Professional Planner - August/September 2010 by Conexus Financial Pty Ltd

AUGUST - SEPTEMBER 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 E E - B A S E D A D V I S E R S

FPA comes out fighting

Professional standards

Mark rantall stands up for planners

accountants show how itâ&#x20AC;&#x2122;s done

Client case study

Planner profile

Solving that sinking feeling

All part of the service

Turn

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Contents

August - September 2010 04 06 07 08 10 12

Cover story - page 20

Opinion and views

Practice management

From the editor Sanders Whiteley Slattery The professional body Practitioner perspective

60 Martin Mulcare 61 Peter Switzer 62 Rod Bertino

Professionalism 16 No monkeying around on this standard

SPECIAL REPORT Emerging markets

31 Taming the wild card in the deck

Planner profile - page 36

45 47

Self-managed super

Investor psychology

Avoid non-compliance for expats Cashing out or rolling back: a guide

50 The secrets of successful investing Technical 55 Special circumstances, special trusts

Sharemarket 63 Portfolio planning is for pros

Managed funds

64 Solving the unlisted property puzzle

Property

66 68

Low risk and high potential returns

Private banking Using segmentation to drive service

Philanthropy 69 Low flows were so 2009 Final word 70 More than one way to score a goal

Superannuation 57 Super Cooper: the impact of the review Responsible investing 58 It pays off in more ways than one

Client case study - page 40

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F R O M T HE EDITOR

The wisdom to know the difference W

hen the pace of change is fast, and when the change seems to be never-ending, it is not surprising that a large proportion of the community feels a deep sense of unease. And it’s understandable that resentment sometimes bubbles over when change is driven by factors that appear to be outside one’s control. We see this in our society at large. Massive and rapid change can cause significant social dislocation. Reference points are shifted, the traditional or established ways of doing things are challenged, and it causes anger and fear, and often, a backlash. We see this, writ smaller, in the financial planning industry. It’s difficult to think of any industry that has been subject to closer scrutiny and regulatory review than this one. So it’s easy to understand why a significant number of plan-

ners wonder just who is standing up for them against the forces of change. Critics of the Financial Planning Association of Australia (FPA) who believe the association has abandoned its members to the whims of regulators, industry funds, consumer advocates and the media, should welcome the appointment of Mark Rantall as FPA chief executive. In truth, the FPA has always fought for planners’ best interests. That was certainly the case under Rantall’s predecessor. But confusion or mistrust seems to have arisen in relation to what role the FPA should play as a professional body, as opposed to a trade association. Rantall is adamant that the FPA should commit itself to being a true professional body. It’s not remotely interested in being some sort of industry spruiker or apologist. A professional association exists to set, promote and, when

necessary, police professional standards, codes of ethics and behaviour; a trade organisation exists to promote and protect its members’ interests and help them sell as much stuff as possible. Rantall’s view of the role of the FPA is fairly straightforward: Some change in financial planning was undoubtedly necessary and overdue, and where that change accords with the FPA’s view of itself as a professional association, and of financial planning as a profession, it has accepted that change and worked with regulators when possible to modify the likely impact of the change. But it’s also obvious that some change is not necessary, is potentially counter-productive, and should be opposed. Among those issues are commissions on risk products - Rantall says commissions should be retained both within super and outside super - and the proposal for an

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FROM THE EDITOR

annual client opt-in. In Rantall, financial planners have a champion prepared to fight their corner, and push the profession’s best interests. As the saying goes: Grant me the serenity to accept the things I cannot change; courage to change the things I can; and the wisdom to know the difference. Rantall had been in the job only a few days when he spoke to Professional Planner, but it’s clear that in their new chief executive, FPA members have a leader not only prepared to fight, but a wise one, to boot. Rantall will spend the rest of this month attending FPA chapter events and meeting members. Keep your eyes peeled for when the Rantall show rolls into town - it could be the ideal opportunity to meet the new guy, and see for yourself.

was set straight on this issue myself, while talking to two well-known industry identities, Ray Griffin and Peter Bobbin. While Future2 was set up as “the foundation of the financial planning profession”, and the FPA provides some administrative support, Future2 operates autonomously. Ray and Peter are preparing for a 1250+ km bike ride from Bourke to Sydney. They start on August 4 and if all goes according to plan will roll into Sydney on August 13. Their aim is twofold: firstly, and perhaps most importantly, to raise awareness of Future2 and the work it does helping the disadvantaged in our communities. And secondly, to raise funds along the way. At the time of writing, BT had signed up as a gold sponsor, with Matrix Planning Solutions and Telstra as silver sponsors. Ray and Peter were hoping to attract further sponsors, and to garner donations and financial support along the way. Ray and Peter aren’t the first, and certainly will not be the last, people involved in the planning industry to support Future2 and its works. But if you read about their ride at www. future2foundation.org.au/wheelclassic you’ll get a sense of why this event is a little different from some others. In Sydney a week or two ago, Ray certainly looked up for it. He’s covered some 8000km on his bike this year, in preparation. Peter? Well, Peter had completed his first 160km training ride. All he has to do now is string together seven or eight of those in a row, and he’ll be home and hosed. Simon Hoyle simon.hoyle@conexusfinancial.com.au

August - September 2010 - Issue 25

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 : Saurav Aneja Planner Profile Photos: Paul Jones www.pauljonesphotography.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.

*** If the financial planning industry is truly worried about its public image, then it could do worse than be seen to be putting something back into the community. That’s the thinking behind the Future2 Foundation, which is now three years old. This foundation is often thought of as the FPA’s foundation - erroneously, as it turns out. I

Executive Directors: Colin Tate, Debbie Wilkes, Greg Bright

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

Circulation 9312

COLUMN

he past year has seen a flurry of government reports, ministerial announcements and even legislative change in the world of financial planning. If you can climb over the wall of noise that this generates, wade through the sea of newsprint dedicated to dissecting and (often) misinforming you about these changes, and navigate your way through all the detail - then, if you’re very lucky, you’ll make it to the safe and quiet shores of tomorrow. At least this is the promise we keep making to ourselves - that things will always improve; if we can just make it over this next regulatory hurdle, things will be brighter on the other side. Some even suggest that if we can just make enough noise, then it will all go away. The bad news is that this won’t go away. Yes, the policy might change slightly, or possibly go away for a little while. But the reality is that the financial services sector is now the largest contributor to GDP; and Government intervention will not go away completely, given the importance of the superannuation and investment industry to economic performance and the national interest. The Government also believes there’s something slightly risky about financial advice, and so they’re always tinkering with it - or in some cases blasting away. These “risky issues” are not the bogeyman of “commissions” or institutional licensees or even product relationships. It seems to be the niggling suspicion, the “perception”, that the “client’s interests” are not always put ahead of “self interest”. This

misperception has been a driving influence in almost all the reform programs over the past few years. This is the real challenge that the Future of Financial Advice (FoFA) reforms represent. The proposals go too far - the pendulum has swung too hard and we need to fight tooth and nail to ensure that consumers and an entire profession are not harmed by misperception. Success of the FoFA reform program won’t be measured by the detailed nuance of a fiduciary obligation cast in law, or the technical application of product-related regulation, but by the far more fundamental issue of how the financial planning profession is perceived by the public and by politicians. The question is, how do we change the current perception? How do we win their hearts and minds and gain genuine professional respect for the extraordinary work that financial planners do? I don’t think we can do it by yelling loudly, acting hysterically or by offering non-constructive ultimatums to a government that doesn’t consider financial planners to be a voting constituent of interest. In fact we’ve done the maths on this as part of our election planning and our data shows that only 10 per cent of FPA members reside in marginal seats held by Labor. Some people have pointed to the work of the mining lobby groups as a successful tactic that should be employed in financial planning. Leaving aside the impossibility of building the reported $100 million advertising budget that the mining companies had available, the point of their campaign

was to deliberately strike fear into the Government about their own voting constituents. The consequence might seem like a victory for the mining industry; but the reality is, they still have a new multi-billion-dollar tax, and now also a Government with a long memory. It seems to me that the strategy for the financial planning profession should be the opposite. Our goal shouldn’t be to instil fear but to instil confidence and trust in the future of financial planning and the central role it plays in delivering a financially successful future for Australians and their government. We want to deal with the issues of perception and practice once and for all, so that financial planning is not the whipping boy every time a new story is needed. We will fight on those issues that are detrimental to consumers and to the integrity of your professional future. But getting to an effective outcome will take considered dialogue and strong lobbying, driven by deep thinking about the issues and a constructive approach to genuine change that recognises the battle is as much about changing perception as about changing the law. The goal through all of this is to ensure a strong professional future; one that rewards you as long as you choose to work within it - a profession that has gained government respect and community trust. To comment on this article go to . www.professionalplanner.com.au Deen Sanders is deputy chief executive and head of professionalism for the Financial Planning Association of Australia

Sanders

What’s it all really about?

Deen

COLUMN

esearch commissioned by Industry Super Network (ISN) suggests that the Government’s Future of Financial Advice reforms will substantially increase opportunities to provide financial advice. Late last year, ISN commissioned two important studies that examined the demand for and supply of financial advice. The first study was an online survey by Forethought Research of 804 adult Australians with superannuation, regarding their use of financial advice in the two years to November 2009. The second study consisted of modelling by Rice Warner Actuaries of the impact of a commissions ban on the financial advice industry. The two key messages that arose from both studies were: • Currently, the major consumers of full financial advice are high-networth individuals and those close to retirement. • A ban on commissions on financial advice (including for risk insurance) will stimulate a rapid increase in the supply of non-complex advice. (“Non-complex advice” refers to single-issue and intra-fund advice, as opposed to “complex” or holistic financial advice. Advice is said to be “ongoing” if it is provided at least once a year.) The survey conducted by Forethought Research found that onethird of all respondents sought some form of financial advice in the two years to November 2009. The survey results confirm that younger people and low-to-middle income earners are untapped markets for financial advice. Only 23 per

cent of respondents earning a gross personal income less than $100,000 sought complex advice (ongoing or one-off ) between November 2007 and November 2009, compared to 51 per cent for respondents earning more than $100,000. Analysing the demand for ongoing complex advice by both age and income, it is evident that only 12 per cent of respondents who were (a) aged 18-54 and (b) earning less than $100,000 per annum, sought ongoing complex financial advice. The corresponding number for respondents aged 55 and over was 31 per cent. The influence of income was much less pronounced for single-issue and intra-fund advice. Eighteen per cent of respondents earning $100,000 or less sought single-issue or intra-fund advice in the two years to November 2009, compared to 24 per cent of respondents earning $100,000 or more. While Forethought Research’s data confirm the relatively low consumption of advice by younger and less wealthy people, Rice Warner’s modelling suggests that these groups will be the chief beneficiaries of the Government’s financial advice reforms. Rice Warner estimate that by 2024, consumers will receive more than 900,000 additional pieces of advice than would have been the case with no regulatory change. This increase will largely be driven by a rapid expansion in the supply of single-issue and intra-fund advice (137 per cent), with the growth in the supply of complex advice remaining stable (5 per cent). In addition, Rice Warner project that greater price transparency and competition will induce a 48 per cent

decrease in the weighted average cost of complex and non-complex advice by 2023-24 ($3400 to $1800). Rice Warner do not expect financial advice reform to affect total adviser employment or revenue significantly, although they do anticipate that more labour hours will be devoted to the delivery of non-complex advice and less to complex advice. All these findings should inspire confidence that the Government’s reforms will make financial advice more accessible and affordable, and therefore open up new markets for financial advisers. Further, the removal of commissions and introduction of a fiduciary duty will build consumer confidence in the professionalism and integrity of financial advisers. It is therefore essential that the Future of Financial Advice reforms are legislated intact and receive the full support of the industry.

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

David Whiteley is chief executive of Industry Super Network

Whiteley

Encouraging advice

DAVID

COLUMN

he final Cooper Review report confirms what many of us have long known: the self-managed super fund (SMSF) sector is functioning well and is successful. In the 504-page report (including parts one and two), there were relatively few recommendations applying to SMSFs, highlighting the strength of this growing sector. An area that did receive attention - and deservedly so - was SMSF advice. The Self-Managed Super Fund Professionals’ Association of Australia (SPAA) has long advocated for higher standards of SMSF advice. Indeed, it’s our primary reason for being. The Cooper Review is now calling for higher competencies for SMSF auditors and advisers. In particular, Cooper adopted our recommendation that SMSF auditors be registered with ASIC and that appropriate competency and independence standards be developed and policed appropriately. Anticipating higher professional standards, SPAA will soon be releasing updated SMSF adviser standards as part of our specialist accreditation program. These new standards now cover a much broader range of content for all SMSF professionals - advisers, tax agents, auditors, and accountants alike. Previously focusing on advice, plus understanding and application of the Superannuation Industry Supervision Act, Taxation Act and Corporations Law, the new standards will now test a range of knowledge and skills across the SMSF sector, including investment strategies, managing risk and superannuation choice. Expanding the remit of our accreditation standards creates new

opportunities for specialist SMSF education providers, including the range of universities that we accredit. We look forward to continuing and expanding our relationship with leading educators as the new standards are rolled out. Industry participants knew that higher professional standards would be expected. We’ve seen a significant increase in interest in our specialist accreditation programs over the past six months with a 20 per cent jump in advisers completing the program. There are now 585 SMSF Specialist Advisers with a further 279 advisers in the process of completing the accreditation. Similarly, demand for specialist auditor accreditation grows by the day. We have had a 330 per cent increase in auditors completing the specialist auditor accreditation in the past six months, albeit from a lower base of 11 as at December 2009. For those contemplating joining the swelling ranks of SMSF specialists, you should know the process is tough, but not unreasonably onerous for those already working in the field. As you’d expect, the standards must be set at an appropriately high level. Indeed, the Cooper Review panel recognised our efforts “to increase SMSF competency by requiring advisers to complete specialised training before they can provide financial advice on SMSFs”. Our resolve in raising the bar remains. In the case of advisers, accreditation is set at an equivalent undergraduate level, while for auditors it’s set at a master’s level equivalent. We test competencies in a 120-question online examination. In addition, specialists must have at least two years experience in SMSF-related

work and be performing at least 20 per cent of their work in SMSF-related activities and advice, among other requirements. To undertake the specialist accreditation you need to be a member of SPAA. You can join and register for an accreditation program online at www. spaa.asn.au, or contact the SPAA head office in Adelaide. With the growing public scrutiny of the quality of advice, our goal is for more trustees to understand the importance of specialist advice and to seek out SPAA-accredited practitioners. Expect to hear more from SPAA in this regard as we continue our efforts to fly the flag for SMSF specialisation and higher professional standards.

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

Raising the bar, again

Andrea

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T H E P R OFESSIONAL BODY

FPA: the gloves are off Mark Rantall must cope with three major regulatory reviews, an industry in a state of flux, and pockets of a membership that harbour great hostility. He spoke exclusively to Simon Hoyle

he new chief executive of the Financial Planning Association of Australia (FPA), Mark Rantall, has a message for members or former members who believe the association has caved in to pressure from regulators, consumer groups and the media. “The FPA is not rolling over,” he says. “We absolutely will be the advocate for our members, in terms of negotiating with Government and any other interest groups, for those members - and it’s the majority of those members, I should say - who are doing the right thing and moving forward in helping us become a professional organisation, and signing up to the code of conduct and the ethics and educational requirements that go with that. “Where things are not in accord with the way we think a professional body should operate, then absolutely we will stand up for that, and we’ll stand up for our members and for the great job that they do. “This is the fine line that a professional body walks, which is between, on the one hand, being an advocate for their members, and lobbying in that regard; and on the other hand, sometimes being the policeman who has to enforce the standards that professionals sign up to. “We will fight for the right things. The other things, we need to build our position in consultation with Government. There is no use in just being totally aggressive towards a regulator or the Government. It does not get you anywhere.” Rantall says the FPA is unapologetically evolving into a true professional association. And that is something quite different from a trade association, which some elements of its membership seem to want it to be. “The real difference between an industry association and a professional association is the professionalism of its members and how they

Mark Rantall

interact with their consumers,” he says. “The differentiator is all about the professional standards that the membership is prepared to sign up to; the minimum educational and continuing educational standards that the membership signs up to; and importantly, the ethical behaviour that the membership agrees to adhere to. “If you look at those three things, they’re a big differentiator between [a professional association and] a pure advocacy or lobby group, if you like. My sense is we’re the pre-eminent professional [financial planning] association in this country, and we’ve led the way in setting those standards and enforcing those standards.”

Rantall also rejects the suggestion that the FPA has put the interests of the big end of town ahead of individual practitioners. “Let me refute that statement to start with,” he says. “That has certainly not been my experience or observation, in terms of the domination of the board by institutions. “We have one individual representative who comes from an institutional background. We have two independent board members who come from more of a professional background both legal and accounting - and then there’s three members of the board who are CFPs and run their own individual practices.” Rantall says that in the hurly-burly of regulatory reviews and claim and counter-claim by interested parties, the role of financial planners has often been misrepresented. “Who creates the public perception? It’s the media,” Rantall says. “And there are some vested interest groups who have fuelled that. It’s time for that to stop. Enough is enough. “I’m determined to take that on, and call them on their behaviour. It’s not doing anyone any good. All of these problems have not been just financial planners. There have been systemic product failures that have hurt clients. You could argue that financial planners have a role to play in that, and they absolutely do… but it hasn’t all been just the financial planner mucking up. And there’s a big difference between bad advice and fraudulent behaviour, and I think those two things get mixed together sometimes. “I just think the whole debate has got out of perspective.” Rantall says that what is needed is “a broader vision for why it is we’re doing what we’re doing” in terms of the reviews of the industry and looming legislative changes.

THE PROFESSIONAL BODY

“Australians need to take control of their own destiny, as it relates to their financial independence,” he says. “There are a number of ways they can do that, and the three predominant ways are superannuation, investment in various forms outside of superannuation, and through having the right protection and estate planning in place - broadly. “My view is that it’s extraordinarily difficult to build that plan on your own. My view is that getting advice from a call centre or an automated phone system - even worse - is going to leave you short on building a holistic plan. Therefore I think the role of a financial planner is absolutely critical in helping Australians achieve their objectives. “I’m concerned that that broader message, and that vision, is getting lost in the detail of the focus of some of the reviews - as an example, just focusing on costs, in itself, is not going to see Australians that much better off in their financial future. “Some of the figures that were quoted around reducing costs by removing commissions, and removing costs by driving down the cost of admin, was going to save $40,000 over an investor’s working life - but adding $20 to $30 a week, increasing your superannuation contribution or savings by $20 to $30 a week, could give you in excess of $100,000. “I hope we haven’t given up on the concept of educating people and advising people about how they can have a better financial future. Some of the things I’ve read coming out of some of the reviews around most people being disinterested in their superannuation, for example - if we accept that position, I think we’ve lost. “And the great role that financial planners play has been absolutely underestimated, and in some cases undermined, by some of the advertising that we’ve seen, that has been funded from members’ superannuation balances. I’m not so sure whether it’s achieving the greater good. I’m not so sure it’s helping Australians, or if all it is doing is forcing them back into trying to do it themselves.” Rantall says in situations where regulatory change is inevitable, the FPA has to work constructively with lawmakers. But where it believes

‘The FPA is not rolling over. We absolutely will be the advocate for our members’ change may be counter-productive, it will not hesitate to fight against it. “I’m quite happy to come out and say I disagree with removing commissions on insurance in super, particularly given we’ve got the concession of not having commission banned on insurance outside of superannuation,” he says. “It does not make sense to operate two systems. I think we’re in danger of throwing the baby out with the bathwater. “I’m not so sure what the problem is we’re trying to solve with insurance. I don’t see that insurance has been a big problem, for the Government or consumer groups. Commission in products for insurance has been used to distribute insurance for decades - car insurance, house insurance, life insurance. “Insurance is different because it’s an annual contract; the consumer has absolute control over that contract, and whether that contract continues or not, on an annual basis. That’s completely different to investments, where commissions were embedded in product, over which the consumer had no control. “It’s an annual opt-in, the consumer has control, and provided those commissions are absolutely transparent and consumers know what they’re getting and what they’re paying, I don’t see what the issue is. “You’re not talking about people’s life savings, and the potential that they could lose their life savings, and the tragedy that surrounds that. It’s just a different product. The real danger of removing commission in super, as an example, and not outside, is that I’m concerned that the majority of people could end up dealing with a

call centre or a phone system, and I’m not sure they’re going to get what they need, basically. “The other big issue that I’m prepared to fight on is opt-in. I think opt-in has the danger of using a sledgehammer to break a walnut. Opt-in could potentially be inconvenient for clients. [Reviews don’t always happen] on an annual event, on a day when an opt-in certificate is going to have to be signed and sent off to a fund manager - or whatever, because we do not know how it’s going to operate. “But more important, I think it could be potentially dangerous; because if Cooper is right, and most people are apathetic towards their investments, the time that a client might need to be opting in might be exactly the time that they decide not to bother. A great example is the GFC that we’ve just gone through. It can be disastrous for a client to get out at the wrong time. The consequences…can be catastrophic, and very hard to recover from. “The final reason that opt-in, in my opinion, is not necessary, is that we’ve already moved on from commissions in investment, and we’re going to be operating in a fee-for-service environment. In a fee-for-service environment, the client has absolute control over a transaction; any fees are totally disclosed; and if a client wants to stop those fees, or not see a financial planner, at any time, they have the control to opt out. At any time. Why is an opt-in necessary? Once again, what is the problem that we’re trying to solve? “And as a broad comment, I’d like to know if anyone can tell me of any profession in the world, or for that matter any business contract in the world, that operates on a fee, that has legislated opt-in. To my knowledge, there is none.”

