Fast little loans
The best thing that happened for you at the recent assembly hosted by the financial services industry body, the Association for Savings & Investment SA (Asisa), on the country’s savings crisis was that some of the bigger guns in the industry actually started to debate the debilitating effects of costs on your savings.
For many years, government appeals for restraint on costs have simply been given the finger, and costs have continued to escalate, and have become more and more difficult to understand and assess. So it was interesting to see the industry itself raising a few questions about costs.
But don’t get me wrong. Too many in the industry are still putting up strong defences against an aggressive campaign to drive down costs – many of the presentations and remarks at the assembly were a defence of costs. So you, as an investor, must continue to tread carefully and demand full details of all costs and their impact on your savings.
Although any product will have its advantages – such as life assurance endowment polices allowing you to nominate beneficiaries so you can save 3.5 percent plus VAT on executor’s fees and protecting from your creditors the first R50 000 of your payout – these cannot be used to excuse the product’s downsides.
It is the total “value for money” that is important.
The attendees at the Asisa assembly represented the financial services industry (with the notable absence of the banks – which received their usual, probably deserved, lambasting – and the short-term insurance industry – which is increasingly dipping into products that have been the preserve of the life assurance companies – both on the basis that they are not Asisa members), National Treasury, the Financial Services Board and organised labour.
It was quite an achievement for Asisa to get these groupings into one room and talking to each other in more or less civil tones. In fact, more of the scrapping was between members of Asisa than between Asisa members and the other groupings – and there was much focus on costs.
Despite this, there were a number of elephants in the room relating to “value for money” for you that were not discussed (see the article below). These are all issues that the industry knows full well undermine the savings of those who do save and that discourage other people from starting to save.
As long as the industry behaves the way it does, it cannot criticise government for entering the market with far more competitive and transparent products. Nor can the industry bleat about the additional cost of regulation. It has been shown time and again that the additional cost of regulation amounts to far less than the expensive misbehaviour it stops.
If the financial services industry behaved properly and did not try to find ways around the spirit of legislation, there would not be a need constantly to update and strengthen legislation, which comes at a cost to investors. An example is the offshore product designed to side-step tax that Old Mutual provides to the very wealthy, so increasing the tax liability of lesser mortals, which I covered in my column last week.
It is not only a question of what is lawful; it is a question of ethics, morality and sound corporate governance, all of which too many in the financial services industry too often forget, to the detriment of savings.
THE ELEPHANTS IN THE ROOM
The products and practices that add to the cost of saving that the financial services industry should be discussing are:
Life assurance endowment products. Why does the life assurance industry continue to sell these products as they are currently structured to people on low tax brackets, undermining value for money? The problems with endowment products include:
* The upfront cost structures make it virtually impossible to receive a decent return, particularly over the shorter term and now that investment markets are expected to provide lower returns than they have over the past 10 years.
* Life assurance companies pay, on your behalf, income tax annually on any interest, net rental and foreign dividends at a rate of 30 percent, and capital gains tax at an effective rate of 10 percent.
In most cases, this silently increases the tax commitment of many, if not most, policyholders, particularly because you lose out on any potential annual tax exemptions on interest, net rental, foreign dividends and capital gains.
* They are inflexible – once you have signed up, the life company will penalise you if you reduce or stop paying your premiums or if you withdraw your savings, even if your reason for doing so is a financial crisis such as losing your job.
Life assurance retirement annuity funds. They have the same disadvantages as endowment policies, with one exception: they have significant tax exemptions.
Double-charging of asset management fees. A singular cause of high costs are asset management fees, particularly when you are charged twice for the same work. All too often, you are charged an annual management fee as a percentage of your savings. This is already a performance fee, because the better the performance, the more the asset manager will receive in rands. To charge a performance fee on top of this is wrong, particularly when you do not receive an equivalent payback when there is under-performance and when the so-called out-performance is a result of what the market is doing and not the asset manager’s skill.
There was dissension over performance fees at the Association for Savings & Investment SA’s assembly, with the benchmarks used by asset managers and others being questioned. As one speaker put it, anyone can out-perform some of the inappropriate benchmarks set mainly by the industry players.
Another issue raised by industry speakers was why asset management fees are so much higher for products sold to individuals than they are for institutional investors, such as retirement funds. Obviously, bulk is one reason, but the difference still seems to be too great.
The costs of linked-investment services provider (Lisp) administration platforms. The charges for these platforms can be extraordinary, mainly because you are offered the facility to switch between underlying investments, something that very few people need to do and, when they do, they normally switch at the wrong time.
The costs of passive investment products, particularly exchange traded funds (ETFs. Although the costs of passive funds are lower than those of most actively managed funds, they are still above those offered by foreign operators. And if you are using an administration platform that offers ETF investment plans, your costs can more than double, bringing them into line with those at the lower end of actively managed funds.
Commission fee structures, particularly the use of default fees and commissions. These default commissions have been around for a long time in the case of life assurance products, but they have now also quietly snuck up on Lisp platforms, pushing the default commission from 0.5 percent to 0.7 percent a year, without explanation. Someone has yet to explain to me why the default should not be zero, with any further amount subject to negotiation.
It is not that financial advisers are not entitled to be paid, but we should know how much they are being paid, in percentage and rand terms, and what they are being paid for. Are they being paid to flog a product or to provide you with proper advice?
Much was made of research in Australia, where it has been found that people who receive financial advice are better off than those who do not. But that is Australia; there are no properly researched, comparable figures for South Africa. In fact, from what I hear, in South Africa there is not much difference between the returns received by people who make their own investment decisions and those who take advice.
Strange structures set up, mainly by the life assurance companies, to side-step commission regulations and which ultimately increase the overall costs. The structures include:
* Sign-on bonuses and share incentive schemes initiated by Discovery Life, where money and other benefits are paid in order to poach representatives from the sales staff of other companies. Many of these schemes have built-in sales targets, which can perversely encourage mis-selling.
* So-called Netco structures where product providers indirectly give backhanders to financial advice companies by paying money to an associated company (the Netco), ostensibly for administrative functions, most of which the advice company has to provide anyway. These structures are aimed mainly at larger brokerages, such as bank brokers, and can more than double the effective commission received by the advice company.
* Structures aimed at smaller independent brokers. This is a new trend that Personal Finance is still investigating. In simple terms, normally someone who is not involved in the sales process is nominated to receive additional commissions when a company sells a product. So one amount goes to the advice company and another to a spouse or a secretary who is not really involved in giving advice. Personal Finance will let you know more about this practice once we get to the bottom of it and have a list of all the misbehaving companies.
Leon Campher, chief executive of the Association for Savings & Investment SA (Asisa), says: “You make a number of valid points in your column, and, as you heard at the Asisa assembly, the industry is well aware of its shortcomings.
“However, we also maintain that the industry has implemented significant changes in recent years with the aim of improving its offering and service to the consumer. There will always be exceptions, but overall we believe our industry is moving in the right direction as one. In this regard, Asisa feels that in fairness it should also be pointed out that there is a willingness to change and that this is being done through Asisa.
“Asisa is engaging with the Financial Services Board and National Treasury on a regular basis to fix what is wrong, including costs, transparency and treating customers fairly. Many of these work streams are at sensitive stages, prohibiting us from publicly stating how we will fix things.
“Johan van Zyl (Asisa chairman and chief executive of Sanlam) made reference to the 1 800 member representatives that are involved in various Asisa projects. All of the 45 projects mentioned will bring about positive change once finalised and implemented.”