The price of advice

By MARK FRYER

Can You get decent investment advice when your adviser has one eye firmly fixed on the commissions he or she stands to earn? Not likely, says a report released this week.

The report, on the investment industry in Britain, says people who tell you what to do with your money should not be able to call themselves "independent" or even use the word "adviser" if they receive commissions from organisations such as fund managers or insurance companies.

Any limitation on commissions would be a terrifying prospect for many New Zealand financial advisers.

Not only do they receive up-front commissions when you invest, in many cases they also get "trail commissions" for as long as you keep your money with a particular manager.

And there are a host of other inducements to sell certain types of investments, such as prizes for reaching sales targets.

All of which raises a question - when an adviser suggests you entrust your money to a particular manager, are they doing so because it's the right decision for you, or the right decision for them?

The British report, commissioned by the Treasury, looked at the "retail" market for medium and long-term investments - things such as unit trusts and some types of insurance policies, sold to individual investors.

While many of its findings apply only to Britain, where the market for such investments is more complex and more regulated than it is here, its recommendations on advisers have some lessons for New Zealand investors, and are particularly timely given that the Government is considering proposals for tighter regulation of advisers in this country.

The British report, headed by Ron Sandler, a former chief executive at Lloyd's of London and chief operating officer of the NatWest Group, says choosing an investment is not the same as choosing a new car, a fridge or any of the other things we spend our money on.

Most of us have very little understanding of how the competing investment products work, we don't buy them very often, it's hard to work out what they cost and the advantages or disadvantages of a particular investment may become apparent only years down the track. That explains why many would-be investors turn to advisers, rather than making their own investment decisions.

Advisers also help the organisations that provide investment products, which face the problem of selling their wares to consumers who don't really understand what is on offer and are often reluctant to save anyway.

The report says the providers concentrate on selling their products to the advisers, rather than to the investors - a situation which sounds very similar to New Zealand.

But because the providers use commissions to encourage advisers to sell their products, there is the danger that investors will be sold unsuitable investments because they are the most profitable for the adviser.

The report says research in Britain has found that differences in commissions do influence the investments that advisers recommend.

And because investors think they are getting "free" advice, there's no incentive for them to demand better or cheaper service.

The traditional answer, it says, has been to make sure that advisers reveal the commissions they are paid.

That is the approach that applies in this country, where anyone can call themselves an "investment adviser", "financial planner" or any other term they want to use, and where the business of giving financial advice is relatively lightly regulated.

The Government is considering recommendations from the Securities Commission which would tighten up the rules while still relying on the idea of disclosure. Under the proposals, advisers would have to reveal any benefits they stand to gain before they give any advice.

The British report goes much further. It says relying on disclosure is an uphill struggle because investors still don't have any choice about the level of commission paid, and the way the information is presented generally makes little difference to them.

The Sandler report says advisers should be able to describe themselves as "independent" only if they don't receive any commissions from the providers of investment products. Even the word "adviser" should be used only by those who meet that definition of independence.

Instead of relying on commissions, it says independent advisers could agree on a fee with the potential investor, either as an hourly charge or a set amount, or a percentage of the amount invested.

At the start of their relationship, an adviser would have to show potential clients a "tariff sheet", setting out their charges for various services.

Commissions would not be banned, but anyone receiving them could not describe themselves as "independent" or as an "adviser".

The organisation which represents Britain's independent financial advisers said the report's recommendations would see many advisers giving up on the business, although some would be able to adapt, reported the London Financial Times.

Commissions are already under fire from Britain's Financial Services Authority - the regulatory authority covering the investment business - which has suggested even tougher rules that would require "independent" advisers to charge by the hour.

If that happened, said the advisers' association, nine out of 10 advisers would not be able to attract enough business because customers would not be willing to pay.

In this country, Phillip Matthews, chief executive of the Financial Planners and Insurance Advisers Association, backs the idea of more disclosure but doesn't like the idea of limiting commissions.

"It's really not necessary to stop advisers receiving commissions, as long as there is full disclosure made to the client of the fact that commissions are received, of any business relationships which might affect those commissions and some sort of idea of the quantum of the commissions," he says.

What matters is that advisers go through a proper process, he argues.

"If there's a commission received as the result of that, that doesn't alter the quality of the advice."

While there is a trend towards advisers charging fees, says Matthews, most still rely on commissions. If they had to rely on up-front charges, some investors would not be prepared to pay.

"The New Zealand investing public are simply not - in large part, anyway - attuned into paying fees for financial advice in that way. Given that we already have a low takeup of professional advice, anything that would reduce it would be unfortunate."

The organisation already advises members to be careful about using terms such as "independent" or "impartial" if they can't back up those claims.

As well as taking aim at commissions, the Sandler report also criticises the way many investors and their advisers go about choosing investments.

It says most investors don't pay enough attention to asset allocation - the decision on how to divide your money among the various classes of investments, which ought to come before you start selecting individual investments.

It also says that, in Britain at least, investors worry too much about short-term performance, don't pay enough attention to the cost of investing and are too likely to choose active investment managers - those who try to pick the best investments - without considering cheaper passive investment strategies.

"Large numbers of retail investors who are not in a position to identify superior managers are nonetheless investing in actively managed funds. This is of concern because the average actively managed fund underperforms the market index after charges," says the report.

It also says that - unlike many of the things we buy - paying more for investment management does not suggest you are likely to get a better quality result. "Consumers who pay more usually receive no additional benefit."

* To contact Personal Finance Editor Mark Fryer write to: Weekend Herald, PO Box 32, Auckland.
Ph: (09) 373-6400 ext 8833. Fax: (09) 373-6423.

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