P R A C T I TIONER PERSPECTIVE

The dilemma we face in taking commissions out of risk products Despite growing calls to “de-commission” risk products, Wayne Leggett argues that doing so would only undermine the role played by financial planners

he momentum of the campaign to eliminate commissions from the world of financial planning, while disconcerting to members of some quarters of the industry, is an inevitable consequence of the endeavour to transform financial planning into the profession most of its practitioners would wish it to be. Hand in hand with this campaign is the introduction of the obligation on financial advisers to become “fiduciaries” - although few could argue with the suggestion that, if we weren’t already acting as such, we should have been. The Future of Financial Advice paper suggests that the legislation will require advisers to take “reasonable steps” to ensure their advice is in the “best interests” of the client. While this is an obviously beneficial development in the industry, try explaining to a client why you don’t already operate on that principle. While most of the proposed changes have been largely met with the approval of industry participants, one issue that is proving a “bone of contention” is that of the retention of commission on risk products. There may be an element of inevitability in the ultimate demise of commission payment for insurance products. However, in the short term, at least, this is an area in which we need to exercise caution. Proponents of the case for removal of risk commissions, not surprisingly, include Choice, who are lobbying for the banning of commissions, which they suggest are “perverse incentives”. However, one would suspect that they hold that view about commission on any product. In their article “Insurance is not a special case” (Professional Planner, June-July 2010), Claire and Tim Mackay suggest that because Choice holds this view, that indicates “consumers

‘In the short term, at least, this is an area in which we need to exercise caution’

Wayne Leggett

themselves do not believe banning commissions would be to their detriment”. However, the flaw in this argument is that, although they lay claim to doing so, Choice do not represent the average consumer. This is because the premise behind Choice is that of doing your own homework and making decisions for yourself based on the research you have conducted. Thankfully for us, however, the majority of consumers prefer to engage the services of a qualified expert. Therefore, to suggest that the views of Choice mirror those of the typical consumer, and to then use their opinion to suggest all consumers agree with the idea of eliminating commission, is perhaps not an accurate reflection of reality.

In the same article, the Mackays suggest “it is in the consumers’ interests to have fewer professional advisers who they trust...”. It is difficult to fathom how having fewer advisers better serves the interests of consumers, given that we already have a well-documented problem with underinsurance - something they acknowledge in their article. In fact, they suggest that underinsurance has “arisen entirely under the existing commissionsbased system”, as if commission is the reason for the underinsurance. The reality is that underinsurance has always been a problem; but one that would, in all likelihood, be worse if not for the incentive that commissions provide to recommend insurance. The Mackays state that “currently, the cost of commissions is hidden, wrapped up in the premiums paid”. Unless an adviser is failing to comply with their disclosure obligations, clients are clearly told how much commission is being paid, both in dollar and percentage terms; there is nothing “hidden” about that. They also suggest that eliminating commissions would help solve the underinsurance

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P R A C T I TIONER PERSPECTIVE

problem because it would result in “premiums immediately falling by between 45 and 51 per cent”. Call me a cynic, but I wouldn’t be holding my breath waiting for a halving of premiums in the wake of the removal of commission. Without an incentive to do so, why would insurers immediately pass on the entire savings on commission in the form of premium reductions? Currently, commissions are a legitimate marketing expense. If, or when, they are removed, it is almost certain that the insurers will look to alternative methods of marketing and promoting their products to retain market share. Hence, the likelihood of seeing any substantial reduction in premiums is remote. Furthermore, it is hard to see how a reduction in premiums would resolve the underinsurance problem, given that evidence suggests that the primary reason for underinsurance being such a problem is lack of initiative to address the issue rather than reluctance to meet the premiums being asked. If the above assumptions are correct, it is likely that insurance premiums would, in fact, not reduce greatly in the “no commission” universe. So, if we already have a chronic underinsurance problem, how much worse will it become if consumers are asked to pay advice fees in addition to the premiums? Claire and Tim Mackay state that, “Rather than competing on premium price (sic), insurers compete on the level of upfront commission”. If this statement had any validity whatsoever, the insurance company paying the highest commission would be the recipient of the bulk of the new insurance business written; the reality is that there would appear to be little, if any, correlation between commission levels and premium inflows. To suggest there is an inordinate focus on commission to the exclusion of other factors completely discredits the thousands of risk advisers who ethically and professionally analyse client needs and match them to available product - the majority basing their decisions on the outcomes determined by independent comparison

Professional Planner June - July 2010

software. Commission may be one factor in the decision for some advisers, but for a great many advisers, it doesn’t even enter into consideration. Furthermore, a comparison of commission levels suggests that, in the long run, there is very little difference between the commission rates offered by different companies. Another factor that puts the relevance of commission in perspective is that most insurers receive a significant amount of their new business written under either “level” or “hybrid” commission terms. If commission were the inordinate focus that the Mackays suggest, there would be very little business written in any form other than upfront commission. If commission is such an incentive to write risk business, why do we have such a paucity of planners recommending risk? Financial advisers are on the horns of the proverbial dilemma in their endeavours to be recognised as a true profession. Unlike other “professions”, an integral element of financial advice is the recommendation of financial “products”. Some have suggested that there should be a distinction in law between an “adviser” and a “salesperson”. However, such moves would be both divisive in principle and difficult in application. The introduction of “fiduciary responsibility” should, in theory, at least, eliminate such considerations and obviate the need for the consumer to seek financial advice from one source and be forced to go elsewhere to implement the advice. As stated at the outset, the disappearance of commission from the financial planning landscape, including risk, is inevitable. In time, the public can be educated as to their insurance

needs to a sufficient extent as to increase their preparedness to address these issues. Perhaps this increased awareness can be provided, in part at least, by increased advertising by insurers (funded by the removal of commission, perhaps). However, until such time as the industry has developed the resources to market risk products under a different remuneration model and the public has become accustomed to paying for financial advice - risk insurance included - let’s not rush into an environment that has the potential to exacerbate the underinsurance problem, create an exodus of ethical senior risk advisers from the industry and undermine the value of risk-based advice businesses. After all, no claimant ever complained that their adviser had sold them too much insurance!

P R O F E S SIONALISM

No monkeying around on this standard Robert MC Brown says one profession is leading the way in raising standards and serving the public - and it’s not financial planning

hould the Government’s well-intentioned financial planning reform legislation ever see the light of day (and much of the industry would prefer that it didn’t), it is unlikely to be effective. This is because the legislation will ban commissions, but it will not adopt a comprehensive approach to remuneration reform, thereby allowing the continuation of conflicts of interest, low levels of trust, and poor behaviour by planners. In addition, the legislation will be full of transitional measures, carve-outs and political compromises, which will make it lengthy, complex and costly to administer for regulators and AFSL holders alike. Consequently, market distortions will be considerable as advisers hang on to their trailing commission arrangements in perpetuity and the “old and bold” dare to hope for the long-awaited comeback of high-commission life insurance products. Responding to a clear need for comprehensive reform of financial planning, the accounting profession’s independent standard setting body, the Accounting Professional and Ethical Standards Board (APESB), has issued a proposed standard titled APES 230 - Financial Advisory Services (APES 230). This has been issued as an Exposure Draft (ED), meaning that it is open for public comment (in this case until September 15, 2010). The main principles in APES 230 are that members of the accounting profession who provide financial planning services are acting in a fiduciary relationship (putting their clients’ interests ahead of their own), and that in so doing they must remove conflicts of interest, particularly those conflicts caused by certain types of fees and remuneration. The standard proposes that from July 1, 2011, accountants (in whatever employment

New guidelines for accountants The proposed APES 230 includes mandatory requirements and guidance in respect of: • Fundamental responsibilities of members; • Fiduciary responsibilities of members; • Professional Independence; • Terms of the financial advisory service; • The basis of preparing and reporting financial advice; • Client’s information, monies and other property; • Fee for service; • Soft dollar benefits; and • Documentation and quality control.

Proposed Standard: APES 230 Financial Advisory Services Prepared and issued by Accounting Professional & Ethical Standards Board Limited EXPOSURE DRAFT ISSUED:

02/10 (June 2010)

Copyright © 2010 Accounting Professional & Ethical Standards Board Limited (“APESB”). All rights reserved. Apart from fair dealing for the purpose of study, research, criticism and review as permitted by the Copyright Act 1968, no part of these materials may be reproduced, modified, or reused or redistributed for any commercial purpose, or distributed to a third party for any such purpose, without the prior written permission of APESB. Any permitted reproduction including fair dealing must acknowledge APESB as the source of any such material reproduced and any reproduction made of the material must include a copy of this original notice.

The fundamental principles in the proposed APES 230 ED are that members who provide financial advisory services act in a fiduciary relationship (putting their clients’ best interests ahead of their own interests) and that in so doing they must remove conflicts of interest, particularly those conflicts caused by certain types of fees and remuneration. This standard proposes that members who provide financial advisory services must only charge clients on a fee for service basis (as defined in the standard). Such a fee for service minimises conflicts of interest because it is not calculated by reference to products sales or the accumulation of funds under management. Consequently, this standard proposes that members who provide financial advisory services must not use practices that cause conflicts of interest (or perceptions of conflicts of interest) such as commissions, percentage-based asset fees, production bonuses and other forms of fees and remuneration that are calculated by reference to product sales or the accumulation of funds under management. As a result, members create relationships of trust with their clients, which is the central feature of any professional relationship. It is proposed that these requirements will apply to all new and existing clients (including those from whom trailing income is being received) of members from the commencement date of this standard. Proposed operative date It is intended that this Standard will be operative from July 1, 2011.

Source: Accounting Professional & Ethical Standards Board Proposed Standard: APES 230 - Financial Advisory Services, exposure draft 02/10

capacity they operate) must only charge clients on a fee-for-service basis (as defined in the standard). APES 230 proposes that accountants who provide financial planning services must not adopt practices that cause conflicts of interest (or perceptions of conflicts of interest), such as commissions, percentage-based asset fees, volume bonuses, soft dollar benefits and other forms of fees and remuneration that are calculated by

reference to product sales or the accumulation of funds under management. APES 230 sets a high bar, reflecting the view that accountants are professional people whose obligation is to the public interest (first and foremost), then to our clients’ interests and then to our own interests. Ultimately, it is our undertaking to act in the public interest that distinguishes us as a

P R O F E S SIONALISM

profession; and that position of trust has traditionally caused the community to allow us to self-regulate (to a greater or lesser extent). If we breach that trusted position, we should expect to be heavily regulated. This is exactly what has happened to the wider financial planning industry over many years, including recently in the Government’s proposed reform agenda. The key point to understand about APES 230 is the comprehensive definition of fee for service. This will result in a ban not only on the use of commissions, but also on the use of all other sales and asset accumulation-based remuneration models, including asset fees. Much of the wider financial planning industry has masked and avoided this issue for many years by referring to percentage-based asset fees as “fee for service”. APES 230 asserts that asset fees are not an acceptable form of remuneration for a true professional person because, like commissions, they give rise to conflicts of interest and a lack of trust. The principles outlined in APES 230 may be very confronting for the financial planning industry and for some members of the accounting profession who have become financially wedded to the industry’s “status quo”. However, other accountants (the silent majority) will be impressed by APESB’s decision to take a strong ethical position on financial planning, and they will be more inclined to offer this service to their clients as a legitimate professional activity, rather than as a thinly disguised product distribution network which they have hitherto avoided. Some critics of APES 230 will suggest that it is unnecessary and that the industry’s efforts to lift educational standards of planners, along with more disclosure, transparency, financial literacy programs, and the banning of commissions, will solve the industry’s problems. They won’t. All of these are positive initiatives, but without trust between financial planners and their clients, all the disclosure, transparency and education in the world won’t help. There were many well educated bankers on Wall Street during the global financial crisis. That didn’t make any difference, because the ethical fundamentals were

Robert MC Brown

not in place. APES 230 puts those fundamentals in place. Others will suggest that APESB is imposing hourly rates on accountants who are offering financial planning services. It isn’t. Of course, some people may wish to use that basis of charging, which is often criticised because it is alleged to lead to conflicts of interest in the same way as percentage-based asset fees. This criticism is illogical. There is no doubt that hourly rates may give rise to inefficiencies and inappropriate billing levels, but they do not give rise to the conflict to which APES 230 is referring; that is, the pressure to sell products or to accumulate funds under management. Many accountants may wish to adopt a flat fee, an annual retainer, or a task-based charging model, all of which will substantially overcome the allegation of inefficiencies inherent in hourly rates. The main issue is that the charging model must not be reliant on the sale of a product or the accumulation of funds under management. Finally, while APES 230 is not retrospective, it does require adherence by the nominated start date. However (and thankfully), there are no transitional provisions, no carve-outs, no political compromises and no exceptions, such as for life

insurance commissions. In this way, accountants will not suffer the uncertainties of large market distortions, horrendously complicated legislation and increased compliance costs. And most of all, accountants offering financial planning services will avoid conflicts of interest, leading to unqualified trust, which is the central feature of any professional relationship. To the best of my knowledge, APES 230 is a world first. Some countries have acknowledged the problems, but have ended up banning commissions, leaving other conflicted remuneration models in place because of commercial pressures (“it’s all too hard”) or because of a lack of understanding of the issues. Adoption of APES 230 is a measure of the Australian accounting profession’s willingness to be truly professional. It is to be hoped that the rest of the financial planning industry will now lift itself to this high standard of practice. So doing is not only in the public interest. It may also lead to a position in which pending legislation becomes unnecessary, and self-regulation becomes a reality, much to the relief of both the industry and our legislators alike.

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.

C O V E R STORY

Turn

Down

the volume The proposed abolition of volume-based payments has the potential to radically reshape planning practices. Simon Hoyle reports that the likely changes will ultimately be for the best

ernie Ripoll’s review of financial products and services made no explicit mention of volume bonuses. But the banning of volume-based payments is a natural extension of Ripoll’s recommendations. Ripoll recommended banning payments from product manufacturers to clients; the Minister for Superannuation, Financial Services and Corporate Law, Chris Bowen, has extended the idea to explicitly outlaw “any form of volumebased payments” - including to dealer groups or licensees. The Government has in its sights any planning practice or dealer group that relies on volume-based payments from platforms and/or

products for a significant part of its income. Bowen says volume-based payments, of any kind, do not foster the kind of behaviour the Government and the public expect of planners. If the Ripoll and Bowen reforms go through, volume-based payments will be gone from July 1, 2012. For some groups that have had the volume cranked up to 11 in recent years, the sudden silence could leave a gaping hole in their revenue. “For some groups, in simple terms, it will reduce their revenue,” says Arun Abey, executive chairman of ipac Securities and head of strategy for AXA Asia Pacific. “They can do one of two things: they can go with reduced revenue and cut their costs and

services accordingly; or they can go back to the client.” Abey says that assuming the provider of the volume bonus reduces its cost to reflect the fact that a volume bonus is no longer allowed, the net cost to the client of using the product or platform should not change. But the adviser may need to renegotiate their fee with the client to make up a shortfall in revenue that would otherwise have flowed from the platform or product. “Advisers are going to have to rethink their value proposition,” Abey says. “They’re going to have to make up the revenue loss. This will have an impact on some advisers’ practices, but not all.

C O V E R S T O RY

0 “For some groups it will be significant, and it’s the larger dealer groups for which this is going to be a large issue - or not necessarily the dealer group, but the members of it.” Abey says the question is: “How can an adviser compensate for the potential loss of revenue?” “It’s by refining their value proposition,” he says. “Let’s take that one step further. If you look back over the 15 to 20 years that we’ve been speaking, in many areas the industry has changed. In many ways the professionalism of the industry is better; in many ways the technical standards of the industry are better. “But there are still too many advisers whose

11 value proposition focuses too narrowly on technical stuff - especially tax - and also on selling an investment proposition.” Abey says ipac and AXA have conducted due diligence on a number of potential acquisitions over many years, and he has seen “zero evidence that advisers have added value in that dimension”. “In a rampant bull market you can still get away with…what I would call a flawed value proposition; the central value proposition of too many advisers - around an investment proposition - is flawed,” Abey says. “And these regulatory changes are happening in a bear market, not a bull market. “Some advisers are providing more broadly-

based value propositions, and these advisers will be able to, or have a good chance of passing on what they [lose in volume bonuses] in the form of additional fees from their clients.” Abey says if clients are asked to pay more for a service - and what’s more, pay it directly to the planner - they’re likely to be far more critical of the service they’ve received. If a planner has made an implied or explicit investment promise, and that promise has been broken, there may be trouble. “If [the client] looks at this, and they see their investment return has been zero - the adviser may have been doing a good job, but investment markets are investment markets - then the client is going to resist that,” Abey says.

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.

C O V E R S T O RY

‘Unless you can articulate that extra value very clearly... they’re not going to pay it’ “The market for what always was, but is now more evidently, a hollow value proposition can be strong [in a bull market], but in a bear market it’s going to end in tears. “The old door is closed; the door to the hollow value proposition is closed. But for the current generation of advisers, there’s this other door. Rather than staring at the closed door, they have to work out how to open this new door, and work out how to go out with a value proposition that’s not focused on investment.” The managing director of Business Health, Jim Stackpool, says it’s likely to be the more established “old-and-bold” financial planning practices that run most foul of the volume payments ban, and face the biggest task adjusting. But they also stand to reap significant benefits by getting it right, and by beginning to converse with clients in terms that clients can more easily understand. Stackpool says clients no longer want to be sold products; they want to be sold outcomes, or results. And by pitching their services the right way, advisers can tap into a potentially rich revenue stream. Pitching it the right way means talking to clients in the right language - telling them how much advisory services are going to cost in dollar terms, not in percentages; and certainly not in percentages that can change over time without the client knowing. Stackpool says that even though practices and dealer groups have no choice but to adapt, the changes will ultimately lead to a stronger, more trusted and more professional industry.

What Bowen said … and where he differed from the Parliamentary Joint Committee (PJC) Future of Financial Advice Reforms - key points Removal of conflicted remuneration structures The reforms will reduce conflicted remuneration structures in relation to advice and distribution of financial products. This includes a ban on: - Any form of payment relating to volume or sales targets (including employee sales and volume targets) from any financial services business, relating to the distribution and provision of advice for retail financial products. This measure is targeted at removing other volume-related payments which have similar conflicts to product-provider-set remuneration. The form of these payments does not engender the right behaviour. The PJC’s recommendations, and the Government’s response: PJC recommendation: The committee recommends that the Government consult with and support industry in developing the most appropriate mechanism by which to cease payments from product manufacturers to financial advisers. Government’s response: Support with additional strengthening. Summary of the differences between the PJC’s recommendations and the Government response Summary of difference: The PJC recommended that the Government consult and support industry in developing an appropriate mechanism to cease payments from product manufacturers to financial advisers. The Government proposal strengthens the recommendation by introducing a legislative ban on conflicted remuneration structures, including payments from product providers to financial planners. Furthermore, the reforms strengthen the PJC recommendation by including other conflicted incentives - such as asset-based fees in relation to geared products or investment amounts - and extending these standards to superannuation products and services. Explanation for the difference: The legislative approach is important to support the steps that some industry members have been taking in transitioning away from commission payments, by establishing a single legislative framework that applies to the retail financial services industry as a whole. This is necessary for the ban to be effective in addressing the distortions the remuneration structures create. Source: The Future of Financial Advice Information Pack, issued by the Minister for Financial Services, Superannuation and Corporate Law, April 26, 2010.

But it’s going to require a change in how these businesses’ principals think. It means pricing services on the value to the client. Too many businesses still link price to product, and to volume. “I think they are using product as a fundamental factor to price [their service], rather than value as a factor to price,” Stackpool says. He argues that fees should be based on the value of the service to the client. “If I’m getting some fees from [a platform or product], and that’s part of my overall fee, provided I have not priced on that…that is just cream, and I’m taking that while I can get it,” he says. “But it’s the client’s money.

