Two weeks ago, we looked at the No 1 reason for inappropriate investment advice in New Zealand and Britain.
The blame goes to the high level of annual fees embedded in the retail financial advisory industry and its effect of causing financial advisers to recommend more risky portfolios better able to sustain this level of fees.
One of the key roles of a financial adviser is to assess the client's risk profile and create an appropriate portfolio. High fees are a fundamental impediment to achieving this.
In Britain and New Zealand, regulatory authorities demand that advisers put their clients' interests first. But their strategies for achieving this aim are markedly different.
This week, we will compare the strategies of the Financial Services Authority (FSA) in Britain and the Financial Markets Authority (FMA) in New Zealand, and speculate about their effectiveness.
In January the head of the FSA called for a radical rethink of consumer protection in the area of investment products, including the introduction of caps on fees and bans on some retail products.
The FSA chairman told the Financial Times that "the way we do things now is not good" and the FSA has recently begun moving to a much more intrusive level of supervision of financial products.
According to the FT the FSA particularly scrutinises products that make lots of money with the intention of making sure that charges are realistic.
In a discussion paper, the FSA says: "We think the starting point for most customers should be a low-charge product and higher-charge products should only be used where the benefits can be shown to outweigh the higher charges."
This initiative, and banning commissions, is a huge step towards giving British retail investors a fair deal.
The FSA is also trying to bring annual fees down to reasonable levels in a roundabout way by forcing advisers to consider in their recommendations to clients low-cost exchange-traded funds that invest passively. The FSA is making advisers choose from the entire universe of products and the onus is on the adviser to justify the advice.
Such funds haven't been popular with British advisers because they don't pay trailing commission and the idea of buying the market with no active management is inconsistent with the marketing strategy of the average financial planning firm, which says "pay me high fees and I will deliver outperformance".
Even the normally critical FT is optimistic about the FSA's changed strategy.
Unfortunately for New Zealand investors, the FMA's proposition for reform is far less intrusive, although it might not feel like that to Bernard Whimp and a few other unfortunates.
The main thrust of new local legislation is that advisers will put clients' interests first on the basis of having completed a one-hour ethics exam, together with the threat that the FMA is going to get tough with bad behaviour, and and the setting up of a disputes resolution scheme.
This scheme is a big step in the right direction. But there are many reasons to be sceptical that there will be much change for the better.
Perhaps the biggest cause for optimism is that many of the worst advisers have been publicly exposed and left town in a hurry and the nastiest products, such as finance company debentures and CDOs, have likewise disappeared into the sunset. But serious impediments to good advice remain:
Many of the advisers - certified financial planners and NZX advisers - who were behind the mis-selling disasters of the past have glided into AFA status with virtually no extra study. The FMA says 30 per cent of the newly qualified AFAs did the ethics exam only. Mr/Mrs Certified Financial Planner, who could have filled his or her clients' boots with finance company debentures, CDOs and Feltex shares, could therefore have earned their certificate with no retraining, just a 30-minute walk-in-the-park ethics exam.
The single biggest determinant of bad advice - the industry-standard high and unrealistic annual fee structure relative to future returns - remains firmly in place. High fees mean high risk asset allocation. Total annual fees average 2 to 3 per cent a year. Ten-year NZ government bonds yield less than 5 per cent. Even with shares, the Global Investment Returns Yearbook estimates returns will exceed that from bonds by only 3 per cent a year. A 3 per cent-a-year fee structure means that government bonds are off the menu and even equity investment offers retail investors the unpalatable combination of the risk of shares with the return of bonds. Neither of these scenarios could be described as "putting clients' interests first".
Commission payments remain a fact of life for many, meaning some advisers are working for a third party. Again, this doesn't sound like putting clients' interests first.
Many stockbroking firms have investment banking and retail arms but, because investment banking has the potential for really big fees, retail advice is often compromised.
Advisers haven't put clients' interests ahead of their own in the past and until "putting clients' interests first" is defined by the FMA and interpreted by the courts, a huge gulf is likely between how advisers interpret the code and how a reasonable person might understand it.
A sceptic might even wonder if the new rules would have stopped the finance company debentures mis-selling debacle. In order for finance company debenture investment to have been unethical advisers could argue that they would have needed to know the entire industry would fail.
The argument continues that retail investors wanted lots of income, which finance company debentures gave - for a short time, anyway - so their needs were met.
But we all know that finance company debentures weren't the right thing to do and, in particular, when combined with equities didn't make a properly diversified portfolio.
Having a properly diversified portfolio would probably be at the top of the list of the FMA's objectives of putting clients' interests first but the British experience shows it didn't happen with light-handed regulation.
However, it is early days for the FMA. It has hired what look to be some good people and the hope is that its bite is worse than its bark.
In terms of progress on the frontline, it is essential that the FMA knows what best practice looks like. Were finance company debentures wrong simply because they went bust? Of course not, they were wrong for three reasons - their weightings in portfolios didn't reflect their weightings within the universe of fixed-interest assets, they were not best practice and, most importantly, they were junk bonds.
To effectively prosecute "putting clients' interests first", the FMA needs to get to grips with what is and what isn't the right thing to do, abolish commissions and ensure annual fees are realistic in light of future returns.
There is a marked lack of high-fee paying products at present but, like Dracula, the intermediation industry needs to feed regularly, so watch for a new wave of high-cost saving solutions coming soon with private equity, commodity, infrastructure and hedge funds all likely suspects.
In the meantime, the industry's response to the end of the finance company debenture bonanza has been to overweight equities and pray for another bull market. That's hardly putting clients' interests first and, with the 10-year US Government bond at around 2 per cent, virtually guaranteeing a recession, probably not good advice either.
* Brent Sheather is an Auckland authorised financial adviser and his adviser/disclosure statement is available on request and free of charge.By Brent Sheather Email Brent