weighed heavily and created the growth of the SMSF sector. The cost of investment management, the disillusionment of managed investment schemes not protecting assets on

the way down, has probably been a key driver in that. The cost of platforms, et cetera, has just overweighed most people’s reason for using the traditional sectors. And in response, what’s happened is corporate Australia is now clamouring to get into the SMSF sector, to sell to it, and I don’t think selling to it is the solution. I think actually working with it is probably a better outcome. Colley: Yeah, I agree with you. I think that what corporate Australia failed to do probably around about 2000-2003, when we saw a drop in the market, was actually understand the self-managed fund market, to develop products which either would have slowed down the growth of self-managed funds, or been complementary to the development of those funds, from an investment product point of view. And it seems to have failed to do that, and that’s why people go directly, without virtually any products and support. Keenan: And I think that’s the point about control. If you think about the three sectors that dominate - property, cash and shares - it’s because most investors understand, they can touch those brands that they invest in through shares, they can touch the property they invest in, they understand the cash they’ve been investing in. That comes back to this element of emotionally owning that element of control. Fifty per cent of our shareholders in iShares in Australia are in self-managed super funds. I think that comes back to that control element, controlling the cost, controlling the liquidity, and understanding what they’re investing into. Knox: I think the challenge for the financial planning community was the reader of the magazine; historically speaking, until recent times, nearly all people who were licensed have had an overweight decision to managed investment schemes, because dealer groups themselves have not been comfortable with planners dealing in direct asset ownership, whether it be equities or the others. So dealer groups have literally said, ‘We will not deal with the SMSF sector.’ But the message I’m giving there, ultimately, is direct asset ownership is the key to the growth of the SMSF sector, not managed investment

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schemes, except for hard-to- get-to areas such as small cap stocks or emerging markets, or something where clearly unitised investment can add demonstrable value. And ETFs [exchange traded funds] I think are a lay down misere for the growth of the sector, because they’re easy to get to, give the same exposure and they cost very little. Wells: So does that mean that advisers need to have a new skill set, and that is the ability to advise on direct? Dixon: I think there’s a structural challenge in that. I don’t think it’s the skill set or the mindset of the adviser. It’s to do with the legacy of the way the industry has grown up, where the licensing provisions make it extremely difficult for the responsible managers to manage the affairs of an adviser dealing with direct securities. And therefore, PI [professional indemnity] protection, they almost preclude people from doing it. Hogan: It’s becoming more common though. I do direct shares, and have done direct shares for a number of years, with self-funded clients and non-self-funded clients as well, and there’s not a concern. Knox: I agree with that, Peter, but what I would say is that’s probably because of the growth of the SMSF sector. If that hadn’t grown, I don’t think the call for direct asset ownership would be quite as strong as it is today. Wells: I think there’s a number of things aligning. There’s the point that you’re making, the growth of the sector, and there’s the GFC and this focus on fees. And all these things are aligning to encourage the dealer group to allow advisers to advise on those assets. And certainly the statistics that we’ve seen from Investment Trends show that more and more SMSF advisers who have SMSF clients are looking to advise also on shares. And the ones who are already advising on shares tend to have more SMSF clients. Keenan: And is it linked to independence as well? By far and away the greatest take-up of - and again I’m speaking from the ETF perspective, that’s where I come from - but most, by far and away the biggest take-up of our product in

‘More and more advisers who have SMSF clients are looking to advise also on shares’ Patricia Curtin

Australia is in the independent financial adviser market. And it’s our experience that, you know, they are the ones more likely to be managing large self-managed super funds. Knox: Why do you think that is, Tom? Keenan: Because I think they have more flexibility in their approach than just direct equities. Alan Dixon

Dixon: Unfortunately…the accountant

with the CPA logo and Chartered Accountant logo is far more trusted in his community than any financial adviser. So, even if you go and force these accountants to go and get an AFSL licence, they’ll probably go another step up on the row as being [regarded as] slightly more trusted, and doing the right thing for the clients.

When people get upset with the accountant, you see this [statement]: “Accountants are forcing people into SMSFs.” No, they’re more comfortable dealing with their accountant every year, who’s been helping them with their either personal tax or business tax. And a lot of financial planners don’t realise that these guys over in the accounting side, or the accounting independent side, are being respected more in the community. And…when they tell someone [to set up an SMSF], they think, ‘Hey, they want me to do my own thing, and have my own control; this guy’s on my side.’ Whereas [when a planner says it, they think], ‘You want me to go into the AMP, there must be some sort of commission in this for you, there must be some sort of fee; I don’t trust you.’ Colley: That fits also with the characteristics of the individuals that go into self-managed funds, because they’ve usually got their own businesses, some sort of structure. So self-managed funds is just an adjunct to the corporate structure they might have. Hogan: The interesting comment that I think Cooper made at the conference a couple of weeks ago was that the reason why he’s becoming more comfortable with self-managed super funds in the sector is because of the engagement of people in it, who use self-managed superannuation funds, they’re actually actively involved in their retirement savings. Wells: They’re hungry, they’re hungry for investment, specifically, information; they’re hungry for it. I mean, it’s such a contrast to the industry fund.

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And the biggest threat to industry funds is the more affluent end of the industry fund [membership] going into and setting up their own SMSFs. The industry funds aren’t really able to respond to that. And that’s an opportunity for the advice community as well. Knox: A point I’d like to really put to the table is most of the discussions around the SMSF sector always seems to want to compress and control it. So the responses tend to be either licensed accountants or whatever, and I thought Cooper’s comment was quite embracing. I thought it was an encouraging statement. I think if the whole key word shifts to an education program, ultimately the more educated people are on the whole concept of SMSFs, the more they’re likely to behave in the regulatory environment. Very few people genuinely want to step out of that. And I think the so-called areas that are difficult are those people [who] have set their SMSF up and have difficulty understanding that the assets are not theirs, they’re actually part of a trust, and they get a bit carried away and want to use those assets for paying down personal debt or buying personal assets. And if you control that - there isn’t a lot of evidence that that’s rampant I think the rest of it’s an education program. Wells: That’s really an important point, because if you’re trying to have a conversation with SMSF investors, I think it’s really important for the companies to realise that they have to get their head around the fact that they’re not in control anymore, it’s actually the investor who’s in control. And so there’s an element of respect that has to come with that, in terms of how you have the conversation with the investor. And I think, clearly, advisers who are working with SMSF investors understand that, understand how that works. It’s a little bit like social media, you know: ‘Oh, my goodness, I can’t control the message!’ But the fact is, people are talking anyway, and this is a really engaged audience. They’re talking anyway, they’re making decisions, they’re doing it whether we like it or not. And so if we can actually get involved in that conversation without trying to control it, then it’s going to be much

Peter Hogan

more effective. Colley: There’s probably two ways your financial planning can go. We get involved with the comprehensive financial plan, but often what you find with some clients is that they only want to go halfway, so they get the strategy advice, and the actual investment decision is left with them. So off they go and do their direct investing. Do you find that, Peter?

‘Certainly what we find is that they’re open to suggestions around diversification’ Hogan: Yeah, yeah, a lot of people like to have a conversation about certain shares and stocks, but they tend to initiate that conversation, rather than wanting me to be actively ringing them up and playing broker. They don’t want me to be broker, but they want someone to bounce ideas off. Skelly: So is that the right kind of advice that SMSFs should be getting? I mean, isn’t there something at a portfolio construction level

they could be missing if they [only] want to talk stock stories? Hogan: Yeah, sure there is. No, that’s absolutely right. And I think the thing is that we try and encourage our clients not to be in just Aussie shares and cash, and that there would be international funds, managed funds that perhaps they should use. Certainly what we find is that they’re open to suggestions around diversification, provided that what you’re suggesting is things they can’t easily do themselves. They’re quite happy to use the third party provider, but if they feel they can do it themselves, then that’s typically what they’ll want to do. Curtin: There is a good point in that one. There is inherently a bias within SMSFs. There is an asset concentration there. Sixty per cent of assets are either in Aussie shares or in cash. So I think there is an awareness that we need to give to clients in that, you know, diversification is key to reduce your risk. So rather than chasing return, and getting a better result from the APRA fund, you know, what we should be considering is the risk piece as well. So I would put it to the table that there is a return-versus-risk conversation or risk conversation to be had with clients. One of the things that we’re identifying is the education piece. We know the sector is very, very confident, maybe even over-confident, we know they want control, whatever the definition is around that control. However, I would suggest that confidence and control doesn’t equal competence, so there will always be a need for advice in some way, in this sector. And that issue of education is absolutely critical, because there is just not enough education out there. And we’re seeing in this sector that they are highly educated, they are the higher income earners, as such, and yet, when tested, 69 per cent of SMSFs said that they had a good understanding of their obligations, yet only 51 per cent of investors said they were the trustee. Hogan: Getting back to what you were saying about competency, one of the driving areas that SPAA [Self-Managed Super Fund Professionals’ Association of Australia] has been set up for, when it was set up seven or eight

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years ago, was how to raise the standards of the professionals in the industry, who are advising this space, because I think it was probably fair to say it’s not a problem that’s been entirely solved; and whether licensing of advisers or even separate licensing for accountants who can do audits, whether that’s the answer or not, I don’t know. There does need to be more work done in that area. But we found that the professional advice that was given left something to be desired in a number of cases. The accountants, particularly, play an incredibly important role in this sector, because in the end the Tax Office can’t possibly audit 420,000 funds a year. They rely entirely on the auditors of those funds to actually, as best as they can in the circumstances, ensure that the funds that they look after are run appropriately. And so they’re critical. And the fact that a large number, as you said, of accountants do fewer than ten [audits] - some would only do one a year - I mean, with all the other things that accountants have been asked to do in their professional lives, how can they possibly stay on top of superannuation when they have such a tiny part of their business devoted to superannuation? Something needs to be done. Hoyle: How well developed are the average SMSF trustees’ asset allocation and portfolio construction skills? Satill: In my experience with SMSFs, what people basically want is to try and stick within the Australian market, because they can see it, and they can follow it. And they have an aversion to investing in international shares, because a) they don’t know how to do it, and b) they don’t like the concept of managed funds, they don’t understand it. So really it is an education process that we try and deliver, and I’m finding that I’m gradually educating my clients to diversify, and to have investments overseas, and by using either ETFs or managed funds for those areas. But it is a slow process, because people can’t control their investments overseas, because they don’t know how to follow - so this is the big issue.

Trevor Satill

‘I just think that basically they just compare themselves to their friends’ And, you know, again with ETFs, I use ETFs in a big way, but again the thing is that unless there’s something listed, like an iShare, right, and we don’t know how to monitor, they don’t know whether it’s good, bad or indifferent. Hoyle: But is an SMSF trustee more or less receptive to your advice and guidance than a non-SMSF client? Satill: No, I think they’re both the same. A lot of people have watched the market over the last year, and people talk to their friends the whole time, and they’ll compare levels of advice. You know, someone will say, I have one client who is risk-averse, he says, and you’ve got probably 70 per cent of his portfolio in cash at the moment - term deposits. And today you’ll find them saying, ‘I’m not happy with the performance of my fund.’ So this is the situation that you’re having to deal with.

Hogan: Are you accountable for the investment performance of his fund? Satill: Yes. I am, actually. Hoyle: So an SMSF member, or trustee, doesn’t necessarily come to you equipped with a higher level of skills and expertise than what’s called an ‘ordinary’ client? Satill: I don’t think they’re any different. I just think that basically they just compare themselves to their friends, and they talk amongst their friends, and they say, ‘Why have you told this person this, and not me that?’ Curtin: But isn’t this a typical example of investor behaviour? In some ways it’s becoming much more tactical. You know, ‘What stock will I buy?’ rather than the strategic. Asset allocation drives between 80 and 90 per cent of your return, and the other 10 or 20 per cent is clever stock picking. Well, we seem to have the exact reverse here, and investor behaviour getting embedded in the SMSF industry, which is, I become more tactical and I just become a smart thinker. But at the end of the day, this SMSF is a super fund. It is for retirement. So the driver should be to accumulate your wealth for retirement. How much time have we spent around thinking of the asset allocation that’s required within SMSFs, which I think is probably the most critical thing? So is that another natural bias that we’re seeing in the SMSF market? So we’re seeing that immediate investor behaviour issue; we’re seeing local over global; we’re seeing concentration over diversification. So we’re seeing all these things happening, and I think we have got to shake this tree a little bit harder to make sure that we don’t have inherent biases in SMSFs, which maybe have grown up in other segments. Keenan: You can’t control what you can’t understand, and so outside domestic shares and cash, and property, people have less understanding of fixed income. They’re not as familiar with the brands in international investing as they are with Australian companies. And so it comes back to that point about education.

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We need to make asset allocation sexy, because if we can prove to the SMSF investor that it does impact their performance, then perhaps they’ll be more inclined to listen. But one of the marketing strategies we’ve always adopted when talking to SMSF investors directly is you never talk about asset allocation, because their eyes glaze over. You have to talk opportunistically. You know, hopefully you’re talking to them about an opportunity that is going to benefit them, of course, but that’s one of the things that, you know - when you’re talking to advisers, yes, talk about asset allocation; when you’re talking to SMSF investors it’s not opportunistic enough. You know, when you’re looking at what are you competing with in the marketplace in terms of messages, you don’t think, well, it’s going to be other - one part of what you might be competing with is another ETF, for example. But you’re also competing with residential property and you’re competing with shares and structured products, and all these other things that they’re looking at right now are the competitors, which is not an asset allocation argument. So I think a big education piece around asset allocation…is absolutely warranted, I agree with you. But I think we need to…really prove the benefits to them, so that they’ll embrace it. Hoyle: What do we actually know about the asset allocation and the investment performance of SMSFs as a group? Colley: As a body, our clients, they represent a balanced pool. I could pick particular funds where they’ve got large exposures to bonds, and they have had for many, many years, and that’s been a successful fund as well. And I’ve got some pensions which are in rather diabolical situations at the moment, because they’ve gone heavily into equities. But basically the overall portfolio we’ve got is a balanced portfolio. Skelly: One thing I want to put on the table, we’re assuming SMSFs do get the right financial advice, whereas in the financial crisis I think one in five stopped getting professional advice. So I think that some of the stats that we’re hearing around the room are based on SMSFs ever getting advice. In fact, there’s a large proportion who aren’t. Wells:

Tom Keenan

Hoyle: Something like eight out of ten

SMSFs are set up on the advice usually of an accountant. And that accountant is often not licensed to give investment advice. Satill: They’re not recommending a financial planner either. Hoyle: Right, so these funds get set up, presumably the contributions go into the fund, and then they’re effectively saying to the trustees, ‘Right, you’re on your own.’ And is this why we get these weird asset allocations in SMSFs? Amanda Skelly

Keenan: We even see that in our products, where a typical advice client will have a portfolio [that is] typically along the MSCI World, MSCI All Countries World, benchmarks. The non-advised are buying more things like China, or our emerging markets [ETFs] only. Obviously

that’s because they’re chasing return, and not constructing portfolios but being more opportunistic. Hogan: If you have an adviser, part of the process, where you get them engaged in asset allocation, is that they have to have an investment strategy. And so you have to sit down and have that conversation with them - first question you ask a new client is, well, where is it? And they’ll sort of go, ‘I don’t know.’ So the first thing I do is write one for them. Hoyle: Doesn’t an accountant have to do the same thing? Hogan: The accountant’s not allowed to. Hoyle: But doesn’t the accountant have to say, ‘You’ve got to have an investment strategy - I can’t help you with it, but you have to have one’? Wells: The number one [source] for who’s having the largest influence on your investment decisions, the number one is ‘my own research on the internet’. And then number two is daily newspapers. Satill: People are trying to do a lot of research themselves. But one of the big problems they are faced with today is that you read every day in the papers that Australia’s got the strongest economy in the world, the second strongest economy in the world. How do you go and tell a person that you should go invest internationally when you read Europe is a basket case, China’s holding back at the moment? You might have a China philosophy or you might have a particular philosophy, and you might say, Okay, the US dollar is at an all-time high against Australia. Maybe now is the time to get into ETFs for S&P 500, when the Australian dollar starts weakening you’re going to make some money. When? Knox: I do respect your expertise as planners and the ability to guide. But, as an adviser, why wouldn’t you focus on big picture issues in investment disciplines and asset allocation, rather than delving down to believing you can create an investment portfolio where the performance gets monitored and it’s better than somebody else’s? Satill: Let me say, I do, I do have asset allocations and I have a strategy, and I try and convince my clients; but you’re always going to