“The client will not pay extra unless they see extra value, and unless you can articulate that extra value very clearly, with a more comprehensive value proposition, they’re not going to pay it. “If you do not have the skills to articulate that proposition, you’re not going to be anywhere in the ballpark in terms of getting that extra money.” Stackpool says a well-structured advisory business, with a clear and comprehensive value proposition, should be aiming for profit to equal about 40 per cent of revenue. “You know the cost of running your business [and] you know your cost base, and you want to be able to sell [your services] at a mark-up,” he says.

C O V E R STORY

‘It’s a great thing, because they are going to have a better business for it’ Sue Viskovic, managing director of Elixir Consulting, says it can take three to six months to redefine a value proposition and to work out an appropriate fee level to cover the cost of delivery. And it can take much longer than that to get every client’s acceptance and approval of a new fee structure, even assuming every client gets a review once a year. What to do with so-called “dormant” clients is another issue entirely. Viskovic says any planning business should be able to meet (or beat) the July 2012 deadline if it has already accepted the need for change, and “if they are on to it now”. “It will take them three to six months to formulate, depending on where they are on the journey - and to pull it all together can take 12 months,” Viskovic says. Progressive dealer groups will help their advisers get there as quickly and easily as possible. “It’s going to be extremely challenging for many of them, but it’s potentially the best thing that can happen to them,” Viskovic says. “When advice practices are forced to price what they are going to do, they have to go back first and look at what they do, and how they do it. “As much as I understand the fear, and that people are annoyed that they are being told what to do, for an individual planner it’s a great thing, because they are going to have a better business for it.” Viskovic says it’s possible that a planning business will strengthen its relationships with clients and become more profitable, and that

Reforms to advice - Adviser remuneration Form of remuneration Description

Permitted under the new regime?

Any form of payment based on volume or sales targets Volume based Volume bonus and fee rebate

Whether this is in the form of a payment, from a product provider, or from any financial services business, in relation to the distribution of or advice for retail financial products

Not permitted

Paid by the product provider to the licensee or adviser and is generally conditional on the licensee having large funds under management (FUM) with the product

Not permitted

. Volume based Payments from licensees to their employee Not permitted Volume based payments or advisers or authorised representatives for sales incentives distribution of retail financial products, which are calculated based on meeting sales targets Volume based Payments based on volume that are paid Not permitted Shelf space fee payments from the fund manager to the platform (based on volume) provider and from the platform provider to the licensee Shelf space fee payments (not based on volume)

Payments not based on volume that flow Permitted to and from the platform, including a product access payment (provided that payment is not based on volume)

Source: The Future of Financial Advice Information Pack, issued by the Minister for Financial Services, Superannuation and Corporate Law, April 26, 2010.

financial planning will improve its standing as an occupation in the community. Tony Graham, head of Macquarie Adviser Services, says it’s relatively simple for wrap providers to accommodate the proposed Bowen changes by “netting off ” the cost to clients - in other words, to reduce the cost to clients by cutting out the rebate paid to the adviser (which may or may not have been rebated back to the client). But he agrees the loss of volume rebates will present challenges for how some planners relate to clients. “We net the price off at the individual client level, so the client gets a cheaper price,” Graham says. “Half of our client base already does that now. “In our case, it’s more that we can just switch

on the netting process.” The ultimate cost to the consumer might not change much, Graham says. “The pie is the same size; it’s putting a different label on it,” he says. “Then it’s how do you explain that value to the client? There’s some challenges there. “Regardless of volume bonuses going, they are probably going to have to charge more for advice. “The simple answer is you need to go back and demonstrate the value of advice, and what you are doing. If you’re dealing with a client where you have not been very active in their reviews you almost need to treat them as a new client again.”

C O V E R S T O RY

Solid platforms for growth Ian Knox says savvy advisers should develop value propositions that reduce the cost of administration and portfolio management

n the wake of the Government’s Future of Financial Advice reforms, it appears some financial planners are reconsidering their future as the ban on commissions and volume bonuses makes it harder to earn a living from giving advice. Some say it’s just getting too hard, while others feel it’s time to retire or get out before practice valuations fall. While we await the final outcome of regulatory change, it’s worth pondering some of the likely outcomes emerging from the reform and, in particular, the implications for platforms and their financial relationship with dealer groups. Platforms provide a useful level of consolidated reporting for advisers and, according to the Government reviews, a somewhat questionable and conflicted thoroughfare to shared revenue via rebates for many dealer groups. Dealer groups use this revenue to fund support services for their planners and increasingly to top up profits - because when product revenues cease, future profits will be squeezed. The business model is believed by many to be dated and financially unsustainable as the industry moves to fee for service. There is also an increasing view that platforms can create conflict because they are selected based on volume bonus agreements or the dealer’s ownership, not their administration capability. Interestingly, consumers, not planners, pay for the platform - although it’s portrayed as the planner’s back office service function. If fiduciary responsibilities become enshrined in law, one wonders what will happen if it’s in the client’s best interests not to use a platform. Whatever the regulatory outcome, it’s clearly time to change work practices. What a shame the wealth management leaders failed to self-regulate

‘One wonders what will happen if it’s in the client’s best interests not to use a platform’ with a conflict-free, low-cost and more efficient set of technology tools. So much for platform heads giving wise advice to planners to change their business models when the main game in town is equally looking 10 years out of date. By way of perspective, the platform market in Australia has been dominant in terms of product flow and market share for more than 10 years, having made its entrance via master trusts in the late 90s and wraps in the early part of this decade. Indeed, some are still selling master trusts at circa 3 per cent annual fees. After nearly 15 years of technology progress, consumer activism and talk of scale benefits, the sad reality is the cost of diversified investing hasn’t actually fallen for most consumers. While there are many reasons for this, it can be argued technology development has been deliberately limited to support high margins. High margins assure distribution rights to planning practices. This is why some platforms offer badges with dealer groups; it has very little to do with transparent pricing or lower processing costs for consumers. Now the volume bonus genie is out of the bottle, it seems many aren’t equipped to handle

the potential banning of these lucrative earners. Indeed, the platform operators and, in particular, those that offer badged versions, are lobbying against changes with the argument that platforms are a service and not a product. It seems the Government may have to settle on a compromise lest too many in the industry struggle to adapt without the income. That’s why many dealers are talking about “white labelling” and assuming the trustee role, so the product is owned by the dealer, not the platform operator. This only creates further conflicts at the advice level, which is exactly what regulation is trying to address and what independent advisers claim is wrong with institutional dealerships. Further thought may be needed before entering the fray dressed like one’s opponent. For the purists, platforms are strange beasts in that they are classified as investor directed portfolio service (IDPS) “like”, instead of being classified as a product. Go figure the difference: one pays commissions, the other pays a volume bonus. Retaining volume bonuses while banning commissions doesn’t exactly reflect the spirit of the reform’s intent, which is prompting many to pursue lower-cost, non-conflicted alternatives or rebate bonuses back to clients. Despite this trend, platforms have been slow to respond with technology improvements that support client rebates. Platform heads need to accelerate this capability and those that respond early will be better placed to capture market share. Let’s also remember that, somewhat ironically, eliminating volume bonuses won’t actually cost the platforms money with the big dealerships anyway. This is because they don’t keep the margin; it’s just a cosmetic tool used to retain distribution relationships.

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C O V E R S T O RY

The final point worth making is the role of platforms, fund managers and planners in a deleveraging investment world where an expected return from a diversified managed portfolio is about 8 per cent per annum. If this is true, then nearly 30 per cent of this 8 per cent will be eroded by fees and charges, leaving consumers with the choice of a risk-free return in bank deposits without advice - or seek advice and carry an equity risk to attain the same rate. The end result leaves advisers at the coal face to carry the burden of unrealistic fees and charges for what amounts to portfolio reporting. That’s one ugly aspect of the reforms - the truth in cost of services. In Australia we are now seeing some competition for the platforms with the arrival of simple and easy-to-use technology supporting individual and separately managed accounts so-called managed accounts. This is a natural and progressive development where portfolio reporting is low cost and the assets are capable of being held in the name of the client, thus providing better tax benefits, greater flexibility and ultimate transparency. This market has been prevalent overseas for years where competition is rife and delivery of personalised reporting is commoditised. This is not a new development and advisers have a right to demand less complacency in platforms and more technology breakthroughs for clients. Managed accounts are not to be confused with a managed fund, which is investment via a pooled unit trust structure. Many feel this process of investment is dated, expensive and ineffective for smart investors, particularly the private client style operators and the self-managed super fund (SMSF) market. These markets are trending towards low-cost diversification and direct ownership through exchange traded funds (ETFs). ETFs are effectively a direct share investment that recreates a given index. They are liquid, traded on markets and owned by the investor. By putting the new technology and ETFs together, advisers can now access capital markets effectively with portfolio reporting, custody,

administration and asset management - all for less than 1 per cent. This differs from many of today’s platforms (and dealer badges) which charge up to 1.2 per cent for administration plus up to 1.2 per cent for funds management. There’s not much money left over for advice when these costs are tallied up. Yet advice carries the risk, the liability and the client engagement process - it’s all back to front. Finally, it’s fair to acknowledge the proposed reforms have an overall spirit of intent that is well meaning but, when enacted, has the capacity to adversely affect today’s work processes such that short-term turmoil evolves. This is inevitable unless some grandfathering occurs, but it is equally a challenge for us all to work seamlessly in meeting the agenda. This means the platform market must also be reformed, not just advice practices. As the old saying goes, the trend is your friend and the trend seems to be: • Growth in member directed accounts • Growth in managed accounts • Growth in ETFs • Growth in SMSFs • Growth in fees-based advice Our industry challenge is to respond to all of the above with an eye to how it improves clients’ lives and meets their objectives using better technology and improved adviser skills. Then we’ll be in control and able to minimise regulatory intervention. The target is clear: lower cost administration and portfolio reporting; lower cost funds management; and higher revenue in the critical part of the value chain: advice.

Ian Knox is managing director of Paragem www.paragem.com.au

C O V E R S T O RY

Are you about to see your practice value halved? The abolition of commission and volume bonuses will affect the value of many financial planning practices. Wayne Marsh explains

ver the past decade-and-a-half, financial advice practices that provide investment and superannuation solutions have had a successful relationship with institutionallyowned product administration platforms. The platforms have delivered some client management efficiency and a highly effective means for advice practices to collect asset-based fees by way of trail commissions and/or dial-up advice fees. In addition, revenue has been enhanced when licensees (and boutique practices with their own AFSL) have negotiated volume-based rebates or bonuses with platform providers. For some larger licensees the rebate represents more than 50 per cent of total revenue. This symbiotic revenue relationship with platforms has allowed many practice owners to build highly reliable cashflow and recurrent revenue for their businesses. This annuity stream remains the envy of other professional services businesses, such as accounting practices. In an open market, where demand for quality practices far exceeds the supply, sales of advice practices have been negotiated at a multiple of 3 to 3.5 times the annual recurrent revenue, compared to accounting firms at 0.8 to 1.2 times annual revenue. The relatively premium prices paid for financial planning practices are also a function of: • The double-digit growth inherent in wealth management; • The baseline provided by institutional buyer-of-last-resort (BOLR) pricing facilities (these cover 40 to 45 per cent of the practices in the industry); • The relatively low working capital requirements (an accounting firm needs 25 per cent of

its annual billings as working capital); and • The certainty of income provided by asset-based trail and service commissions. For larger financial planning practices, with annual recurrent revenues greater than $1.5 million, the market has valued the practices at an earnings before interest and tax (EBIT) multiple of 5 to 8 times - double the price typically paid for small businesses in other industries. However, we know that the financial planning industry agenda has been set around: • The removal of upfront or trail commissions from investment platform or product solutions; and • An advice regime that may require clients to opt into advice fees. In the short term, the loss of the certainty of annual recurrent income will see practice values decline, perhaps to a level between that paid for other professional services, and the current level of pricing. For all practice owners, the key concern and business focus has to be on how to replace the quantum and the certainty of annual recurrent income, once trail commissions and advice fees are removed, and clients have to opt into advice fees on a yearly basis.

Wayne Marsh

tive management of each component of the client relationship. These “new world” practices have migrated to a business model that acknowledges that there are at least three, and in some cases four, opportunities in the relationship with a client, where it is possible to add value, and to charge a combination of fixed and asset-based fees for that value. Advice fees

A new-world business model

In the same way technology allowed platforms to become entrenched in advice business models, is present-day technology about to provide a new age solution? From a business model perspective, the most effective response we have seen to the loss of certainty of income is from practice owners looking to migrate away from the reliance on a master trust or wrap platform, to take more ac-

The first opportunity is in the initial advice provided to a prospective client. In this step, “new world” practices go beyond interpreting the complexity of the superannuation regime or making recommendations on the various client tax structures, and have implemented a valuesor an objectives-based lifestyle financial planning process. The offer is a client engagement process that starts with documenting lifestyle aspirations, rec-

C O V E R STORY

onciles this with a client’s current circumstances, then leads the client through decisions around the risk/return trade-offs they have to make, strategies they can consider, and lifestyle choices they need to accept or forgo. The client decisionmaking is supported by interactive software. On an annual basis, depending upon their financial circumstances, clients go through an abridged version of this process to monitor where they are at, and make the necessary choices to achieve their lifestyle goals. The cost of the initial advice and any ongoing advice are agreed with the client and provided on a fixed-fee basis. These initial fees range between $2500 and $10,000. Investment and management fees

As every practitioner knows, you cannot build a premium business asset and a scalable business model if you charge only fixed fees. The second client offer in these new world business models is in-house asset management. Rather than using externally managed funds, these financial planning practices favour direct investment, with active asset allocation and securities selection being the building blocks of a personal portfolio management service. Using the services of research providers, they perform investment decision-making functions previously outsourced to institutional or boutique funds management groups. In some cases the practices buy in wholesale model portfolio services and set their own prices to clients. In the direct investment model, an adviser is afforded many opportunities to talk directly to clients about their investments or their portfolios - a conversation that was more difficult and less relevant in a business model that outsourced investment decision-making and implemented strategies via managed funds. The business and investment model is particularly effective with medium- to highernet-worth clients, and valuable for self-managed super fund (SMSF) clients. In effect, the investment model is the private wealth management equivalent of an institutional fund manager, and captures all the investment

Comparison of income streams Traditional financial planning model

“New world” private wealth management business model

Initial advice fee: $2500 to $10,000

Initial advice fee: $2500 to $10,000 Ongoing Advice: $Variable

Trail commission: 0.25 to 0.5 per cent Dial-up fee: 0.5 to 1 per cent

Investment Fees: 1 to 1.25 per cent Administration fees: 0.3 to 0.6 per cent

Licensee rebate: 0.2 per cent

Licensee rebate: Nil

Recurrent practice revenue: 1.2 per cent (approx)

Recurrent practice revenue: 1.5 to 2 per cent

EBIT (after owners’ drawings): 10 to 20 per EBIT (after owners’ drawings): 40 per cent-plus of cent of revenue revenue Revenue uplift (net of expenses): 40 to 50 per cent Cost to client (incl. platform fees): 2.5 to 3 per cent

‘The loss of the certainty of annual recurrent income will see practice values decline’ fee income from assets under management. The fee scale varies by asset class, but the practice can collect 1 to 1.25 per cent of assets under management This migration to in-house investment management is the most significant step practice owners are taking to produce an appreciating, fee-certain, scalable and highly valuable annuity income, to protect and ultimately grow the value of their business. Administration fees

The third step is administration and client reporting - the traditional domain of master

Cost to client: 1.5 to 2 per cent

trusts and wraps. You may recall the initial impact that platforms had on the industry. At first, they were considered to be a technology solution for a business problem: administering and reporting on client assets. Their improved functionality and web enablement has made them an integral part of many traditional financial planning businesses. In the “new world” solution, practices are buying-in a desktop administrative solution. This solution has full web-based practice and client reporting and, where required, integration with specialist accounting software, at a fixed cost per client. Practices then on-sell the service to clients, at an asset-based fee. This administration fee is the second source of asset-based fee income at 0.3 to 0.5 per cent of assets under administration. Compliance fees

In models that specialise in or provide an SMSF service, the preparation of financial statements and the management of a relationship with an external auditor are the fourth source of practice income, via a fixed fee. If the investment funds are discretionary savings, then often there is a tax service at this point.

C O V E R S T O RY

This new world model is completely compliant with the Cooper Review’s recommendations and intent. There are no commissions; advice fees are fixed-dollar and only need to be discussed with the client when advice is provided. Investment management and administrative fees remain asset-based, and in this new world model, all fee income is captured inside the practice. The offer is particularly attractive to SMSFs, medium- and high-net-worth clients. The clients like: • The transparency of pricing and illustration of value added by the adviser at each step in the relationship; • The opportunity to choose which of the four services (advice, investment management, asset administration, tax) they want. They want, and inevitably choose, all four; and • The pricing, which can be 50 to 100 basis points less than a traditional financial planning relationship. From a practice perspective, migration to

‘For some larger licensees the rebate represents more than 50 per cent of total revenue’ this private wealth management model has seen well-run practices achieve a 40 per cent (net of expenses) improvement in annual revenue, and replaces the uncertainty of trail and dial-up income with income certainty from investment and administration fees. The key reasons for the premium prices being paid for financial planning businesses include demand, industry growth, BOLR valuation conventions, low working capital requirements

and certainty of income. In the private wealth management model, the variable over which a practice owner re-asserts control is the certainty of annual recurrent income and its asset basis. The practice does not need, or receive, a volume-based rebate to improve financial viability or return to shareholders. When a practice designs its business processes to support its client engagement model, then the business is capable of delivering EBIT twice that achieved by practice owners using traditional platforms, and at a minimum, a preservation of the current value of the practice. If EBIT valuations become the norm, then these businesses are well positioned to command a premium price.

Wayne Marsh is a director of Centurion Market Makers - www.centurionmarketmakers.com.au

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The healthiest type of growth starts from the ground up.

It’s no longer news that the world’s fastest growing economies are in Asia. China, for example, is now the number one contributor to global growth. Tapping into this phenomenal energy however, requires specialised know-how. With more than 28 years’ experience in the Asian region, Fidelity has established a foundation of local insight, backed by a vast global network of information – information that can be priceless in export-driven economies. For you and your clients, that means maximising the potential of these markets, while reducing risk. Visit the Fidelity Asia Blending tool at www.fidelity.com.au/fab to learn how blending Asian markets into your clients’ portfolios makes it possible to be part of the growth of today – and continue to build on it tomorrow. Better research. Better minds. Better ideas. To know more, visit www.fidelity.com.au

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S P E C I A L R E P O RT - E M E R G I N G M A R K E T S

Taming the wild card in the deck Emerging markets offer attractive investment opportunities, but opportunity comes with risk, as Lisa Pennell reports

merging markets could well be described as the wild card in the deck of international investment options. Including the regions of South America, Latin America, Eastern Europe and much of South East Asia (excluding Japan), the term is used to describe developing countries that are industrialising at a fast pace. Emerging markets (EMs) are exciting to investors, offering high potential gains over the medium to long term. Few EMs offer significantly higher yields than developed markets - it’s all about the potential for capital growth. The flipside to the possibility of superior returns is that EMs are volatile and carry high risks for investors, particularly in the short term. Typically, EM economies feature relatively low levels of income per capita, but have the potential to significantly increase the level over time. To qualify as an EM from an investment perspective, they must also have a local stockmarket that is available to foreigners for investment. The biggest and fastest growing countries in the EM category that have attracted the bulk of investor attention over recent years are Brazil, Russia, India and China - also known as the BRIC economies. Along with these, there are opportunities in less prominent but also promising countries, including Thailand, Hong Kong, Taiwan, Malaysia and Korea. Between 2003 and 2007, EM funds outpaced most other types of managed funds with a F I Drate 0 0of3 growth; 1 _ P Pbut _ M o sunfolding t . p d global f Pa healthy the financial crisis (GFC) served to highlight intrin-

‘Volatility is exactly what makes these regions attractive to long-term investors’ sic risks and volatility. EM share prices were hit harder than those in developed markets, with the MSCI Emerging Markets Index plummeting by more than 40 per cent in $A terms in 2008. This drop was significantly more than falls in the MSCI World index and the S&P/ASX200 Accumulation Index of Australian shares. But rather than serving as a warning to avoid EMs, the trend of volatility is exactly what makes these regions attractive to long-term investors with an appetite for risk. Post GFC, EMs recovered earlier and more strongly than developed markets, mainly due to their match fitness when the crisis began. Most of the EM countries had built up reserves pre-GFC that they were quickly able to draw on; and they also had low levels of debt - both of which insulated those economies from the more serious effects of the crisis suffered in many developed markets. g e Nader 1 9 Naeimi, / 7 / 1 senior 0 , 1 0 : 4 8 strategist AM investment for AMP Capital, says EMs had the will and

resources to provide stimulus to their economies without incurring the levels of sovereign debt that the US, UK and Europe have. “Many EMs still have significant resources, are still in surplus and are able to continue to stimulate their economies. It’s a global rebalancing - the emerging world has all the dynamics of growth with a good combination of external and domestic demand,” Naeimi says. “The exception is Eastern Europe, which is still quite vulnerable.” And the official statistics support this. In the most recent World Economic Outlook released in July 2010, the International Monetary Fund (IMF) showed that while advanced economies grew by just 0.5 per cent in 2008 and contracted by 3.2 per cent in 2009, emerging/developing economies grew by 6.1 per cent and 2.5 per cent, respectively, during the same periods. Going forward, the IMF has predicted that growth in emerging economies will continue to far outpace that of developed economies in the near term. In 2010, advanced economies are projected to grow by 2.6 per cent, dropping slightly to 2.4 per cent in 2011, while emerging and developing economies are slated to grow by 6.8 per cent this year and 6.4 per cent in 2011. These figures hide quite large variations within each of the categories. For example, while the UK is projected to grow by just 1.2 per cent in 2010 and 2.1 per cent in 2011, China is projected to grow by 10.5 per cent and 9.6 per cent over the same periods. Other high EM performers include India at 9.4 per cent in 2010 and 8.4

The most important investment we’ve ever made is in our own resources. Better research. Better minds. Better ideas. To know more, visit www.fidelity.com.au This advertisement 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.

