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Authorities reveal disquiet over LIC fees

The ethical and business dilemmas about whether financial advisers should accept ‘selling fees’ from fund managers took a dramatic twist last week with the release of documents under a Freedom of Information (FOI) request. Although the internal memos from the regulator, ASIC, are not released publicly on their website, they are available on request following the FOI inquiry by The Australian Financial Review.

We have written extensively on this subject, such as here, as it is crucial for the future success of Listed Investment Company (LIC) and Listed Investment Trust (LIT) issuance. Investors have pumped $4 billion a year into the sector in the last two years, and so settling the debate has major implications for thousands of investors, especially those whose investments are guided by a financial adviser.

It's a fact that it is impossible to raise a billion dollars in a month for a relatively unknown fund manager without paying selling fees (officially, 'stamping fees') to financial advisers and brokers. In the wake of the Royal Commission and the industry's new Code of Ethics, the advice industry must answer the question:

Why would an adviser put clients into a new LIC or LIT when there are hundreds of similar choices readily available if not for the incentive of earning the selling fee?

The ‘made things and provided services’ exemption

The FOI release (a zip file of emails and documents) shows the regulator feels the scope for conflicted advice is amplified by section 7.7A 12B of the Corporations Act, which allows financial advisers to collect a stamping fee. The most telling section comes from Anna Dawson, Senior Specialist, Financial Advisers at ASIC, who says:

“The initial carve-out was given because of an argument that companies would not be able to raise capital. The carve-out was restricted to companies that ‘made things and provided services’ – hence investment companies were excluded unless they were investing in infrastructure, so, the initial carve-out for stamping fees did not apply to LICs and REITs.” (my emphasis)

This is a fascinating revelation. The carve-out from FoFA which has encouraged billions of dollars of LICs and LITs to be issued was not initially available.

And here’s the sting in the tale, as ASIC continues:

“ASIC was consulted on the ‘streamlining’ package which extended the stamping fee carve-out by including investment companies. In December 2013, ASIC wrote to Treasury again opposing the expansion of the carve-out for the following reasons …

Broadening the exemption will expand the scope for conflicted advice and corresponding consumer detriment. It will also cause an undesirable market distortion by preventing conflicted advice in the secondary market (transfer acquisitions) but permitting conflicted advice for the whole primary market (issue acquisitions). From a consumer protection perspective, we do not see any policy rational for this distinction. 

We are also concerned that any broadening of the exemption will lead to arguments by other industry sectors that they have been put at a competitive disadvantage by the uneven playing field that the exemption creates. Subsequent relaxing of the FoFA reforms will inevitably lead to consumer detriment.” (my emphasis)

So what happened? ASIC’s advice was ignored under intense lobbying from sections of the financial services industry which benefit from allowing advisers to receive selling fees.

Why do the businesses that rely more on unlisted funds, including many of the major platforms, not object to this special treatment which allows a competitor product (in the listed market) a special ability to pay a fee to an adviser?

In Item 20 from the ASIC file, this time written by David Dworjanyn, Senior Specialist (Legal & Policy), Markets, ASIC, he says:

“The poor performance of the majority of these funds don’t justify the fee structure generally and it makes me question any advice to go into these products, particularly at the issuance stage.”

Meetings between ASIC and Treasury

It’s also fascinating to see how many resources Treasury and ASIC have devoted to this problem. The emails include detailed analysis of the LIC and LIT market. The email below shows David Dworjanyn copying 10 people into the analysis on stamping fees in August 2019.

However, these results are not as clear cut as ASIC suggests. For example, some of the LICs that did not pay fees were not new issues, but rather, LICs involved in some internal restructuring that did not involve funding. Furthermore, analysis of LIC prices is fraught as discounts and premiums change almost daily, and prices are affected by modest amounts of supply and demand. 

Nevertheless, regulator opinion of the market is shown by the following charts from the slide presentation. They indicate the higher the stamping fee, i) the greater the discount to NTA and ii) the worse the investment outcome.

With the dispute on adviser selling fees growing in the media, Treasurer Josh Frydenberg recently wrote to ASIC saying:

"I am sure you share my concern that ASIC's analysis revealed some correlation between higher stamping fees and underperforming LICs. Can you please provide me with details as to how ASIC is monitoring LICs and other investments to which the stamping fees exemption applies to ensure that the interests of consumers are not being compromised."

Advisers don't know how much will be issued

The float of a company that ‘made things and provided services’ differs from an investment company. When a company such as Afterpay or Xero is floated, there is a set amount of stock available, valuing the floated company at a specific price. There is often a scramble for the limited supply.

With a LIC or LIT, the fund manager can accept every dollar offered and then simply buy more assets. There is an enormous incentive to ‘back up the truck’, as L1 Capital did with its $1.3 billion raise and KKR did with its $925 million issue. Both then struggled in the secondary market under the weight of supply and traded at discounts to NTA.

Yet financial advisers and brokers put $2 billion into these two issues, readily accepting the selling fees, even after the originally-advised minimum transaction amounts were massively exceeded, with the inevitable oversupply issues

How can an advice licensee assessing whether an adviser’s action was motivated by the selling fee argue that a LIC or LIT that trades at a discount is in the best interests of the client?

What is the relevance for investors?

Many SMSFs and more sophisticated retail investors assemble their portfolios using ASX-listed investments, and Exchange-Traded Funds (ETFs) have now reached $60 billion, while LICs and LITs are about $50 billion.