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find the clients who try and say - who argue with you, saying why they shouldn’t do it. Hogan: Financial planning is a process where you do the strategy first. And the last step of the process is the investment. But you still come to a point when they want to talk about particular stocks, or they want to talk about how they invest in a particular asset class. Colley: What we find with our largest self-managed funds is that there’s a propensity to have more managed funds. The less money they’ve got, they’ll go to direct stocks. Now, whether that’s a more gambling sort of approach than those that have only got a small amount of money; or those that have got a lot more money in there, the self-managed funds, whether they’re prepared to go to advisers, and advisers then balance their portfolio with managed funds. Skelly: What about the intersection of tax advice and investment advice? Are we as an industry doing enough on the tax-meets-investment side? Dixon: No. Because, for example, ETFs, if they’re run with a very passive approach to index turnover, are so much better for your client than even the best active manager. Because the active managers, with their high turnover in the accumulation phase, are spitting out short-term capital gains all the time, getting taxed while you’re still in the accumulation phase. That’s taking 15 per cent off the table. The better ETFs that I’ve seen keep that to a minimum, because index changes are relatively small. So it’s a much, much better result. So let’s say you’re XYZ product manufacturer, you should be thinking about going, well, I’m going to have a fund for you, but this is the SMSF version where we’ll consciously reduce the turnover, and we won’t just keep selling. You know, we’ll try and reduce the amount of short-term capital gains. Skelly: So we need to evolve our products to think about tax? Colley: Exactly, because it gets back to control, flexibility, and that idea where people can actually pick a stock, sit on it for as long as they wish, and then make that decision as to whether

Ian Knox

they get the capital gain. Dixon: So if I was an active manager, I’d at least create a low turnover version of every one of my funds, because a lot of the turnover they create, they’re just thinking about winning the league table with the gross returns, because that’s how they pay them, that’s how they benchmark them, that’s where flows come from. But SMSFs are not totally unique, because a lot of people try to develop products in retail land that can do the same thing. But one of the massive advantages is, you can hold your assets from the age of 40, convert to a pension at 60, and never pay the capital gains tax. Colley: So you probably want to have an accumulation-style fund in that phase of super, and a pension-style fund, if you might have large capital gains coming in. Hoyle: Do we have any idea of what proportion of self-managed super funds are actively advised? And what proportion are not? Satill: I would say to you that if 20 per cent of self-managed super funds were advised, that would be a lot. Wells: That’s exactly the number; it’s 19 per cent. Well, certainly 19 per cent of SMSF investors used an adviser in the last 12 months. That was at August 2009. It’s actually probably a higher figure than that. And 45 per cent said they’d used an accountant. Satill: Accountants are lacking control. I’ve seen it over the years. And accountants don’t

‘The number one [source of information] is “my own research on the internet”.’ readily recommend that a client goes to see a financial planner. And it’s almost from a fear of losing that client, because if [the client gets] comfortable with that financial planner and the financial planner says something which the accountant has not said before, the client starts wondering about the other advice that the accountant has given. And accountants are always scared, and that’s why you’ll find - if you look at any accountant/financial adviser relationship, the accountant and financial planner are not in partnership. You will see that only a small portion of clients use the financial planner. Colley: I think it works both ways. You see financial planners reluctant to recommend accountants, and accountants reluctant to recommend financial planners unless they’ve got some close relationship, like you point out. Satill: The problem is professional indemnity insurance for accountants. Accountants are petrified of giving advice, and they’d rather give generic advice, and really don’t want to give investment advice. I’ve seen that time and time again. Hoyle: Tom, you’ve said that half of your investors have self-managed funds? Do you ask them why? And where does cost come into that decision-making process? Keenan: Cost is a big driver, but it all comes back to this, what we’ve been talking about for most of the morning: control. Control over cost, control over liquidity, control over the after-tax outcome. Control in a lot of the things that the traditional managed fund traditionally

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hasn’t helped. And so, yeah, an ETF can give exposure to equity markets for a fraction of what has traditionally been the case, and that is a major driver. Dixon: If you’re an adviser, it takes a while, particularly if your businesses works on commission, but it leads you to actually have the guts and ask for your fee. I’ll tell you with the GFC, it’s hard to ask for your annual retainer. It’d be much easier to keep on slipping it out the back door. Don’t forget how powerful for a retail investor it is showing something like [listed investment company] Argo that charges 0.1 per cent per annum, and Rob Patterson has been running it since before I was born - I think he started his job in 1969 - and it’s beaten the market by 1 or 2 per cent a year. And that’s a chart that’s pretty easy to show people. Keenan: And the MER on a fund is just one part of it. They’re traded on the ASX, so the savings from implementation are real from an adviser’s business [perspective] as well. Dixon: And the record keeping is a lot easier. Same with people’s accounting systems. Deals really well with ASX listed shares, and talks to CHESS. Every managed fund provider is using a different platform. And have you tried transferring a managed fund in specie, compared to transferring an ASX share? Not something I’d recommend to anyone who likes themselves. You know what I mean? It’s a horrible experience. ETFs certainly - if you want to get your [managed fund] into self-managed super funds, whatever fund you have, turn it into an ETF as well. Curtin: Managed funds today, I think they constitute maybe 10 per cent or even less of all assets within SMSFs. So I guess that in itself, that’s not the major competitor. If I look at the asset allocation of that self-managed super fund, we’re talking about direct shares and cash; so is ETF the proxy for a direct share option, as well as investing that cash that’s out there in the market? Because with the direct share pieces you can become very tactical, do your own research on each stock and then you choose that, et cetera. At the end of the day you actually have a

Sally Wells

little bit of risk in that research, and the rigour behind it. So do you see that ETFs are going to actually provide that rigour for clients, and become an easier implementation piece? Hence why it is becoming quite popular? Keenan: I think the benefit of ETFs is flexibility. So they can be used to allocate longterm, buy-and-hold strategic asset allocation. And we see that used a lot. And I think as well as they can be used, actually. So if someone wants to make a call on a market, and that’s not a long-term view, then they can do that. But the point is that they control when they enter, when they exit; they control exactly what market they’ve been looking for. So we’ve heard a lot that international investing is difficult, not a lot of self-managed super funds invest internationally. And I think part of that is that they haven’t had a vehicle to do so. International managed funds tend to be more expensive, they tend to be less liquid, and so therefore the end investor has less control over that international investment. [An ETF is] on the ASX, T+3 liquidity, like any other stock, and so it brings that element of control. And so, hence I think that international investing may become more popular than selfmanaged super funds, given this new vehicle that is now there for them to look at. Knox: A trustee can be both tactical and strategic: they could compose a portfolio, a new class in ETFs around the risk profile, if they had that discipline. Conversely they can sell quite rapidly through impulse or tactically if they want

to, on a weekly basis. I’d suggest a lot of them will do that. Wells: I think that’s an important point, because part of the opportunistic nature, particularly when it comes to the share trading of SMSFs, is I want to win, you know, I want to beat the market. A lot of active traders are trying to do that, and many active traders are SMSF investors. And so I think that’ll be the education piece, because I’ve still got to feel like I’m achieving - the human nature element of it. It’s got to still feel like I’m achieving something. If I’m just buying a market, I can’t really beat that market. So therefore, I think the point you make about having those different tweaks, I think that will become appealing. Satill: One concern though, about ETFs, some ETFs, is the thinness of the volumes on a daily basis. And you never know if…your share is fairly valued or not. And who’s buying the shares? Is it iShares buying it back, or is it another person? These are always the concerns that a lot of people have, either management or whatever. Curtin: I think the notion of being clear on the outcome. I think, what if the outcome of this portfolio, as such, is going to be more critical, and what’s its role in the portfolio? One of the things that we’re considering at Russell is this outcomeoriented portfolio piece, and considering what we’re building our ETFs [for] and saying, ‘Well, what role did that play?’ Is it playing the income role, is it playing the high dividend role, et cetera, et cetera, for an SMSF player. So I think focusing on the output is as critical as focusing on the inputs, from an ETF perspective.

I N V E S T OR PS YCHO LOG Y

Short-term focus, long-term pain Share investors require the patience to let companies implement long-term plans, says Bob Van Munster

Short-termism - the evidence

As a participant in the investment industry for more than 35 years, I have been observing the increasing focus on the short term from a variety of aspects - from a shareholder investing on behalf of our clients, and as a fund manager being constantly scrutinised for performance by the industry. I have observed a marked increase in the level of short-termism in the market in recent years, as

evidenced by higher turnover in the sharemarket, shorter tenures for CEOs, and remuneration packages for senior management that have a heavy bent towards short-term performance. I see this behaviour at its strongest during company reporting season. The last reporting season in February was a particularly enlightening one, where we saw a high level of “fast money” looking for a turnaround in company performance and profitability, which exited quickly if reality fell short of expectations. This included companies that reported a lift in profit, but which still disappointed. Qantas was a case in point. It returned a good result for the first half of the year (it delivered a profit while most airlines languished in the red), has worked at rationalising the business, and is well positioned to take advantage of the expected increase in travel as the global economy gains momentum. But the market was expect-

ing more of that positive outlook to be delivered now. When the company didn’t increase its guidance for its full-year profit, the stock fell 12 per cent in a week (see chart 1). Nothing had changed, except that the analysts had forecast a linear recovery and were disappointed. The company’s advice that price increases take some time to flow through to higher revenues should have been heeded. With no change to the longerterm fundamentals the stock slowly recovered its losses over the next month or so. This “fast money” trend, where investors are looking to make quick gains, is not new and we expect it to continue for some time yet. Similarly, we expect the average holding period for stocks to continue the decline that has now been in place for several years. During the last reporting season there was an unusually high level of turnover in the sharemarket across all sectors, which is an indicator of

Chart 1: Qantas feels the heat from short-termism $

Qantas share price A$

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n the wealth management industry we constantly advocate the need for investors to take a long-term view - we have even written about this many times ourselves in this column. Sadly though, many continue to focus on the short term - and it’s not just investors or day traders either. This behaviour is widespread from professional investors, to analysts, corporations and even fund managers - either by their own doing or just the sheer pressure of others. Working in the funds management industry I see this behaviour every day; and like the other investor behaviours we have explored in previous articles, it’s not necessarily a rational or healthy approach. In this article we look at how “short-termism” can not only impact investor returns, but can ultimately be detrimental to long-term economic growth. Investors chasing the next big stock phenomenon, hoping to make a quick capital gain; companies facing constant pressure to meet analysts’ profit expectations; and fund managers being increasingly scrutinised for their shortterm performance, are all damaging behaviours. Indeed, they run counter to the underlying premise of investing in shares in the first place, with the majority of Australian share funds having an investment time horizon of three to five-plus years.

Source: IRESS and Tyndall Investment Management Limited

I NV ES T O R P SYC H OL O GY

Bob Van Munster

the average holding period of stocks. Indicative numbers show that the Australian sharemarket, which has a market capitalisation of around $1.3 trillion and an annual turnover of around $1.430 trillion, effectively turns itself over every nine months. This compares with every 15 months just four years ago; and roughly every two years, 12 years ago. Those companies that have high turnover in their shares make it very difficult for management to have confidence in implementing long-term investment plans. This trend for a lower average holding period is also evident overseas. In the US, the average holding period for stocks on the New York Stock Exchange has progressively fallen over the past 70 years. In the 1940s the average stock holding period was around 10 years. By the 1970s this had fallen to six years; but by the late 2000s this had fallen to just six months. There are a number of reasons for this decline; however, there is clearly a trend for investors to turnover their stocks much more frequently.

This trend was further evidenced by a fall in the holding period for US mutual funds. In a paper written by John C Bogle, founder and former chairman of The Vanguard Group, in the Financial Analysts Journal in 2005, he commented that the average holding period for mutual funds in the 1950s was 10 years, but by 2004 it had fallen to around four years. Gone are the days when investors bought funds for the long haul. Bogle cited the plethora of managed funds in all shapes, sizes and sectors now available to investors as one of the reasons for the higher turnover. Similarly in Australia, investors have an incredible array of managed funds to choose from. Each time an investor switches from one fund to the next, they are more than likely paying the price in one form or another - namely transaction costs - which perhaps unbeknown to them could be having an impact on their net returns. Corporates feeling the pressure

Companies are feeling the pressure of this short-term focus on their profits, especially by analysts. Each reporting period there are high expectations for companies to deliver on their profit forecasts - not for the next financial year, but the next six months. Analysts are increasingly expecting companies to not just meet, but exceed their expectations. If they don’t, then the share price suffers. This constant pressure for companies to exceed short-term profit expectations means that often long-term investment can be sacrificed. Cost cutting to the muscle is a reflection of companies making short-term gains for long-term pain. The danger here is that companies are less willing to invest for the long term, as the pay-off period is too lengthy for a market obsessed with short-term earnings results. This is not beneficial for a company’s growth or indeed the economy. One way management are getting around

this dilemma is to participate in private equity deals, rather than staying listed (or listing) on the stock exchange. One example of this was Myer. In June 2006 retailing giant Myer was sold to a private equity (PE) group led by Texas Pacific Group and which also included the Myer family and company management. The PE group implemented significant changes, including updating the look of the stores, new IT systems, changing the store-card and loyalty program and the management reward system. By going private, company management were able to make changes and turn the company around. While the company may have been able to make these changes if they had remained a public company, the market would have punished them severely. According to Myer CEO Bernie Brookes, “Because you are no longer a public company, the focus of your communication on the changes can be internal; ie, your own staff - you don’t have to explain yourself again and again to a stream of financial analysts or shareholders.” He also stated, “We don’t need to ‘sugar-coat things’, we can make smart financial decisions that have long-term benefits, and the owners are sophisticated enough to understand and endorse that approach.” The PE group paid $1.4 billion for Myer and it was subsequently floated on the Australian Stock Exchange in September 2009 for a value of $2.3 billion - delivering them a very handsome return of 64 per cent. Fund managers under scrutiny

Fund managers too are feeling the pinch, with an increasing focus on their short-term performance. The release of the performance tables by various research houses, and accompanying media reports about which fund manager was ranked number one over the previous month, are testimony to this behaviour. The constant focus on short-term perfor-

Value every moment of retirement. For information about the Tyndall Australian Share Income Fund visit www.tyndall.com.au/shareincome Disclaimer: The value of an investment can rise and fall and past performance is no guarantee of future performance. Any information contained in this advertisement has been prepared without taking into account an investor’s objectives, financial situation or needs. Investment decisions should be made on information contained in a current Product Disclosure Statement (PDS) and applications to invest will only be accepted if made on an application form attached to a current PDS available from Tyndall. The Responsible Entity of the Tyndall Australian Share Income Fund ARSN 133 980 819 is Tasman Asset Management Limited ABN 34 002 542 038 AFSL No 229 664 (trading as Tyndall Asset Management). 2214_PP

I N V E S T OR PS YCHO LOG Y

mance runs counter to the investment philosophy for many fund managers and is also contradictory to the investment objective of share funds, which tend to have investment horizons of three to five-plus years. At Tyndall Investments, we adopt a threeyear view and look beyond the market “noise” to find intrinsic value in stocks. This can mean our share portfolios may underperform in the short term as we buy certain stocks as they continue to fall, remaining steadfast in stocks we believe will outperform over the long term. However, our disciplined approach is generally rewarded with strong long-term outperformance when the market re-bounds and re-focuses on a company’s fundamentals and long-term growth prospects. A good example of this occurred during the recent global financial crisis when many cyclical stocks were sold down heavily and represented exceptional value, providing good buying opportunities for value managers. Unlike the tech boom, where optimism fuelled demand for growth stocks, this time pessimism fuelled demand for defensive and “safe” stocks. Investors were prepared to pay a premium for stocks in sectors such as healthcare and consumer staples. As an intrinsic value manager, we recognised that cyclical stocks represented excellent value compared to defensives, with the price-to-earnings spread between the two widening to extreme levels (see chart 2). Accordingly, taking a three-year view, we positioned the portfolio to benefit from an expected market upturn. While we did experience short-term underperformance on some of these stocks, as fear remained supreme, our strategy did pay off with cyclical stocks subsequently bouncing back in March and April 2009 (as evidenced by the narrowing in the P/E spread in chart 2) as investor confidence returned. This pressure to outperform in the short term can mean some fund managers may be reluctant to make investments in stocks that don’t pay off for a few years. This of course can lead to some active managers being accused of being index huggers - which is not what investors

Chart 2: P/E of Australian defensives versus cyclicals

are paying for. The short-term focus can also mean fund managers can be terminated too early in the cycle. Research by Goyal and Wahal (2004) on the hiring and firing of fund managers by US pension funds between 1994 and 2003, showed that fund managers are fired at the wrong point in the cycle, with excess returns of the fired fund managers usually turning positive after being fired. They concluded that if the pension plans had stayed with the fired investment managers, their excess returns would have been similar to those from the newly hired managers. David Gonski, chairman of the Australian Securities Exchange and chancellor of the University of New South Wales, believes the way fund managers are continually monitored and graded is one of the biggest reasons for the market’s short-term focus, summing up the situation succinctly stating: “We judge investment managers on their ability to perform well in the short term, which is crazy since many of these managers are funding whole-of-life situations.” Gonski went as far to say that short-termism actually contributed to the global financial crisis, with the ready supply of cheap credit and the constant pressure to produce quick profits substantially weakening company balance sheets.