S P E C I A L REPORT - EMERGING M A R K E T S

per cent in 2011; and Brazil at 7.1 per cent and 4.2 per cent, respectively. Outside of short-term projections of growth, David Urquhart, portfolio manager of the Fidelity Asia Fund, points to other compelling factors which suggest further outperformance in the future for EMs. One is the sheer size of the opportunity - around two-thirds of the world’s population live in EMs. He says 20 years ago, 70 per cent of the world’s growth was generated by developed economies and nearly a third of this by the US alone. Today, EMs now account for almost three-quarters of global economic growth. “A comparison of the developed and emerging worlds shows clearly where the potential growth is to be found. The size of EM economies per head of population is still a fraction of the equivalent measure in places like Japan, Germany and the UK. In Japan for example, GDP per capita stands at $44,000, while in China it is still less than $4450,” Urquhart says. “In 2000, developing countries were home to 56 per cent of the global middle class, but by 2030 that figure is expected to reach 93 per cent. An increasing middle class means an increase in the associated demand for goods and services, as well as increasing political stability. “Additionally, credit ratings have been slashed among some Southern European countries of late, while at the same time these rating houses have been boosting outlooks for Asian countries, including India, Indonesia, South Korea and the Philippines.” Urquhart points out that another positive side effect of the GFC for EMs, particularly in Asia, was the opportunity to expand market share in developed markets, due to cost-consciousness fuelled by the troubled times. “During the crisis, brands like Acer, Hyundai, Samsung and LG became more attractive F I D 0 0 3who 1 _were P P looking _ B i gfor . pgood d f value Pa g to consumers for money. So even though total consumption

‘The key aspects to be wary of include sector biases and the effect of government policy’

Pat Farrelly

declined, the market share of some Asian brands was increasing, resulting in a stable or even growing performance for those businesses.” Urquhart adds that local EM brands often have more success expanding in their own local markets than in developed markets, so investing directly in EMs can be more effective than via multinationals with EM exposure. “EMs are generally looking for a lower price point for products. It’s much easier for a local company in that market to provide that product, then add features to suit developed markets, than the other way around. “Also, those local businesses will not have the drag common to businesses which have the bulk e of 1their9enterprise / 7 / 1 0based , 1in0the : 4slower 9 Agrowing, M developed markets. EM businesses have the full

advantage of fast growth in all aspects of their operation, leading to faster growth overall. “The more evolved a business or the marketplace is, the harder it is to grow.” While there is a clear potential upside to investing in EMs, the risks should not be underestimated. Some of the key aspects to be wary of include sector biases, the effect of government policy, and general volatility. Emerging economies usually rely on a narrow range of sectors - especially agriculture and commodities - to fuel their development. Because of the homogeneous nature of commodities, the price is not set by the producer, making markets that are dependent on them vulnerable to global price fluctuations. When the price of oil plummeted in the midst of the financial crisis, for example, Russia suffered a significant drop in GDP. Patrick Farrell, head of Advance Investment Solutions for BT Financial Group, says China has evolved beyond an agricultural economy and is now in an industrial phase. India has effectively leap-frogged the industrial phase, becoming a service-based economy, including a significant number of call-centre services to developed economies. He points out that while it would be complicated for countries that have outsourced their manufacturing centres to Asia to bring

Big pictures consist of small details. Better research. Better minds. Better ideas. To know more, visit www.fidelity.com.au This advertisement 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.

S P E C I A L R E P O RT - E M E R G I N G M A R K E T S

them back in-house, it’s relatively easy to retract service contracts, leaving the Indian economy somewhat more vulnerable. A further risk is in the protection of personal and intellectual rights. Developed markets tend to have more sophisticated checks and balances, while legal systems may not be enforced as rigorously in EMs. In some cases, EM systems are complex to negotiate and may even be compromised by corruption. Political intervention can also dramatically affect the way an EM functions. EMs are often relatively unstable and governments can make sudden changes to rules and regulations, take actions to restrict foreign investment, or even nationalise corporations. An example of the effect of political intervention was the recent increase in tax on foreign investment by the Brazilian government. In another example, many Chinese companies are controlled by the state and there’s no guarantee that shareholders’ interests will be aligned with the government’s interests. Given the nature of EMs, before moving to the stage of selecting a product or a fund manager, planners should establish an investor’s risk profile, age and time horizon. If an investor doesn’t have the cash-flow, the time or the stomach to ride out short-term volatility, EMs are probably not the most appropriate investment vehicle. If EMs are a suitable investment, asking the right questions will help determine the right asset allocation for a particular individual’s circumstances. Farrell points out that many investors already have an exposure to EMs through their existing allocation to global multinational companies, which have growth exposure in those markets. In terms of asset allocation, he suggests a reasonable further allocation to direct investment in EMs might be around 10 per cent of the total internaF I exposure D 0 0 3 to 1 _equities. PP_ Put . pdf Pa g tional Alternatively, Urquhart suggests that a

‘Anyone directly investing in specific shares in an EM would need to be very careful’

Nader Naeimi

reasonable allocation to overseas equity markets would be around 25 per cent, with around onethird of that directly invested in EMs. “You’re not looking at where those markets are today, but where they’re going to be in five to 10 years. If those markets are going to make up half of the global output and you only have a 10 per cent representation in your EMs exposure, that’s clearly out of kilter. “The simplest and safest way to invest is via a fund. Anyone considering directly investing in specific shares in an EM would need to be very careful.” Naeimi is far more aggressive in his recommendations for EM exposure, saying he e personally 1 9 / has 7 / 80 1 0 1 of 0 :his 4 own 7 A M per, cent superannuation equities allocation in EMs and only 20

per cent in developed markets. He says even a more conservative investor should have around 50 per cent of their total portfolio in equities and around two-thirds of that in EMs. “The risk is higher, but the fundamentals for EMs are much sounder than they were; where before we saw overvalued currency and budget deficits, we’re now seeing the opposite with government savings and stable currencies.” It’s Farrell’s belief that India and China will dominate the scene for the next decade or two. Urquhart also lists those two markets as being amongst the EMs with the most potential growth going forward, in addition to Indonesia and Thailand. “Indonesia has a lot of headroom and is becoming politically more stable. Incomes are growing, interest rates have dropped to single digits and inflation is now under control. “While Thailand still has political risk, it has strong agricultural prices and auto exports. Ford has just made a half-a-billion-dollar manufacturing investment there, which is a big vote of confidence.” Farrell says sector-wise, technology and media look promising, while consumer goods and retail generally are likely to grow as wages in those countries continue to grow. Naeimi agrees Asia represents the top pick

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 advertisement 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.

S P E C I A L REPORT - EMERGING M A R K E T S

emerging Performers Fund Name

Net Assets $m

Return 1 yr %

Return 3 yr %pa

Return 5 yr %pa

Return 10 yr %pa

Aberdeen Emerging Opportunities Fund 260.50 ANZ OA IP ING Glbl Emerg Mkts - EF/Sel 12.47 ANZ OA IP ING Glbl Emerg Mkts - NE 25.01 BNP Paribas Asset Management Emerg Markets Equity 3.45 Colonial First State WS Global Emerging Markets 940.13 Dimensional Emerging Markets Trust 275.24 GMO Emerging Markets Trust 440.69 ING OA IP ING Glbl Emerg Mkts - EF/Sel 9.88 ING OA IP ING Glbl Emerg Mkts - NE 8.00 ING Wholesale-ING Global Emerging Markets 23.32 ipac Strtgc Invest Srv - Global Emrg Mkts 3.55 Lazard Emerging Markets Fund (I Class) 1,029.51 Legg Mason Emerging Market Trust (Class A) 141.04 Macquarie - Emerging Markets Share # 2.42 Vanguard Emerging Markets Shares Index Fund 864.70

29.37 13.61 12.64 12.31 16.05 17.91 12.54 13.50 12.57 14.60 15.77 22.55 16.73 17.94 15.84

6.77 -6.63 -7.43 -10.34 2.34 -1.95 -6.28 -6.55 -7.32 -5.78 -5.11 -0.36 -2.90 -2.18 -0.99

14.60 7.83 7.05 5.16 13.25 10.87 8.17 7.86 7.09 8.72 6.93 14.23 9.37 11.55 11.63

— — — 2.81 — — — — — — 0.30 9.90 7.28 7.05 6.06

Source: Morningstar Performance data to 31-May-10 Only funds with five year performance data are shown in the table

for growth going forward, followed by Latin America, due to its richness in commodities. Farrell says while the trend is going towards specific country funds, he believes this approach is fraught with risk, adding that aggressive investment in any one region or sector could easily result in a bubble. “Ideally, you need fund managers who can move funds about and have a diversified approach. Investors and planners should look for equity managers with EM capability, who understand the risks and have an exit strategy,” he says. Naeimi agrees on the potential for pricing bubbles, saying that while there’s no evidence of one approaching any time soon, they are sure to come at some point. “Wherever there’s potential for a bubble, it’s better to get in early. By the very nature of an EM fund, a good analyst can add so much more value than in a developed market fund,” he says. As an alternative to equities, Farrell says EM F I D0 0 3 1 _ PP_ L o o k . p d f Pa bonds look quite attractive and that yields will improve to a similar level as those of developed

# = closed to new investment

markets over time. “As EMs build up their credit ratings and manage inflation, confidence in those markets will also improve and bonds will become attractive for income. Bonds could be a good way to access EMs now, with the benefit of currency appreciation as those economies improve,” he says. Naeimi agrees the corporate bond sector could be interesting, suggesting there is likely to be a need for funds in the future. He recommends some allocation to Asia in particular, although adding that it’s hard to get excited about EM bonds in the short term. Urquhart agrees the fixed-income bond markets in EMs are somewhat underdeveloped currently. “With the governments in surplus, there’s not a large market for bonds,” he says. “And with balance sheets strong, many companies don’t need to issue them. There’s an overall shortage of supply, and were they available, the yield would ge 1 9 / 7 / 1 0 , 1 0 : 4 5 AM be lower in any case. “The Asian crisis in particular taught those

countries a lot about debt, and the lessons of the past couple of years have just been a refresher course.” Farrell says exchange-traded funds (ETFs) are another option for investors and can supply a broad and cost-effective solution for diversification. All three commentators agree that an expert fund manager who understands the culture and the dynamics of what’s happening domestically and overseas is a must. “An expert is not necessarily going to just follow trends and is able to invest opportunistically,” Farrell says. “EMs will continue to develop, and with that will come opportunity for investors,” he says. “But critically, it’s important to remain cognisant of risk and enlist advice from experts in those markets.”

Look closely. We do. Better research. Better minds. Better ideas. To know more, visit www.fidelity.com.au This advertisement 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.

If seeing is believing, we don’t blink.

21 31

53 1

54 29

22 24 26

7 8

6 5

34 37

12 10

45 36

44 25

At Fidelity we don’t just pride ourselves on our in-depth analysis, but how often we conduct it. Every 90 days we review around 90% of the world’s largest listed companies, giving us up-to-the minute information on thousands of companies, helping us avoid surprises. Does this discipline give us a better view? We certainly think so. Better research. Better minds. Better ideas. To know more, visit www.fidelity.com.au

This advertisement 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. Company contact data is based on FIL and FMR coverage of the MSCI World Index as at 31 March 2010. © 2010 FIL Investment Management (Australia) Limited.

P L A N N ER PROFILE

PLANNER PROFILE

All part of

the service For the Australian Private Banking Council’s outstanding investment adviser of the year, Catherine Robson, the award reflects a decade of work. Simon Hoyle reports

atherine Robson’s thesis at university was on prospectus regulation. Specifically, it focused on the prospectus issued for the demutualisation and float of the NRMA, and the overlap of the Trade Practices Act with prospectus rules. “Wait till we get to the pointy end of the studies I’ve done - you’ll realise what a fascinating person I really am,” Robson jokes. Earlier this year, Robson was named Outstanding Investment Adviser of the Year by the Australian Private Banking Council (APBC). The award was based on a number of case studies submitted by Robson and her team at NAB Private Wealth, based in Melbourne. Robson says the award was “the culmination of a journey that my business has been on for a couple of years”. “I joined the NAB 10 years ago and did a

pretty good job of building a client base, and finding some good people to work with, and plodding along,” Robson says. “But I came back from my second set of maternity leave a couple of years ago, and felt that if I was going to spend time away from my family, I wanted to be doing a job I could absolutely adore, and was really passionate about, and was the best it could possibly be.” About two years ago, Robson’s business turned to another arm of the NAB empire, the MLC Adviser Business Centre, to revamp the business offering, from the ground up. “They really sat with us in our business and helped us understand what our clients were actually looking for - to go to every single client and ask them what do you value, what can we do to improve the business - and then build a process to deliver what clients found of value,” Robson says.

“And then, when we understood what our clients were looking for, to embed that in every single interaction that we had with clients - every email, every letter, every time you answer the telephone - to support that value message. “When clients tell us what they want, it’s very seldom [that] I want this share or that share; it’s much more I want the feeling of confidence that I’m making the right decision, I want to feel comfortable that I know that in 15 years, when I’m not working my guts out, I’ll have something I can rely on. It has really informed the way that we relate to our clients and the way we do new business with new clients. “The award is a natural conclusion of that process. We set out to build a business that we passionately believe in. We had the opportunity to get the best out of the relationship we have with out clients, and for our clients to be as happy as they can possibly be.”

P L A N N ER PROFILE

Robson says one of the case studies submitted for the APBC awards was “a client of ours [who] has a very heavy concentration of assets in shares in a company of which he was formerly a senior employee”. “He has a couple of sons who he would like to buy property for; he’d like to sell shares in that company, but then the share price is not currently where he’d like it to be to sell,” Robson says. “So we said to him, why don’t we write some call options against that company? It will generate several hundred thousand dollars in option premium [income] for you to do it, and the strike price is at the price that notionally you’d like to sell at anyway. So if, in the next year or so it bounces around and never gets to that price, you’ve generated a couple of hundred thousand dollars that your sons can use to purchase properties; if it gets above that point, fantastic.” In another case study, there was a client whose accountant contacted NAB Private Wealth about an excess superannuation contribution problem. “[The accountant] said we’re wanting to put in place a regular payment plan to the Tax Office because the client had exceeded their contributions cap for the 2007 year by $1.6 million,” Robson says. “We said that didn’t sound right to us, can you give us some more information? This was a newish client that we didn’t advise at the time. The accountant said, ‘Here you go, have a look at the information, but we’ve been through it and we know what’s going on’. “We looked at it, we went to the superannuation providers at the time and they said there was nothing they could do; again, we thought this doesn’t make sense. We drew on our internal technical resources, and it was actually an employer eligible termination payment that had been rolled into superannuation, in addition to an undeducted contribution at the time. There was actually no excess contributions tax to be paid whatsoever. “So that’s not strictly investment advice, but

‘Clients are asking us to deliver outcomes; to them it’s not of value how much time it takes’ that is, in our mind, putting the client’s interests first and rather than saying, ‘Not my fault’, [saying], ‘How do we get a good outcome on this?’.” Robson says her business could not approach issues such as the excess super contribution if it relied on transactions to generate income. “We work on an agreed fixed-dollar-foradvice basis, and that’s been a relatively recent change,” she says. Making that change involved “reviewing what it cost us to deliver our service, and then putting in place a pricing structure that delivered what clients were looking for, and then obviously is profitable for us, and for us to have a mechanism to determine what it’s going to cost us to deliver the service”. “So it’s not a flat fee in the sense that every single client pays the same amount; the fee is determined on the complexity of the client’s need and the level of intensity of service,” Robson says. “We would not be able to run a profitable business if we did not genuinely understand what the input costs of doing business look like. It didn’t take long, because we’d done the process bit first, and genuinely knew how much time everything takes. “You can under- or over-estimate what it costs to deliver service to particular clients, but… everything we do we time record, so we have a workflow system that means every time you work on something there’s a timer going that records how long it takes; and at the end of the month we can aggregate how much time we’ve

spent as a group, or on a particular client, or on particular activities. We had that information, and we already knew we wanted to go to a fixeddollar fee, but we just needed that mechanism to get there. “The pervasive reason is we want clients to feel comfortable to use our service whenever they need out help. The disincentive for people to pick up the phone to talk to their accountant or their lawyer is that it’s going to cost them money. Because our clients are asking us to work with them to deliver outcomes; to them it’s not of value how much time it takes. For them the value is what the outcome is. [They] do not care if it takes you 50 hours; they care about feeling like they’ve got

PLANNER PROFILE

that confidence, or that they’ve got an after-tax result that was much better than before, or that they are buying properties for two of [their] kids that means [they’re] not selling other properties to do it. “Clients understand that some years their needs are going to ebb and flow, but on the whole they really value the service, and for us to deliver the service, that’s what it costs. Some years it may be less profitable for that particular client, but in the scheme of things we’re confident that it’s a robust pricing mechanism.” Robson says the cost to the client is estimated at the initial meeting, but a binding fee is not quoted until a full picture of the client’s

needs emerges. Robson says a new client would typically pay between $11,000 and $15,000 for initial advice, and the average annual fee is $20,000, but there are wide ranges around this average. All commission is rebated to the client, including commissions on risk products. An amount for the work involved in setting up insurance is built into the initial and annual fees. Robson says she has found rebating commission and charging a fee on risk business works better for the firm. “Because we’re so confident it’s in our client’s best interest, and because we’ve got no vested interest in strongly recommending they take the

insurance cover we think is appropriate for them - and it’s very clear to the client that’s the case - invariably the client will take our recommendation,” she says. “Previously it was much more like a sales conversation: ‘I know I’m going to get $10,000 commission, but you should take what I’m saying, and do what I say’. “Insurance doesn’t sell itself; no one wants to pay for insurance. But we believe passionately that our advice can be made redundant if things don’t work out the way clients expect them to from a health perspective and they’re not properly protected.”

C L I E N T CASE STUDY

That Feeling

Sinking

While renowned for their ability to fix relationship problems, one mental health professional discovered that a strong rapport with her financial planner would resolve her own crisis. Mark Story explains

ith credit cards maxedout due to years of chronic over-spending, plus lingering HECs fees, and other personal loans, 30-something Brunswick-based psychologist Ariadne Lack was struggling just to service the interest on a whopping $35,000 in debt. To make matters worse, she had no assets to her name (beyond super) and had not filed a tax return for years. Desperate for help, Lack turned to Colling-

wood-based financial planner Susan Jackson, after seeing her business listing in a local phone directory in April 2002. What attracted her to Jackson’s firm, recalls Lack, was the implication within the company’s name - Women’s Financial Network - that it was set up to service the needs of female clients. “Limited as they were, my previous experiences with financial planners involved grey-headed men in suits talking a foreign language who weren’t able to empathise with my predicament,”

recalls Lack. “And considering the financial mess I was in, I wasn’t sure if too many financial planners would have been too bothered to try and help me until I had something to invest.” Lack’s two most precious dreams - of one day opening up her own private practice, and moving from “shared digs” into a home of her own - relied on changing nasty spending behaviours. So Jackson’s initial recommendations focused on a debt-reduction strategy.

