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What’s the point of independent advisers?

This month John Berry from Pathfinder asks what exactly is the point of independent financial advisers?  Should small independent firms still exist or are they a relic from the past? Should all advisers be tied to a single provider? If independents have an important part to play in NZ financial services, what exactly is that role?

Monday, September 1st 2014, 6:00AM 5 Comments

by Pathfinder Asset Management

So what is the point of independent advisers? This question was thrown to me in a three way discussion with an executive at a large fund manager and a legal/regulatory expert. Their views can be paraphrased as follows:

“Small independent advisers will not exist in the future.  They tell investors they review all available product and choose the best, but don’t have the resource to do that – that misleads investors.  Every adviser should be tied to one provider so investors know exactly what they are getting.  That is the future of advice.”

Have we really moved on from the need for independent advisers?  If not, what is their function in the market?

First place to start is to define what we mean by “independent” advisers.  To me this means non-aligned – they are free to choose any product provider.  They have no quotas, targets or business arrangements that sway them towards a particular provider.  They can continually look at what is available in the market and choose what they see as best for their clients.  This article focuses on small independent adviser businesses but we also need to acknowledge there are many larger firms that can be called independent.

The benefits of independents
Here’s how I see it.  In general, small independent operators are nimble and focused on their investor relationships.  But more than that, their business model enhances the investment landscape by avoiding conflicts of interest and offering real choice.  Some larger institutions do tick these boxes – but many larger or tied firms don’t tick them all.  Let’s look at each of these in turn:

  • Nimble: Small independent advisers can consider and react to new ideas. They are not bound by layers of committees which can lead to inertia. 
  • Customer focused:  Small advisers are intensely loyal to clients and typically have long and deep relationships.  Advisers make great efforts to retain their client base as their clients are hard-earned.  Independents also provide a level of staffing continuity that can be harder to find in large firms.  
  • Avoiding conflicts of interest:  When advisers are paid commissions or have sales quotas there is a conflict of interest when providing advice.  Whether quotas / commissions actually influence behaviour is not the point - the point is whether a perception of possible conflict exists.  The same conflict exists if an adviser business is also a manufacturer of fund product or if an adviser business pays its staff bonuses linked to new product sales. By contrast these conflicts of interest do not exist if an adviser is not tied to a product manufacturer and does not accept commissions - they can choose what they see as the best of breed product.  A provider of a wide range of in-house funds cannot sensibly regard all their offering as best of breed (if this were the case then the market would only need one provider!)
  • Offer real choice:  Not everyone wants product dominated by a single large provider.  A local delicatessen or grocer often provides better quality product, better service and a better experience than your local supermarket.  There may not even be a price difference.  Small independent advisers can be similar to the delicatessen by offering a unique or bespoke service.  More choice for investors is good – particularly where small independents can be flexible and avoid a “one size fits all” approach. 

Do independents have shortcomings?
The New Zealand economy relies heavily on SMEs.  Financial services are no exception with small adviser businesses being an important component of the industry.  But with any business model, there can be shortcomings.  These may not necessarily arise from the adviser being independent, but rather from the fact that they are likely to be a small business. In other words, regardless of adviser type (tied or independent adviser), small businesses may well share the same problems, such as:

Depth of pockets:  When things do go wrong, large players have deeper pockets to put it right.  Although not always willing larger firms can write a cheque (think Credit Sails and DYF).  On the other hand, an errant small independent adviser may not have the resources to do this.  The first line of defence (before relying on the depth of pockets) is to have effective regulatory oversight such as rules protecting client assets and rules stopping “unsuitable” individuals becoming advisers in the first place. 

Economies of scale:  Increased regulatory oversight is a good thing for confidence in NZ markets – but it comes at a cost for financial businesses.  While large corporates can achieve cost efficiencies through scale, smaller advisors face a comparatively heavier burden.  In fact from what we have seen compliance has the potential to overwhelm an under-resourced independent – for many small businesses regulation is fast becoming a case of “death by a thousand cuts”. 

Research and training resources:  Small advisers are unlikely to have the depth of internal research or training that large players do.  Research is, however, something that can to some extent be outsourced.  The PIA (Professional Investment Associates) network of independently owned and operated firms is a fine example of collaboration by independents – this now comprises 10 non-aligned advisory firms through the country.  The group has achieved synergies by developing common compliance processes and an independent research process.  In the new world every adviser business whether large or small, independent or tied, must have a research process that is objective, defensible, robust and (most importantly) applied in practice.

Final thoughts – independents are important
Financial markets would be less dynamic and offer investors less choice if all adviser businesses were either large firms or small aligned firms tied to one product provider.  Small and independent locally owned adviser businesses make an important contribution to our industry. 

