Far from me to sit on my porch playing the fiddle, while watching the business district i live in being burned to the ground.
That once-magnificent newspaper, the Australian Financial Review, yesterday headlined the changes in the financial industry as some institutions move to drop commissions from their products. All very laudable steps. Follow the directions to page 20 (AFR 18th May 2010) and there is comment on the issue of bias and commissions. Unfortunately, more repitition of the same theme – that this will result in lower fees and less biased (and therefore more appropriate) advice. As Shrek says, “what a load of…”.
I will categorically state that this will NOT lead to a reduction in fees. It will lead to an increase in costs. People can argue as much as they like about the distribution of that total cost but it WILL result in a higher overall cost of advice.
If you are a client of Wealth & Security Planners, feel free to simply pass this on to your friends and contacts – because you know that we have always adopted a very open approach to our fees and costs, and continue to believe that the individual should be free to choose how they pay for our services. Some clients pay hourly rates, others pay fixed rates and still others pay variable amounts based on funds under advice.
Here is the logic that is behind my rhetoric… IF you get the time to read this then it will leave you scratching your head and asking yourself “why are people pushing for these changes…?” Although imbued with a great respect for the nobleness of society as a whole, i am forever reminded of the phrase from Nietzsche “Human, all too human”.
The AFR article suggests that the price of managed funds will fall by the amount of the trail commission. I’d suggest that is wishful thinking. I am going to prove to you in figures below that the total costs to investors is going to increase under the proposed arrangements. Providing advice is simply an expensive exercise, and adviser costs are not just for advice. Over the years product providers have migrated more and more of their administration and distribution costs to planners. For example, printing out of documents, distribution of information and materials, collection of responses and much more. This all has a measurable cost. Being able to pass on that cost allows institutions to keep their costs low and most importantly, variable. Some will keep more profit for themselves and others will not. This will change over time and is just one version of selection that planners use to help filter products that they will or will not recommend. Even if the product costs fall, the cost of advice will rise. The only alternative is that the advice will become MORE biased through the application of excessive filtering of “approved products” in an endeavour to keep the cost of providing advice as low as possible.
Let’s move on to a concrete example…
APRA is a regulating Government body that looks after aspects of superannuation compliance and reporting. Among many publications is a quarterly report on the position of major superannuation funds (200 of the largest funds). How about we apply some of this lynch-mob logic to some of the figures in that report? I have simply selected two funds – the Colonial First State First Choice fund (we’ll use CFSFC), and the REST industry fund. As usual keep in mind that i am making no recommendation in any way for or against either of these funds, i just needed to pick two and these are the two that i chose. The CFS fund because it is a very competitively priced model and the REST fund was a purely random choice.
The tables suggest CFSFC has 529,195 members. Total operating costs are shown as $233,850,000. Cashflow adjusted net assets are shown as $31,182,621,000. That works out at 0.75% of assets.
The same tables suggest REST has 1,965,511 members. Total operating costs are shown as $90,454,000. Total investment costs are $56,206,000. Cashflow adjusted net assets are $15,163,368,000. That means operating costs work out at 0.597%. Investment expenses work out at 0.371% giving total operating and investment costs of 0.968%.
The tables aren’t all that clear in some respects. My assumption from the above figures is that CFSFC figures do NOT include the cost of investment. So… let’s assume that CFSFC “give in” on investment and use the same asset consultants and process as the REST fund and therefore obtain that investment process at 0.371%… This would mean that CFSFC’s total operating and investment costs come out at 1.121%.
The difference between the two in this scenario? 0.153%…. In terms of total return and cost variables, this would verge on “statistically immaterial” in terms of differentiating between the funds.
Now let’s move on to assume that the entire REST fund is operated by some band of advisers on a fee of 0.5% of assets per annum. Remember, this is the grossly unfair, inefficient and very bad way of charging, according to lynch-mob logic. Total cost to the fund would be $75,816,850. If it were to be 1% then the total cost would move to $151,633,680.
Let’s assume that each member of the fund will need one hour of professional advice in a given year. That’s not unreasonable, as even those that go for a number of years with no advice, will encounter large bills when they eventually do. So i am going to averge it out as one hour for the year. If we use the Industry Funds advice group reported fee of $220 per hour, what do you think that would add up to? Take a guess…
That’s equal to around 2.85% of the fund assets. Massively more expensive than anyone is going to tell you it will be.
Now i am going to provide the benefit of the doubt to the position, and assume that the REST fund is beset by double accounts, and other inefficiencies that derive from a large percentage of casual, temporary members. i’ll reduce the number of actual members to a smaller figure. Let’s say it is 1/4 of the stated figure. It still comes out at $108,103,105. In other words, about the middle range of the cost of advice were in the form of trailing commissions. As a by-the-by, the total number of members of these top 200 funds being reported on is 30,281,741. Bureau of Statistics figures tell us that there are 10,991,900 persons in employment in Australia currently. This is one of the clearest examples of why the default fund for every person in Australia should be a single government operated fund that is invested in a cash or government guaranteed option. Anyone that wants to go anywhere else has to obtain advice. This would reduce operating costs, take away inefficiencies and remove low balance accounts from the private system, dramatically improving product delivery costing models. Feel free to argue that one with me anyday.
My figures could be incorrect for any number of reasons. You could argue the asset basis, efficiency targets, member numbers or anything else you want. However, the core principles will remain the same. The only way that costs will be brought down is by lowering the level of advice provided. Down to call-centre or internet Do-It-Yourself process levels. This will be achieved by increasing bias.
The lynch-mob aren’t going to listen to my calls for rational thought. But i am hoping that you will. Please send this note on to as many people as you can. i don’t have a massive marketing budget or a bucket of other people’s money to fund my contribution to this ideologically charged debate, so your voluntary help would be much appreciated. This “compare the pair” rubbish should NOT be allowed to continue. It is wrong, even if pushed for the right reasons.
A genuine attempt to act in members’ best interests would not be leading the current lynch mob.
If i am beginning to sound angry on this issue then take it for a fact that i am.