CLIENT CASE STUDY

C L I E N T CASE STUDY

“Just as it had taken some years to get into this debt, realistically I knew it would take years to get her completely out of it,” Jackson says. Debt-reduction strategy

Based on a plan to immediately commit 80 per cent of Lack’s then $33,000 net annual income to expenses and debt reduction, Jackson estimated that it would take Lack up to five years to put this debt behind her. To ensure that Lack stayed committed to her debt-reduction program, Jackson arranged meetings every month for the first two years. “Fortunately, Ariadne realised that unless she changed her reckless spending behaviours she would remain in a rut, and this would continue to stifle her ability to progress both personally and professionally,” Jackson says. Each fortnight, Ariadne’s salary was allocated across three different areas: bills, debt-reduction and spending. This meant she: a) had the money to pay bills as they came due; b) was progressively reducing her debt; and c) clearly identified how much there was left for spending. “Regular meetings spent indentifying situations where Ariadne was vulnerable to overspending, or making poor money decisions, allowed us to work on creating some new behaviour around managing her finances,” Jackson says. “Getting all her tax returns up-to-date resulted in a tax refund which also helped provide some monies to get this new system into place.” No pain - no gain

While there was no avoiding the pain involved with paying down this debt swiftly, Jackson says it was just as important to cater for unexpected expenses, plus a small allowance for entertainment. She says it was also important to allow for the odd relapse in buying behaviour triggered by random bouts of restrained “retail therapy”. But to minimise potential moments of weakness, Lack recognised the need to replace the reckless buying behaviour inherited during childhood with a new way of thinking about budgeting.

Having identified that Lack kept her work life on track through her diary, Jackson suggested that she also start using it to help manage her finances. “Susan helped me grasp a better understanding of money, and through this I managed to pay down all my debts within four years,” says Lack.

The Planner Susan Jackson Managing director Women’s Financial Network, Collingwood, Victoria

Private practice

With the debt completely paid off by mid2005, Lack looked to Jackson for advice on how to establish a private practice as a self-employed registered psychologist. In addition to charging a nominal rate for surplus office space within her building, Jackson also assisted Lack with marketing; identifying the right business structure; tax and compliance issues; plus managing business cashflow, especially during the set-up phase. With Jackson’s assistance, monies that Lack held within a poorly performing Government super fund were rolled into a fund of her choice (Australian Ethical Fund). And by contributing to her super on a monthly basis, Jackson says Lack is reducing her tax bill, while building up her retirement savings. And while she continued to meet with Jackson every two months, Lack says that what was happening in the business rapidly became the primary focal point of these catch-ups. She says she couldn’t have contemplated setting up her own business had she still been in debt. “The good money management disciplines Susan taught me created a solid foundation on which to build my business,” says Lack. “On a personal note, being so seriously in debt was never going to be the right environment in which to enter a relationship with my future partner in life.” Multiplier effect

A continual improvement in business cashflow, combined with improved spending habits, plus no outstanding debts, effectively created a multiplier effect in Lack’s ability to save. Within five years, Lack had amassed sufficient funds to be able to buy a home, together with her partner, Hutch. In 2009, Lack and Hutch bought their pri-

A licensed financial planner with a Diploma in Financial Planning, Jackson has held numerous advisory, sales support and management roles within the financial industry over the past 20 years. Having identified a major void in what she regards as the predominantly “male-oriented” financial planning industry, Jackson established The Women’s Financial Network in 1995. A regular speaker/facilitator at money education programs, she received the 2007 Financial Planning Association of Australia’s Value of Advice Award in the Community Contribution/ Pro Bono category, and has twice been a finalist in the Telstra Business Awards. She recently launched an online financial resource for women: www.msmoney.com.au. Advice structure In addition to a fixed fee for an initial consultation, fees are based on a graduated annual membership scale - bronze through to platinum - commensurate to the scope of advice required by the client. Jackson believes that a fee for service is a more honest and transparent basis than commission on which to provide advice. Jackson says what women (and many men) value most is the level of personalised advice. “Meaningful relationships with female clients go far beyond a superficial ‘pink-my-product’ approach,” she says. About 35 per cent of Jackson’s clients are males. History Ariadne Lack made initial contact with Jackson in April 2002, via a business directory listing, looking for help with her chronic debt problem. While Jackson was the first financial planner that Lack contacted, she felt sufficiently comfortable not to look elsewhere for the right solution. Strategy With Lack struggling to service interest on mounting debts, what she needed most was new “money management behaviours” that would help her establish a comprehensive debtreduction strategy. Much of Jackson’s initial role was as budgeting mentor. Once debts were finally paid off, Jackson proceeded to coach Lack though her transition into self-employment - before outlining a strategy for future wealth creation.

CLIENT CASE STUDY

Financial situation Fee for advice in first year:

$1,500 annually.

Fee for advice now:

$6,000 annually

Credit card debt in 2002: $35,000 Credit card debt now:

Nil

PAYE earnings in first year: $50,000 gross Earnings now:

$120,000 gross approx

Personal super in 2002:

$20,000 Government super.

Personal super now:

$25,000 Australian Ethical Fund.

Insurance Cover in 2002: Nil Insurance Cover now: Income protection, death and trauma. Net wealth in 2002:

Nil - More debt than assets.

Net wealth position today: $100,000 (Approx) Residual benefits:

Long-standing smoking habit broken within two years.

mary residence in Melbourne’s inner north suburb of Preston, for $678,000. And the ownership of another property, belonging to Hutch, was restructured to create tax-effective debt while providing some tax benefits for both of them. Neither Lack nor Hutch wanted to talk about the “yucky stuff ”, but Jackson says they recognised the need to formally distinguish between individual and jointly-owned assets - should they ever part company. “At their request I facilitated a discussion that helped to pre-determine the methodology needed to recognise ownership if they split and kids were involved,” says Jackson. “This allowed them to come up with a plan that they were both comfortable with.” Family plans

Having decided to start a family late in 2010, the pressing question, adds Jackson, is how the couple will cover necessary expenses and mort-

‘There was no avoiding the pain involved with paying down this debt swiftly’ gage payments when Ariadne goes on maternity leave. And while this strategy is still evolving, all parties agree that getting ahead with the mortgage is the smartest strategy. “During the time Ariadne is on maternity leave, this strategy allows them to either revert to an interest-only loan or redraw some of the payments made in advance,” Jackson says. Playing to strengths

Looking back, Lack says that when she first met Jackson, Lack was similar to many of her professional friends, who despite having cerebral “horse-power” were never taught financial literacy. Lack also recalls how Jackson’s ability to “de-jargonise” financial language resonated with her obvious need for plain speaking on money matters. “We all have areas where we struggle, and my relationship with money happened to be my weakest link,” confesses Lack. “By teaching me the psychology of money and how to change some unhealthy buying behaviour, Susan taught me to play to my strengths.” Lack says she quickly realised that the financial knowledge Jackson was transferring was just as valuable as the professional mentoring Lack had been accustomed to paying for as a psychologist. More importantly, she recognised that if she didn’t improve her financial acumen she’d remain in a professional rut indefinitely. One of the most empowering acts, recalls Lack, was eventually cutting up her credit cards and sending them to Jackson in the post.

“I started to change my behaviour when I finally realised that shopping was not an immediate cure for everything, and this galvanised my willpower to realise my financial dreams,” she says. Lack’s ability to chart a course of wealth creation was embedded in her ability to successfully pay down debt, Jackson says. She doubts Lack would ever have moved into self-employment, let alone home ownership, had she not been able to correct long-standing negative beliefs about money that were holding her back. “Financial planning is ultimately about helping people create the lives they want,” says Jackson. “But planners are unable to do this unless they’re non-judgemental and sufficiently approachable to forge meaningful relationships with clients.”

The 21st century presents

many new and unfamiliar challenges for advisers and their clients – climate change, financial market reform, the rise of emerging nations, an ageing and growing population, affordable healthcare, energy, water and food security. These big economic themes now dominate our investment landscape. Advisers are expected to know so much more, while clients are becoming more educated and questioning. By providing responsible investment advice, you can grow your practice and get better returns for your clients. Did you know that in the year to December 2009 responsible investors fared better than other investors across one, three and five years?

Source: Corporate Monitor, 2009.

Take on the

elephant in the room

Stand out from your competitors ■ Attract new clients ■ Appeal to HNW Build client loyalty and trust ■ Find smarter investments Elevate your community profile ■ Know your clients better Find out more at ■ www.responsibleinvestment.org

RIAA 7TH INTERNATIONAL RESPONSIBLE INVESTMENT CONFERENCE 14 & 15 SEPTEMBER 2010 DOCKSIDE, DARLING HARBOUR, SYDNEY FINANCIAL ADVISER MASTER CLASS PROUDLY SPONSORED BY

SELF-MANAGED SUPER

Avoid non-compliance for expats Bryce Figot examines how to deal with clients who are Australian citizens and have moved overseas for work

lients are often very happy to cease being classed as Australian residents for tax purposes as it results in a lower personal tax bill. However, if such clients have self-managed superannuation funds (SMSFs), financial planners must ensure that the residency rules for the fund are met. Failure to meet these rules can result in automatic non-compliance for the fund. In the real life matter of CBNP Superannuation Fund and Commissioner of Taxation [2009] AATA 709, there was a self-managed superannuation fund with only one member, Ms M. Ms M was also the only director of the fund’s corporate trustee. Ms M ceased to be a resident of Australia for income tax purposes, moving to New Zealand. Ms M installed her brother, Mr M, as a fellow director of the fund’s corporate trustee. Nevertheless, all decisions in relation to the management and control of the fund from then onwards were made by Ms M in New Zealand. Ms M personally borrowed about $118,000 from fund assets. This loan could give rise to many different contraventions, including: • a contravention of the limit on investments in in-house assets; • a contravention of the prohibition on loans to fund members; • a contravention of the rule that the fund only be maintained for certain core and ancillary purposes (that is, the sole purpose test). The fund’s auditor focused on the first contravention and reported it to the Commissioner of Taxation. The Commissioner then audited the fund. Upon auditing the fund, the Commis-

‘Failure to meet these rules can result in automatic non-compliance for the fund’

Bryce Figot

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sioner realised that the fund failed the residency rules. The Commissioner issued a notice of non-compliance. The fund’s total assets were approximately $273,768. The notice of noncompliance resulted in a tax bill for the fund of approximately $146,000. The fund appealed the notice of noncompliance to the Administrative Appeals Tribunal. The Tribunal found that it was “most unfortunate that Ms M will suffer a significant reduction in her self-managed superannuation fund benefits. The Tribunal sympathises with her and the position in which she finds herself, but has no greater power than the respondent under the SIS Act to assist her.” Accordingly, the tax liability stood. Whenever a financial planner has a client who is moving overseas, alarm bells should ring and the planner should ask: does the client have a self-managed superannuation fund? If the client does, specific steps must be taken.

S E L F - M ANAGED SUPER

Failure to take the specific steps can result in a hefty and unnecessary tax bill, as well as little avenue for successful appeal. Specific steps

There are three key steps to ensure that a self-managed superannuation fund with overseas members meets the residency rules. First rule Either the fund must have been established in Australia, or any asset of the fund must be situated in Australia. This rule is invariably met. Second rule The central management and control of the fund must ordinarily remain in Australia. The Commissioner believes that this means the strategic and high-level decision making processes and activities of the fund must ordinarily remain in Australia. He believes that the strategic and high-level decision making processes include: • formulating the investment strategy for the fund; • reviewing and updating or varying the fund’s investment strategy as well as monitoring and reviewing the performance of the fund’s investments; • if the fund has reserves - the formulation of a strategy for their prudential management; and • determining how the assets of the fund are to be used to fund member benefits. The Commissioner further believes that formalistic or administrative activities do not constitute central management and control. Examples of formalistic or administrative activities include the actual investment of the fund’s assets pursuant to a pre-existing investment strategy. Accordingly, one way to try to meet this rule is to ensure that the fund’s trustees ordinarily only make the strategic and high-level decisions while in Australia. However, this is not the preferred course of action for a number of reasons. One reason is that factually proving where the trustees

‘Whenever a planner has a client who is moving overseas, alarm bells should ring’ ordinarily make the strategic and high-level decisions is easier said than done. The preferred way to meet this rule is to transfer trusteeship (or directorship if a company is the trustee) to a trusted Australian family member or friend. This should happen before the client leaves Australia. The trusted Australian family member or friend should then centrally manage and control the fund. On its face this poses a problem: the fund no longer appears to be a self-managed superannuation fund as the members are no longer the trustees (or directors of the corporate trustee). However, provided that the trusted Australian family member or friend holds an enduring power of attorney in respect of the members, the fund will still be a self-managed superannuation fund. The Commissioner has set out his views on the uses of enduring powers of attorney in Self Managed Superannuation Fund Ruling SMSFR 2010/2. Third and final rule Finally, no contributions or rollovers whatsoever should be made to the self-managed superannuation fund while its members are overseas. This is a slight oversimplification of the actual rule, but if clients follow this simplified version, they will never go wrong. If superannuation contributions must be made while clients are overseas, they should be made to a large fund. Then once the clients have

resumed being Australian residents again, they can roll benefits from the large fund to the selfmanaged superannuation fund. Already gone?

These three rules work well where the planner has the opportunity to plan in advance. However, often work constraints mean clients must leave the country quickly and with little time to properly consult with their financial planner. Accordingly, a financial planner might find him or herself in the tricky position of having an overseas client who has a self-managed superannuation fund where the three rules might not have been followed. Financial planners should act quickly in this situation and consult an expert for tailored advice to determine whether the fund still meets the residency rules and whether any other avenues exist. With proper planning, clients may move overseas and retain a complying self-managed superannuation fund. However, if the residency rules are not met, the negative consequences can be significant.

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

SELF-MANAGED SUPER

Cashing out or rolling back: an administrator’s guide Tony Negline says supernnuation fund admnistrators often face problems when dealing with self-managed super fund pension transactions

ensions, and the various different transactions which can occur with them, always present problems for superannuation fund administrators. This is particularly the case with self-managed super funds. This is the first in a series of articles explaining various pension transactions. In drafting this article I have relied on a paper written by my colleague Michael Hallinan, senior counsel at Townsends Business and Corporate Lawyers. For the past 20 years, most pensions provided by small super funds and retail super funds have not been “set and forget”. They require active management from at least three perspectives - asset allocation, income management and liquidity management. Liquidity management is the process used to ensure there is always sufficient cash to meet the pension income payments. Of particular importance is the range of specific administrative and legal issues that have to be considered when cashing out, rolling back, rolling over, refreshing, merging, and establishing/resetting any reversionary beneficiaries. In this article we’ll look at cashing out and rolling back transactions. Before we look at specific issues that apply to the transactions, there are a couple of points which are common to all transactions that involve cashing out or rolling back a pension.

‘Of particular importance is the range of specific administrative and legal issues’ Before a lump sum is paid or the pension rolled back, the pro-rata minimum pension must have been paid. Once the lump sum has been paid or pension rolled back, some people recalculate the annual required minimum pension payment. Ordinarily this minimum pension amount is worked out each July 1. The rules don’t allow the minimum pension to be recalculated. To be explicit, the minimum pension payment is not recalculated because of a lump sum commutation or rolled back pension. From the financial services law point of view, the lump sum is deemed to be similar to the purchase of a financial product. This means that if a licensed financial adviser has recommended the lump sum payment or rolling back

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the pension, then they should issue a Statement of Advice (SoA) and detail why taking the lump sum is an appropriate course of action as well as all the costs involved in the transaction. Cashing out pensions

Cashing out a pension occurs when a lump sum is withdrawn from the pension. This lump sum might be for some or all of the pension’s account balance. Pension payments will continue to be paid from any remaining account balance after the lump sum has been paid. The purpose of this transaction is to release money from the pension. In some cases a lump sum of money cannot be paid. For example, Transition to Retirement pensions can only have a lump sum paid from them if the pensioner is officially retired. The lump sum cannot be used to satisfy this minimum pension payment requirement. There is some conjecture on this point in superannuation circles. Some argue that the words used in the super laws provide that the lump sum can be used to meet the pro-rata minimum pension payment. Others respond that this is making too much of the words used in the super laws and would not have been the intention of the Government who drafted these rules. The lump sum paid is split between the tax-free and taxable percentages, which were

S E L F - M ANAGED SUPER

Tony Negline

worked out when the pension commenced. (Special rules can apply to some pensions which commenced before July 1, 2007.) These percentages are used to work out the taxable and tax-free components. If the pensioner is under 60 when the lump sum is paid and it contains some taxable component, then tax may have to be deducted by the super fund. How are these benefits taxed? If the person doesn’t specifically nominate that they want to receive a lump sum then they will be deemed to

be receiving a pension payment. For those aged at least 55 but under 60, the pension payment will be taxed at their marginal rates less a 15 per cent rebate. For those over 60, these pension payments will be tax-free. If tax does need to be deducted, then the super fund will have to be registered for Pay As You Go (PAYG) Withholding purposes. The process of applying for this PAYG Withholding is relatively simple but can take a bit of time to finalise. This can be a pressure point if the lump

sum is needed urgently. Once the lump sum payment has been made there is no adjustment to the tax-free and taxable proportions in the pension. From a financial services law point of view, in most cases, the lump sum payment does not involve issuing a financial product and as a result the super fund trustee does not need to issue a Product Disclosure Statement. How are these transactions typically completed? It’s generally a 10-step process: • Member requests payment or notifies that they have the right under the terms of the superannuation product; • The trustee confirms entitlement to cash out a lump sum; • The trustee issues a Pre-payment Statement - a specific document issued by the ATO; • The Pre-payment Statement is completed and signed by the super fund member and returned; • The trustee acknowledges whether the member wants the payment to be treated as a lump sum or pension payment; • If required, the trustee applies to be a PAYG Withholder; • If required, the trustee works out what the pro-rata minimum pension payment should be just before the lump sum is paid; • The trustee sells/transfers assets to make the lump sum payment; • The trustee adjusts the pension account balance; • Finally, the trustee pays the lump sum and if required withholds PAYG tax. Rolling back a pension

Rolling back a pension effectively means moving some or all of a pension’s account balance back into the growth or accumulation part of a super fund. In general this accumulation part is taxed at 15 per cent inside the super fund, whereas the pension part is taxed at 0 per cent. Rolling back some part of a pension’s account balance into the accumulation part of the super fund will affect future pension income payments. Obviously if all of the account bal-

SELF-MANAGED SUPER

‘The trustee must make sure that the pro-rata minimum pension has been paid’ ance is rolled back then all future income payments from that pension will cease. The purpose of this transaction is either to eliminate the payment of excess income or to seek protection from creditors. Creditors can often claim income payments, including pension payments, to repay debts but may find it harder to attack a super fund account balance. All account-based pensions - including Transition to Retirement pensions - can be rolled back to the accumulation phase. In some rare cases the rules of a pension do not allow it to be stopped for any reason. This typically applies with death benefit pensions and is designed to stop a spendthrift spouse wasting all the money. The amount rolled back from the pension will not be a contribution for super law purposes and, as noted above, it cannot be used to satisfy the minimum pension payment rules. Before the pension is rolled back, the super fund trustee must make sure that the pro-rata minimum pension has been paid. Tax issues

As this type of transaction is conducted within a super fund, no part of the account balance rolled back will be taxed in the super fund member’s hands.

The amount rolled back will form a member interest within the super fund separate from the member’s pension interest. If the member already has a growth interest, then the amount rolled back will be added to it. There will be no adjustment to the dollar value of the tax-free component of the pension if the whole pension account balance is rolled back. The taxable component will be the balance. A slightly different rule will apply if part of a pension’s account balance is rolled back. In this case the original amount of tax-free component remains unchanged and is split between the amount rolled back and the remaining pension account balance. As noted above, the amount rolled back will not be a contribution for super law purposes. The rolled back amount will also not be a contribution for tax law purposes and hence will not count towards the member’s concessional and non-concessional contribution limits. From a financial services law point of view, depending upon the relationships involved, some financial advisers might be able to rely on replacement product advice rules. Typically these rules reduce the amount of material that has to be disclosed again to an investor. In most cases rolling back will involve issuing a financial product. This means that a super fund trustee should only roll back the pension after receiving an eligible application from the member. A Product Disclosure Statement (PDS) must also be issued unless an exemption can be used. For example, if the member already has the current PDS and it provides all relevant information. How are these transactions typically completed? It’s generally a six-step process: • Member requests rollback of pension or notifies that they have the right under the terms

of the superannuation product; • The trustee confirms entitlement to rollback and acknowledges member election; • If required the trustee works out what the pro-rata minimum pension payment should be just before the rollback is made; • The trustee sells/transfers assets to complete the rollback; • The trustee adjusts the pension account balance; • If the super fund trustee uses segregated accounts for pension and non-pension assets then the trustee will need to ensure that appropriate assets are transferred between pension and non-pension accounts.

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

Who do you turn to for expert advice? Having provided solutions to the SMSF industry for over 20 years, Macquarie knows self managed super inside out. If you’d like to be on top of the latest market developments and legislative changes, our technical team are industry experts.