The focus on the short term is indeed an issue for investors, companies and fund managers alike, either of their own making or because of pressure from gatekeepers and influencers. This behaviour is not beneficial for any party and directly contradicts the purpose of investing. It represents a complete mismatch with each party’s goals - whether it is an individual’s investment objective, a company’s long-term business plan or a fund manager’s performance objective. Shares are a long-term investment, not only because of their volatile nature, but primarily because their intrinsic value (as opposed to their market value) is a function of their future longterm earnings and cash flows. In order to grow and reward their shareholders with dividends and capital growth, companies need to invest in their business, which can involve projects that run for many years. Companies need to have confidence that they can implement these long-term strategies; and investors and analysts need to have patience to let these projects run and deliver long-term benefits to shareholders.

Bob Van Munster is head of equities for Tyndall Investment Management

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S ELF - M ANAGED S UPER

Catch-all and general compliance clauses Even though the terms are often used interchangeably, and both commonly appear in SMSF deeds, there is a difference between a catch-all provision and a general compliance clause, says Tony Negline

general compliance clause is intended to automatically incorporate super legislation changes into the trust deed. An example of a general compliance clause is: “Where compliance with a SIS requirement is a prerequisite for the fund as a self-managed superannuation fund to qualify as a complying fund, and that requirement has not been set out in this Deed, then the SIS requirement will be deemed to have been included in this Deed.” A catch-all provision is intended to give trustees the power to do anything which is not prohibited by law. An example of a catch-all provision is: “In addition to any powers expressly conferred upon the Trustee by the SIS Act or by the provisions of this Deed, the Trustee has the power to do anything which is not prohibited by the SIS Act.” These clauses are a reasonably controversial part of the superannuation arena. Some argue that a decent catch-all clause and compliance clause delays the need to update self-managed super fund trust deeds. To fully investigate the differences between catch-all and general compliance clauses, as well as some important historical background, I interviewed Shannon Lee, a lawyer with Townsends Business and Corporate Lawyers. Negline:

What do these provisions seek

to achieve? Lee: Broadly, catch-all provisions and general compliance clauses are intended to ensure the terms of the trust deed are always up to date and compliant with super law, thereby eliminat-

‘This “OSSA Standards” provision was the first “compliance clause” ’ ing costs of subsequent deed amendments. What is the history of general compliance clauses? LEE: Possibly, the history of general compliance provisions starts with the Occupational Superannuation Standards Regulations, which ceased to exist in 1994. These regulations required the trust deed of a superannuation fund to include clauses that reproduced certain provisions of the Occupational Superannuation Standards Act (OSSA). OSSA was the predecessor to the SIS Act. For example, OSSA Regulation 16 had to be set out in a super fund’s trust deed. This regulation set as OSSA standards the prohibition on funds lending to members, and on funds borrowing or investing on non-arm’s length terms. With the introduction of the OSSA regulatory system for super, most trust deeds were amended to expressly include the various proviNEGLINE:

Shannon Lee

sions which were then required to be included in the trust deed by OSSA Regulation 18. Given the frequent changes to superannuation law, lawyers attempted to deal with new standards by including a provision to the effect that any future OSSA standard that was required by Regulation 18 to be set out in the trust deed of the fund was deemed to be automatically incorporated into the trust deed. This “OSSA Standards” provision was the first “compliance clause”. Gradually, the drafting of the OSSA Standard provision became more sophisticated and attempted to deal with not only new OSSA standards which had to be included in a trust deed but also future modifications of existing

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S ELF - M ANAGED S UPER

OSSA standards and future new standards. At the same time, catch-all provisions became a popular means of conferring power on trustees to deal with any new developments in legislation and practice. NEGLINE: Compliance clauses were useful under the OSSA regime. Do they remain useful under the SIS regime? LEE: The OSSA and SIS regimes for superannuation funds are very different. The Federal Government does not have specific power under the Australian Constitution to make laws with respect to superannuation or to regulate any trustees. In order to make laws, the Federal Government has to rely on one of its own powers. Under the OSSA regime, the Federal Government indirectly regulated superannuation by using its tax powers (that is, by conferral of tax incentives and the imposition of tax penalties). It could not expressly require members and trustees to do or not do anything. But it could indirectly require trustees and members to put those requirements and prohibitions in the deed in order to receive favourable tax treatment. Hence, the need for and existence of OSSA Regulation 18. By contrast the SIS Regime relies on the Federal Government’s corporations and old age pension powers as well as its taxation powers. The reliance on the corporations and old age pension powers allows the Federal Government to directly require trustees to do or not do anything. Under the SIS regime, it is hard to find a section which requires a particular provision to be included in the trust deed. NEGLINE: What about Section 52 - the covenant clause? LEE: This deems the various statutory covenants to be included in the governing rules if they are not already included and therefore

Tony Negline

technically isn’t a contender. The SIS provisions apply by force of law rather than as provisions of the trust deed (the statutory covenants are deemed to be included in the trust deed and therefore are not an exception). The SIS Act does not contain and does

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not need to contain a provision that corresponds to OSSA Regulation 18. NEGLINE: Is there any role for general

compliance clauses under SIS? LEE: Yes, but it’s a limited role. Its use

SELF - M ANA G ED SU P ER

would be restricted to the situation were the trust deed sets out a particular prudential standard and that prudential standard was subsequently relaxed. For example, where the trust deed embeds the 5 per cent in-house asset limit and that limit was subsequently relaxed from 5 per cent to 10 per cent. In this situation an appropriately drafted compliance clause could “capture” the modified standard without the need for an amendment to a super fund’s trust deed.

meant the definition of a member’s “dependent” also expanded. Accordingly, the categories of person eligible to receive a member’s death benefit increased - provided the trust deed allowed payments. If after July 2008, a trustee wanted to pay a death benefit to a person who met the expanded definition of (say) spouse and the trust deed was a pre-July 2008 trust deed but used appropriate catch-all language in the definition of spouse, no deed amendment would have been necessary for

NEGLINE: What are the consequences of a deed containing a general compliance clause? LEE: While the role of these clauses is limited, it will generally not matter if these clauses appear in a trust deed provided they are appropriately drafted. Some compliance clauses are drafted very widely and catch too much. For example, in the Queensland Supreme Court case decided last year, Donovan v Donovan, an SMSF trust deed sought to allow for binding death benefit nominations by simply incorporating the “relevant SIS requirements” via a general compliance clause. The Supreme Court noted that even if the nomination were binding - in fact, the nomination was not binding, as it failed to use the term “binding” or any equivalent terminology - the compliance provision incorporated the SIS rules as they relate to binding nominations within non-SMSF funds.

‘Catch-all clauses are often not accepted by third parties (such as banks)’

Let’s now look at catch-all provisions. Do they enable an SMSF deed to remain up to date without the need for further amendment? LEE: There are changes to the law that a suitable catch-all provision, or the appropriate use of catch-all language, will trap. For example, from July 1, 2008 the SIS Act definitions of both “spouse” and “child” were expanded. The amendment to these definitions NEGLINE:

the trustee to make the payment. However, if the deed merely replicated the pre-July 2008 definition of spouse or member and did not have any catch-all language in the definition, the trustee would not be able to make the payment without the deed being updated. However, it is paramount that trustees and fund administrators understand both the practical and technical limitation of catch-all language and catch-all provisions. What are the practical limitations of catch-all provisions? LEE : Catch-all clauses are often not accepted by third parties (such as banks and state revenue offices and land titles offices) as a source of power for a trustee to undertake particular NEGLINE:

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actions. For example, it is unlikely a major lender will lend to a trustee who relies on a catch-all provision as the source of the trustee’s power to borrow in a super gearing arrangement. Instead, the lender will require the trust deed to include an express power of the trustee to borrow. NEGLINE: What are the technical limitations of catch-all provisions? LEE: Firstly, there is argument as to whether catch-all provisions are at all effective. A trust is not a legal entity - it is the trustee that is the legal entity. The powers of a trustee do not arise as a matter of course (unlike natural persons or companies which are given the powers of a natural person at law). Rather, the trustee’s powers may only be derived through the courts, by legislation, and by the trust deed. If the trustee undertakes an action which is not permitted by one of those sources of power, the trustee is in breach of trust. Let’s look at those sources of power. Clearly, it is impractical for a court to continually confer powers on trustees. Also, while the relevant state and territory trustee legislation certainly confers powers on a trustee, certain superannuation powers are not within their scope. The SIS Act does not give trustees extensive powers. These provisions are generally either prohibitive, or they are permissive.

What do you mean by permissive and prohibitive powers? LEE: Well, prohibitive powers tell a trustee that they cannot do something. For example, “The trustee must not lend to a member”. A permissive power allows a certain action but does not actually authorise a trustee to take that action. NEGLINE:

S ELF - M ANAGED S UPER

So what is a trustee’s dominant source of power? LEE: It’s the terms of the trust deed that are the predominant source of a trustee’s power. This is where the argument as to the effectiveness of catch-all provisions arises. On the one hand, it is argued that the powers must be set out expressly and should not be implied from a catch-all provision. The basis of this argument is that as there is no standard set of trustee’s powers, a positive formulation of the trustee’s powers must be set out expressly in the deed. On the other hand, it is argued that a catch-all provision is sufficient - it is a positive formulation of the trustee’s powers and that power does not need to be express. NEGLINE: What if we accept the argument that catch-all provisions do give trustees power to undertake particular actions? LEE: Even if we accept that an appropriately drafted catch-all provision effectively gives the trustee power to undertake a particular action, they do not set out the mechanics or parameters of using that power. In certain situations, this is extremely important. This can be seen in the context of binding nominations. The SIS laws are not a source of power for a member to make a binding death benefit nomination. Also, they’re not a source of power for a trustee to accept the nomination. The SIS Act simply states that if the trust deed allows a third party (so, a member) to give directions to the trustee, the trustee will not be in breach of its duty not to delegate its decisionmaking power. So, the power has to come from within the deed. Let’s accept the argument that a catch-all provision gives the trustee power to accept a binding nomination. That is all the catch-all provision will do - give power to the trustee to accept the binding nomination. It does not compel the trustee to act in accordance with the nomination. The trustee could follow the nomination if it wanted to, but would not have to under the deed. NEGLINE:

‘The trust deed can be amended retrospectively and signed by the members’

ally depend on the action the trustee has taken, and even then, on a case-by-case basis. Do frequent deed updates for SMSFs give rise to any CGT liability? LEE: The High Court decided a while ago that changing a super fund’s trust deed did not lead to a resettlement of the trust and hence capital gains tax (CGT) will not apply. NEGLINE:

Another example is account-based pensions. The SIS laws say that if a benefit is cashed out it can be paid as either a pension or lump sum. In short, pensions are not compulsory under the super laws. This means that the terms of a pension and its ability to provide for any estate planning objectives depend entirely on the terms of the trust deed. You cannot get around this by simply saying a fund can provide whatever benefits are permitted by the SIS laws. The SIS Act provides that the trustee can pay an account-based pension, but the definition of an account-based pension is not complete. For example, the SIS regs provide that a pension is only transferable on the death of the pensioner. This is not the authority that a particular pension is reversionary or non-reversionary. Whether the pension is reversionary, and the identity of the beneficiary, are determined by the terms of the pension. What should a trustee do if it has relied on an ineffective catch-all provision? LEE: That depends on the particular action the trustee has taken. If a member has given a “binding nomination” to the trustee on the basis of a catch-all provision, then the deed should be amended to expressly provide for binding nominations. The member should then make another nomination in accordance with the terms of the amended deed. For other actions, perhaps the trust deed can be amended retrospectively and signed by the members to ratify the trust action. It would reNEGLINE:

Tony Negline is general manager, corporate strategy, at SUPERCentral - www.supercentral.com. au. He is also the author of “A How to Book of Self Managed Superannuation Funds”. Details about the book are available at www.atcbiz.com.au/smsfstore.php

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What Cooper means for SMSFs Bryce Figot casts an eye over what the review of the super system means for self-managed funds

n mid-2009, the Federal Government announced a comprehensive review of Australia’s superannuation system to be headed by Jeremy Cooper. The review was broken into several stages. The stage involving the review into self-managed superannuation funds (SMSFs) has just been released. This article examines some of the more significant recommendations it makes.

‘The review... recommends that the jurisdiction of the SCT be extended’

SMSFs may borrow for at least the next two years

Since 2007, SMSF trustees have been allowed to borrow, assuming they meet strict requirements. This is often referred to as an “instalment warrant”-type borrowing. However, there was always a question mark over these borrowing arrangements. Many questioned whether the law would actually allow SMSF trustees to borrow to buy real estate. In April 2008, the Australian Taxation Office (ATO) confirmed that it did. However, people still wondered whether these laws would be repealed. The review considered this aspect. Although the review does seem to consider the borrowing laws to be a concern, it does not recommend that they be abolished. Instead, it recommends a more cautious approach. It suggests that the laws allowing borrowing be reviewed in two years’ time to ensure that borrowing has not become, and does not look like it is becoming, a significant focus of superannuation funds. Accordingly, SMSF borrowing is here to stay - for the time being at least!

Superannuation Complaints Tribunal

Bryce Figot

More and more money is being held in superannuation. Furthermore, now that superannuation monies do not have to be paid out upon retirement, more wealth is in superannuation upon death, rather than being held in individuals’ names upon death. Of course, Wills typically don’t govern how superannuation fund assets are dealt with upon death; the rules governing a superannuation fund do. Therefore, rather than challenging Wills, more and more disappointed potential recipients are now looking to challenge a superannuation fund trustee’s decision as to how death benefits are paid out. In the early 1990s, the Government established the Superannuation Complaints Tribunal (SCT) to hear such disputes as a quicker, easier and cheaper alternative to a court proceeding. However, the SCT does not have the jurisdic-

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S ELF - M ANAGED S UPER

tion to hear disputes involving SMSFs - only those involving non-SMSF superannuation funds. The review proposes a change to this. It recommends that the jurisdiction of the SCT be extended to resolve death benefit disputes between an SMSF trustee and a beneficiary who is not a member. If implemented, this will be a significant change. For disappointed potential recipients, it will be a godsend, since it will be much easier to bring an action. However, given this increased ease in bringing actions, it could see an even bigger rise in SMSF death benefit disputes. No more in-house assets

Broadly, an in-house asset is an investment in a related party. Often these related parties run businesses that might employ fund members. Therefore, if superannuation fund assets are invested too heavily in the related parties, there is a risk that if the related parties get into financial difficulties, this can mean fund members can get hit with a double whammy. Whammy number one is that the fund members could lose their jobs and thus lose their employment income today. Whammy number two is that they could see their superannuation investments fall in value and therefore lose their retirement income tomorrow. For this, and other reasons, a fund’s ability to invest in related parties has been restricted. Under current law, no more than 5 per cent of a fund’s assets can be invested in in-house assets. Therefore, an SMSF with $1 million in assets might still be able to legally invest $50,000 in a related party. The review has advocated an end to this “5 per cent limit”. It also recommends that fund assets must not include any in-house assets. It must be noted that those fund trustees whose portfolios include in-house assets must dispose of those assets by 2020. There are currently many exceptions to what is an in-house asset. Notably, these exceptions include business property that is leased to related parties and unit trusts that were invested in before 1999. The review does not recommend

‘The review does give a nod to the special role of SMSFs in the superannuation industry’ altering these arrangements. Rather, these arrangements would be grandfathered and should be able to continue indefinitely.

Professional valuations and market valuations required

The ATO has always maintained that it is best practice to use a qualified valuer where assets are being acquired from related parties and those assets do not have readily observable markets (for example, real estate). Further, although SMSFs are not currently required to report assets on their balance sheets at net market values, the ATO has nevertheless encouraged it. See the ATO’s Superannuation Circular 2003/1. The review proposes that both of these best practices become a legal requirement. Although some of the review’s recommendations result in more regulation, the review does give a nod to the special role of SMSFs in the superannuation industry and acknowledges that SMSFs are here to stay.