One fact illustrates that industry participants know investors like independent advisers.  It is this – more often than not on the website of a tied adviser it can be hard to find references to them using only one main product provider.  If they are “tied” why not advertise it prominently and proudly….? 

In summary, size is no indicator of quality.  While Mitre 10 Mega take the view “big is good,” when it comes to financial advisers small can be even better.  

John Berry
Executive Director
Pathfinder Asset Management Limited

Pathfinder is a fund manager and does not give financial advice. Seek professional investment and tax advice before making investment decisions.

Pathfinder is an independent boutique fund manager based in Auckland. We value transparency, social responsibility and aligning interests with our investors. We are also advocates of reducing the complexity of investment products for NZ investors. www.pfam.co.nz

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Comments from our readers

On 1 September 2014 at 9:29 am btw said:
Great article. Is one of the problems also that the providers (banks/insurance companies/fund managers etc) don't offer clients of independent advisors cheaper rates (they should be discounted by the amount of commission paid to other advisors)? The independents need to start lobbying for that. FMA should intervene and be setting industry standards on this.
On 1 September 2014 at 9:32 am Brent Sheather said:
Good work from Mr Berry. The “views paraphrased from the large fund manager” are ridiculous and if these views are widely held offer some hope to independent advisors. Contrary to the “views paraphrased” the future of the advice, if we look at the UK experience, is that the regulator compels all advisors to review the entire universe of products and choose the best one. Anything else is breaking the law. What this has meant in practice is that advisors are compelled to consider low cost products ie investment trusts and ETFs. This is the reason UK investment trusts are trading at the narrowest discount that they have for many years.

The word independent may require a change in strategy from some advisors to maximise the advantages that independence offers. This means no commission and no acceptance of incentives from fund managers. It also probably means lower margins from existing clients but this will eventually be offset by economies of scale.

There is another less obvious but hugely significant disadvantage from being independent. Because all the big banks are not independent and because the regulatory people frequently move from the regulator to the banks and back again possibly via the government, regulation has tended to favour the big players. Whether this is intended or not facts are facts and any major move to attack the likes of Westpac, ANZ or whatever would severely curtail an FMA executives future career prospects. It is also a worry that many people in government and in the FMA have an investment banking background. Most people acknowledge that investment bankers are not retail investors friends.
Regards
Brent Sheather

On 2 September 2014 at 8:52 am Wayne Ross said:
John thanks for the observations. You have highlighted a few of the reasons why we will remain independent advisers but there are many more. However I wonder if the real question we should be asking is what is the point of advice. It seems to me that the real issue for our industry is the majority of investors currently prefer to get advice from anyone BUT an adviser, regardless of whether they are tied or independent.

Unfortunately discussions like this invariably end up focusing on product sales and delivery rather than the real issue which is quality advice. There is nothing stopping institutions delivering best of breed product right now or independents using poor products. The same goes for both good and bad advice.

Maybe its time for all industry participants, including the regulators, to acknowledge that advice is a continuum, different clients require different solutions and there is a place for all advice forms and firms.
On 2 September 2014 at 5:24 pm John Body said:
I agree with John’s view that independent financial advisers have a key role to play in the market. At ANZ we fully support and encourage greater access to trusted financial advice for New Zealanders and believe that independent financial advisers will continue to be a critical channel for this.

We know that New Zealanders seek advice in different ways and this has and will continue to change over time. Many will go with their major bank, some will look at aligned advisory firms, some for DIY digital solutions and some will look for independent advice. All have a role to play and the crucial thing for our industry is to be able to provide trusted options for New Zealanders to get good advice and solutions at a price consumers will pay and in a transparent manner.

As a manufacturer we will continue to support the independent advisers by providing consistently performing funds with competitive fee structures, full transparency around fees, high quality concise and effective documents and rollout of digital tools to help advisers and customers. Independent rating of funds and access to comparable performance data will continue to assist advisers in assessing solutions to their customers.

As an employer of over 100 AFAs we see the provision of quality advice as critical to the success of New Zealander’s financial well-being. Quality risk profiling, appropriate asset allocation and selection and the on-going monitoring of performance and customer appropriateness are all critical. We set a very high benchmark internally for quality and believe we can help make a difference in how New Zealand views the advice profession.

With over 2m New Zealanders now invested in managed funds through KiwiSaver and a growing understanding of the importance of retirement planning I strongly believe there is a place for independents in the industry. We all need to focus on how we get more New Zealanders to access quality advice to ensure more comfortable retirement outcomes.

Regards
John Body
On 11 September 2014 at 4:22 pm Alistair Bean said:
Nice to see the reintroduction (and acceptance ??) of the term Independent - Alistair Bean, Independent, Authorised Financial Adviser...

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