Call Macquarie Adviser Services on 1800 005 056 or visit macquarie.com.au/cashflow

I N V E S T OR PSYCHOLOGY

The secrets of successful investing The same emotions affect fixed income investors just as much as share investors, says Roger Bridges

he same powerful forces that drive share investors - greed and fear - also affect the behaviour of fixed income investors. The greed element was no more apparent than in the lead-up to the global financial crisis (GFC), with investors’ thirst for ever-higher returns in a low-interest-rate environment prompting many to invest (often unknowingly) in higher-risk “so-called” fixed-income securities. However, the tide has turned, with greed replaced by a prolonged period of fear, and investors now focused on the aftermath of the GFC specifically Europe’s debt and banking problems, as well as doubts about the strength of the US economic recovery. Investors are more worried about the return of their capital than the return on their capital. They are in turn tending to shy away from risk, preferring the comfort of good old-fashioned “safe haven” sovereign bonds (mostly US, Canada, Germany and Australia at present), sparking strong rallies in global bond markets. In this article we provide insights into how the greed and fear emotions and associated investor behaviours can be tamed, or at least kept at bay. Recognising and understanding these behaviours is one thing, but changing them is something else. As a fund manager, we are not completely immune to these behaviours; however, there are steps we take and disciplines that we adopt to help minimise their influence on our investment decisions. Essentially it comes down to one word - “process”. Having a process that sets boundaries and rules permits you to challenge the status quo

Chart 1: The rise and fall of credit

and it stresses your biases; it allows you to have greater control over the greed and fear emotions, and ultimately make more rational investment decisions. In this article we share some of the Tyndall fixed income team’s secrets to successful investing. The rise and fall of credit

Fixed income, specifically credit, has stolen the limelight in recent years as a result of the GFC and knock-on effects on world economic growth. The increased demand for, and supply of, credit in the late 1990s saw this sector grow rapidly as a proportion of the UBS Australian Composite Bond Index (Index), peaking at 36 per cent in 2006 (as shown in chart 1). Meanwhile, Commonwealth Government bonds

declined sharply during this period, due largely to the elimination of the Federal Government’s budget deficit, which was replaced by a significant surplus. In a post-GFC world though, the picture has changed. Credit issuance virtually came to a standstill in 2007-2009 with corporates unable to issue debt due to lack of demand, or their unwillingness to pay the yields required by investors. Meanwhile, governments around the world increased their bond issuance to finance their stimulus spending. In Australia, credit as at May 2010 had fallen to around 17 per cent of the Index while Commonwealth Government bonds had risen to 28 per cent, with semigovernment debt and Supras making up the

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

INVESTOR PSYCHOLOGY

balance. (“Supras” are highly-rated sovereign and supranational issuers, and securities issued by banks, guaranteed by a domestic or foreign government.)

Chart 2: Risk/return and portfolio construction

Index investing doesn’t necessarily deliver the best risk/return

As an observation, in the early stages of the “de-risking” process, many investors sought the safety of index investing, perceiving credit securities to be too risky. The only problem with that, of course, is that at that time many bond indices had high exposures to credit securities - so investors weren’t necessarily escaping from the “bad” credit. This raises one of the biggest downsides of index investing in fixed income - those companies that need to issue large amounts of debt end up representing the largest proportion of the Index, exposing investors to greater risk than they probably realise. Index investing can only be justified if the markets are totally efficient. However, it is our belief that markets are not always efficient. Our experience shows that markets often incorrectly forecast short- and medium-term influences and conditions. As market participants respond differently to the information available, investment opportunities can arise when interest rates move away from their fair value, therefore creating the potential to add alpha. From a portfolio construction perspective the Index is not an efficient portfolio, particularly in the current environment. As a result of the large amount of Australian government bond issuance that has taken place in recent times, the average credit rating of the Index is now close to AAA. In chart 2, we estimate the Index (marked with an “x” on the chart) lies approximately half-way between AAA securities and Commonwealth Government Securities (CGS) but sits off the efficient frontier. By altering the composition of assets, less risk and more return can be achieved to move the portfolio out to the efficient frontier. For example, by investing in lower-grade credit securities (that is, moving from AAA to AA) we

are able to reduce the risk of the overall portfolio and increase return. Simply, this means that buying less CGS and more bonds issued by banks than the Index weighting dictates, can provide an active manager with the ability to add value and reduce price volatility. However, it requires the manager to be able to pick securities with a low risk of default and generally stable or tightening credit spreads. Herd mentality creates investment opportunities

The chase for equity-like returns from fixedincome securities is a classic example of the “herd mentality” where investors follow the crowd and invest in the latest trend or hot tip - based on the simple premise: “If others believe, then it is safe to also believe”. It is one of the many investor behaviours that can lead to the mispricing of securities, providing investment opportunities for active managers and savvy investors. In the lead-up to the GFC, we recognised credit was over-priced, particularly when spreads between credit and government bonds narrowed from 200 basis points in 2005 to just 30 basis points on average in 2006 (that is, the higher-

risk credit securities were only yielding 0.3 per cent more than AAA-rated government bonds). Credit margins had declined to the point where they covered very little of the risks inherent in these securities, particularly those rated BBB and lower. We subsequently avoided many of these securities, focusing more on the high-quality, highly-rated securities and government bonds. We suffered underperformance in the short term as credit continued to run, but over the long term this strategy paid off for our investors, with no securities in the Tyndall bond funds defaulting. Additionally our flagship fund, the Tyndall Australian Bond Fund, has outperformed its benchmark, the UBS Australian Composite Bond (All Maturities) Index over the five-year period to May 31, 2010, by an average of 0.62 per cent per annum before fees - with less risk than both the Index and median Australian bond fund (Source: Morningstar). Please note past performance is not a guarantee of future performance. Tips and tricks

Fund managers are not infallible by any means, but there are steps and disciplines they

I N V E S T OR PSYCHOLOGY

implement to help reduce the influence of investor behaviours on their investment decisions. By far the most important method used by fund managers is the investment process. The process sets in train steps and rules to follow - it enforces a discipline to keep them on track to achieve their targeted risk and return objectives. At Tyndall, we adopt a multi-layered process comprising research, analysis, sector allocation and stock selection decisions, risk management, execution and review. It’s this last step in the process that is perhaps one of the most important and, if overlooked, can potentially be the biggest investment trap for investors. Process over outcome

Our team are strong believers in process over outcome. Often investors can fall into the trap of focusing on the outcome rather than their methodology and valuation process. When we receive new information, we don’t focus on the outcome - that is, the impact on the return we are seeking to achieve - but we review the process and how the new information affects our valuations and ultimately positions in particular securities. We believe that by focusing on the valuation and the risks, the returns will look after themselves. Our team of seven investment professionals meet first thing every weekday morning to review the previous day’s and overnight market movements. We review what’s happened, why it happened and the impact it may have on the assumptions and valuations that underpin our investment strategies. We also question what’s happened: is it an over-reaction? Often the market can over-react to a new piece of information, such as a US employment number, which can lead to a sharp sell-off in bonds. If you focus on the outcome, you may get caught up in the momentum and sell down your holding. If, however, you focus on the process, this information and market reaction could actually be a valuation trigger and represent an excellent buying opportunity. Our focus on process over outcome is the reason we don’t believe in having stop loss posi-

tions - it places too much emphasis on the sale price and not enough on the process and true value of a security. Having said that though, stop losses can work for some investors - particularly those who are risk-averse or have short investment horizons. Expect the unexpected

Another critical component in our process is to expect the unexpected. In our daily meeting we look at various “what if ” scenarios. What if the Reserve Bank of Australia reduces rates earlier than expected? What if Australia’s unemployment rate peaks at 10 per cent and not the forecast 7 per cent? Or what if the European Monetary Union collapses? In this regard, we reframe our mindset from one of risk aversion to loss aversion. We subject all our positions to what type of loss may ensue if the unexpected happens. By having procedures in place that allow us to price in the impact of “what if ” scenarios, it gives us greater control and a sense of comfort that should the unexpected happen, our portfolios will be better positioned to weather the storm. It also means we are able to take advantage of investment opportunities when they arise. Don’t get trapped by “groupthink”

Fund managers are often criticised for displaying “group-think”, whereby everyone in a team thinks the same and hence their biases are elevated rather than eliminated. This is a challenge for fund managers and is something that we work very hard at managing at Tyndall. The key is having a diverse group of team members on a number of levels including age, sex and personality. Our fixed income team ranges from an age of 25 up to the early 50s; there are five males and two females; and there are mixed backgrounds and equally mixed personalities and experiences and to add a little more spice to the equation, we sit in a very small room. Having such diversity provides greater scope for different views and importantly provides the

forum for debate. The biggest challenge here is to ensure that all team members have a voice and are listened to. In many respects I play a devil’s advocate role by challenging views, encouraging alternative views and encouraging the pursuit of a broad range of information sources and contacts in the industry. At times I even ask each team member individually what they think, to ensure everyone has a say or provides input. Embrace volatility

We are no doubt experiencing a period of prolonged volatility, and it’s certainly been a wild ride for investors. But it’s important to remember short-term volatility does not equal risk if you have a long-term horizon. Over longer periods of time, volatility can actually present active investors with good investment opportunities. We often see too much focus on the short term, causing panic and large sell-offs during periods of uncertainty. However, these periods often provide excellent investment opportunities for the long-term investor. The GFC is indeed a perfect example of how investors cannot only be hurt by, but also benefit from, the ever-powerful forces of greed and fear. As highlighted in our previous articles, emotions and behaviours can dictate investor decisions - often poor ones. Adopting a long-term view, remaining disciplined to an investment strategy, and seeking and listening to advice from a professional planner are steps investors can take to reduce the impact of these behaviours, leading to more informed decisions and better investment outcomes. Outsourcing the investment decisions to a professional manager is another way investors can overcome these behaviours. While they are not completely immune to the behaviours, they have a number of “checks and balances” in place in the form of an investment process which helps them reduce the impact of these behaviours and make more rational and objective investment decisions.

ar e f , d e ing e r invest f G o y cholog

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seminar kit for financial advisers

Looking to rebuild your clients’ confidence in investing? Do it by the book. The “Greed, fear and the psychology of investing” booklet is Tyndall’s highly sought after educational tool that explores the psychology of investing and some truths and traps for investors. Developed specifically for financial advisers this booklet helps you explain the importance of seeking professional financial advice throughout all investment cycles and can help restore your clients’ confidence in investing over the longer term. The booklet is part of the Tyndall Psychology of Investing Kit which includes a presentation that provides you with the opportunity to prepare and present a tailored investment seminar on the booklet’s concepts for your clients.

To request your free booklets and Psychology of Investing Seminar Kit visit…

www.tyndall.com.au/greedfear Any information contained in this advertisement has been prepared without taking into account an investor’s objectives, financial situation or needs. The value of an investment can rise and fall and past performance is no guarantee of future performance. ‘Tyndall’ means Tyndall Investment Management Limited ABN 99 003 376 252 AFSL No 237 563. 2213_PP

www.praemium.com.au

TECHNICAL

Special circumstances, special trusts Louise Biti shows why Special Disability Trusts are now worth a second look for families with disabled children.

hen the concept of a Special Disability Trust (SDT) was established it seemed like a good idea; but the restrictions placed into legislation made them impractical and tax-ineffective. As a result, they have not been popular. Recent changes to both social security and tax legislation make these trusts worth reviewing as a strategy for clients. An SDT can help with estate planning for families with a disabled child as well as provide Centrelink advantages.

could only pay for costs that were necessarily higher due to the beneficiary’s disability. For example, trust money could not be used to pay for general property maintenance or renovations unless they were required as a direct result of the beneficiary’s disability and were to rectify problems that may put the beneficiary’s safety at risk. New rules that commence on January 1, 2011 will expand the range of purposes that the trust money can be used to pay for. This makes an SDT more effective in providing for a disabled person’s needs.

What is an SDT for?

An SDT can be used by family members to set aside money for the future care and accommodation needs of a person with a disability. The money is placed into a trust for the benefit of the disabled person as the sole primary beneficiary. This is attractive from an estate planning viewpoint as it allows parents to set aside money for a disabled child, avoiding the potential for any estate conflicts over this money. In NSW and WA, issues may arise from notional estate provisions if the trust has been set up within the three years prior to the donor’s death. The original rules were very restrictive and the trust money could only be used to pay for care and accommodation costs relating to the person’s disability. This meant that the trust What’s New From January 1, 2011: • The trust will be able to pay for the beneficiary’s medical expenses, including the premium for private health insurance. • The trust will be able to pay the maintenance expenses on assets owned by the trust. • The trust will be able to spend up to $10,000 in a financial year on discretionary items not related to the care and accommodation needs of the beneficiary.

• provide annual financial statements; and • conduct independent audits when required. Useful resources A copy of the model trust deed and a useful client booklet, Special Disability Trusts: Getting Things Sorted, are available at: http://www.fahcsia.gov.au/sa/carers/ progserv/Pages/SpecialDisabilityTrusts. aspx What are the Centrelink

What are the qualifying rules?

If an SDT is being considered, the first criterion to check is whether the intended beneficiary is eligible for an SDT. The person for whom the trust is set up must meet the definition of severe disability. In essence, this means the person must have a physical, intellectual or psychiatric impairment assessed at 20 points or more (criteria to qualify for Disability Support Pension). There are also restrictions on work ability, living arrangements and means testing. The full definition can be checked at www.centrelink.gov.au. Some relief is provided from January 1, 2011 as the trust beneficiary will be able to work up to seven hours a week in the open labour market. A solicitor should be engaged to draw up the trust deed, as the trust must meet the following requirements of an SDT: • be “protective” in nature; • have only one principal beneficiary (the person with the disability); • have a trust deed that contains the clauses as set out in the model trust deed; • have an independent trustee, or alternatively have more than one trustee; • comply with the investment restrictions and have a documented investment strategy;

concessions?

Immediate family members* can transfer up to $500,000 (combined) into the trust without the normal Centrelink gifting rules applying. This can enable clients to set aside money to help a disabled family member without a negative impact on their own Centrelink entitlements. *An immediate family member includes natural, step or adoptive parents, legal guardians, grandparents and siblings. Example: Roy and Elvira have assessable assets of $1.2 million. As part of their estate planning they set up an SDT for their disabled daughter (Debbie) and transfer $500,000 into the trust. Gifting rules do not apply, so Roy and Elvira’s assessable assets reduce to $700,000. This may help them to qualify for a higher age pension.

An assets test exemption of up to $563,250 (indexed each year) is available for the trust beneficiary. In addition, neither the trust income nor distributions from the SDT are assessable under the income test. This means the assets of the trust will not jeopardise the person’s eligibility for Centrelink benefits.

T E C H N I CAL

Example:

Debbie is unable to work and applies for a Disability Support Pension (DSP). Under normal trust rules the $500,000 invested in the trust would be an assessable asset to her, but if it is set up as an SDT the assets up to $563,250 (2010/11) are exempt. This may allow her to continue to receive the full DSP (subject to other assets and income).

Toby and Roslyn are both in their 50s and working full-time when they set up an SDT for their son Colin. They transfer $500,000 into the SDT. They do not qualify for any Centrelink benefits so they do not receive any benefits from the gifting exemption. The trust still provides asset and income test exemptions for Colin, who receives the DSP. Toby’s father Ross wishes to transfer $50,000 into the SDT. He currently receives an age pension. The $500,000 gifting exemption is a combined family limit and has already been fully used by Toby and Roslyn. Therefore, Ross will be assessed under the normal gifting rules with a $40,000 deprived asset. A more effective outcome would have been for Ross to make his $50,000 gift first to receive the full gifting exemption.

How is the trust income taxed?

In the past, the trust came under normal taxation rules for trusts, with a person presently entitled to income. Any income spent on the trust beneficiary was taxed at the beneficiary’s marginal tax rate. However, income retained in the trust was taxed at the penalty rate of 45 per cent. Due to the purpose restrictions on expenditure, this may easily result in income being retained in the trust. Changes in tax legislation will make the trusts more tax-effective. These changes are: • Unspent income from an SDT will be taxed at the beneficiary’s personal income tax rate, instead of the highest marginal tax rate. • The capital gains tax main residence exemption has been extended to include a residence that is owned by an SDT and used by the beneficiary as their main residence. Traps in gifting strategies

If more than one family member is making gifts into the SDT it is important to consider the gifting order. The $500,000 exemption only applies once and will apply to gifts in date order, even if the person making the gift does not qualify for a Centrelink/DVA payment. Centrelink/ DVA recipients should make their gifts first.

The disabled person and/or spouse cannot transfer assets to an SDT to avoid gifting rules on assets in their own name unless the assets come from either a direct inheritance or superannuation death benefit received within the previous three years.

Louise Biti

The Government is continuing to look for affordable ways to support people with disabilities, and these recent changes will help to make SDTs more attractive. Families who are concerned about the estate planning aspects of looking after a disabled family member should consider whether an SDT is appropriate. And along the way, it may also provide some Centrelink advantages. Not many strategies exist anymore to reduce assessable assets, but this is one that does work in special circumstances.

Example: Luca and her husband Josef have assets above the couple homeowner pension limits, so although Luca suffers from a severe disability, she does not qualify for the DSP. If they transfer $400,000 into an SDT for Luca, the assets and income of the trust are exempt, but $390,000 is a deprived asset under the income and assets tests for five years from the date of gift.

Louise Biti is a director of Strategy Steps, an independent company providing strategy support to financial planners. For more information visit www.strategysteps.com.au

S U P E R A N N U AT I O N

Super Cooper Richard Weatherhead assesses the likely impact of the Government’s review of the governance, efficiency, structure and operation of Australia’s superannuation system

he Super System Review (the “Cooper Review”) has delivered to the Government its final report into the governance, efficiency, structure and operation of Australia’s superannuation system. Given the scope of the Cooper Review, the potential ramifications for the superannuation industry are enormous. However, the recommended changes for the self-managed super fund (SMSF) segment are relatively benign. The most significant changes are contained in the April 29, 2010 report, Self Managed Super Solutions; but other reports, particularly the March 22, 2010 report, SuperStream, will also impact on self-managed superannuation funds. At first glance, the changes for the SMSF market are modest, with most headlines focusing on the recommended ban on investments in collectables and personal use assets. However, there are a number of other preliminary recommendations which are also important. These include: • Permitting the ATO to apply a range of graduated penalties for breaches of the SIS Act, rather then relying on the extreme measure of declaring the fund non-compliant. These would include the power to enforce mandatory education for trustees who have contravened the SIS Act; • Extending the jurisdiction of the Superannuation Complaints Tribunal to resolve death benefit disputes between an SMSF and a beneficiary who is not a member and to resolve disputes involving external insurance; • Further consultation on potential changes to the AFSL regime to ensure financial advisers are subject to a comparable level of regulatory supervision in relation to the provision of tax services as would apply if they registered with the Tax Practitioners Board - or

‘One theme running though all proposed changes is the increased use of technology’ to bring financial advisers permanently within the tax agents services regime itself; • A possible requirement for prospective SMSF members to complete an online module on a government website which would evaluate their suitability to participate as a member and trustee of an SMSF; • Compulsory registration of approved auditors, with auditors being independent of any firm providing any service in connection with the SMSF or its trustees; • Removal of the 5 per cent in-house assets investment limit so that no in-house assets would be allowed (with grandfathering of existing in-house assets until June 30, 2020); • Increasing disclosure to members of key information relating to the fund, such as the binding death nominations in place, whether pension arrangements are provided to any member, the amount of insurance cover provided, and investment returns over the previous financial year; • Improved fund and member identification data to improve security of rollovers to SMSFs; • Changes to the SIS Act to reduce the frequency of trust deed updates for essentially

administrative and compulsory compliance reasons; • Development of standard online forms for all funds, including SMSFs, covering common processes such as rollovers; • The exchange of tax file numbers between funds, including SMSFs, enabling the trustee of the fund to which contributions are currently being made to invite the member to consolidate their accounts. Clearly these changes, if put into effect, would have a profound impact on the SMSF industry. This would be particularly the case for those holding collectables or in-house assets. One theme running though all proposed changes is the increased use of technology and online data collection and transmission. This would continue a trend that has been occurring for a number of years, with more and more sophisticated functionality being provided online. A growing number of superannuation products enable online application. The general level of functionality available within online superannuation products is strong and many of the preliminary recommendations of the Cooper Review, if implemented, would facilitate further improvements, particularly driven by the use of the tax file number as an identifier. Overall, the potential impact of the Cooper Review could be to significantly increase the use of online superannuation products and functionality, and the SMSF sector is presented with both opportunities and some threats in this new e-commerce world.