No more collectables or personal use assets

Some SMSF trustees invest in “exotic” or “alternative” assets. Such assets are broadly the same as the tax law concepts of “collectables” and “personal use assets”. They include things like paintings, jewellery, antiques, stamps, wine, cars, golf club memberships, race horses and boats. The review has formed the view that these should not be regarded as investments that build retirement savings. Accordingly, it is recommended that SMSF trustees be prohibited from making such investments. For SMSF trustees that have already invested in them, it is proposed that such assets must be disposed of by 2020.

The full text of the review’s recommendations is available at: www.supersystemreview.gov.au/ content/downloads/self_managed_solutions/ self_managed_super_solutions.pdf

No more off-market transfers of listed securities

Those SMSF trustees that invest in listed securities might acquire such securities from - or dispose of such securities to - related parties. To save on brokerage fees, these transfers are often done by way of off-market transfers. The review recommends that, moving forward, off-market transfers will be prohibited and instead, where there is an underlying formal market (for example, the ASX), transactions with related parties must be conducted through that market.

Bryce Figot is a senior associate at leading SMSF law firm DBA Lawyers - www.dbalawyers.com.au.

T EC HN I C A L

Turning insurance inside out Jennifer Brookhouse explains why TPD premiums may become less effective inside super

common strategy to reduce the effective cost of total and permanent disability (TPD) insurance premiums is to hold the policy inside superannuation. However, this strategy may become less effective from July 1, 2011. This gives advisers a year to provide new advice to affected clients and, in some cases, move the insurance out of superannuation. If legislation is not passed to ensure this change applies only from 2011, the reduced deduction could be backdated to July 1, 2004. Reducing the cost of premiums

Superannuation is commonly used to allow a client to cost effectively pay for life insurance premiums. The cost of premiums is reduced through a combination of salary sacrifice (or personal tax deduction for contributions) and the ability for the trustee to claim a tax deduction for the premiums to offset the contributions tax. This is shown in the diagram below.

Concessional contribution* $1,000

If the trustee passes on the value of the tax deduction directly to the client, tax is not deducted from the contribution. The new interpretation of legislation

Changes to legislation wording on July 1, 2007 highlighted a problem with the full deductibility of TPD premiums. This issue has been in dispute for the past two years. The Australian Taxation Office (ATO) is sticking to its position that the new wording did not change the rules, and its current interpretation - that TPD premiums are not always fully deductible - should have applied since July 1, 2004. Temporary relief is proposed to allow the industry time to make adjustments and to avoid backdating. If legislation is passed, TPD premiums will remain fully deductible until July 1, 2011, but from that date the circumstances around the policy need to be examined to deter-

Super Fund

Assessable income of the fund

Insurance Policy premium $1,000

Tax deduction to the fund

* Contribution is salary sacrifice or a personal deductible contribution or employer contribution.

Superannuation fund tax return: Assessable income Less deduction Taxable income

$1000 $1000 Nil

mine how much of the premium is deductible. The current interpretation is that the TPD premiums will be deductible only to “the extent the policies have the necessary connection to a liability of the fund to provide disability superan-

nuation benefits to their members and not other types of insurance for which premiums are collected from their members”. In simple terms, this means that if the TPD policy definition matches the Superannuation Industry Supervision (SIS) permanent incapacity release definition, the full premium is likely to be deductible. However, the premium for policies with other definitions, such as “own occupation”, may only be partially deductible or potentially not deductible at all. The changes are proposed to apply from July 1, 2011, but this may have immediate implications for advice strategies to determine whether policies should: • be selected with disability definitions that are likely to maintain the full deductibility, or • be moved outside superannuation by July 1, 2011. Adviser action - impact on advice

Legislation to defer the new interpretation to July 1, 2011 has not been passed, so advisers should keep abreast of the developments to assess the final outcome. Unless the ATO concedes to any further changes, advisers will need to consider the following steps. 1. If TPD is recommended inside superannuation, review the policy definitions to determine which policy is most suitable for the client and consider the taxation implications. 2. If the TPD premium is not fully deductible, the benefits of holding the policy inside superannuation compared to a non-superannuation TPD policy may reduce. For some clients, the advantages inside superannuation may no longer offer sufficient value and they may wish to transfer to a non-superannuation policy. 3. Clients with TPD insurance inside a self-

T EC H N I CA L

Case study Ethan is a specialist surgeon and is age 45 when he is advised to commence a TPD insurance policy. He has death cover but did not think he could also afford TPD cover. Ethan earns $120,000 per annum (39.5% marginal tax rate including Medicare for 2009/10). If he holds the policy outside superannuation he will need to earn $1652.89 to pay the premium. Gross income $1652.89 Tax payable $1652.89 x 39.5% = $652.89 Net cash available $1000 To help Ethan reduce the effective cost of the premium his financial adviser suggests that Ethan holds this cover inside his superannuation fund. He arranges with his employer to salary sacrifice $1000 into superannuation to cover the premium, to ensure he does not deplete his accumulated retirement savings. The superannuation fund trustee claims a tax deduction for the full $1000 premium and passes on the value of the tax deduction to Ethan. Tax is not deducted from the contribution. The full $1000 contribution is available to the trustee to pay the insurance premium. Because Ethan is in a specialist occupation he has chosen an insurance policy with an “own occupation” definition to provide the best cover for his needs. If he is injured or becomes ill and can no longer operate as a surgeon, his TPD claim could be paid even if he is still able to be a general practitioner. With this type of policy, his claim could be paid but he may not meet the SIS permanent incapacity condition of release so a disability superannuation benefit will not be payable. This policy is affected by the new interpretation of the tax rules and the premium may not be deductible or may only be partially deductible. From July 1, 2011, the superannuation fund trustee will need to assess how much of the premium is tax deductible. This may require an actuarial calculation. To the extent that the premium is not deductible, the 15% tax may be deducted from the contribution. This will reduce the tax effectiveness for Ethan and may reduce the value of holding TPD cover inside superannuation. Assuming the trustee is not able to claim any deduction for the premium, two options arise for Ethan: Option 1 - Increase contribution to $1176.47 to cover the tax and premium. Gross contribution $1176.47 Tax deducted $1176.47 x 15% = $176.47 Net contribution available $1000 Option 2 - Maintain a $1000 contribution and use accumulated savings to pay the balance of the premium. Gross contribution $1000 Tax deducted $1000 x 15% = $150 Net contribution available $850 Premium deducted from account $1000 (use $150 from balance) Alternatively Ethan could decide that the tax advantages inside superannuation no longer adequately compensate for the preservation risks and could transfer his cover to a non-superannuation insurance policy.

managed super fund (SMSF) will need to determine whether the premiums are tax deductible. This may require an actuarial calculation. 4. Statements of advice (SOAs) recommending clients take TPD inside superannuation should now include a warning about the potential change from July 1, 2011 and the need to review circumstances closer to that date. 5. Review all clients with TPD inside superannuation (especially with policy definitions other than “any occupation”) before July 1, 2011 to notify them of the changes and make any required adjustments to their strategy. 6. If legislation is not passed to start the limited deductibility from July 1, 2011 (and remove the backdating from July 1, 2004) trustees of SMSFs will need to review previous tax returns and determine if they need to be lodged again to reduce the amount of the deduction. The trustees will need to work with their tax advisers. Transferring insurance policies

While an insurance policy that is owned by a member or a related party cannot be transferred into a superannuation fund, there is no restriction on transferring policies out of a superannuation fund. Therefore, if it is no longer appropriate to hold a policy inside superannuation, the TPD policy can be transferred to an ordinary non-superannuation policy, unless restrictions are imposed by the life company. Before taking any action you should speak with the insurer to understand requirements and any limitations.

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F U TU R E-PROOFI NG YO UR B US I NES S

A viable business is built on its clients The third, and final, webinar in the Professional Planner/MLC series on future-proofing your business looked at building a viable and sustainable planning practice. Simon Hoyle reports

t’s a simple proposition: no clients, no business. Building a viable and sustainable financial planning business means delivering to clients a service that they need, one that they value, and one they’re prepared to pay a fair price for. Tony Stephens, a principal of Business Health, says an important first step is to identify exactly what sort of clients you want to work with, and what you’re going to offer them. “The practice needs to provide value to the client, but the client also needs to think that they’re getting value and they need to want the service, but they also need to pay for the service,” Stephens says. “And one of the things that certainly looks at the sustainability or proving the sustainability of the business is having clients who pay for the service directly as opposed to being paid from a manufacturer. “This is not meant to be anything about commission. But the fact is…that what we’ve seen is businesses that have clients paying fee for service are more valuable than those who pay through a commission.” Bob Neill, national manager of MLC’s adviser business centre, says a sustainable business is one that “in tough times survives and delivers a return to its stakeholders, and in good times is able to take advantage of opportunities that are presented to ensure that they stay ahead of their competition”. “I think from a valuation point of view, the critical thing is ensuring that business actually has control over its revenue sources. If it doesn’t have control over its revenue sources then its viability is threatened. The best control you can have over those revenue sources is to have that direct relationship with your clients, where they’re the sole determinant as to whether they

Bob Neill

pay you your fees or not. “I think if you look at the experience the finance broking industry had over the last couple of years, where their revenue sources were largely dictated by sources beyond their control, it’s been a sad and sorry tale for their value and viability I think.” Neill says that whether a planning business finds clients and then defines a value proposition, or defines a value proposition and then goes looking for suitable clients, “depends a little bit on whether you’re starting with a clean sheet of paper or not”. “And most businesses these days do not start with a clean sheet of paper,” Neill says. “If you’re starting with no legacy - from scratch, so to speak - I think you’re far better with a business proposition, being very, very clear around what it is that you’re going to deliver to

your specific target group of clients, and how you’re going to ensure that their requirements are met by you. “In reality, most businesses have been built over time where they have clients that have come to that business from a number of different sources with a number of different demands, and we have a number of different expectations from those clients. So one of the challenges businesses face, when they are looking at their clients, is how do you actually ensure that the business that you’ve built up over time, when needs and demands and circumstances were different, is a business that’s going to prevail with you going forward.” Stephens says there is no single “best” value proposition, and no single way to define it. “I wouldn’t like people out there to think that there’s only one value proposition out there,” he says. “But it’s got to be around providing holistic financial advice. I think there can be a lot of different value propositions in your business, a lot of different things that you provide. “I think the most important thing to remember is that whatever the value proposition you have in your business, that’s what you’re going to be judged on. So if the value proposition you have is to be the lowest cost provider of investment advice or life insurance products, if that’s your value proposition, there’s nothing wrong with that. “McDonald’s are a profitable company, as are the Rockpool [restaurant] or whatever it is. They both serve food, they just serve different kinds of it at different prices. But if price is the issue that you’re going to be competitive on, [then] as soon as someone comes in with a lower price, then you’re in trouble.” Neill says the key elements of a customer

FU T UR E- P R O O F IN G Y O UR BU S I NES S

value proposition are “having very clear articulation around what you offer to your clients; having a business capable of delivering that type of capability into the future; taking out the key-person risk and ensuring you control things that you can control - and build some robustness to withstand the challenges from those you can’t”. Stephens says a value proposition “has got to be succinct”. “One of the things I’ve seen in the US is they have a thing called a ‘30-second elevator speech’. The story is that if you get into an elevator with somebody, and they say, ‘What do you do?’, you have to explain to them what you do by the time the elevator gets to the 30th floor. “Now that may sound a bit cheesy and salesy, but I think basically, again…it’s got to be succinct. It’s got to be relevant. It can’t be verbose; otherwise people will lose interest. I think that a really good outcome of the CVP [client value proposition] is whatever statement you make, the client says, what do you mean by that? Or can I have some more information. I think ‘What do you mean by that?’ would be a good response from a client.” Stephens says there then arises the issue of how to put the proposition into practice - how to deliver it to clients. “Having a client value proposition is very important; delivering that client value proposition is probably more important - doing what you say you’re going to do. “And by the way, it’s very difficult, in our experience, to actually get a documented value proposition. But then to actually live up to that and to deliver that, I think is much more difficult.

“The other guiding thing is that, whether it’s business sustainability, whether it’s ongoing revenue, whether it’s client reviews, everything is based around the fact that we have to, as business people, take some time out and think about our business and make some informed decisions moving forward and don’t just react on a day-to-day or month-to-month basis.” Once the business has defined its value proposition, another issue is translating that proposition into a marketing plan - so that the clients you want to target know what you’ve got. Neill says it “boils back to being very clear around, first of all, that you can articulate what that value proposition is, so you’re able to communicate that; you live and breathe communication, so that it doesn’t become just a few hollow words on your web site or on the wall”. “Your avenues to market will depend a lot on where your particular skill sets lie,” he says. “If you’re a brilliant orator and a great speaker, then standing on a platform and talking to people is a great environment. “It’s [about] finding a strategy. And this is the thing that we quite often see missing in businesses: there’s no clear strategy around how they’re going to take their message to the market place. “So one of the strategic requirements for a business, essentially, is to sit back and clearly understand how best they’re going to take their proposition to the market place, and have a defined way that they’re going to roll it out, with benchmark expectations around performances, and a review around how successful

it’s been. “And there’s no one strategy that fits everyone. There’s no silver bullet. It’s ensuring that you’re very clear around what your message is - that you’ve identified the most effective way for you to take that to the market utilising the capabilities that you’ve got, and ensuring that you follow through with that strategy with a sense of discipline and implementation. “Most businesses have no problem with strategic planning. They have lots and lots of problems implementing that strategy because they don’t necessarily have the discipline and the accountability to follow it through.” Once a viable business model has been determined, “‘sustainability’ means having a profitable,

efficient business that can attract and retain clients”, Stephens says. “At a very high level, it’s as simple as that. “Those clients need to be able to, by definition, pay the fees that are required to maintain that profitability. And you add on top of that, is it a business, so it’s not a one-man band? “It’s profitable, and it is successful in recruiting new clients, and it is successful in maintaining existing clients over the long term. I think that’s an important aspect as well.” Neill says lack of key-man risk is critical, as is the ability of the business to adapt. “It’s got to be a business that’s able to adapt to change, particularly in the dynamic environment that we operate in,” Neill says.

