Advisers move away from commissions

Financial planners are moving into a role of being a trusted fiduciary who will help you to make informed decisions and to get what you expect out of financial products, the annual convention of the Financial Planning Institute (FPI) heard this week.

A fiduciary is someone who prudently takes care of money for another person.

The convention also heard that the days of financial planners earning commission for their services are nearing an end and you will have to pay a fee for the professional services your adviser performs.

In addition, the convention heard that advisers should be playing the role of your financial coach rather than attempting to select the best performing fund manager for you.

Financial planners who attain one of the highest qualifications an adviser can achieve, namely the Certified Financial Planner qualification, belong to the FPI and subscribe to its code of ethics.

Gerhardt Meyer, a member of the international Financial Planning Standards Board Regulatory Advisory Panel and the executive head of strategy at financial planning company acsis, told the convention that, based on discussion documents released by National Treasury and regulation that has been introduced in other countries, he expects South Africa will ban brokers and advisers from earning commission on investment products sold to you if you are in the middle- to upper-income bands.

Instead you will have to remunerate your financial adviser for his or her services by paying a professional fee.

Meyer says Treasury is aware that it will not be easy or even possible to scrap commission earned on financial products sold to low-income earners because they do not have the means to pay the fees.

Large upfront commissions on risk products will definitely be banned too in due course, Meyer says.

Phil Billingham is director of the Institute of Financial Planning in the United Kingdom, a member of the international Financial Planning Standards Board’s Regulatory Advisory Panel, and an expert in the Treating Customers Fairly (TCF) legislation that was implemented in the UK. TCF legislation, which will oblige financial product providers, intermediaries and advisers to threat you fairly, is also due to be implemented in South Africa.

Billingham says that to comply with TCF legislation in the UK, biases in remuneration paid to advisers have had to be removed and standard commission has been introduced on all products.

Around the world commission is seen a barrier to fairness, and regulators are taking action, Billingham says.

He says the commission system generates distrust, even when advisers feel they have disclosed to you what they will fully earn.

Consumers do not understand why advisers still win by earning commission when their investments fall.

In the UK, financial advisers have moved to charging fees and informing clients that they should rather pay fees because their financial advisers’ services are worth it, he says.

Financial advisers are increasingly separating the services they offer – the design of a financial plan, the implementation of a financial plan, and the regular review of a financial plan, he says.

In addition, Billingham says, financial advisers are increasingly classifying their clients and offering the clear indications of services each kind of client will be offered in accordance with the fees they can afford to pay.

Meyer says while some countries have tried to legislate what a financial planner is and to distinguish these professionals from brokers and other intermediaries, he believes professional financial planners will continue to be identified by the value they offer and the higher standards to which they voluntarily subscribe.

Meyer says he does not think South Africa will get involved in “the silly debate” about whether an adviser is independent or not, because while it may be possible to determine which advisers are not linked to a product provider, it may not be possible to define how many products an adviser must provide to qualify as independent.

Meyer says financial advisers who belong to the FPI need to show regulators that they have principles and voluntarily adhere to high standards.

Billingham says TCF will have six outcomes that will affect the way in which your adviser relates to you:

1. It will ensure that you can be confident you are dealing with a company where TCF is central to the corporate culture.

2. It will ensure that products are designed to meet the needs of a specified group of consumers and are targeted at that group. Your financial adviser will be able to advise you when a product has been designed to meet needs other than your own and to steer you to the correct products.

3. It will ensure that product providers give you clear information about their financial products and keep you appropriately informed before, during and after the sale of a product.

4. It will ensure that product providers and your financial adviser give you suitable advice that fits your circumstances. Billingham cites a case of a product that did not suit the investors to which it was sold: Barclays in the UK sold a share investment to investors who could not afford huge losses but who subsequently lost 40 percent of their investments.

5. TCF legislation will ensure that you will have to be provided with products that perform as you have been led to expect them to.

6. TCF should ensure that you do not face any barriers when you want to change a product, switch providers, submit a claim or lay a complaint.

Billingham says the reason TCF was adopted in the UK was because existing legislation had resulted in some financial services providers complying with the law but nevertheless providing some “shocking” advice. In addition, he says, regulators realised that many consumers were being treated unfairly but not complaining and too many complaints were going to the ombud for financial services and being upheld.

The days of selling consumers financial products with the “buyer beware” warning are over, Billingham says, because it is up to your adviser to make sure the products are suitable.

But your adviser should also not be patronising by not explaining anything to you. Rather, he or she should see the world through your eyes and work with you to choose suitable products and services that are designed to be fair to you.

In this way the adviser becomes your trusted fiduciary, looking after your best interests.

Advisers will have to sharpen up the checks (due diligence) they do on products, not only to justify a sale but to ensure that they do not recommend to you any toxic products that end up harming your financial well-being, Billingham says.

What your adviser rejects as unsuitable for you will in the end determine the quality of the products recommended to you.

More attention must be paid to investment costs

Financial advisers will in future have to pay more attention to the cost of financial products, particularly investments, they recommend to you, the annual convention of the Financial Planning Institute (FPI) heard this week.

When the proposed Treating Customers Fairly (TCF) legislation is introduced, advisers will have to take much greater account of the costs of any products they recommend to you because costs degrade returns and many costs are not transparent and not fully disclosed, Phil Billingham, an expert in the TCF legislation that was implemented in the UK, says.