Richard Weatherhead is a director of Rice Warner Actuaries

R E S P O N SIBLE INVESTING

Investing responsibly can pay off in more ways than one Megan Lewis argues that advisers with an expertise in responsible investment (RI) could be killing two birds with one stone: satisfying glowing client demand, and meeting their new fiduciary responsibility

rom July 2012, advisers will have a statutory “fiduciary duty” - an obligation to place clients’ interests before their own. These reforms are part of an unprecedented number of reviews globally, looking at the regulation of wealth management products, providers and intermediaries in the wake of the GFC. This new duty of care should see advisers change focus from “product” to “client”. One way to meet the new obligations and gain a competitive advantage is to specialise in responsible investment (RI) advice. RI AND FIDUCIARY DUTY

“Fiduciary duty” will fundamentally change the practice of investment advice, substantially transforming the adviser-client relationship. Advisers will have to spend more time getting to “know their clients”. An in-depth client-adviser relationship is at the core of responsible investment advice. “At the end of the day it’s about really knowing your client,” says Lisa Greeves, principal of Greeves and Associates, a WA-based member of the Responsible Investment Association Australasia (RIAA) and a RIAA-certified adviser. “If you really do know your client and take the time to talk with them at length about their values you will learn of any ethical leanings. It’s then about structuring your investment solution to consider their areas of concern.” Karen McLeod, an adviser with one of Queensland’s dedicated RI businesses, uses her client’s personal values to drive their wealth management plan. Key to that plan though is, does the client have the investment risk

profile to be able to satisfy ethical concerns? For example, are they able to buy direct shares to get the transparency they’re after from an individual company? If not, which managed product can provide the best fit? ESG = RISK MANAGEMENT

There is growing acceptance amongst the world’s largest pension funds that environmental, social, and governance (ESG) issues can pose a material threat to an investment’s performance. This has been driven by the United Nations Principles for Responsible Investment - an initiative with 760 signatories globally representing $20 trillion, or, on some measures, one quarter of the world’s funds. In the world of financial advice, these issues can threaten the performance of each client’s portfolio. It will be part of an adviser’s fiduciary duty to be equipped to advise on these matters, irrespective of a client’s stance on environmental or social issues. According to the landmark 2005 Freshfields Report and the 2009 follow-up report by the Asset Management Working Group of the UN’s Environment Program Finance Initiative, “…it would be expected that the investment consultant or asset manager would raise ESG considerations as an issue to be taken into account and discussed with the client… if the investment consultant or asset manager fails to do so, there is a very real risk that they will be sued for negligence on the grounds that they failed to discharge their professional duty of care…” This report refers to advice given to institutional investors, but the argument could

‘“Fiduciary duty” will fundamentally change the practice of investment advice’ apply to “retail” advisers. “There are pressing ESG issues you need to protect your clients’ investments against,” says Justin Medcalf, another RIAA-certified adviser and director of Green Equity Management. A new paper from the Network for Sustainable Financial Markets, entitled Wealth Management in a Post-GFC World, argues: “The GFC has starkly demonstrated the consequences for investors of ignoring ‘hidden’, long-term risks - a position which threatens to be repeated with respect to climate change and broader environmental, social and governance issues.” It argues fiduciary duties can only be “discharged” if there are mandated legal requirements for effective ESG integration. Advisers serious about fulfilling their fiduciary duty will need to be well informed about how potential investments manage ESG risks. Specialist RI advisers say it’s often clients who are on the lookout for such risks. “Clients will test you on your recommendations because they will typically be watching

RESPONSIBLE INVESTING

After running his own advice business for a year, Adam Ordelman says: “The client and I now make the decision together - it’s a more collaborative process, which means I have to educate the client more, but this builds a stronger relationship.” MAKING THE CHANGE

Responsible investors shun companies with poor enviornmental practices

what the company is doing as well,” says Adam Ordelman, an adviser with Bridges who is certified by RIAA. “The conversations you have with your clients can be quite robust.” RI AS A WAY TO SURVIVE AND THRIVE

Specialising in RI will give forward-looking advisers a way to embrace their new obligations and build a competitive advantage. “The good old days when an adviser offered advice that delivered on their client’s goals but also benefited them through commissions bred an approach to advice that didn’t need to deal with the whole client,” says Medcalf. “But post-2012, with the abolition of commissions, advisers will need to be able to provide a complete service to clients and, irrespective of whether an adviser agrees with a client’s position on ESG issues, they will need to be able to offer advice that takes these issues into account. “There are reports that a lot of practices will close after 2012 because they won’t be able to successfully convert their business model to a ‘fee-for-service’ practice because they don’t have a strong value proposition - again, responsible investment advice can be this proposition.” According to the Network for Sustainable Financial Markets report, all financial service

providers need to address ESG issues if they are to follow industry (and world) best practice. Those willing to shift to more “sustainable models” can thrive: “Scalable, profitable and higher quality business models are achievable, but this requires leadership, new thought, innovation and know-how. Enduring value and market share advantages exist for those players prepared to undertake the necessary transformations. ” ADVISER AS PARTNER AND EDUCATOR

The Network for Sustainable Financial Markets says improving consumer financial literacy is essential. RI advisers say “client education” is key to the strong relationships underpinning their success. Karen McLeod says RI clients take financial literacy seriously. “They expect more information from advisers and they want more information on what they’ve bought. They just don’t want to know the financial performance of companies; they want to know about a company’s environmental performance, their employee conditions. Clients expect returns that go beyond financials… If you can’t find something that fits your client’s profile, often the client is happy to sit in cash until you can.”

So how do you go about transforming into a responsible investment advice practice? The peak body for RI in Australia, the RIAA, offers an online course that takes three to four hours to complete and covers: what constitutes responsible investment; how to create an RI profile; different approaches used to create RI managed funds; how to analyse shares in light of ESG issues; what issues drive responsible investors; and how to start offering RI advice. You can also get a first-hand understanding and meet other RI advisers in September this year, in Sydney, at RIAA’s conference, featuring a one-day adviser master class. You can become a Certified Responsible Investment Adviser through RIAA. You will need to successfully complete the online course; incorporate appropriate questions in your Fact Find; ask clients what ESG or ethical issues they want addressed; and have RI products from more than two providers on your approved list. As a Certified Responsible Investment Adviser you demonstrate your commitment to providing RI advice and join just over 30 other certified advisers.

Megan Lewis is marketing and communications director at the Responsible Investment Association of Australia (RIAA)

P R A C T I CE MANAGEMENT

Are we there yet? Martin Mulcare explains why regular contact is critical to achieving clients’ goals

he lead-up to June 30 is usually characterised by a succession of client meetings, which are often described as “review meetings”. What is the purpose of your review meeting? If you regard it as a chance to touch base with your client and review the progress of their portfolio during the past six or 12 months then I think you are missing a great opportunity. Some advisers have gone a step further and called them “progress meetings”, but forwardthinking advisers have named them “planning meetings”. Let me explain. Firstly, I am making several assumptions, which I should state, to avoid the possibility of wasting your time. Please stop reading if you do not believe the following: • You are interested in a long term relationship with your clients; • You are helping your clients with all aspects of their financial world; • Your clients’ lives are dynamic rather than static. OK, so if you want to nurture your longterm relationship, wouldn’t this meeting be an ideal time to confirm your understanding of their values and aspirations? More specifically, wouldn’t this meeting be a great time to check your understanding of their long-term goals? That would also provide valuable context for your review of their progress against their long-term goals. Similarly, if you want to help your clients make smart decisions about their full range of financial challenges, wouldn’t this meeting be a great time to discuss aspects of their financial life that you are not currently involved in? You may only have been dealing with a slice of their financial life by choice - theirs, or yours - but this may be a good time to revisit that assumption. If the choice was yours, perhaps you have recently expanded your services or your value proposition - in which case, this may be a good

Martin Mulcare

time to inform them. If the choice was theirs, maybe the adviser they had previously dealt with is no longer on the scene, or maybe their level of trust has matured to a point where they can share additional financial concerns with you. In the same way, if your clients’ lives are dynamic, wouldn’t this meeting be a great time to update your understanding of your clients, including your records. Yes, I know most advisers will ask something like, “any changes in your circumstances since our last meeting?” Frankly, I don’t think that question helps you or your client, and you won’t be surprised that the answer is usually, “not really”. A much better way is to carefully review their file and prompt them with more helpful and specific questions. Here are five examples from a myriad of possibilities: • “Your children are now at an age where you may be thinking about high schools. How are your plans for their education coming along?” • “Last year you mentioned your interest in

supporting your favourite charities at some stage. Is this a good time to explore potential structures for philanthropy?” • “Our notes indicate that your company was introducing a new share option scheme last year. How can we help capitalise on the new plan?” • “In the past you have been keen to manage your own investment properties. If we are to ensure that you achieve your goals, it would be useful if we had some insight into all of your assets. How are they performing?” • “Last time you announced that your ex-wife was recently engaged. How was the wedding? Is this the right time to review your estate planning?” If you aren’t conducting an annual planning meeting with your clients which: • Confirms your understanding of their values and long-term goals; • Seeks to solve their financial challenges beyond your current scope of work; • Identifies changes in their life which may have an impact on their financial world; then, in summary, I think that you are missing a great opportunity to provide greater financial certainty to your clients in these most uncertain financial times. For you and your business, there is potential for more business (and more fees); clients that are more committed to working with you; and more productive use of the time allocated to review meetings. For your clients, they will feel that you are more interested in where they are going (not just where they have been); more of their financial problems will be addressed; and they may feel more confident about their financial future.

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

PRACTICE MANAGEMENT

Making money made sexy If only making money were truly interesting, laments Peter Switzer

ot long ago, Sydney’s Daily Telegraph showed government pointy-heads how to promote a worthwhile cause when it talked about how the Federal Government, following its Cooper Review into superannuation, was going to make super sexy! Now there’s someone thinking about their target audience. The lesson could also be used by the financial planning community, because there is a tragic lack of understanding in Australia about what financial planners can actually do for clients. Of course, the Federal Government should be applauded for having an “Understanding Money” website - www.understandingmoney. gov.au - but like a lot of public sector initiatives, these websites are not properly marketed to the people who could get some real value out of them. The Australian Securities and Investments Commission (ASIC) has a great website to help investors, savers and consumers, but they called it FIDO! I bet if you asked 100 people the name of ASIC’s website, designed to help and protect you from shonks and dodgy operators, you

would be lucky to find 10 people who know it. Similarly with that great consumer advocate group - Choice. Too few people think about and use their services; and this not-for-profit group, like the Government, has a marketing problem. What is needed is a serious marketing program, much like the very successful industry fund ads, which compared long-run returns for super savers inside and outside an industry fund. The bang the industry fund groups got for those ads shows what the Federal Government and its Financial Literacy Foundation need to aspire to in trying to promote the “Understanding Money” website. Martin Grunstein, who is one of Australia’s best customer service business speakers, always reminds business owners that their marketing has to answer one very important question: “Why should I buy from you?” The industry fund ads answer it by showing how much someone could save if they switched. The Government’s website does no memorable public advertising. I reckon as people get into their 40s and approach those 10 years before retirement, then

understanding money becomes a more interesting topic; but most Aussies either go to a planner or throw up their hands and hope nothing goes wrong. The latter group is much, much bigger than the wise people who seek out professional help. And part of the reason is that our industry has not been good at answering the question: “Why should I buy from you?” Regrettably, many people have, by default, answered the all-important marketing question with: “I won’t buy from you because I don’t trust you. I believe these people don’t really want to understand money - they think that sounds boring. What they want is to get richer, and they want to do it as safely as possible. When it comes to financial literacy or helping Aussies with their super and retirement plans, the Federal Government needs to make the deal more sexy and alluring, because the end results are so important. Similarly, we as financial planners have to make our services more attractive and sexy; but it should not be based on promises of big returns, using margin loans and ridiculously risky products. It is time we started selling the really sexy bits of our industry: the goal-setting; the modelling of our clients’ alternative futures; the choices between buying a property, investing in shares or funds, and/or even paying off our houses in double quick time. What most people nowadays have latched onto is the idea of a coach - a fitness coach, a diet coach, an executive coach - and so we should be money coaches, and not the boring, old and oftmaligned title of financial planner. When, as a group, we build a new reputation as money coaches who help make our clients richer - as safely as possible - then we will end up with a sexy reputation and the customers will follow.

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 MANAGEMENT

The best of times, the worst of times Less than one in three firms formally surveyed clients during the GFC. Rod Bertino wonders what the Dickens is going on

he importance of regularly seeking feedback from your clients can never be overestimated. This is especially so when you consider the increased volatility, high-profile corporate collapses, multiple government enquiries and the negative media our profession has endured over the past two years. Given this, we were somewhat surprised that our recently released Future Ready IV whitepaper found that less than a third of the country’s top advisory firms had formally surveyed their clients during perhaps what was the most tumultuous period in living memory. It would appear that 70 per cent of Australia’s advisers agree with the second part of the title of this article and the opening line from Charles Dickens’ epic novel, A Tale of Two Cities - for them, it would appear now is not a good time to measure your clients’ satisfaction levels. We completely disagree. In fact, we argue that, in times like these, you simply cannot afford to just assume all of your clients are comfortable and content. And, for those who may think that the roller-coaster ride we have all been on for the past two years makes it impossible to obtain an increase in underlying client satisfaction, let me share with you the following real life case study. The Tynan Mackenzie practice

in Adelaide, headed by Glenn Sterrey, first completed a Business Health CATScan Client Satisfaction Survey during the second quarter of 2008. While the overall results were very strong, the CATScan did highlight the following three key areas of concern. • As much as the clients trusted Glenn and truly valued his advice and guidance, many expressed concern that if something should happen to him, their future financial security could be at risk. The practice subsequently added a younger adviser to the team who now attends all client engagement and review meetings. • In the lead-up to the 2008 CATScan, Glenn’s Adelaide practice had replaced its own longstanding personalised newsletter with the corporate publication produced through Tynan Mackenzie head office. Many of the comments we received throughout the survey made it clear that while the clients still appreciated the new communication vehicle, they sorely missed the personal and intimate nature of the previous editions. The Adelaide practice decided to recommence the local bulletins and use these to supplement the corporate pieces. • Some clients also expressed a desire for more personalised and proactive communication, so a series of specific communication programs were developed for each of the different client segments.

KEY VALUE DRIVER FORMALLY ASK FOR FEEDBACK No Yes

These were heavily tailored to the known needs and interests of each group. We recently conducted a second CATScan survey of these clients and I am delighted to advise that when measured against the 2008 results, the Adelaide practice recorded an increase in client satisfaction (especially in the areas of communication and reviews) and achieved top quartile ratings in every one of the nine key service delivery areas covered in the CATScan. Further proof to us that, provided you are willing to listen and then act (don’t embark on any survey process unless you are serious about doing something with the results - client feedback that is perceived to be ignored or discounted can do more harm than good), now is the ideal time to find

PROFIT* PER PRINCIPAL $298,970 $520,336

Increase in profit - 74%

out what your clients may not be telling you. And, if you need further convincing, the following extract from the Future Ready IV paper clearly shows that the practices that invest the time, effort and money to find out what their clients are thinking, not only strengthen their relationships, but also generate, on average, a 74 per cent increase in bottom line profit. So, as you finalise your plans for the remainder of 2010 and beyond, consider how your clients would rate your performance in the following areas - these are the current national benchmark standings from the 40,000 plus clients that have completed our CATScan survey (see graph). Rod Bertino is a partner and director of Business Health www.businesshealth.com

SHAREMARKET

Portfolio planning is for pros This is not a job for amateurs, says Ron Bewley Chart 2: Median volatility benefits of focusing on Large Cap stocks in 2008/9

Chart 1: Diversification benefits of increasing the number of stocks in a portfolio 120%

70%

65%

Annualised volatility!

100%

Annualised volatility!

efore the global financial crisis (GFC) gripped our world of portfolio construction, I was happy to think in terms of a highly concentrated portfolio of eight to 15 blue-chip stocks. It is easier to find a few good stocks than a large number; and the diversification benefits fall off rapidly when increasing the number of stocks. I based my analysis on my 2005 simulation experiment of historical stock returns. In 2008 I was asked if I had changed my rule. I didn’t have the time during the GFC to do a proper analysis, so I had arbitrarily increased my range to 15 to 20 stocks. Even with supposedly quality stocks, some companies looked likely to fall over - or at least take a massive hit in price - but knowing which ones was tricky. With 15 to 20 stocks there is less dependence on any one stock, should it get suspended - or worse. Now it is time to revisit the number of stocks question using my previous analytic methodology. I took daily price returns data from the ASX 200 stocks for the two financial years 2008/09 and 2009/10 and simulated the volatility of hypothetical equally weighted portfolios from that historical data. I constructed one million randomly-drawn portfolios for each size of one through fifty stocks and calculated the historical volatility separately for the two financial years. In Chart 1, I show the volatility of the median-volatility portfolio for the two years - and the worst performing portfolio for 2009/10. The black line gives a visual guide for the median volatility of a one-stock portfolio (an average single stock). Unsurprisingly, the volatility of the median portfolio in 2008/09 is much higher than for 2009/10 no matter how many stocks there are in the portfolio. Indeed, I can see that a worst-case portfolio (allowing for the volatilities and correlations of the component stocks) of five five-stock portfolios in 2009/10 has about the same volatil-

2009/10 Median! 2009/10 High! 2008/9 Median!

80% 60% 40%

60%

ASX 200! ASX 50! ASX MD! ASX 100!

55%

50%

45%

40%

20%

35%

0% 0

Number of stocks!

Source: Woodhall Investment Research

ity as an average portfolio of the same size in the previous year. By following the black line to the right from the one-stock average portfolio in 2009/10, I can see that it crosses the red line at eight stocks. This was my basis (in 2005) for choosing a minimum of eight stocks in a portfolio - somewhat arbitrary - but my minimum requirement is that I want my portfolio to have no more volatility than an average stock. The blue line flattens out quickly by about 15 stocks. In a chart not shown here, a similar analysis on the 2008/09 data produces a minimum number of stocks of 13. The old rules of thumb appear to be back on track! But what happens to these results if the set of stocks is restricted to the ASX 50, ASX 100, or mid caps (stocks 51 to 100)? I show only the median volatility portfolios in Chart 2 for 2008/09. The chart for 2009/10 looks similar, except all volatilities are much, much lower. The ASX 50 curve is below the ASX 100 everywhere - but more so in a relative sense for a larger portfolio. The difference between mid caps and the ASX 200 is very small. Indeed, the median volatility of a seven-stock (or more) portfolio selected only from the ASX 50 is lower than for any sized portfolio from the ASX 200. Adding more small cap stocks does little to reduce portfolio volatility.

30% 0

Number of stocks

Source: Woodhall Investment Research

So what are the rules? The number of stocks should match your risk profile but a few simple rules of thumb flow from this analysis - and a modicum of common sense: • Eight stocks seems a reasonable minimum in “good times”, and this should be increased in bad times - say to 13 or 15. • No matter what your choice set, there is little to gain in a volatility sense by holding many more than 20 to 25 stocks from the ASX 200. • Restricting your choice set to stocks from the ASX 50, or ASX 100, has sizeable diversification benefits that cannot be easily bettered by including a large number of smaller capitalised stocks. • Using unequal weights has advantages when the weighting is in tune with volatility and correlation. • Having regard to sector weights helps when those sector returns are less correlated than the returns within a sector. • The “old rules” seem to still be working and didn’t need too much modification during the GFC. • Portfolio construction isn’t for amateurs. Ron Bewley is adjunct professor, finance and economics, at the University of Technology, Sydney

M A N A G ED FUNDS

The unlisted property puzzle Dug Higgins looks at just where direct property fits into the investment jigsaw

he unlisted property funds sector has been hard hit by the events that have unfolded over the past two-and-a-half years. While a large number of funds - and their investors - have suffered as a result, the investment class retains merit, as long as certain ground rules are taken into account. The current climate could also be considered a trigger for investing in this asset class, based on improving real estate fundamentals. While not without risks, current fundamentals are moving in the right direction as the cycle turns. Each investment opportunity needs to be judged on its merits, but we consider that direct property as an asset class retains significant merit when used appropriately as part of a diversified portfolio. At its simplest, real estate can be bought either directly by an investor (direct ownership) or via an investment fund. Property-based investment funds can be divided into three main categories: â&#x20AC;˘ Direct investment vehicles: The vehicle purchases and holds the asset(s); â&#x20AC;˘ Indirect investment vehicles: The vehicle invests only into other direct vehicles which purchase and hold assets, but does not purchase assets in its own right; or â&#x20AC;˘ Hybrid vehicles: The fund has a combination of both direct and indirect exposure to assets. In this article, we will focus on direct investment vehicles only - specifically, property syndicates and unlisted property trusts. Generally, each investment vehicle tends to have distinct attributes regarding asset strategies, structures, leverage and liquidity. This will affect investment decisions and portfolio allocation. It is also important to understand that each type of vehicle may use different performance

benchmarks and that these benchmarks must not be confused. where does it fit in?

Property is generally considered to be a medium-risk asset class - but this is directly related to the structure of the investment used. When taking into account the range of investment strategies and vehicles available, the assessment of risk can range from medium to high, compared to other asset classes, depending on leverage, portfolio composition, management strategy and structure. Why commercial real estate?