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F U TU R E-PROOFI NG YO UR B US I NES S

“If it doesn’t have a process of continuing to review its strategic direction and adapt to the changing circumstances and the external environment, then it will get left behind. And ‘sustainable’ means that it has a longevity about it. It’s capable of surviving for long periods of time. “We see probably the key challenges are to emerge from these smaller and key-person-type operating businesses into the more corporatised world, and the governance structures and decision-making processes and the strategic direction decisions they have to make…around this sustainable business challenge that they’re going to face.” A formal client review process often underpins a viable and sustainable business. Stephens says Business Health surveys show that “one of the key drivers in an ongoing client relationship is the client review process”. “The happier clients are with their review process, the happier they are with the overall service,” Stephens says. “And the happier they are with the overall service, the more likely they are to stay, obviously - but they’re also more likely to refer clients as well. “If the goal of your business is to create a long-term client relationship, that can’t be done without an effective client review process.” Neill says a formalised client review process, embedded into the culture of a business, helps through both good times and bad times. “We’ve long been envious of the trusted relationship that accountants have with their clients, and largely that’s driven off the necessity of those clients to engage with their accountant at least annually,” Neill says. “And I think good businesses that are walking their way through a strong review process are bedding those clients into their business and the relationship. Now that relationship is important for all of those business opportunities we talked about - the referral of new business, and investment of further funds. “But it’s also a very good defensive measure when things do turn sour. “Businesses that maintain that interaction

Tony Stephens

with their clients when portfolio values were falling, have largely experienced the client loyalty and the retention of those clients. Where they weren’t engaged, the clients have shown a much greater propensity to leave. So I think it’s a critical part of bedding the client relationship with the business which is a critical factor in building a long-term sustainable value business.” Stephens says the review process must “close the loop” by being directly linked to the business’s initial client value proposition. That’s why the proposition must be carefully thought out to start with. A proposition that is focused on investment outcomes is asking for trouble. “There’s nothing you can do about investment returns,” Stephens says. “And so if your value proposition is about investment returns, and then [in] the review process the news about investment returns is all bad, then there’s nowhere where you can go, really. “The more effective client review process looks at the outcomes that the client is looking for. “It’s not necessarily good news either. But if the client wanted to retire at 60 and they wanted a million dollars or two million dollars, and they’re not going to have that amount of money

when they’re 60, there’s only two things they can do. They can either save more money or they can work a little bit longer. There’s not much else you can do. “But again, from what we’ve seen in terms of the client responses and the surveys, they want to know about their financial situation. The review needs to be about their financial situation in totality, not just about their investments. An investment review is not a client review.” Another issue businesses inevitably face is growth. A degree of scale is necessary, to achieve some economies. But, says Neill, “growth just for the sake of growth is a bit pointless, in my mind”. “I do think that businesses are facing a scale imperative,” he says. “I think the reality is the challenges that businesses are going to face as we move forward, around perhaps pressures on their revenues, and perhaps clients with increasingly complex demands and an increasingly complex and perhaps more regulated or tougher regulated environment, means they are going to have to get some scale to meet those challenges - whether it’s to drive efficiency, whether it’s to create diversity in their revenue streams, and whether it’s to have the sort of business to attract the young talent and afford to pay young talent. “For all of these reasons, I think we are facing a scale imperative. I think businesses are going to have to make a choice around whether they stay small and niche - very specific - or whether they actually look to scale and become effective. “I think the danger place is the middle ground because I think if you’re stuck in the middle of those two options, you may very well be severely challenged around the competition that you face from businesses that make one of those decisions.” Neill says “growth always has to be focused growth”. “There has to be a clear strategy around how you’re going to grow, how you’re going to manage that growth,” he says. “[Scale] adds a layer of complexity around the management and expectations as they get bigger. So our business owners are faced with the dilemma of how they most effectively utilise

FU T UR E- P R O O F IN G Y O UR BU S I NES S

the key resource in their business, which are their senior people. Are they managers or are they advisers, or are they directors of a large business with some executive support around it? “So I think my personal view, and it has been for some time, is that businesses are going to have to achieve some scale to be as effective as they can to meet the increasing complexity. They need to be very careful how they manage that growth. And growth for growth’s sake, as I said, is pointless. If you’re growing profitability and you’re growing value, and you’re growing liquidity in the equities that you hold, then you’re on the right journey. But it’s going to need to be planned and executed effectively.” Neill says small practices,

perhaps built around just one planner, are not necessarily going to be unviable or unsustainable. “Don’t read into my comments any denigration of the skill or the talent or the value that the individual interacting with the client has,” he says. “The challenge is to ensure that you build the capability to deliver that advice and leverage the skill set and talent that individual has into other people that come through, because if you’re not able to do that, then the client will clearly recognise that the attraction that the business has for them to remain a client will dissipate when that person goes. “And yes, businesses will always be highly dependent on the skill of their key people. The challenge is ensuring that that skill is able to be

Culture shift

between product advice and professional advice. 3. Ensure that advice is affordable and accessible for all Australians - tax deductibility would be a big step in this direction. 4. Stop the public vilification of financial planning and instead acknowledge what the rest of the world already knows - that the Australian financial planning profession is the best in the world. It’s important to acknowledge that the Minister has recognised some of these issues and promised reviews and consultation to support these issues; but we will be holding the Government to account for the cultural leadership role it must play in delivering these reforms, just as we encourage you to do your bit to ensure consumer confidence and trust in the profession.

Continued from page 06 away from the single best service they could access to ensure their financial future. We will do our bit for reform, but we will also ensure the Government does its bit. And we will communicate our recipe for government reform in this area, including challenging them to: 1. Deliver on the promised reform of barriers to advice in all its scalable forms. We want the Government to go beyond intrafund advice and into a review of the Corporations Act and the compliance burden that discourages flexible, affordable advice. 2. Encourage Australians to seek professional advice. By all means allow product advice for the simplest of needs but also clearly communicate the difference

Deen Sanders is deputy chief executive and head of professionalism for the Financial Planning Association of Australia

delegated, and filtered through your organisation, so the client perception is one that it’s the business that delivers the service. Sure, it’s going to rely on skilled individuals. It’s always going to do that. But the challenge is to ensure that they don’t see it coming from one individual and one alone.” Neill says businesses in regional areas “do face some really peculiar challenges”. “The nature of them is that they are generally built, even more strongly than city or suburban businesses, along the personal relationship characteristics of the key person in that business. And they tend to be smaller in nature, so the capacity to delegate that work to others who are skilled is limited. “The question is, are they sus-

tainable? I think they are sustainable, so long as the key individual remains involved. The challenge of course is what happens when that key individual may want to depart the operation. Can they convince someone else that they are able to replace that person and give the clients the same experience that they’re used to with that individual? And that’s not an easy exercise.”

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Added Value (pa*)

Micro Cap

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Small Ords

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Small Companies

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Small Ords

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Australian Shares

May 1999

ASX300

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Income Generator

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LPTs/Bonds

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15.2%

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SPE CIAL R E PORT: CA P I TA L- AND IN C O ME- P R O T EC TE D P R O DU C T S

The action here is behind the scenes Although they’re designed to be simple from an investor’s perspective, much goes on behind the scenes in capital- and income-protected products. Simon Hoyle reports

apital-protected and income-protected products are a little like the proverbial duck. On the surface - from the investor’s perspective - they seem serene, paddling around unperturbed, oblivious to any turmoil in markets around them. But below the surface, there’s an awful lot more going on to keep things on an even keel, with hedging strategies and constant monitoring of assets to make sure that the product provider’s obligation to investors can be honoured. The sophistication of techniques designed to provide guarantees - both of capital and of income - have evolved steadily over the years. From nothing more exotic than a bond-and-call structure, with capital guaranteed only at maturity, capital- and income-protected products now offer continuous protection, and offer investors a chance to withdraw capital at virtually any time they wish. The development of capital- and incomeprotected products mirrors the development of the securities and instruments available to fund managers to create, manage and honour guarantees - all at an increasingly reasonable cost to the investor. Irene Deutsch, head of distribution for Macquarie’s specialist investments division, says the older-generation capital-protected products involved investors’ funds being invested in bonds and call options - bonds, so investors’ capital would grow over time and replenish the cost of the options; and the options, to capture any market growth. But capital could only be guaranteed at a specified maturity date. Then came the so-called “threshold style” of capital protection, “where clients are invested in an underlying asset and cash at any point in time, and there are triggers that are a signal for [the

‘You can walk away during the life of the product, without incurring break costs’ manager] to move into cash…to ensure that the product was capital-protected at maturity”. Deutsch says a common feature of these older products were break costs - often significant ones - if investors wanted to withdraw money before a maturity date. “New generation products offer continuous protection,” Deutsch says. “That means you can walk away during the life of the product, without incurring break costs.” Deutsch says a case in point is Macquarie’s Flexi 100 Trust - a product that offers a geared, capital-protected investment in a number of different asset classes, with no manager-imposed penalty for walking away - although, if investors have geared and pre-paid interest, they may forgo the interest paid. “It’s a very simple, flexible product,” Deutsch says. The general manger of investment and retirement products for ING, David Kan, says there is growing interest among advisers for capital- and income-protected products. “When we did market research and we spoke to advisers and investors - both before we

launched MoneyForLife, in developing MoneyForLife, and we’ve just completed another round last month following up on the experience with it - certainly there’s a lot of people burnt by the financial crisis,” Kan says. “They have seen large hits to their capital, going into retirement. This is particularly true of pre-retirees, and a lot of them had to modify their plans, basically work longer or reduce their lifestyle expectations. “What either a capital-protected or incomeprotected product allows you [to do], in the lead-in to retirement, [is] to lock in the value of where you’re coming in. And ideally, you do not wait until the point of retirement; you actually need to lock in several years before that, so if you have an event like the GFC that happens on the eve of your retirement, or just before that, you’re neutralised against that. “At the end of the day, capital protection is useful to a point, but you have to turn that into an income. The end goal is income, to support a lifestyle in retirement, and for an increasing time that you’re in retirement; so the real risk is longevity risk, which is outliving your retirement savings. “You can take a product like MoneyForLife in the accumulation phase, and lock in an income base. For example, if you’re 55, let’s say, and you invest in MoneyForLife and you’re still working and accumulating, you can lock in that protected base - basically, put in a floor, but still let it grow, if markets grow, and lock that in, so by the time you retire you’ve got that protected base. “We’re always looking at that, how to do it better and cheaper. And there are developments that happen along the way. For example, one of the capital-protected products we launched more recently last year, was a protected Aus50 fund,

S PE C I A L R E PORT: CAPITA L- A ND IN C O ME- P R O T EC TE D P R O DU C T S

based on the Top 50 Australian stocks. Typically, with a capital-protected product, they use a price mechanism to allocate between a growth asset - in this case it’s the top 50 stocks - and then a ‘riskless’ asset - so let’s say cash. “We introduced a modification to that, which is basically volatility-triggered, as well as price-triggered. So when markets become more volatile, which is typically when they’re going down, then the allocation to growth assets [is] reduced. And as they become less volatile, the allocation increases. So we’re always innovating on that, and we’re always looking, obviously, at ways to reduce price and to improve the features. “When we do research, which we do, and go out and talk to investors and advisers, they’re always asking for more benefits and lower price - in a general sense, but then you look at specific attributes, and what you can do in terms of meeting those specific needs.” Adrian Emery, general manager of sales and marketing for AXA, says product providers can make the cost and outcomes of capital- and income-protected products simpler by being very careful about what rules they build around the product. In the case of its North product, AXA has “designed the product to have certain rules and David Kan features around it, which help us to manage risk”. “So we start by managing our risk, by being very clear about what [clients] can and cannot But once parameters for the underlying do. We make that as flexible as we can, but we’ve investments have been determined, the cost thought about what client behaviour we would of protection can be calculated. The cost is expect, and that has gone to help in modelling greater for underlying investment options with [product] features.” a high proportion of growth assets than it is for Emery says the nature of the underlying underlying investments with a lower level of investment funds is critical; and a fund - or growth assets; and it’s more expensive to provide individual manager - whose performance is likely protection over short periods of time than it is to to be outside a certain index tracking error is provide it over longer periods of time. generally excluded, because hedging that level The fee paid by investors to cover the cost of of investment A X A 0 8 8risk 5 _isLvery H Pdifficult, _ D P Sand P . very pdf P a protection g e 1 can 1 1 be / 5thought / 1 0 ,of like 9 :an4insurance 7 AM expensive. premium.

“We collect the premium and that’s what buys the futures and options, or we put in cash,” Emery says. On the one hand, the product has a liability to pay investors a given sum of money, at some point in future. On the other hand, it has an asset - the premium collected for protection. Emery says the liabilities are treated as a pool; approaching it this way provides a higher degree of predictability (and hence reduces costs) than individually protecting each investor. “We’re pooling all of this; we get a lower risk

If your clients invest in AXA’s North, money can be the least of their worries

SPE CIAL R E PORT: CA P I TA L- AND IN C O ME- P R O T EC TE D P R O DU C T S

profile that what your risk profile would be as an individual, and we manage it as a pool,” Emery says. “We know on any day exactly what our exposures are. “It’s a very sophisticated computer program. At any point in time we know what our exposures are, and we trade futures and options to match our exposures.” Emery says that if the trading strategy goes perfectly right, “then it exactly matches our liabilities”. But in practice, because clients’ behaviour is not 100 per cent predictable, some minor protection inevitably comes at a cost. Generally mismatching can occasionally occur. When this speaking, the cost of protection rises when marhappens, the capital set aside by the life company ket volatility rises, and declines when markets are comes into play, to potentially make good any less volatile. losses. (It should be noted that the mismatch “If you look at the way the fees are divided between assets and liabilities is generally short- and this is all disclosed when you look at the lived, and often usually only on paper.) PDS - there are different fees for different purWhile liabilities and assets are monitored poses,” Kan says. and measured daily, Emery says it’s not always “There’s a fee that relates specifically to necessary to execute trades, especially when the guarantee component; there’s fees for the market volatility is low. underlying investment funds; and then there’s When markets are rising, of course, the value broadly speaking, I suppose, what you would call of the investors’ underlying funds also rises. If an administration-type fee. markets fall, however, then the hedging instru“In providing a product with a guarantee ments put in place pay off “and that matches our - say, a guaranteed income for life - there’s an liability for what we pay to investors”, Emery obligation to pay an investor, depending on what says. the level of that guarantee is. Let’s say they’re a “The theory is simple,” he says, although in person who has a 5 per cent guarantee for life on practice it is a little more complicated. a protected income basis at a particular point in “Large, sophisticated investors, with large time. amounts of money, do this individually,” he says. “There are risks associated, from a provider Investors see little of this complexity, Emery perspective, or issues associated with providing says. that guarantee. That’s the role, what the provider “That’s the duck analogy,” he says. “For the does, managing those risks collectively on behalf client it’s set-and-forget, whereas we [potentially] of the investor. Principally, there’s longevity risk, rebalance on a daily basis. At the moment we’re there’s market risk, and there are other risks. doing it weekly, but when markets are more “The markets move up and down. In terms volatile frequently.” investments, the: value A X Awe 0 rebalance 8 8 5 _ Rmore HP_ DPSP. p d f P a of g ethe underlying 2 1 1 / 5 / 1 0 , 9 4 8 ofAthose M Kan says capital protection or income underlying investments will move up and down.

‘For the client it’s set-andforget, whereas we [potentially] rebalance daily’

Adrian Emery

“What we do is have a program in place to neutralise the effect of the market movements. So we actively hedge - and I mean ‘hedge’ in the true sense of the word; we’re not a hedge fund, I want to make that quite clear. We’re not a hedge fund where we’re trying to make money out of market movements. We’re trying to neutralise the effect of those movements, which then puts us in a position to manage the payout to clients down the line. That’s one level. “There are other levels. There are certain things we can manage actively in capital markets, like, for example, market movements, and we can hedge those. There are other risks, like, for example, longevity risk, that are not actively hedged but you have to take a collective view on risk. You need to make provision for that.” Kan says that in addition, “as a last line, these [products] are provided by a life company, and a life company has to provide capital to back those guarantees, and that’s taking into account the fact

AXA’s North Protected Retirement guarantee AXA’s new North Protected Retirement guarantee provides your clients with a guaranteed income for life – even if their money runs out – while invested in growth assets. To find out more, contact your business development manager on 1800 644 644 or visit north.axa.com.au

This advert has been issued by National Mutual Life Association of Australasia Limited AFS Licence No. 234649

S PE C I A L RE PORT: CAPITA L- A N D IN C O ME- P R O TE C TE D P R O DU C T S

that there is a hedge program”. “To the extent that there’s any ineffectiveness in that, that’s what the life company does: provides capital in order to make good on the guarantee in the long run,” he says. Kan says the instrument the product provider uses to hedge its liability to investors “depends on what the market risk is”. “Broadly speaking, there are futures available, there are options available,” he says. “You can use different instruments to hedge different risks, swaps, depending on whether it’s specifically market risk, the level of indices, interest rate risk or volatility risk. “In MoneyForLife there are three diversified investment portfolios. They are fixed asset allocation; they’re all index-managed within the actual asset class - so, for example, the Australian equities component will be managed to track the index. “The international equities component there is in each of them a different proportion that’s currency-hedged within the fund, so that’s something that’s managed within the fund. “The risk depends on the individual asset class. If you look at the fixed interest component, that’s all invested in Australian Government bonds, so the credit risk related to that is minuscule. But there is still interest rate risk in relation to that. And in the equities component there is market risk in relation to that. “We use different instruments depending on the duration of the risk. “There’s a liability we have. It’s like two sides AXA0 8 8 4 _ 6 7 x 2 0 0 _ PP. p d f of the balance sheet: there’s an asset side and a liability side. The liability side is the obligation

‘It’s like two sides of the balance sheet: there’s an asset side and a liability side’ we have to pay out to investors, and the asset side is basically our hedge position. Then we use various instruments…to neutralise the effect of market movements on those liabilities. So we try to have an asset-liability match.” Kan says it’s important to understand there are two components to the mechanism by which an income or a sum of capital is guaranteed. “Let’s be quite clear,” he says. “The underlying assets that the investor has, they will invest with us, and we will put their money into underlying investment funds. The value of those investment funds will rise and fall with the markets. What we then do is have a separate statutory fund, which we basically manage around to offset the fact of what’s happening. “[The net effect of that] is to match at all times as closely as possible the asset position that we have, either in terms of the actual underlying assets - which are the funds held by the investors - or the hedge position against the liabilities. Pa ge 1 1 1 / 5 / 1 0 , 9 : 4 3 AM “We actively rebalance; we do not just setand-forget. We don’t just take a hedge position

and say that’s it; we rebalance that hedge position. It’s active. It’s active within bounds. If the market is very volatile it will be more active, and if the market is less volatile, and more stable, it will be less active. “The guarantee [cost] varies between 110 and 140 basis points, depending on the actual underlying mix of the assets. If they have got more growth assets, the cost of hedging that is higher than if there’s a lower proportion of growth assets. “You choose your underlying investment blend, and then the cost of hedging that [asset mix] is higher or lower, depending on that.” AXA’s Emery says products like North have been tried and well tested in developed markets, particularly in the US. And the systems and strategies behind North have been extensively back-tested. “The beauty of being part of the global AXA group is that they’ve been running these products for a number of years - in the US, at least 15 years,” Emery says. He says that period has encompassed both good and bad markets. “In the US, they had the tech wreck,” he says. “The US would have been through more volatility cycles than we have.” He says the products held up well even when volatility was extreme. “We would not be pushing it if it hadn’t held up OK.”

