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Advisers 'out of their depths'

Many authorised financial advisers are out of their depths discussing bonds with their clients, industry commentators claim.

Tuesday, November 11th 2014, 6:00AM 7 Comments

by Susan Edmunds

AFA Brent Sheather wrote an opinion piece last week, in which he said many bond portfolios were lower quality than they should be. He said many financial advisers were recommending high yield/high risk bonds that were effectively junk, instead of sticking with lower-risk council, SOE and bank bonds.

Those junk bonds would act like shares at the first sign of trouble, he said, instead of going up when the stock market fell, which was a driver for many people including bonds in their portfolios.

“As is often the case the reasons for bad behaviour can be traced back to fees - if you are charging a 1% monitoring fee and another 0.5%  in platform fees your client isn't going to generate a satisfactory return from low risk bonds yielding 4% to 5%,” he said. “This was the reason behind the popularity of finance company debentures and the same theme continues today with higher risk bonds.”

He told Good Returns that most people were compromised in one way or another. “Typically it’s that they have high fees so they have to buy higher-risk bonds.”

He said there was a lack of practical advice for advisers on how to put together and manage a fixed-interest portfolio. “This isn't altogether surprising because a sensible bond portfolio couldn't sustain a high annual fee structure and few people involved seem to know or care what best practice looks like.”

Michael Naylor, of Massey University, said Sheather was generalising too much. He said advisers who were CFP qualified would resent the way he attacked all AFAs but cited just a few bad cases.

“At the lower end of AFAs, however, my impression is that advice is becoming far worse than even Brent alleges. Aiming for a CFP has stopped becoming de facto – and the unfortunate impact of regulation has meant that many new advisers, especially those bank-based, are settling for level five certification. These advisers are so far out of their depth discussing bonds that it’s scary.”

Naylor said authorisation had given advisers the idea that they could advise on bonds, “when they don’t even know the depths of what they don’t know. These AFAs should certainly stick to saying – ‘put x % in our provider’s KiwiSaver and x% in our provider’s fixed deposit.’  Their main focus should be on client behaviour and creating a savings/ investment plan, via low-cost funds.”

He said Sheather’s point about fees making it hard to recommend low-return bonds was a good reason for advisers to move to set fees.

“As noted in other industry discussions, it would help if the FMA required all NZ funds and platforms to release all fees, including embedded fees.”

You can read Naylor’s full response in the blog section.

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Comments from our readers

On 11 November 2014 at 6:20 am Pragmatic said:
Unfortunately I tend to agree with Brent's observations

From what I have seen, there is a significant-enough number of advisors who have exposures to higher yielding bonds (both directly & indirectly) without fully understanding what the default rates can do in times of change
On 11 November 2014 at 7:47 am John Milner said:
I've discussed the issue of higher education with a bank adviser. Rather than him being happy to settle for AFA status, it's actually a case of the bank no longer being prepared to support their advisers in achieving CFP. To be fair, nobody supported us non bank staff. That didn't stop us.
On 11 November 2014 at 10:56 am alan clarke said:
Bonds have gotten more and more complex

Now more complex than shares ??

especially with the new offers and all the complex clauses written by lawyers protecting the borrower - see recent ASB issue for an example

Joe Blogs and most AFA's would not have the resources to get inside them

DFA offshore at 30 BP and AMP and Harbour at 40 to 50 bp look like good value to me

Diversification and liquidity is excellent and NZ$ hedging taken care of too

Why would I want the headaches of buying bonds direct ?

I only have so many hours in my day (regulators please note)

I feel I can do far more good working with my clients than trying to be a fund manager

Having said that, there are some fund managers I trust but sadly a lot that I don't
On 12 November 2014 at 9:39 am investing said:
alan - unfortunatly as an invester than relies heavily on the "advisory" industry that is exactly what i am paying for, working with me to manage my funds, so i guess that makes you co-manager off my funds working WITH me and giving me advice from the best availible information to enable me to generate the best possible return.
On 12 November 2014 at 1:30 pm R1 said:
I had a prospective client (80 year old couple) recently come to me with large nominal value of perpetual, annual reset, bank bonds in their portfolio (approx. 25% of portfolio) which they thought were term deposits. According to the couple the bank had 'sold' them as term deposits and I have no reason to believe otherwise. They were experienced share owners but not so for bonds.
On 13 November 2014 at 1:38 pm Pragmatic said:
Thank you for your comments "investing". It's refreshing to hear from an actual investor....

Sometimes it seems that the nz financial services industry makes a statement that appears to be completely devoid of client (investor) expectations

My impression is that clients are prepared to pay their advisors for delivering a service beyond what they're able (or willing) to do themselves. For this, this advisor charges a fee / recieves a commission (personally I don't care about the form of payment as long as it's fully disclosed to enable the investor to make an informed buying decision)

All due respect to Alan (any many others like him) who discharge their responsibilities by deferring these to a fund manager. In order for an advisor to earn their fee, they should have a view, and above all else be aware of what the underlying investment (direct or via a fund manager) is doing to support this view.

Whilst I'm not a believer of a passive approach to markets (after all - this is something that most investors can do direct, without the need to pay an advisor any ongoing fees) I accept that this is a "view" of sorts.

I would encourage advisors to develop a keen awareness of various sectors (and in particular the hybrid / corporate debt sector) to understand the risks that a market drawdown will present to a portfolio. The "fund manager does this" or "hold to maturity" rhetoric isn't really adding value to clients portfolios
On 14 November 2014 at 12:47 pm alan clarke said:
to “Investing” – it’s not just about the best possible return - it is about doing well in good times BUT also about surviving in bad times e.g. 2009

When it comes to bonds, the big borrowers have an army of lawyers writing the terms and guess who they favour – not the mum-and- dad investors.

Hence mum and dad (or me) must hire an army of lawyers to protect our money – just not realistic – paying 30 to 50 bp for DFA or AMP or Harbour makes a lot more sense – they have the lawyers – and the analysts - so we use them – and the combined diversification is over 12 countries and over 500+ bonds - and they are always liquid - and NZ$ hedged if we want it - another consideration we discuss with clients - I think this sort of advice is worth a few bp

And many financial advisers just don't work in the investment space - some of us do a lot of work with clients looking at retirement planning, can I afford to stop work yet, can I afford to lend money to my children, how long will my money last, can I afford a bigger house, should I downsize, retirement village one way traps, do I need a family trust etc etc etc – read my “26 years at the coal face” 2nd book to see how far and wide our advice goes

to Pragmatic - I have been 26 years in this industry - the first 18 trying to get a decent result from active investment – but only ever got mediocre !!

For the past 8 years I have used asset class and DFA - all I can say is I wish I had found them 26 years sooner

We all know (and dozens of stats confirm) that about 80% of active managers underperform the index - that includes fund managers, active advisers, DIY investors , and share brokers.

The 20% who do outperform are rarely, if ever, from the top 20% last year.

If there was someone who could consistently outperform, they would have everyone’s money - mine too - but I have not met them yet

And there is another way in between passive and active - it is very low cost and sophisticated - but still no stock picking or forecasting – that is the method I use

But to each his own – if you are doing a good job, that’s all that matters

NB todays headlines - “AMP considering going less active / passive ”- is no surprise to me

Perhaps they have learned what I did over my first 18 years in this industry

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