Commercial real estate, as an asset class, has several key attributes that make it potentially attractive to investors as part of a diversified portfolio.

the total return (about two-thirds) comes from income, and the rest from capital gains. Direct ownership of real estate over the long term has proven that while capital values fluctuate on a cyclical basis, income returns show very low levels of volatility. It is in the order of less than 1 per cent per annum, as an asset class, according to the Property Council of Australia and Atchison Consultants. While the income returns over time show an impressive level of stability, it must be remembered that this data takes into account a very large number of properties, real estate asset classes, regions and tenants. The ability of an individual to invest into real estate on the same basis is virtually impossible, although vehicles with very large diverse portfolios may be regarded as a proxy. competitive returns

defensive and growth attributes

Asset classes are generally classified as being either defensive (cash and fixed interest) or growth (equities and alternatives). Real estate tends to have both defensive and growth attributes. It comprises solid, income-producing assets - when supported by quality buildings with strong tenants on medium- to long-term leases - and generally shows lower levels of volatility in capital returns than other asset classes. However, depending on the investment strategy used, real estate can be structured to be more or less defensive or growth in nature. It should also be appreciated that valuation lags tend to have a smoothing effect on capital returns volatility. Low volatility of income

Commercial real estate as an asset class generally follows the rule of thumb that most of

Over the long term, total returns from real estate are competitive with those from other asset classes, particularly when accounted for on a risk-adjusted basis. While the data does not fully account for the impact of the decline in property values, which began to bottom in late 2009, the total return calculated for property does include the effect of the property downturn of the early 1990s, which was more severe in terms of falls in asset values than that experienced post 2007. property lowers volatility

Given the nature of low-volatility income streams generated by quality, stabilised real estate, an allocation to direct property lowers volatility within a portfolio. Real estate provides an effective way of accessing assets with low or negative correlation, even compared to A-REITs, over the longer term. This highlights that listed property tends to

MANAGED FUNDS

Dug Higgins

be a weak proxy for direct real estate investment in some situations. While investors need to be conscious of periodic shifts in correlations (such as those experienced between listed property and equities during the latter half of the decade), overall, direct property provides an effective way to lower risk. Direct vs investment vehicles

While real estate as an asset class has lots of compelling attributes, the risks and limitations associated with unlisted direct property funds must be appreciated. Because of the way asset class performance is measured, unlisted direct property funds generally cannot diversify enough to closely replicate these attributes, due to the high cost of acquisition and illiquidity. As such, prospective investors in unlisted funds must take care that investment funds present an appropriate risk/ return trade-off. Is now the time to invest?

As with all investment cycles, human behaviour tends to rule much of the decision- making

process, unless sentiment is removed from the equation and logic applied. Having been dragged through a significant period of wealth destruction across multiple asset classes, investors have typically (and understandably) reverted to being extremely risk-averse. While this is a natural phenomenon, this should not ideally be at the expense of forgoing periods where cyclical opportunities present themselves. Looking at the market cycle, 2009 largely represented the slide to the bottom of the sentiment cycle for unlisted real estate investors. The early adopters - the private investors and highnet-worth individuals - have already moved into the real estate market during 2009 and cherrypicked assets where they could see mispricing and counter-cyclical opportunities. We are currently at a point where opportunities are likely to come up, and retail investors should take advantage of those that adhere to sound investment principles. As measured by the PCA/IPD Australia Property Index, the market commenced bottoming out in late 2009 and the recovery phase has been initiated. It is apparent at this stage that the pace of the recovery is shaping up to be faster than that experienced in the early 1990s, when a significant overhang of commercial stock dragged out the recovery. The unlisted direct property funds sector is now arguably split into two main segments, in terms of investment opportunities. Firstly, there are those existing open-ended funds that have borne the brunt of the credit crisis and the decline in asset values and are facing a bumpy road to recovery. Some will eventually recover and others will not make it. Opportunities exist, but are relatively few at this point. There will also be a large number of closedend property syndicates due to mature shortly but whether or not these will provide investment opportunities is difficult to determine in advance. Secondly, there is a range of newer funds, launched from mid-2009 onwards - both openended trusts and closed-end syndicates - which

should be able to capitalise on the correction in asset values. However, care will need to be taken with issues such as potentially untested new entities and management groups; cost of financing; and the prospects for individual property markets. Zenith reiterates that investors should be strongly discerning in investment selection, as this is a sector that poses significant threats when structured poorly. But if it’s all done properly, the rewards are certainly worthwhile. The key risks and issues which need to be considered going forward are: • The strength and timeframe of the real estate recovery, which is predicated on broader economic drivers, both domestic and global; • The short- to medium-term financing costs and debt availability for the sector; • The implications of significant amounts of debt refinancing faced by the sector in the next one to two years as a result of short-term rollovers in 2008-2009; • Determination of a prudent use of leverage in a vehicle; and • A realistic assessment of liquidity in openended funds and its implications. While the sector recovery is not without risk, and any investment opportunities must be approached with careful planning and assessment, Zenith believes that the unlisted direct property sector retains merit when participating with strong management, appropriate structures, prudent leverage and quality assets. Despite the inherent qualities and attributes offered by exposure to real estate as an asset class, history continues to teach us that the acquisition of quality assets cannot compensate for poor investment structures or inappropriate decision-making. When enacted prudently and when taking advantage of cyclical opportunities, however, the rewards are well worthwhile.

Dugald Higgins is a senior investment analyst at Zenith Investment Partners www.zenithpartners.com.au

P R O P E RTY

Why property now offers low risk and high potential returns Frank Gelber examines whether we should invest in equity and property markets right now, or wait until the pack moves in

he GFC correction isn’t over. We’ve had the yield correction. Next comes the recovery in incomes; but we need to differentiate between financial equity investment and real investment (construction, equipment et cetera) in capital stock. Real investment needs to be funded, through equity investment and/or debt. That’s why financial investment cycles tend to lead real investment, both in upswing and downturn. But the incomes that drive investment returns rely on the real economy, and they’re driven by demand for and supply of services related to capital stock. Superimposed on that are fluctuations in capital returns (prices or yields associated with inflows and outflows of equity funds). Investment markets, both financial and real, are enormously cyclical, and this cycle was a beauty. The financial engineering boom drove an inflow of debt funding, augmented by increased equity funding which underwrote strong growth in real investment. Real investment is a key driver of the economy. Investment in the financial engineering boom drove strong economic growth and profitability, boosting financial returns (both yields and capital growth) and encouraging more investment and gearing. Over the past 30 years we’ve only seen two major phases of investment. In both episodes, debt played a key role. During the 1980s, aggres-

‘The logic was to generate a cash return, with income greater than interest, and gear it’ sive banks - looking to build their books - forgot about risk. In the last episode, driven by the logic of financial engineering, we were going to make all of our money by structuring product rather than by returns to real investment. The logic of financial engineering was to generate a cash return, with income greater than interest, and gear it up to improve return on equity. The equity analysts were all in on this party and would castigate anyone with the hubris to stick to old-fashioned, low-geared returns, accusing them of having lazy balance sheets. The weight of money associated with the resultant inflow of both debt and equity funds drove yields too low. Markets were overvalued. The GFC triggered a correction in yields, cleaning out the over-valuation. In overseas markets, where the financial

engineering boom held more sway for a longer period, oversupply in some real investment markets caused a more significant downturn -affecting cashflows, compounding the impact on equity prices and causing the banks to write off substantial bad debts. Much of the developed western world had a financial crisis in the banking system. For them, real investment won’t recover until excess capacity created during the boom is absorbed. It’ll be a long, hard haul. Just like it was for Australia in the 1990s. But that didn’t happen in Australia this time. Certainly, in some property markets demand fell in the downturn. But real investment hadn’t time to build into significant oversupply. That’s why we had a downturn, not a recession. Asset values corrected, but didn’t fall enough to cause significant debt write-offs. Incomes weakened in some markets but were unaffected in others. Meanwhile, the GFC pulled the rug out from under new investment, while the blowout in yields meant that increased returns were required to underwrite financial feasibility. Now, incomes will start to recover as the economy continues to strengthen, with demand running ahead of capacity. And that’s the next step. Given low investment, it won’t take long to absorb any excess capacity. So the next upswing isn’t far away. That’s true for property and mining markets and the general business sector.

P R O P E RT Y

Property sales, and prices, will pick up as the economy improves

Meanwhile the financial markets are still recovering from shock. Heightened awareness of risk has caused a flight to secure assets, particularly fixed interest, and a flight away from perceived risky investment. Likewise, debt funding has dried up and is now only tentatively starting to return. Very tentatively! That’s looking at risk through the rear vision mirror. Most of the risk is gone. The correction knocked over-valuation out of the system. Risk is now low, not high. But debt remains risk averse and equity is shy. We think real investment will be slow to recover. The equity investors and debt funding required to finance it will be slow to let go of the purse strings. We’re a lot more cautious now. We won’t see aggressive investment driving growth. Rather, income, underwritten by demand in a recovering economy, will be the first to pick up, thereby driving rising prices. Only later will investors return in force. This is the stage of the cycle when people ask where the money will come from to finance the

I’m not sure of returns over the next one or two quarters. But I’m pretty sure of returns two, three and four years from now, and that’s where my investment horizon lies. It may not please the short-term performance analysts that set the investment agenda. But, to me, it’s a more sensible investment approach. This is the time to get set in undervalued equity investments - not on a short horizon, but to set up returns two to five years from now. It’s not the time to sit on the sidelines avoiding perceived risk. The GFC correction took care of over-valuation. And we’ll need the capital stock as the recovery proceeds - and quite soon in the scheme of things. Not all sectors have the same prospects, but around me I see a world littered with low-risk, high-return equity investment opportunities on a medium-term horizon.

‘I see a world littered with lowrisk, high-return equity investment opportunities’ next round of investment. My stock answer is that there will be no shortage of funding when the financial feasibilities work. And that will require increased returns. What will drive returns? Shortages of stock, that’s what. This is one of those rare times when we know returns have to rise to underwrite financial feasibilities. And, given risk-averse debt and equity markets, we’re unlikely to see premature investment underwriting future returns.

Dr Frank Gelber is director and chief economist of BIS Shrapnel.

P R I VAT E BANKING

Using segmentation to drive service Delivering solutions successfully to clients depends on knowing exactly what clients need, says Alan Shields

rivate banks have endured a significant downturn in revenue during the economic crisis. But when it comes to the question of what to do about it and how to restore revenue growth, agreement is harder to find. After several years of accelerating growth, the economic crisis brought growth in private banking to a sharp stop for most. Assets under management fell precipitously during 2008-09. At the same time, operating costs increased, as clients demanded more advice and firms tried to counter poor portfolio performance with greater levels of service. Research from many sectors shows that placing clients at the centre of the business model pays dividends. While some recent reports have shown that the most profitable wealth managers have the lowest ratios of clients per relationship manager across each wealth segment, this is only part of the story. It is clear that relationship managers need time and space to build relationships and to grow to understand their clients’ (and their clients’ families’) needs, and to identify the best and most profitable ways to serve these needs. But as is often the case, there is a balance to be struck between too little service and too much, which eats into profitability. Client segmentation can be a useful tool to manage both the level and type of service. Traditionally, private banks have segmented their client bases according to assets under management. It is easy to manage and to see which client belongs in which segment, and it is intuitively simple to assign greater levels of service to the wealthier clients who provide more income. But where a large proportion of income comes from fees, it may not be an ideal indicator of revenue. If applied without subtlety, and without a view to potential assets, it can cause relationship managers (RMs) to under-service clients to whom it might be beneficial to give

more time and service - perhaps those with high net worth who have only a proportion of their money with the bank; or those who may be moving quickly up the wealth scale, whether they be high earners, business owners about to sell up, or heirs about to inherit. On the other hand, it can also lead to overservicing if RMs find themselves expected to provide the same levels of service they give to the leader of a wealthy family to other members of the family who may not have such significant assets under management (AUM). The financial crisis underlined the vulnerability of service models that fail to align client value with actual cost-to-serve in a detailed and sensitive way. Recent research shows that leading firms have begun to supplement the simplistic segmentation by AUM with more sophisticated models that use detailed knowledge about clients to provide a more carefully calibrated service model matching revenue to service. While AUM and potential AUM provide part of the picture, much can be learned from banks that have pioneered the use of other forms of segmentation. It is becoming increasingly common to segment and serve on the basis of the source of wealth, assuming that those within each of the groups - such as entrepreneurs, business executives, financial professionals and inheritors - will have similar needs. While this approach makes obvious sense at certain times - for example, when organising meet-and-greets for client groups - it is by no means obvious that simply because two clients share a similar source of wealth they will also share other needs and attitudes. Another approach that’s becoming more popular is to segment and serve based on geographical origin; so we see increasing numbers of teams set up to serve, for example, wealthy

Indians abroad, or indeed the internationallymobile wealthy of any nation. The value of this approach is that it allows private banks to team up their clients with RMs who speak their language - not only literally, but in the sense of a shared culture and shared values and attitudes to wealth. The most sophisticated approach involves gathering information directly from clients and segmenting them according to what they reveal about themselves and their needs. Some of the questions that private banks can ask their clients in order to develop their segmentation models include: • Confidence: How confident are you in your own financial knowledge and skills? And how much advice do you feel you need? • Complexity of needs: How complex do you feel your financial situation and needs are? • Value placed on expertise: What value do you place on expert financial advice and how willing are you to pay for it? • Engagement: How interested are you in wealth? How often do you check on the performance of your investments and what sources of information do you use? The answers to questions such as these when cross-referenced with existing product holdings, value and cost-to-serve information - can help private banks to identify both how much to serve the client and in what ways the clients’ needs can most profitably be met, and provide relationship managers with the tools they need to do the job.

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

PHILANTHROPY

Low flows were so 2009 Greater financial and regulatory certainty have spurred wealthy philanthropists to ramp up their giving programs, writes Simon Mumme

ndrew Thomas and his philanthropic services team at Perpetual were busy for all the right reasons at the end of June. Many of their wealthier clients were either distributing through their charitable trusts, or adding to the corpuses of their philanthropic funds before the end of the financial year. How different the story was just one year ago. “In mid-2010, we are in a much better position than mid-2009, when philanthropy almost stalled because of uncertainty around the guidelines for private ancillary funds [PAFs] and the global financial crisis,” Thomas says. “We now have more economic certainty, and certainty around PAF legislation, so that’s increased philanthropic giving leading up to June 30.” Thomas’s clients were among the many high-net-worth individuals in Australia fuelling a revival in giving after the financial crisis undermined confidence, and the Federal Government’s review of the rules governing PAFs stalled some donors’ plans. The Government mulled over the idea of setting a compulsory annual distribution rate of 15 per cent, which was deemed by many donors to be ultimately counterproductive because it could, over time, erode trusts to nothing. In the end, the Government agreed with the 5 per cent distribution rate recommended by philanthropists. But now philanthropists in Australia are giving in force and maintaining the trend of increased giving seen in the past decade. The volume of tax-deductible donations has increased by 300 per cent in the 10 years to 2007-08, rising from $600 million to $2.35 billion, Thomas says, citing statistics from the Australian Taxation Office (ATO). Wealthier people are leading the way: 63 per cent of people earning more than $1 million each

year make tax-deductible donations, the ATO figures show. In 2007-08, as the financial crisis began to take hold, but before the calamitous fall of Lehman Brothers, their average donation was $102,543 - more than double the $48,548 average in 2006-07. “So while everyone is increasing the amount they give, it is [among] the high-net-worth individuals (HNWIs) where the recent growth in giving has been the highest,” Thomas says. And while men give a larger average donation than women, women give a larger percentage of their taxable income. Thomas says the major driver for this surge in philanthropy is the general willingness of Australians to give, combined with non-profits’ increasing nous in seeking donations, and their ability to explain how funds are used. This gives philanthropists more confidence in the impact of their donations and increases their interest in charities’ work, engendering a closer involvement. Also, more foundation or endowment structures have been developed to suit a wider range of philanthropic aims and, crucially, allow donors to use donations to offset tax liabilities - a feature that clinches the deal for many philanthropists. Before the arrival of prescribed private funds - the predecessors to PAFs - in 2000, philanthropic structures were restricted to estate plans. Contributions to the newer trusts are invested in a tax-free environment and can generate a sustainable stream of distributions that is “far more important than any one lump sum” donation to recipient charities, Thomas says. “The structures are available for people to make a long-term difference - not just for multimillionaires; there are structures for people to give at much lower levels.” Perpetual oversees more than $1 billion in charitable fund assets as a manager and trustee. But besides being a destination for philanthropic

funds, it also runs educational seminars and one-on-one workshops with financial planners to brief them on the subject. “Often organisations will contact us for specialised advice around philanthropy,” Thomas says. “It’s something their clients have a need for, and they might not be experts, and it can give financial advisers the confidence to talk about philanthropy with their clients.” This not only means being able to recommend the most suitable giving strategy for donors, but which organisations they should support. Here planners need to be able to measure the relevance a charity has to their client’s philanthropic aims, and to monitor the effectiveness of the charity’s work. “Accountability is important. If a client is giving away money, what difference is it going to make, and what’s the timeframe around that?” Thomas says advisers’ general level of awareness about giving strategies is definitely growing. “But it’s one of those areas where the more you look at it, the more you understand how deep it is. Some clients have specific needs around who they want to see benefit,” he says.

Simon Mumme is editor of Investment magazine www.investmenttechnology.com.au

T he Final W ord

More than one way to score a goal Late nights watching the World Cup got Dixon thinking about the rules of the game

ne set of rules, but numerous solutions. Some solutions are elegant, and some are highly technical. Some are thoroughly pragmatic, and some seem to be fairly useless. There’s intense scrutiny on the participants. They work out and execute carefully plotted strategies. Everyone’s an expert, especially those who know least about it. At 4.30 in the morning, there seem to be more similarities than I first thought between what we do for a living and the World Cup. In keeping with Final Word’s view that real sport involves engines or balls (or, if you’ve ever seen Mark Webber in action up close, both), and almost never involves snow and lycra, the past month or so has been sheer bliss. Three Formula 1 Grands Prix and a full month of world-class football - does it get much better? As history now records, Spain won the 2010 World Cup, beating the Netherlands 1-0. As a showcase for the game, it left something to be desired. The pressure of a final often stifles the players’ natural flair and creativity, and the best games of the tournament are often played in the earlier rounds. But the tournament overall showed how there is a wide range of possible solutions to a simple goal - in the case of football, overcoming 11 opposition players (or 10 if you’re playing against Australia) to put the ball into the back of the net. It’s a deceptively simple goal, but the philosopher Jean-Paul Sartre is said to have remarked: “In football, everything is complicated by the presence of the opposite team.” (Sartre also said: “Hell is other people” - and I think we can all relate to that, too.) In a broad sense, the World Cup demonstrates how ingenuity and know-how can be applied to produce a wide range of different responses, even though every team is subject to exactly the same rules. The way Spain plays football differs as much from how England plays

Dixon Bainbridge

it (England does still play football, doesn’t it?) as much as it differs from how Ghana plays it; the way Germany plays football differs from how the Netherlands plays it as much as it differs from how Argentina plays it. Competition is a fine incubator of innovation. There’s competition at a World Cup, and there’s competition in business. And even though we do not yet know what the rules for financial planning will finally look like (though we can have an educated guess), I’ll bet you a dollar right now that once the rules have been finalised and legislated, there will be as many solutions as there are planning firms. Well, almost - but you know what I mean. The laws governing football are not meant to prescribe how teams play. They accommodate the strengths of different players, allow for teamwork alongside moments of sublime individual brilliance. They allow teams to adopt different strategies - the best contests are when two teams approach the task in contrasting ways. After the

World Cup final, a lot was made of the fact that Spain has shown the world how to play football “properly”. But a Spain v Spain match would be utterly dreadful. Neither side would ever get near the ball. And the laws governing financial planning are not meant to prescribe in detail how planning businesses work. Different firms will pursue the goal of providing financial advice in different ways, using different techniques, and playing to their own strengths. They’ll define a range and scope of services, and devise innovative ways of charging for them. In both cases, the rules are merely the framework within which players have quite a lot of freedom to move, literally, in football, and figuratively in financial planning. In other words, we have little to fear from the new rules, provided everyone who plays the game is subject to the same rules. In football we wouldn’t countenance one team (not even France) being allowed to use its hands, for example; everyone providing financial advice should also have to play by the same rules. But if that’s the case, we can look forward to a range of innovative and elegant solutions to the question of how to deliver meaningful financial advice to as wide an audience as possible.

Dixon Bainbridge picked a Holland-Spain final in the office tipping comp. He also thought England could beat Germany. You can rub it in, on info@conexusfinancial.com.au

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