AXA’s North is managing the risks in retirement AXA’s North Protected Retirement guarantee With the oldest Baby Boomers turning 65, the retirement investment game has changed. Which is why our industry must now balance wealth accumulation with strategies that manage risk to generate predictable, sustainable incomes for the next 30 years or more.

your clients with a guaranteed income for life – even if their money runs out – while invested in growth assets. To find out more, contact your business development manager on 1800 644 644 or visit north.axa.com.au

AXA’s new North Protected Retirement guarantee does just that, providing This advert has been issued by National Mutual Life Association of Australasia Limited AFS Licence No. 234649

AXA’s North, a new direction for retirement income planning

AXA’s North Protected Retirement guarantee Over the next decade and a half, more than two million Australians will retire.1 It’s the single biggest issue facing our industry, because thanks to longer life spans, those millions of retirees will need risk management solutions that ensure a sustainable and predictable retirement income that lasts 30 years or more. AXA’s new North Protected Retirement guarantee is an innovative superannuation and pension solution which allows retirees to reap the benefits of investing in growth assets with the safety net of a guaranteed income for life - even if their money runs out. To find out more contact your business development manager on 1800 644 644 or visit north.axa.com.au

1. Source: Australian Bureau of Statistics, KPMG. This advert has been issued by The National Mutual Life Association of Australasia Limited AFS Licence No. 234649

RISK

Government unleashes a regulatory avalanche Three Government reviews will have a big effect on the planning landscape, says Richard Weatherhead

uch has already been written about the various preliminary reports from the Cooper Review, the publication of the Henry Tax Review and the Government’s response to the Ripoll inquiry - The Future of Financial Advice. Adviser groups and product providers are rapidly reassessing the strategic opportunities and challenges in a new environment. So perhaps now is the time to take out the crystal ball and speculate about the long-term impact on our industry if the proposed changes come to pass. Three of the main affected sectors are superannuation, managed investments and risk insurance, with the changes to advice transcending all of them. Superannuation

The much feared attack on superannuation “perks” for the “wealthy” no longer appears likely to occur and the Government has found room to effectively eliminate contributions tax for those earning less than $37,000 per annum (helped by the proposed new resources tax). Nevertheless, the $25,000 concessional contributions cap for those with balances above $500,000 (or $50,000 for those with assets below $500,000) from 2012 will lead to an increasing number of “dual investment strategies”, with part of the client’s investments being held in super and the remainder outside super. This will provide a long-term boost to wrap platform and separately managed account (SMA) providers. It will also tip the scales back towards risk insurance being written outside super rather than inside it, so that risk insurance premiums do not eat up part of the member’s available

concessional contributions. The three broad superannuation categories of MySuper, Choice and SMSFs will develop very differently. MySuper

MySuper will become the default superannuation vehicle for many employees, particularly those who do not seek financial advice. Competition will drive MySuper fees down, perhaps significantly lower than the 1 per cent per annum overall fee threshold set as a target by the Federal Government. Most award superannuation will flow to MySuper accounts and these will have deferred member sections, making Eligible Rollover Funds (ERFs) redundant. MySuper providers will offer intra-fund advice, either packaged into the base fee or for a nominal fee for each single piece of advice, in the range of $250 to $500. Some dealer groups may forge alliances with superannuation funds to provide advice services in this area. Full advice will be available to MySuper members on a fee-for-service basis, but in practice this will rarely be taken up. The governance surrounding MySuper providers will be strengthened significantly as a result of the Cooper recommendations. Changes will include: • An annual review by the trustees to confirm that the fund has sufficient scale to provide optimal retirement savings for members; and • Avoidance of cross subsidies between members and a formal allocation of costs between MySuper and Choice super categories. This will accelerate the consolidation of

‘A key focus of advice will be on the additional services, investment options and insurance’ superannuation funds, giving economies of scale across the industry, thus further driving down Shannon Lee costs to members. Choice super

Detailed proposals regarding the regulation of Choice superannuation funds have not yet been published. However, these are likely to be less stringent than those proposed for MySuper on the grounds that members in this category have, by definition, elected to join a Choice fund and can therefore be assumed to have carried out their own research or received professional advice before making that decision. Nevertheless, the Future of Financial Advice proposals will mean that financial advice relating to Choice superannuation can only be provided on a fee-for-service basis with an annual opt-in for advice by members. Commissions will still be permitted for risk insurance but this will be the subject of further consultation. We can expect significant changes to pricing structures for Choice superannuation. This is because members will be able to compare

RISK

investment option costs with those available under MySuper products. Thus, competitive forces will drive down costs for members, and product providers will have to justify the additional cost of Choice products in terms of the additional services provided. In particular, the “flipping” of Choice members out of corporate sub-plans into retail superannuation products at higher fees and higher insurance charges is likely to cease, except to the extent that employer subsidies of administration costs are removed for those who have left their employment. Choice superannuation will be a significant area of activity for advisers, and a key focus of advice will be on the additional services, investment options and insurance products available in a Choice environment. Advisers will develop ongoing relationships with clients through regular contact, providing annual review services for a modest fee. Employer Super

Relationships between advisers and their employer clients will change radically. Many employers will conclude that their staff will be better served through a MySuper account and there will be significant conversion activity, reducing the impact of the grandfathering provisions under The Future of Financial Advice. The opportunities in this sector will be to provide comprehensive advice to directors, managers and senior executives within employer firms; intra-fund advice services to employees within MySuper accounts; and overall strategic superannuation advice to the employers, on a fee-for-service basis.

SMSFs

The proposed changes to selfmanaged super funds (SMSFs) are relatively benign. Accountants will lose their exemption from ASIC licensing. This may lead to further consolidation between advice practices and accounting firms, although many accountants will simply obtain their own licences. Advisers will continue to be able to provide tax advice under an extension of the current exemption from registration under the tax agent regime. The long-term evolution of the SMSF market is likely to be influenced more by demographic changes than regulatory changes. Many current SMSF holders are reaching their more mature years (55 per cent of SMSF members are aged 55 and over) and the initial attraction of running their own SMSF will wane, particularly if: • Superannuation platform providers launch cheaper products which provide comparable functionality; and • The ban on the “exotic” assets proposed by the Cooper Review comes into effect. Overall, the SMSF market will be a fruitful ground for advisers who can demonstrate the value they add by taking the administrative burden away from members and recommending products with comparable benefits, often at a significantly lower cost. Managed Investments

Managed investments will be significantly impacted by the Future of Financial Advice changes. Products will be redesigned to remove fees currently required to

fund commission payments - this will affect both initial and ongoing product fees. The recent increase in prominence of indexed funds, including exchange traded funds (ETFs), will continue, particularly through advisers who offer portfolio management services - essentially taking some of the margins currently enjoyed by fund managers through advice fees and using sector-based, including indexed investment vehicles, to implement recommended investment strategies. In this way they will also be able to demonstrate that the overall cost of product fees and advice fees is reasonable relative to the overall service provided on an ongoing basis. For example, product fees for ASX300 ETFs are currently around 0.30 per cent per annum.

Risk Insurance

The longer-term impact of the changes for risk insurance will depend on the outcome of the promised consultation period under The Future of Financial Advice and the approach taken to commissions under Choice superannuation. If a move to a fee-for-service regime were contemplated for risk insurance it would raise many issues that would need to be considered and resolved. For example, a key part of the overall service provided by the adviser occurs at the time of claim, which, thankfully, only happens for some, and not all, clients.

Richard Weatherhead is a director of Rice Warner Actuaries

Partnership/Association Part Acquisition Opportunity Quantum Planning Solutions is a dynamic growing financial planning practice based on the Gold Coast and Brisbane. We seek an alliance/partnership/association with a growth orientated practice/group in order to achieve further commercial scale. Quality experienced advisory team with large client base and significant strategic alliances offering comprehensive financial services and advice. Flexible licensor options including any alliances which add value. For further information please contact Gary Scallan garys@quantumplanning.com.au 07 5509 8999

P R A C T I CE MA NAG EMEN T

Let’s talk about fees When it comes to telling clients how much your services will cost, Martin Mulcare says there’s no benefit in being shy

e all know that the number one issue in the industry today is fees. There is plenty of attention given to how to determine the right price, how (and when) to present the fee, and various business transition strategies. I would like to address an issue that is of serious concern for most of our clients - and, I suspect, for most advisers - but one that seems to be taboo. If I may be provocative, I think that most advisers are very uncomfortable talking about fees with their clients. So, let’s talk about the fee conversation. It’s not difficult to understand how the discomfort has arisen. Historically, financial advisers have had little experience in verbalising their fee arrangements. It’s not just that commission structures had removed the need to talk about fees. It’s also the result of an industry culture of “full disclosure” that put all of the emphasis on documenting rather than enunciating the fees. That documentation also meant that advisers never had to mention fees again; and so even those advisers who gained experience in explaining fees at the initial engagement rarely mentioned them at subsequent review meetings. However, I would like to suggest that the real cause of the discomfort is more insidious: I’m not sure that all financial advisers really believe in the value that they provide to their clients. When I hear advisers talking about how to “justify” or “sell” their fees, I detect a defensiveness that indicates a disturbing lack of belief. This also manifests itself when I hear it argued that, “ordinary Australians are not able to afford financial advice”. This issue boils down to a simple but profound question. What do you do? If your answer is along the lines of “investment advice”, “retirement incomes”, “wealth management” or “wealth protection”, then I suspect that Aus-

Martin Mulcare

tralians may not be prepared to pay much for that. Even if your answer is along the lines of “providing a road map for people to achieve their financial objectives”, I doubt that many Australians are prepared to pay that much for a plan. Clients don’t want to pay for products or hours - they want to pay for results or outcomes, even intangible ones. You see, I believe that many Australians are prepared to pay you well if they trust you to provide “time”, “peace of mind”, “confidence” and/or “financial freedom”. And the key word in that sentence is trust. There are some advisers who think that trust takes years to build. I would argue that trust can be built in the very first meeting if you can deliver the following experience for your potential client: • A conversation that is all about your potential client and not about you, your firm or your process.

• An in-depth exploration of the values and goals of your potential client, without judgment or “me too” responses, producing increased self-awareness. • An understanding of the complexity of their financial lives and the options that are available to solve their problems and achieve their goals, in the long term. If you would like to be able to speak more confidently to your clients about fees, not just when you are pitching your services but at every review meeting, your client must have the right mindset about your relationship. More importantly, you must have the right mindset about your relationship. Clients can smell fear and they can also detect uncertainty. If you can’t explain your fees clearly and confidently, and if you don’t believe that you can genuinely add value to their lives, you can expect to be challenged, or at least queried, about your fees. How can you improve your confidence, your belief in your value proposition? Perhaps you can think about why you are in this business. Perhaps you can reflect on a recent client experience that delivered great personal satisfaction - to you. Alternatively, you could meet with some of your favourite clients and ask them: “What do you value most about our relationship?” These insights may provide you with some words to express what you do and, more significantly, reaffirm your personal commitment to financial advice. These are the best of times to hone your skills in enunciating your fees - based on a solid foundation of belief in the genuine value that you can add to your clients’ lives.

Martin Mulcare can be contacted on martin@scat.com.au

P R A C T I CE M ANA G EMEN T

Brace for change Peter Switzer says it’s coming and it should bring out your best

inancial planners are being asked to accept a hell of a lot of change in their working lives and businesses right now. And undoubtedly, many would be wondering if they want to keep in the game. However, it is at times like these that I take a lot of comfort out of the advice that “if nothing changes, nothing changes”. Change can have only two directions - progress or regression - and in my mind there is no choice. However, it can be a challenge to go for progress as it invariably insists that we get out of our comfort zone; and right now there is plenty to take us out of our comfort zones. The Reserve Bank loading up the mortgage belt of Australia with rapid and relentless interest rate rises. And it comes when question marks are again looming large over the global financial system, as the Greek bailout raises doubts over other governments, such as Spain and Portugal, as well as the European banks that have bankrolled these potential defaulters. Of course, a country can’t disappear like Lehman Brothers and Bear Stearns. People can be taxed and public servants can be fired to fix up

the books, but the political process can drag out and undermine financial institutions that have played bankers for debt-troubled countries. Then we have the Americans trying to reform their financial system, which is an overdue good idea; but as we saw with Goldman Sachs, it has rattled market confidence, if only for a week. Keeping up the market-frustrating role of governments, our own has decided to undermine our best-performing export sector - miners - to repair its budget and GFC-created indebtedness. And all of this comes as the Rudd Government, via its Cooper and Ripoll reviews, wants to change the way financial advisers do business and handle super. It is all putting a fair bit of pressure on we financial planners; and many might be wondering if they want to continue in the industry, or how they should respond as business owners or professionals. Recently, on my Sky News Business Channel program, I interviewed Andrew Inwood from a company called brandmanagement. He has a database of more than 100,000 Australians in the A-B demographic - our classic target customers.

He made the point that people who had a financial planner over the past two to three years were worse off compared to those who did not have an adviser! But it’s not all bad news. Over the past eight years, those who have had an adviser were miles better off for the experience than those who had been their own money advisers. This of course does not surprise us, as we have always lived by the mantra that we invest for the long term, and it is time in the market, not timing the market, that has proven to be the wiser strategy. Sure it is better if you can time the market, but history shows we are not good at timing our decisions. The challenges of the market, and even government policies aimed at GFC-related issues, will settle down and the market upward trend will again be our friend - time and compound interest do that sort of thing. However, the impact of the Rudd Government changes have to be seen as an opportunity and not a threat. As a business owner you have to listen to your customer base. You have to change the product/service, or more correctly and relevantly, you have to sell the great quality service of advice, instead of the product. These imposed changes will bring out the best in you and your business, provided you confront the brutal truth and have an overwhelming belief in what you can create. The old world of financial planning culminated in the debacle which was Storm, but the new world where advisers advise and really look after the interests of their clients will create wonderful businesses and a reputation for financial planners that all of us will be proud of. And if this does not happen, the reform process should continue until it does!

Peter Switzer is founder of fee-for-service financial planning firm Switzer Financial Services and hosts SWITZER on Sky News Business Channel.

P R A C T I CE MA NAG EMEN T

Facing your moment of truth Rod Bertino says that even though the pace of change in the advisory profession shows no real signs of abating, the anecdotal feedback confirms that market sentiment is slowly improving and confidence is on the rise

Business Health HealthCheck analysis

Future Ready IV - Overall Health Results 49

Percentage of practices

t appears to us that the principals of Australia’s advisory practices face an interesting dilemma. How do they react to an improving marketplace? With the ever-present limitation on resources available for small businesses, what should be the strategy in 2010? Should the major focus be on recouping “lost” revenue, or should the focus be based on a return to better business practices? Or maybe a balance in between is more appropriate? Of course, there won’t be a “one size fits all” answer to these questions. The key findings from the recently released Business Health Future Ready IV research paper provide real insight. As can be seen from the following graph, when comparing the health of practices today to the position in 2007, we have seen incremental improvements in some areas; but at a high level, there seems to have been little progress. While the stronger practices seem to have become stronger, the number of firms rated Healthy or better dropped from 82 per cent to 75 per cent. On the other hand, the number of Poor and Average Health practices has actually increased over the past two years - they now stand at 25 per cent of our data set, up from 18 per cent in 2007. Although in many regards this still represents a strong result, and Australian firms remain at the forefront of global practice management, the fact remains that one in four of the better firms in this country are still in need of a stronger “health” plan. With so much talk being devoted to practice management/business development over the past two years, this obviously begs the question: Why are we not seeing more dramatic progress being made? While each practice is unique and the challenges (and hence solutions) vary from firm to

30 19 15

15 6

0 Poor Health Source: Business Health

Average Health December 2009

firm, without doubt, the tumultuous market conditions of late have had an enormous impact. Many principals have (in most cases quite rightly) had to divert much of their management focus and attention to addressing other more immediate concerns. While most acknowledge it is important to develop and strengthen their underlying business processes, dealing with the fallout from the global financial crisis (GFC) has caused a lot of the practice management initiatives to stall. The results recorded in the areas of communication (client and staff ), business, and succession planning are good examples of the reactive responses many practices have taken to the “immediacy” of the situation (over longerterm, directional activities) - at what cost will be determined over the next few years as practices begin to climb out of their GFC predicament. However, one has to also question the appreciation and commitment of some principals to best practice and perhaps even the capability of the people charged with the responsibility of de-

Healthy

Fit

Super Fit

March 2007

livering practice management support (business coaches, advisory boards, business development managers and practice development managers). Nonetheless, it remains incredibly difficult to run a successful (and profitable) advisory practice in today’s marketplace and it is almost impossible for one person to be totally across all of the issues. The skill sets required to do everything that needs to be done exceptionally well, are now just too diverse. Practice owners are in need of, and are searching for, help and support. They are looking for people they trust and respect; people who bring complementary and valued capabilities and resources; people who can help them position their business for sustained success into the future. And given that, according to our latest analysis, the average age of principals is 57, the clock is certainly ticking! Rod Bertino is a partner and director of Business Health, a consulting firm specialising in the financial services industry.

