This industry is about the creation of wealth, the trust industry and the retirement dignity of fellow Australians.
So let's start with two simple survey questions.
Question 1: Is the wealth management industry transparent, honest and focused on the end customers' best interest?
We know the answer should be yes, after all we have governing industry bodies and regulators that provide guiding statements that are enshrined in our principles.
Question 2: When a client asks who gets what out of the money they invest through a platform (service or product), is it clear and simple to answer?
After more than 25 years in the industry and having run a platform business, co-managed a funds management business and managed a dealership I couldn't answer the second question with any confidence. Why is this so and is it possible to rectify quickly and easily without industry fallout?
Who gets what out of the value chain depends on a variety of circumstances as one would expect in any commercial environment - but notwithstanding this, it is apparent we have some way to go as an industry before we can trumpet transparency and integrity. Let's examine what this means and some of the options.
One way to move forward is to acknowledge and embrace the areas that create the most value for end clients and work backwards from there to see where change is needed for improvement.
There are three primary partners in the wealth management industry. Let's call them the three As - advice, asset management and administration.
If we were to prioritise which is the primary function and which should be rewarded accordingly, I believe the answer should be advice first, asset management second and administration third.
Now sit and look at the Australian wealth management industry and see what we get in terms of who sits where in the value chain.
The outcome is a by-product of history, but frankly it's all back to front in Australia.
Administration (platforms) is first, and frequently determines trends and remuneration levels.
Asset management is probably second (sponsoring platforms and dealerships) and advice falls out afterwards and is typically rewarded for growth with volume bonuses from the administrator.
Obviously there is some generalisation in all of this but the point is the area that should be the most basic commodity actually controls the advice industry far too often and it leads to conflicts of interest and slows down the move to advice-based fees.
Not hard to see why the institutions own the platform world, integrate the dealerships for distribution of product then overtly reward planners with volume bonuses for using the platform.
Little wonder the industry funds are swatting with a cutlass at the advice industry and hitting a few home runs.
And we can all observe the demise of the corporate superannuation industry, which was dominant until 10 years ago when the industry funds flexed their muscle and provided a better outcome for superannuants. Can the same occur in the mass middle market of advice?
During recent months, Paragem has been advising potential new entrants to the wealth sector on what the Australian market looks like across the value chain and inevitably the 'who gets what' question arose.
The research answer always had a 'depends' scenario, but we set out to try and capture graphically, in a single diagram, a number of scenarios typical to the majority of the market. This has never been done before in industry papers.
We are willing to share the diagram below, which is a small part of the outcome and probably the first of its kind in Australia.
The margin splits are wide and varied because of the variety of deals that are done, but they do represent a broad typical cross section and with detail can be confined to accurate outcomes.
Typically platform net fees are 30-40 basis points but typically clients pay 88-300 basis points - even with badged ones.
The older master trusts are three times more expensive than contemporary wraps. One imagines they would be a legacy product if it were not for the margin sharing and embedded capital gains tax making it difficult to move clients. What is apparent and what most industry experts have bemoaned for years is that about 50 basic points of funds under management sloshes around in no-man's-land as a lubricant for business placement. These are known as volume bonuses (VB).
Is this transparent? Is it disclosed and do the governing bodies disagree, condone or support it as a free market outcome?
The FPA regards it as dealership entitlement and as such not conflicting or breaching guidelines.
The Investment and Financial Services Association (IFSA) regards it as transparent, but IFSA critics argue IFSA is embedded with the platform owners.
So, who is looking after consumers and if we eliminated this slush fund would it help to build consumer confidence? I imagine if we increase consumer confidence we will increase the growth in all facets of the wealth management industry - and no better way to do this than have clarity and transparency on who gets paid what - it's a pretty stock standard question after all.
Incidentally, statements of advice (SOA) cannot accurately disclose the amount because the amount is dependent on how much is placed at any one time and is generally funds under advice (FUA)-based, which moves with the market.
This fortuitously means the actual amount cannot be disclosed easily other than to say some additional amount could be payable. Is that disclosure or is it worthless commentary?
However, the trouble is a dealership doesn't make any money out of being a dealer without all the volume bonuses.
So we have an industry-wide problem that we should face up to, discuss and try to improve. We can't afford to have large dealerships going out of business if the Government legislates against commissions, for example, because no matter how you cut it, a VB isn't a beer, it's commission.
Interestingly, The Australian Financial Review recently reported Count Financial regarded VBs as advice fees - which just goes to show the ambiguity of the English language.
All of this leads to the next likely wave of change to occur within the industry and where the VB lubricant ironically creates unforseen damage to the very dealerships that receive them.
Scenario 1
As time progresses and successful practices within a dealership become aware of their contribution to the additional revenue being generated, further margin sharing is called for and the dealer is forced to start sharing or shelling out a percentage of the VB.
Of course, all of this is being controlled by the platforms' ability to keep paying this excess amount for what the platform industry calls scale.
Let's be realistic about this, it's not scale in a linear sense. The administration fees are too high and accommodate enough margin to allow money to be paid out for growth.
This isn't scale; on the contrary VBs are paid out for size of growth, not profitability of an advice practice or the interest of end clients. It can also result in adverse side effects to the detriment of all parties.
For example, adviser XYZ feels the market is overpriced in January 2008 and decides to sell direct securities and selected managed investments.
As the portfolio rebalances to cash, the adviser withdraws from the platform because cash balances incur horrendous platform fees.
(One wonders why one platform recently proudly announced over a billion dollars of term deposits with their parent bank.)
What happens when XYZ does this? The dealer's VB reduces and probably so does the advisers take, bearing in mind dealers have contributions to credit option schemes.
Conversely, adviser ABC, who charges advice-based fees (typically as a percentage of FUA), doesn't want the platform VB and just wants a net administration fee.
They take the same route but there is no conflict of income and both client and adviser benefit.
The point in the above exercise is that if VBs were extracted and platform fees were net of VBs, all advisers could charge more for advice without additional cost to the consumer based on present industry costs.
The adviser would need to show evidence of value, of course, which has to be a good step forward in the evolution of the advice industry.
Scenario 2
The larger practices work out that getting 100 per cent of a smaller VB is better than getting a small percentage of a VB that a large dealer gets.
The practice leaves and obtains its own licence. It has no dealer split to pay and gets a negotiated rate with the platform provider that results in an overall significantly higher revenue surge to the practice.
Given the practice has an equity value based on FUA and earnings before interest and tax, it goes straight to the bottom line and translates to increased equity value of the practice.
Last month, IFA and InvestorDaily provided coverage of a dealership that has outraged many practices because the dealer head was allegedly paid a large sum of money in addition to salary for selling on the head licence to a competitor.
It doesn't take practices long to work out owning a licence can increase the value of a small firm because the platform industry will always do a deal.
This takes us back to where we started. Who is focusing on clients needs and how is it that the advice industry is either controlled or owned by the platform industry?
Let's remember, 85 per cent of all new placement of money goes into platforms - which own the advice network. No wonder ASIC has a headache with conflicts of interest and switching.
It should be acknowledged the industry has improved remarkably in recent years and the level of commitment to quality advice, quality investment outcomes and quality administration services has never been higher. Let's indulge in some transparency and separate the 3 As.
Incidentally, the fourth A is the accountancy market, which will become licensed and which has no history of conflicts with products paying for placement. The accountancy sector will move into advice seamlessly in the next 10 years and it won't be selling at 80c in the dollar then.
Ian Knox is the principal and founder of Paragem Partners.