Billingham also says financial advisers are underpaid, and product providers will have to give up some of the costs they earn to ensure that advisers, as the ones who take all the risk, are properly remunerated.

Gerhardt Meyer, a member of the international Financial Planning Standards Board Regulatory Advisory Panel and the head of strategy at acsis, says under the proposed TCF legislation, advisers will have to consider whether it is fair to charge fees based on your assets under management rather than have set fees for a service or for the hours of work involved.

Anne Cabot-Alletzhauser, head of the Alexander Forbes Research Institute, says if you are investing for the long term, costs do matter.

Candice Paine, the head of retail at Sanlam Investment Management, says it is now possible to bring down the costs of investment by using smart beta products. These investments do not slavishly track an index based on the weighting of shares in the market, but rather reconstruct indices so that they deliver returns that are uncorrelated with the market and suffer less of the obvious pitfalls of the market-cap-weighted indices.

Gavin Wood, the chief investment officer of Kagiso Asset Management, says that to beat inflation you must be exposed to equities, and while the average fund manager does not outperform its benchmark after fees, there are a number of fund managers that consistently outperform their benchmarks. These managers, he says, are typically those who invest by making use of the valuations of shares or other assets.

The valuation of a share is its price relative to its expected earnings.

Wood says fund managers who consistently provide good performance above the benchmark and in excess of their fees are those who buy and hold shares when prices are low and who sell or avoid shares when their valuations are high.

Wood says a good financial planner should allow your fund manager to do this and not get fearful or let you get fearful and leave the market when it is performing badly. This is the time a valuation-based fund manager with conviction needs to be buying shares, he says.

Wood says many exchange traded funds that track indices based on market capitalisation do exactly the opposite of a valuation-based fund manager and buy into shares when the prices are high and sell when they are low.

This is because a share’s price affects its market capitalisation and hence its weighting in an index based on market capitalisation.

Passive investments that track indices based on the market capitalisation of shares or other securities can therefore be dangerous, he says.

Wood also says that the days of high fixed fees for asset management are over because the low-inflation environment in which returns will be lower will expose these high fees.

Well-structured performance fees are a way to ensure a fund manager is rewarded only for out-performing a benchmark, Wood says.

Warren Ingram, an independent financial planner and the 2011 Financial Planner of the Year, says he has negotiated with product providers to get investments for his clients at very low fees, ranging from 0.5 percent to 0.75 percent a year.

He charges professional fees for his services that amount to more than the product providers earn, he says, but these fees are transparent and are deducted from clients’ investments on a monthly basis.

Ingram says his fees are based on the work involved in servicing you and are capped and not based on assets under management.

Don’t see your financial adviser as an investment guru

You should not regard your financial adviser as a person who can pick the best fund manager for you but rather someone who can coach you to achieve your investment goals, the Financial Planning Institute’s conference heard this week.

Anne Cabot-Alletzhauser, who heads the Alexander Forbes Research Institute after many years in the asset management industry, says the problem with identifying skillful managers is that there is absolutely no basis for knowing whether their specific skills will be rewarded by the market in the future.

She says financial advisers wrongly believe they can be good investors for you, but their biggest service should be being your financial coach.

Cabot-Alletzhauser says in South Africa there is a cult following active fund management.

But one day one manager is the top performer and the next day another manager is the top performer, and typically advisers and investors focus on very short performance track records, she says.

You may wait 10 years to establish that a fund manager is a consistently good performer only to find that it has grown so big that it is no longer able to produce top performance, she says.

Rather than trying to choose the top performing fund manager for you, your financial adviser should keep you invested, help you handle your debts and advise you when to put the foot on the spending pedal and when to take it off, she says.

Cabot-Alletzhauser says investing is easy because it is about managing risk at a reasonable fee, about getting your asset allocation right and staying in for the long term.

Warren Ingram, an independent financial planner and winner of last year’s Financial Planner of the Year award, told the conference that a professional financial adviser can add value for you by helping you to stick to your long-term goals,

Getting you to invest and stay invested is the heart and soul of financial planning, Ingram says.

What a great financial planner does, he says, is help you to be comfortable with your investment decisions, to not get stressed and to save you from making bad decisions.

Gerhardt Meyer, a member of the international Financial Planning Standards Board Regulatory Advisory Panel and the head of strategy at financial planning company acsis, says advisers will in future have to offer you a value proposition that is not simplistically related to investment returns only, but is related to understanding and meeting your financial needs holistically.

Phil Billingham, an expert in the Treating Customers Fairly legislation that was implemented in the UK, says that when it comes to treating you fairly, advisers should not promise you that you will never lose money on your investment or that you will always be ahead of the market.

Instead, an adviser should be regarded as having treated you fairly if the product or investment into which you have bought behaves as you were led to expect it would.

Billingham says when advisers consider risk they will not be able to just point out to you the volatility of an investment product but will have to engage you and ensure you understand the level of risk involved.

Billingham says that to introduce fairness, advisers will also have to educate you about the possible outcomes of investing in a particular product – for example, that your capital could be eroded very quickly.

Kim Potgieter, a financial planner at Chartered Wealth Solutions with a fascination for the relationship between psychology and money, says your financial adviser should not always be focused only on the returns you can earn from your money.

At times, an adviser may also need to consider the returns you expect from your life and the role your money should play in achieving your goals.

She says a good financial planner should connect with you and should develop a plan for you that resonates with you so that you will be motivated to stick to it.