R ES P ON S I BLE IN V ES T M EN T

Doing the right thing pays off Responsible Investment works and is a good way to cement a relationship with clients, says Philippa Yelland

f the Global Financial Crisis (GFC) made you stop and think about how you’re engaging with clients and how to manage your business, you may also want to look at responsible investment (RI) - the RI sector not only survived the upheaval but also has emerged to outperform the mainstream investment market. The latest performance data published by the Responsible Investment Association Australasia (RIAA) shows that, to the end of 2009, responsible investments delivered above-average returns for almost all periods from one to seven years. These results are proof that RI can deliver strong and sustainable returns, even through the toughest global financial circumstances experienced in more than 80 years. “At its core, responsible investment is a prudent investment strategy,” says Louise O’Halloran, executive director of the Responsible Investment Association Australasia (RIAA), the peak body for RI in Australia and New Zealand. “Its objective is to help investors make better investment choices and maximise their returns by incorporating important environmental, social and governance (ESG) issues into the evaluation process.” Excellent performance is just one reason why there is a global groundswell of participation in RI. Increasingly investors are turning to RI out of disappointment in traditional investment management and in the hope of tapping into opportunities associated with new environmental and social paradigms. In a social media research report completed late 2009 by Our Religion, a digital new media company, and commissioned by RIAA, it was found that there were nearly 10 billion individual English-speaking items related to responsible investment. A lack of trust in large financial

institutions created by the GFC was a prime reason people gave for actively looking for investment products and services that embed sustainable and responsible attributes in addition to traditional financial concerns. “These report findings echo those uncovered by RIAA when we surveyed a number of our financial adviser members in mid-2009,” says O’Halloran. When asked why clients elect to invest all or some of their money in accordance with responsible investment principles, the most frequently cited reasons for investing responsibly were: • It offers competitive and sustainable returns while making a positive contribution to the world. • If you care about the environment and climate change, it is one way you can seek to make a difference. • It can channel funds to companies that take a positive position on important environmental, social and governance issues and demand greater accountability. • It provides a way to “cast your vote” about the environmental, social or ethical issues that are important to you. High net worth (HNW) investors are a group increasingly turning to responsible investment to gain an edge. The fifth annual Wealth and Values Survey by the PNC Financial Services Group (2009), found that most wealthy Americans (who have at least US$500,000 in investable assets) have “green” values, reporting a keen interest in environmental issues and companies that follow a socially responsible path. This survey revealed that “71 per cent have socially responsible and green investments in their portfolio, while 57 per cent say they have up to 25 per cent of their portfolio in such investments, and 9 per cent have between 25 and

50 per cent”. But before you race out and start talking with your clients about responsible investment, listen to a word of warning offered in the EIRIS and Tru-Est Special Report in 2008, called “Wealth Managers and SRI”. This report found that the single largest factor impeding the growth of responsible investment was not lack of willingness from clients, but rather that advisers do not have the knowledge they need to address these issues with confidence. The report found that often advisers had educated themselves about RI in reaction to client requests and that this had led to an ad hoc understanding about specialist products and how ESG issues can affect portfolio value. There’s no need for advisers in Australia to find themselves in this situation. Those keen to tap into this growth market can make a start by completing an online course in RI. Designed by RIAA, this course provides a comprehensive overview of the sector, insights into why clients choose RI, how to integrate these reasons into portfolio construction, and how to introduce RI into a practice. Responsible investment clients are known to be more “sticky” than their mainstream counterparts, meaning that they will stick with their investments even when times get tough, because they have a long-term commitment to the strategy that reaches well beyond short-term financial returns. This provides advisers with a golden opportunity to better serve the client’s real needs, to engender trust and to promote loyalty and word of mouth recommendations.

Where people are not problems to be solved, but people to be met.

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P R I VATE B AN K IN G

Understanding the front line Alan Shields says effective client relationship management is the key to attracting and retaining high-net-worth clients

very six months, as part of the Australian Private Banking Council research program, we interview high-net-worth (HNW) individuals regarding their finances and relationships with financial service providers. One of the more striking themes of these interviews is the importance of the relationship manager in creating a positive experience for the client. At its core, private banking is about tailoring services to individual client requirements. In doing so, a balance must be struck where the right amount of personal contact is delivered in the most optimal way by professional staff. This is highlighted by the fact that HNW individuals consistently cite service-related factors such as continuity of relationship management, lack of professionalism and poor relations with the relationship manager as key reasons for leaving a private bank. With client retention being more costeffective than acquisition, many private banks focus on client retention in a direct way - by attempting to head off potential attrition before it occurs, and getting the basics right. What private banks are increasingly realising is that the satisfaction, acquisition and retention of HNW clients are inextricably linked to the attraction and retention of talented staff. In the long term, private banks will need to concentrate on retaining key staff and develop strategies to grow and develop their people. Exacerbating the importance of talent is the increasingly competitive private banking landscape in Australia. Before the GFC, Australiaâ&#x20AC;&#x2122;s HNW population was one of the fastest-growing in the world, surpassing other affluent countries such as the US, UK and Germany. The fact that Australia has remained remarkably aloof from the impacts of the GFC will only serve to ensure steady increases in the number of HNW

individuals in Australia. And for private banks looking to capitalise, this means hiring more staff to facilitate growth. The big balancing act for private banks is to ensure that service quality does not diminish due to enlarged numbers of new staff and increased churn - as competitors look to poach. While there is not a huge amount of staff poaching here in Australia, it is on the increase and - as mentioned earlier - high turnover of relationship managers can cause client attrition. In essence, what we have learned from our research is that retention of staff and retention of clients are one and the same issue. But how can private banks tackle this? I believe that the answer lies first and foremost in development of talent. By offering staff a means of ongoing personal development, a private bank can ensure not only that staff feel rewarded and empowered, but that they develop the skills necessary to better service their clients. Of course, financial reward is an important criterion for talent retention and any research that suggests otherwise is incorrect. The trick is to find the balance between development and remuneration and to back it up with a clearly defined strategy. A private bankâ&#x20AC;&#x2122;s direction, internal culture, investment in staff development and acquisition are all critical to success. It follows logically that staff turnover is lower in firms with a strong and committed strategy supported by a stable senior management team. Some larger private banks have addressed talent development by setting up their own training programs and colleges for private bankers. For example, Citi has several programs worldwide that attract new recruits with excellent academic results from top universities. UBS and Credit Suisse have also established their

own colleges for private bankers in Switzerland and Singapore, while other banks draw on their own graduate recruitment programs. This is all part of a plan to invest in staff training and foster loyalty among upcoming relationship managers and private bankers. There are also cases of private banks recruiting from outside the industry. Over the past two years, the Australian private banks have used the relative advantage that the Australian economy has afforded by recruiting from overseas and from outside of conventional banking and finance circles. So what does this mean for Australian private banks going forward? Although severe staff shortages and staff poaching are yet to happen in Australia, some private banks here have experienced high staff turnover in recent years - from client-facing relationship managers through to general managers and heads of the business. To control this, private banks will need to focus more on achieving internal stability, direction and cohesion. Investment in the training and development of staff - the most valuable asset of an organisation - goes hand in hand with achieving the ultimate goal of client satisfaction and retention.

Alan Shields is research director for Retail Finance Intelligence (RFI) - www.rfintelligence.com.au

M A N A G ED F UNDS

Sticks and bones It’s that time of year again, when the taxman is lurking and the issuers of agribusiness managed investment schemes get cracking on marketing their latest offerings. Dug Higgins surveys the market

ollowing the collapses last year of Timbercorp and Great Southern, amongst others, and Forest Enterprises Australia (FEA) being placed into receivership in April, it will be thin pickings in the agribusiness sector this season - which will come as no great surprise to anyone. Last season, investors stayed away in droves. This year will be worse for capital raising efforts as the nerves of gun-shy financial planners and their clients have been enlivened, not only by the recent fate of FEA but the public inquiries by the Parliamentary Joint Committee and others. The question arises, is the sector dead? This is a difficult one. I think that for continuation in their previous form, the odds are stacked against them. The Managed Investment Scheme (MIS) tax-effective structure has advantages and disadvantages. However, MIS, contrary to popular opinion, is not specifically the problem, being a common structure used by many asset classes (although for the sake of simplicity I will use it in the context of agribusiness MIS here). But like anything, it is open to misuse and abuse. If you do the wrong thing with it, the best assets in the world will not save you. The inclusion of tax-effectiveness compounds the potential for misuse. It has often previously encouraged issuers to develop a system that maximises the upfront tax deduction, which is prone to creating problems with scheme cashflow later - hence the numerous mentions of a likeness to “Ponzi schemes” for the issuers involved. While we don’t believe a blanket ban should be imposed, the issues it creates should not be ignored. Clearly things have to change. Fee structures

‘Last season, investors stayed away in droves. This year will be worse for capital raising’

Dug Higgins

of schemes, and business structures of the issuing entities, are key aspects, but there are myriad other details that will need reviewing if the sector is to survive and regain some form of trust, which will not be an easy or short process. Some companies are quickly reacting and changing their structures as necessary. Others are already structured in such a way to somewhat mitigate these effects. However, for some like FEA, change may come too late. Is there a place for agriculture in an investment portfolio? I believe that the answer to that is yes, but the list of caveats is long. Agribusiness generally has a low to negative correlation to broader asset classes, which is an obvious benefit in terms of portfolio construction. However, these benefits, when used to promote MISs, are often misconstrued.

This characteristic is often illustrated using standard deviation of returns or correlation comparisons against the wider asset classes of cash, equities, A-REITs et cetera. However, caution is needed. While several studies have been done in this area and have often been wheeled out in marketing campaigns, none of them has clear relevance to an agribusiness MIS because of the general lack of realistic comparison. As an example, some use ASX-listed agribusiness stocks as the proxy for “agribusiness”. While this has in the past included companies such as Timbercorp, Great Southern and FEA, who were issuers of MISs, as well as other smaller companies which somewhat more closely approximate an investment into direct farming, it also includes larger entities like Incitec Pivot, Viterra (ABB Grain), Nufarm and Fosters, depending on whose index you use. In any event, few ASX-listed entities could realistically draw a close comparison to an MIS as an investment, and they are of even less relevance as a justification of asset class performance. Other comparisions are based on “agribusiness” being farmland and/or a farm business’s

M ANA G ED FUN D S

historically provided the main focus. Sadly, too many of these have found that formerly judicious levels of investment turned into a flood, with too much capital going into the hands of those who either did not have the foresight to see the implications of a massive surge in commodity production or deliberately chose to ignore it, seeing it as someone else’s problem. Once capital inflows exceed the point at which an industry is self-sustaining, market forces can quickly become distorted - as the viticulture industry has proved, being only the latest in a string of incidences of this type. Investors and advisers need to understand return on capital. Clearly then, too close a whether or not they are being exposed to induscomparison with a MIS, in relation to other tries which run the risk of magnified boom/bust asset classes using such a measure, is potentially scenarios or to managers or schemes which have dangerous and misleading - unless at the very no market imperative to get the supply/demand least you are investing in the land as part of a equation right. scheme (although there are some opportunities Market signals need to be favourable in order to do this). to succeed. There are certainly worthwhile indusMISs have a host of other issues affecting tries out there whose requirements for capital them, not the least of which is general illiquidshould be able to be aided by private investment. ity, over what is usually a long term, and higher Sorting through them is the issue. management risk from many issuers. A MIS Last month, ASIC released a call for submisneeds to be judged specifically on its merits and sions for Consultation Paper 133: Agribusiness in accordance with its risks, both agricultural Managed Investment Schemes - Improving and management-based, not by a broad-based Disclosure for Retail Investors. CP133 details a approach using dubious methods of comparison proposed list of reporting benchmarks for MIS for the case for investing in agriculture. issuers, similar to those in place for mortgage and Australian agriculture is an industry that unlisted property schemes and finance company often has sub-sectors, which can find injections debentures. of investor capital useful to allow expansion and CP133 proposes to provide a greater level of improvements that would otherwise perhaps not disclosure for investors and advisers and Zenith occur. has made its own submission to ASIC in this There are many niche industries that have regard. found this to be an overall positive in crystallisWe believe that it is important to note that ing their competitiveness. while these efforts on the part of ASIC are posiUnfortunately, there are comparatively few tive, they will not be a “silver bullet” and advisers opportunities by which retail investors can gain will need to be cognisant of5 the implications of access to direct investment in agriculture, as opF I D 0 0 1 4 _ P P 2 4 Ma y . p d f Pa ge 1 6 / 5 / 1 0 , : 0 6 PM such benchmarks which are likely to tell as much posed to the other asset classes, and MISs have

‘Going forward, managers and advisers are going to have to work harder and smarter’

by what issuers don’t say as what they do under the proposed guidelines. Now before everyone starts bombarding me with complaints, I need to make it clear that, in principle, I am a supporter of investment into agribusiness as an asset class - but only into agribusiness that’s done well. Investment into agriculture should be encouraged as long as it is driven by market forces that promote profitability and long-term sustainability. There have been MISs that have performed reasonably to date, in contrast to some of the views expressed here. But they are generally few and far between. Going forward, scheme managers and advisers are going to have to work harder and smarter to ensure positive outcomes for investors in this sector.

Dugald Higgins is a senior investment analyst at Zenith Investment Partners and has been a specialist in analysing agribusiness and property MISs for 10 years. Prior to that he was a grazier in NSW where his family still runs a large cattle breeding operation.

To put better investments together we constantly pull them apart. Better research. Better minds. Better ideas. To know more, visit www.fidelity.com.au This document was issued by FIL Investment Management (Australia) Limited ABN 34 006 773 575 AFSL No. 237865. Fidelity, Fidelity International and Pyramid Logo are trademarks of FIL Limited.

