Financial services claims misleading

By VANCE ARKINSTALL

Gareth Morgan has made a range of unsupported claims against the financial services industry that are misleading, irresponsible and provide little advice or commentary that might improve investors' knowledge.

Morgan attacks a range of investment and savings options that are broadly described as collective investment vehicles.

Collective vehicles enable investors to pool their savings, which are invested in a range of sectors by a professional fund manager who makes informed decisions with the expertise and research that an individual generally does not have.

Collective investment vehicles give individual investors the benefit of diversification, which reduces the investment risk that a small investor would otherwise find difficult to avoid.

They provide flexibility and convenient avenues for investors, small and large, sophisticated and unsophisticated, to access a wide selection of local and global investment sectors. Morgan's articles do not acknowledge the benefit that customers gain from these features.

Worldwide, collective investment funds have become the investment of choice for millions with combined assets totalling nearly US$7.5 trillion ($11 trillion).

It is right and proper for financial analysts to call the industry to account for the fees and charges contained in its products.

The Investment Savings & Insurance Association encourages good financial analysis to promote various options, educate investors and to keep the product providers and financial advisers on their toes.

Members are not complacent, fees have steadily reduced and our members constantly seek the removal of tax distortions and economies to improve the return and competitive position of their products.

In addition, fees are often negotiable. Competition and transparency continue to force improvements, and suggestions of price gouging cannot be sustained.

Specialist financial advisers provide a wide range of services, including research, product evaluation and comparisons, tax advice, stock selection, portfolio monitoring and reporting, security (custodial services and transactional safeguards, for instance) and selection of an investment strategy tailored to fit the risk preferences of the customer. Again, no recognition is accorded the value of such professional services.

Emotive references to mis-selling practices, uncovered particularly in the US, and the implication that these problems exist here, are grossly misleading.

Regulators in Australia and New Zealand have investigated these matters. Australian regulators say they have found no similar problems. The Securities Commission has yet to react but it is our understanding no problems have been uncovered in New Zealand.

Morgan describes the industry as a cartel, yet there are few barriers to entry when it comes to sources of investment advice.

People commonly seek investment advice informally from family, friends and neighbours. They can read books on the subject and search the web.

They can also seek advice relatively informally from their accountant, lawyer or bank manager. They can seek "free" advice from the suppliers of particular products, including commission salespeople.

To his credit, Morgan concedes that there is nothing wrong with selling on commission. But if consumers want real time from professional people who are not reliant on commissions, they know they will have to pay for it.

Professionals know that people will pay for their services only if those services are superior to those their customers can get in other ways. It is incompetent economics to portray an industry with such few barriers to entry as a cartel.

Not content with one economic fallacy, Morgan also proposes that markets cannot be efficient unless participants have "full" information.

This is obviously nonsense. People can't hope to be experts in everything.

It is competition, not "full" information, that allows customers to obtain value for money.

For example, today people can buy cars with confidence without needing to know much about what goes on behind the dashboard. Motorists and investors can buy on the basis of reputation, word of mouth, expert reviews and past experience.

In the financial services sector, the only barrier to any customer becoming well-informed about the level of fees being charged is a disinclination to read relevant material, ask questions and shop around.

The fees charged by fund managers and financial advisers are readily obtainable and are widely publicised.

Full disclosure is a requirement of the Securities Act. Consumers who are unsure have only to ask their supplier for details. The association urges them to do so.

Morgan's articles rely on a distortion that he creates when introducing his ideal fund based on a passive investment model which he compares with industry active investment products.

This ideal fund earns 70 per cent of its return from capital gains and pays no tax on those capital gains. Morgan's fund pays tax on the 30 per cent of the return earned from income (dividends and interest).

The ideal fund pays no fees for professional services, regular reporting and the cost of the financial adviser who sells the fund. It may be ideal but how realistic is that?

Morgan has failed to let readers know that he is not comparing like with like, or that the industry offers both passive and active investment products which give investors a choice.

The investor can select the preference that best suits his or her risk profile. There is no secret about these issues and no excuse for Gareth Morgan to fudge them in his tables.

It is true that the present tax system favours passive investing and that passive investment reduces transaction costs. The question is whether the investors prefer passive investments over the prospect that active investment will bring superior returns. It is a matter of investor choice.

The tax basis for collective investments under present tax laws is not ideal and the industry has long been calling on governments to remove tax on capital gains.

There are signs that a review commissioned by the Government will bring a more uniform treatment, for the benefit of investors. Morgan is well aware of this.

He also claims that some in the industry are doing customers a disservice by failing to provide information concerning past investment performance.

This information is available from the fund managers, the investor's financial adviser, numerous websites and is published in many newspapers. That is a further benefit of a competitive market.

(But here Morgan is misleading readers by inviting them to infer that past performance is a good indicator of future performance. Research indicates that this is commonly not the case.)

Investors who want to choose fund managers with superior abilities should not rely on past performance. Instead they should question their adviser or fund managers closely about the reasons why they expect to be able to provide a superior performance.

The quality and independence of financial advice are central requirements in the distribution of financial products. For more than a decade, a clear separation between the activities of fund managers and distributors (financial advisers) has been taking place. To suggest otherwise is ignoring the facts.

This industry has for some time been calling for a review of regulation applying to financial intermediaries and welcomes the Government's recent announcement of a taskforce to address this matter.

We strongly believe that consumers are entitled to reliable advice at a reasonable price and with sufficient information to be able to assess whether they are getting value for money.

Increased confidence and trust on the part of consumers is an important outcome that this taskforce will achieve. Again, Morgan gives no recognition to this review.

A fact that has not been made clear is that Morgan is not independent but competes directly with the financial services industry to encourage investors to use and pay for his services.

This compromises his position and offers an explanation as to the lack of balance that has been demonstrated.

Morgan offers, and charges for, portfolio management and financial advice and his interests should have been disclosed.

The interests of mum and dad investors are best-served when fund managers and financial advisers have to compete for their business.

Investors are protected by competition, choice, variety and sound laws prohibiting fraud.

They are also protected by the investments in reputation by professionals, whether acting alone or collectively through organisations such as the Investment Savings and Insurance Association.

Of course, it is not foolproof, but neither is government regulation.

Morgan has had the opportunity to use his articles to raise the quality of debate and understanding about capital markets. He is doing himself and investors a disservice by such unbalanced and sweeping attacks on an entire industry.

* Vance Arkinstall heads the Investment Savings and Insurance Association, which represents fund managers and life insurance companies.