By BRENT SHEATHER
Much of the discussion on the financial planning and investment advisory industry concentrates on the way advisers are paid for their services rather than the type of service one gets for one's money.
Yet, different firms have very different ideas of what clients want and, it must be noted, varying levels of success too.
Although much of the marketing stresses the pursuit of out-performance, in reality many retail clients will tolerate poor returns for a long time if they feel comfortable with their adviser.
The simplest method of trading is the "execution only" stockbroker, usually internet based, catering to people who think they know what they are doing.
Returns are up to the client, but data and news feeds are usually provided, for confidence-building purposes if nothing else.
This most basic wealth management service appears to have peaked in popularity in 2000 at the top of the technology boom, when one didn't need any help to succeed.
In hindsight, for many customers internet broking turned out to be just a cheaper way to lose their money.
Like the banks, the internet firms discovered that many clients want some contact with other humans, even if they are stockbrokers.
This is a little ironic; for the person who truly knows what they are doing, internet broking is by far the cheapest option as one can put together a truly low-risk, low-cost portfolio, by buying exchange-traded funds.
Fortunately for the advisory industry there aren't too many people who have the knowledge, experience or inclination to manage their affairs this way.
Today, the typical internet trader appears to be a young to middle-aged male with a local market focus and a reasonably short-term trading philosophy; in short, relatively cost conscious and probably not prepared to pay a fee for advice.
A very small step up the food chain is the no fee unit trust warehouse, also internet based, where Mum and Dad can buy managed funds with no advice and no initial fee.
At first glance this savings model looks attractive, until you realise that for most people front-end fees are the tip of the iceberg and the typical unit trust warehouse usually does not stock the managed funds with truly low fees.
One step higher in sophistication is the traditional full-service stockbroker who is transaction based and will, for a brokerage fee of around 1.5 per cent, speculate with your savings on 10 or so local or Australian stocks that he or she thinks have great prospects.
That is probably being a bit harsh; in recent years this sort of strategy has probably been a lot more successful and less risky than more sophisticated and expensive financial planning offerings.
The advantage of this model is that if you have a good broker who really does embrace the basic fundamentals of good financial planning and couples this with a low fee structure and good advice you won't do better, for the price.
Unfortunately, many advisers do not diversify adequately and disasters regularly occur.
This approach can also be abused by those who "churn" clients' investments - trading frequently to generate higher fees.
The irony of this approach is that churning rarely generates as much in revenue as the 1 per cent monitoring fee typical of financial planners; the damage is usually done simply by bad advice and the losses from concentrating on "hot stocks" and floats.
The next, largest and most lucrative segment of the financial advice industry is the full-service financial planner, private banker or stockbroker who has taken a leaf out of the financial planning industry's handbook. One way these firms can often be differentiated is on the basis of their investment philosophy and the extent to which they embrace the efficient market hypothesis (EMH).
The more virulent strain of EMH says that a share price reflects all known information about that stock, so spending vast sums looking for bargains is a waste of money.
At one end of the spectrum is the extremely active financial planning firm which is continually shuffling its deck of fund managers and asset classes, allegedly on the basis of research, but often on the basis of relatively short-term results, fashion and fees.
At the other end of the full-service spectrum is the less aggressive firm which seeks good returns by recommending low-cost, tax-effective index funds in the equity area, perhaps combined with direct investment in local bonds.
In terms of support and service, the top of the line financial planning firm invariably offers a custodial service, portfolio management, and a cash account via a mastertrust structure which handles all administrative requirements and prepares a tax return, all for a total annual fee of 2 or 3 per cent a year, a big hit in a world where most classes of investments will struggle to beat 7 per cent a year.
Performance is usually calculated and relayed to clients through quarterly reports.
In theory, performance reporting allows the client to compare the return generated by his or her adviser with various benchmarks, such as those published in the Herald on a quarterly basis.
A favourite strategy by which the local financial planning industry has generated positive out-performance and effectively offset fees has been to structure investments within an Australian Unit Trust (AUT) which avoided income and capital gains tax.
For investors on a 33 per cent tax rate, the AUT structure has added upwards of 2 per cent a year to investment performance, but that game appears to be all but over with the Government announcing legislation to address the problem.
For more conventional strategies, EMH suggests that it is exceedingly difficult for advisers to consistently add value.
Thus the elimination of the AUT tax advantage, combined with low returns, might make it harder to beat the benchmarks in the future.
With the major bond and share markets looking fully priced and local bank deposits still yielding around 5 per cent, investors will likely become increasingly focused on relative performance in the future. That will present a tough environment for active managers and hedge funds to beat the markets, after fees.
What strategy to choose? Apparently, buckets of cash are flowing into hedge funds while at the same time the world's most successful investor, Warren Buffett, has US$27 billion ($43.5 billion) sitting on deposit.
Choosing which strategy is right will probably be good luck as much as good management, but focusing on the cash income generating capacity of each option and finding an adviser you trust and who has a similar perception of risk as you is probably a good place to start.
* Brent Sheather is a Whakatane investment adviser
By BRENT SHEATHER