P R O P ERTY

Assessing the true risk of property Now is not the time to be avoiding risk in property markets. But, warns Frank Gelber, not all property markets

ost GFC, everyone has gone risk averse. Not only did that trigger the magnitude of the downturn, but the market remains excessively focused on risk. I regard that as an anomaly. To me, most of the property risk has gone. The current market is low risk, not high risk. Some people think that high prospective returns mean high risk. Not necessarily! Excessive focus on risk has cleaned out overvaluation, cut new supply and set up strong returns in the forthcoming upswing. Indeed, I regard current investment in property as high return/low risk. The correction has taken most of the risk away. Let me explain. Unlike overseas, in Australia we didn’t have a financial crisis. Here, weight of money from the financial engineering boom had led to overvalued property markets, but we didn’t have oversupplied property markets. Hence the GFC triggered a correction in property prices and curtailed investment through a credit squeeze and an equity squeeze without causing a financial crisis. I’m not just talking about lenders. Equity investors, too, ran for cover, taking the hit from falling property prices and limiting further exposure. Certainly, given the inability of listed property trusts (LPTs) to sell property assets, the reduction in gearing required injections of equity. But, with respect to major allocation of new funds, investors are waiting on the sidelines to see how things pan out. And now the regulators are busy trying to ensure that the same thing doesn’t happen again. It won’t - at least not in the same form and not quickly. They’re wasting their time and our

money. The overconfidence and excessive gearing that set us up for the GFC has gone - we’re much more cautious now and it will be a long time before we go over the top again. Moreover, we won’t make the same mistakes again - they’ll be (slightly) different next time. And it’s that next episode that we want to prevent. Why are regulators still so focused on risk? To me, most of the risk has gone. To me, risk is not just high variance. Some look at risk purely as statistical variation without trying to understand where it comes from. That’s not good enough. The danger is that the statistical approach lumps uncertainty associated with knowable outcomes together with unknowable risks - and hence overstates risk. And measuring risk is even more fraught. I don’t mind using maximisers. But I do object to using historical mean and variance of returns. That’s lazy. It’s a recipe for shutting the door after the horse has bolted and locking it so that the horse can’t get back in again. It’s a recipe for buying as the market approaches a peak, and selling when the market has fallen. That’s a dreadful investment strategy. What we really need to use to identify the investment frontier and drive allocation is expected return and estimated variance of expected returns. I’m a forecaster. I look at the future in terms of outcomes and probabilities, always trying to specify what course of events will lead to different outcomes. In looking at risk, I’m more concerned about adverse outcomes, be it to lenders or investors. And there are many types of risk associated with different outcomes, some unforeseen but others foreseeable. In the statisti-

cal approach they’re all lumped together. For me, the objective is to identify as many specific risks as possible and to understand how these risks vary through time and circumstance. How does this relate to property now? Let’s focus on three specific sources of risk. In the financial engineering (FE) boom, which preceded the GFC, the gearing up of equity for property, together with further inflows of equity, caused prices to overshoot. Sheer weight of money for existing assets drove yields too low. However, the GFC-triggered correction in yields and prices has taken away the risk associated with overvaluation of property. Indeed, lower yields mean that the rent required to underwrite financial feasibility of new projects has risen, leaving prices in many property markets below replacement cost levels. Prices are too low. And that means that, as leasing markets tighten, the next correction is upwards. The risk of price falls is low. Further, excessive gearing is a risk in itself. And during the FE boom, gearing became excessive. Again, the GFC-triggered reduction in gearing, largely through increased equity, has reduced risk. During the financial engineering boom, I was concerned about overbuilding causing oversupply, significant falls in rents and prices, and a collapse in many of the office markets. Now, with the collapse of new development associated with the GFC credit squeeze, the risk of overbuilding has gone. To the contrary, we’re now underbuilding and facing the prospect of a shortage of stock driving strong rises in rents and prices. The risk of a cyclical decline is minimal. In the statistical approach, the correction

P R O PE RT Y

would indicate lower returns and higher risk than before. Certainly, measured mean returns have fallen and variance has blown out as a result of the recent decline. But, again, the horse has bolted. The correction has removed the major sources of risk. The risk of a cyclical decline has fallen, not risen. Indeed, now the “risk” is on the up side. To me, expected returns are higher, not lower, than before the correction. And downside risks are lower, not higher, than before the correction. Having said that, we won’t see a massive inflow of investment funds driving yields. Investors are much more cautious now. Rather, the next upswing will come from strength in leasing markets driving rents and hence property values; slowly initially, but then picking up momentum as the upswing proceeds. Only then will investor confidence and a strong inflow of equity funds lead to firming yields. The correction in prices and the overreaction on the supply side has, in some markets, set up the preconditions for a

build-up of momentum into what will become a boom three to five years hence. A quick warning. My comments aren’t uniform across markets. Prospects for different markets are quite different. - The residential recovery has already begun and will build up momentum into what will become a boom over the next three to four years, before rising interest rates curtail the upswing. - In retail, the correction was in prices, but cash flow remained stable. Retail will show solid returns. - Industrial property prices will improve as higher yields require higher rents to get back to replacement cost levels, but an oversupply of industrial land will contain returns. - My pick of investments is office property, where rents and prices need to rise significantly just to get back to replacement cost levels. Indeed, we expect a shortage of space to cause them to overshoot, underwriting the next boom. Sydney, Melbourne and Adelaide will recover first. Brisbane, Perth and Canberra still face

weak markets for a few years before they can absorb oversupply. In BIS Shrapnel’s latest forecasts, we’re looking at internal rates of return of up to 20 per cent in some markets. To me, this is an opportunity to get into what I regard as mis-priced markets. This is an extraordinary time. Forget the statistical approach to risk. And whatever you do, don’t let the historical mean and variance of returns drive your estimate of the investment frontier and your allocation. You can’t drive either safely or well by looking in the rear vision mirror. I’m looking at high expected returns and low risk of adverse outcomes. I’m tactical rather than strategic in my investment approach, both in investment and lending strategy. And I’m really aggressive about shifting my allocation towards property investment on both a defensive and a maximum return logic. Dr Frank Gelber is director and chief economist of BIS Shrapnel.

S H A R EMARK ET

Australia goes it alone in the long run Reading the tea leaves is no substitute for proper, fundamental analysis, says Ron Bewley

Chart 1: Re-scaled price indices for Australian and US markets (Jan 1, 2008 = 100)

110! 100!

Scaled Price Indexes!

90! 80! 70! 60! 50! 40!

0 -20

S&P/ASX200!

0 -20

1 -20

S&P500!

Source: www.ﬁnance.yahoo.com

Chart 2: Price Indicies since May 2000 (Jan 1, 2008 = 100)

110! 100!

Scaled Price Indexes!

90! 80! 70! 60! 50! 40!

-2 ay

y-2

S&P/ASX200!

y-2

FTSE!

y-2

S&P500!

Source: www.ﬁnance.yahoo.com

Chart 3: Price indices since May 2000 (April 1, 2003 = 100) 240! 220! 200! Scaled Price Indexes!

s April drew to a close I wondered why our market seemed to be falling behind the US and UK markets. I was seemingly being bombarded on TV by “Fibonacci retracement levels” and the like, from technical devotees - but I, personally, have no time for such analyses. My volatility forecasts show a clear fall in volatility levels, to return to those that dominated most of the two decades before the GFC. My exuberance or mis-pricing tool is showing fair pricing - and my market fear indexes are all looking good. Everything in my world is looking great - so why do we look so bad in Chart 1 when we scale the S&P/ ASX200 and S&P500 to each be 100 on the first day of 2008? Our market fell by about as much as the US in the bear market and rose just as quickly, until the dip at the start of this year. Of course we did fail to track up with the US in the second quarter of 2008 - but the US rejoined us after the Lehman collapse. Stretching that chart back until the start of the millennium and adding the UK just for

180! 160! 140! 120! 100! 80!

y-2

S&P/ASX200!

y-2

FTSE!

y-2

S&P500!

Source: www.ﬁnance.yahoo.com

fun - a seemingly different picture emerges in Chart 2. Up until the start of the 2003 bull run, our market had trodden water while the US and UK fell in lock

step. After all, we, unlike the US and UK, avoided the “tech wreck”, 9/11 and SARS. We rose faster in the 2003-2007 bull run, due to the commodity

boom and China. But I get a clearer story when we rescale the three markets to be 100 on April Fools’ Day 2003 in Chart 3 - the start of the bull run. Of course the data are the same, but the visuals show the impact of the 2005-2007 commodity boom for what it was. Resource stocks are more volatile than many others and Australia gets the ups and downs for better and for worse. In this picture, $100 in each market in 2003 gave us a wilder ride over the next seven years. An investor from 1st April 2003 in Australia took a big hit in 2008-2009 but remained above water ($100), except for a few days in March 2009. Long-term investors in Australia have been much better off than those in the US and UK; and the much predicted second wave of the commodity boom is only just getting going. Imagine how the chart would look if we started the horse race earlier in the millennium - off the scale - notwithstanding new resources taxes! The problem with analysing data such as those

I have studied here is that for short runs they seem to be very highly correlated. “Spurious regressions” is the term coined by the late Nobel Laureate, Sir Clive Granger, for these illusions. Some series genuinely do move together - and the US and UK are a possible candidate pair - but Australia clearly goes its own way in the long run. I still stand by my optimistic forecasts for the Australian market - a “High Five” for the end of the year. I prefer to follow a scientific basis to my thought process rather than calculating retracement levels and the like. There is room for more than one point of view. Charts can all too readily deceive, as I hope I have shown. We are not falling behind; we are maintaining our long-run performance. To me, charts prove nothing - they just add a dash of colour - when the real analysis is over.

Ron Bewley is adjunct professor, finance and economics, at the University of Technology, Sydney

P H IL ANT H R O PY

Why HNWs like tax time The hook that will bring wealthy clients into philanthropy is tax efficiency, writes Simon Mumme

here are two types of wealthy philanthropists, according to John King, partner with Mallesons Stephens Jaques in Sydney. The first type grew up in a family or faith-based culture of giving generously, and in continuing that practice, like to rack professional advisers’ brains about the most effective ways to donate money. The other type, who have usually built their wealth from humble beginnings and have featured in the BRW Rich 200 List, “think giving $25,000 out of $150 million each year is generous”. But King says that compared to most wealthy donors, it isn’t generous at all. The most appealing incentive for these highnet-worth (HNW) people to give more is the realisation that philanthropy is a more desirable way of using money that would otherwise be captured by Canberra as tax. “For these people, you have to say that they should be giving away about $1 million [annually],” King says. “Those conversations are very difficult and a lot of financial advisers don’t have the courage to enter into them. “But the hook that will get them in is tax efficiency.” The most appropriate time to discuss philanthropy with clients is when they are selling a large asset, inheriting a lot of money or becoming subject to any other transaction that will trigger a large capital gain – which can be offset by a philanthropic commitment. For example, if a client receives a discount capital gain of $100,000, where half the capital gain is included in their assessable income, a $23,250 tax payment is usually incurred (assuming the top marginal tax rate, plus Medicare levy). But if they donate that amount, plus an extra $26,750, which takes the total donation to $50,000, their tax liability is eliminated.

The donor has given away $26,750 plus the money they would otherwise have sent to Canberra anyway. They are effectively “giving away” their tax liability, along with some of their wealth. “If you give away $1, it’s like the government putting in another dollar. And people love that,” King says. The type of large capital gains experienced by HNWs enable these donors to set up a philanthropic vehicle, such as a prescribed ancillary fund (PAF) or a donor-advised fund with a trustee company or community foundation. While setting up a PAF can take a month or more, and requires a bare minimum of $500,000 to be effective, a donor-advised fund can be “done in a week”. Over time, repeated tax-effective donations from capital gains can supply considerable funds to the philanthropic sector. “So you’ve got a lot of money going into a PAF, going to charitable causes over time, and I think that’s a win for the community,” King says. “The person parts with $26,750 from each $100,000 in discount capital gains, but it’s painless.” But all this can go wrong if, close to the end of the financial year, a HNW donor wrongly believes that the realisation of a capital gain occurs when the transaction is settled. For instance, if a client signs a contract agreeing to sell their business on May 1, but the transaction settles on July 2, and they wait until then to commit money to philanthropy, they will be disappointed. This is because CGT law states that capital gains are made when transactions are signed, not settled. “If your client comes in on July 2 and says, ‘I’ve sold my business and want to put the [capital gain] into a PAF’, they’re too late,” King says. “When you settle, the gain is back-dated to

when you signed the contract.” Financial advisers to HNW individuals should be aware of these kinds of significant financial events well in advance; and discussions with clients about how they aim to use capital gains should also happen far ahead of the pay day. And if a client wants to give some of their gain away, it falls to advisers to ensure the transaction and settlement are completed before the end of the financial year. If the transaction and settlement dates straddle the end of the financial year, clients will need to find money through another means – like refinancing a mortgage, for example – and put this debt into the PAF, and then use their capital gain to pay the bank back as soon as possible. But they will lose the tax benefit. HNW people running family businesses through a corporate structure can also eliminate tax on the retained earnings in their business by donating some of its capital, King says. Money can’t ordinarily be taken out of the company without incurring “top-up” tax of about 23.5 per cent, so retained earnings are often left within the company and sometimes left for descendents to deal with. Delaying the withdrawal of retained earnings “is like pretending you’re not going to die”. But tax on retained earnings can be written off if the tax liability plus some of their personal wealth is used for philanthropy. Similar to the discount capital gains scenario, of each $100,000 in retained earnings realised, the client can donate their tax bill of approximately $23,500 plus another $26,500 and then access the remaining $50,000. The Government subsidises the donor dollar-for-dollar, while the donor is not deferring the retained earnings “day of reckoning”. Simon Mumme is editor of Investment magazine www.investmenttechnology.com.au

T h e Fi n al W ord

Dribble…fiddle…piddle...is that it? Some people are never satisfied. It seems that Dixon is one of them

magine the scene: Wembley stadium, London, 1985. An estimated 99,000 people are starting to leave after watching a show that was broadcast to an estimated television audience of 400 million people in 60 countries. In London, and across the Atlantic in Philadelphia, more than 50 of the world’s leading music acts have staged by far the biggest event of its kind to raise money for famine relief in Africa. The concert organiser, Bob Geldof, is wandering around on the stage in London, doubtless reflecting on the hard work and logistics of staging the 16-hour Live Aid event, and the hundreds of millions of dollars raised. Someone from the crowd shouts out to him: “Is that it?” If Bob Geldof felt deflated at that moment, that was nothing compared to how we felt last month, when the Government released its longawaited response to Treasury head Ken Henry’s review of the taxation system. For months, Henry had led a team of highly skilled and highly knowledgeable bureaucrats to fashion a report that could fundamentally overhaul the tax system in this country, radically simplify and streamline it, and create a system that could effectively underpin a modern, dynamic economy for decades to come. The review’s terms of reference said: “The comprehensive review of Australia’s tax system will examine and make recommendations to create a tax structure that will position Australia to deal with the demographic, social, economic and environmental challenges of the 21st century and enhance Australia’s economic and social outcomes.” Don’t forget that the review was commissioned by the Government. The Government wrote the terms of reference. The Government knew what it was getting into. So, after receiving a report that by all accounts brilliantly discharged its commission, and which ran, in total,

Dixon Bainbridge

to more than 1000 pages, what did the Government give us in response? A dribble of increased super contributions, a fiddle with the contributions caps (again), piddly tax relief for small business, and a giddying new tax on miners. Anti-climactic? You bet. Is that it? I’ve never met Ken Henry, but I’ve seen him on telly, and he seems to be a man of great intellect, unquestioned integrity and who has an absolutely vice-like grasp of economic policy issues. And he likes wombats. A lot. No-one who likes wombats as much as Ken Henry does can be a bad bloke. Henry dutifully suffered through Treasurer Wayne Swan’s press conference. I assume he knew beforehand what was coming, so at least it wasn’t news to him. Swan denies that Henry was grumpy with the Government’s response - Swan says Henry always looks that way - but I’ve seen that look before. It’s the look on the football coach’s face when the chairman says he has the full support

of the board. It’s the look on the sacked Minister’s face when the Prime Minister says he’s being “promoted” to a new portfolio. It’s the look on the parent’s face in the headmaster’s office that says: “I’ll deal with you later!” OK, it’s true that it is any government’s absolute prerogative to accept or reject, as it sees fit, the findings of any review it commissions. It has rejected outright almost 30 of the review’s recommendations. Fair enough. But that leaves more than 100 that it has not rejected, but which it’s also not implementing. It’s also true that implementing even 100 separate recommendations is a task that would take years and years. And it’s even true that some of the good stuff in Henry might yet see the light of day, in years and decades ahead. Even so, for a report of this importance and potential to produce such a response so … well, piss-weak is the only term that really does it justice … was incredibly disappointing. The release of the Henry tax review did answer one key question for me, though. I realise now that it was a review of the tax system, conducted by someone called Henry. Up until then I hadn’t dared admit that I didn’t know what a Henry tax was - nor why it needed to be reviewed.

Dixon Bainbridge is no expert on tax, but he knows a cop-out when he sees one. You can contact Dixon on info@conexusfinancial.com.au

6 BILLION REASONS WHY COMMISSIONS ARE BEING AXED. Research by ratings agency Rainmaker * found that in the past four years alone, $6.5 billion has been paid in superannuation commissions to financial planners.# Fees and commissions can add up to a yearâ&#x20AC;&#x2122;s salary over the working life of an average wage earner. Supernomics, a research report produced by Industry Super Network, exposes the market failure within Australiaâ&#x20AC;&#x2122;s superannuation system, as well as ways to address this. To download your free copy, visit industrysupernetwork.com/supernomics Rainmaker Consulting, Commissions Revenue Report, April 2010. www.industrysupernetwork.com/document-library/publications * Commissioned by Industry Super Network, a division of Industry Fund Services Pty Ltd ABN 54 007 016 195 AFSL 232514.

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