But there's a difference between the two. Demand for ETFs is primarily driven by cheap and easy access to index exposure, with many funds available for less than 10 basis points (0.1%). ETF providers devote considerable resources to investor education rather than paying promotional fees to financial advisers and brokers (there are no stamping fees paid on ETFs).

How can LICs and LITs charging active fees of 1% or more compete with such low fees? Some such as Magellan rely on the long-term reputation of the manager, with a direct client base built over a decade of success, engagement and marketing effort. But managers with lower market profiles must pay selling fees to advisers to promote their products. From the manager's perspective, this is fair enough as it rewards the adviser for their distribution.

Without the selling fees, many of these transactions will not come to market. If the latest review by ASIC and Treasury, and the ethical questions raised by FASEA's Code of Ethics, lead to a change in treatment of selling fees, then ETFs will receive a boost, and investors and advisers may need to focus more on unlisted funds.

 

Graham Hand is Managing Editor of Firstlinks. This article does not consider the circumstances of any investor.

Any financial adviser or industry participant is welcome to provide a constructive article explaining why selling fees are appropriate for new issues.

 

10 Comments
Gary M
January 12, 2020

When banks do new hybrid issues, they pay financial advisers (around 0.75%) to place their clients into the new deal. What's the difference between that and a LIC? The payment is an inducement to sell the issue to the client when paper is readily available in the secondary market.

Chris
January 10, 2020

Let me put another perspective.

I do think the one item that Koda and others leave out of the economic debate is the cost to client.

A listed investment client typically pays no upfront and no ongoing advisory or platform expenses. A fee for service unlisted fund advisory client will pay an annual fee for advice and for platform, perhaps 1.75% per annum, or more.

The conflict of having a 20 page application in an unlisted PDS is that the option of investing via a platform brings an annual charge of 82bps per annum on average (quote CBA). Fee for service advisors will not, not even for medium balance clients, fill out a 20 page application. Why? They don’t earn enough in fees, and so, only HNW clients might be offered a service that avoids platform fees.

I’d like to see listed investments be allowed (by government) to buy back stock and hold that stock as treasury stock as opposed to eliminating it; this would encourage buybacks and potentially help larger more liquid vehicles absorb the smaller deeper discounted vehicles, and it would be a magnet for the share price and NTA. The LIC/T industry discounts peaked ~30 June 2019 and the industry has worked hard over the past few months to reduce the discounts, including buybacks and purchasing programs.

The figures being used (by some conflicted journalism) for average discounts are 3-4 times larger than the ‘average dollar invested’ discounts, which does highlight that the market would be better off without small ( less than $200m) listed vehicles. I think the former figure of “average discounts” is misleading when not accurately described. I’m not pointing that out because you have used it, you haven’t, but others do every day. They also compare performance of companies v trusts, without reflection on the former being post tax.

Donald
January 09, 2020

A major issue not receiving enough focus is that this is not only about 'financial advisers' as we know them, but also stockbrokers. It is a brokers' job to spruik new issues to their clients, and accept selling fees in return. It's not about a total financial plan with an SOA and a study of life's goals. It's about turnover and selling IPOs. The poor financial adviser gets dumped on every time this issue comes up and brokers don't rate a mention, but they are all subject to the same regulations.

Randall K
January 09, 2020

When we started our smsf in 2003 and after discussion with our financial advisor our first investment was in an LIC-Carlton Investments (CIN). As an existing product we did not know if the advisor was receiving a fee except for his brokerage fee of 1%. CIN had a market capitalisation of $271m and traded at a 5% discount to NTA at a price of $10.50. It has always traded at a discount to NTA which today according to your Bell Potter LIC data has averaged at negative 12.3% over the last 5 years. Today the company has a market capitalisation of $850m, an NTA of $37.77 and a market price of $32.28. It pays reasonable and consistently growing dividends. Since 2003 we have bought into other LICs and more than a few of these were new companies and involved selling fees. I remain a happy LIC/LIT supporter. A discount ot NTA is almost irrelevant but may represent a buying opportunity. Premium to discount NTA seems to be somewhat cyclic.

So onto your article (and that in the AFR): 1) Is is almost ignorant to be measuring and judging performance over the last two years-far too short. 2) I have no doubt that the franking credit story is a big factor in the recent price drops (and huge recoveries after the election. 3) A comparison to ETFs is almost irrelevant; an LIC is a company. It makes something ie money. As the Buffets of the world say when you buy a share you become a part owner of a business. An ETF is more or less a slave of the market with no added intelligence. 4) You are either mischievious or disingeneous to say that 'With an LIC or LIT, the fund manager can accept every dollar offered and then simply buy more shares'. An LIC is a company with a company structure and a mission which is often along the lines 'To deliver a growing dividend stream over time subject to profits.'.. Running an LIC is a lot more than buying more shares. 5) When you buy a share in an LIC/LIT you are part owner/investor not a 'consumer'. 6) I expect to pay for a new initiative offered by a financial advisor. It is sufficient for them to tell me what fees they will get. And I clearly take the decision to invest. I reject the statement “Why would an advisor put clients into a new LIC or LIT when there are hundreds of similar choices....'. . I struggle to see where there is any more conflict that say a real estate salesperson or a car sales person. I know they will receive a fee if they get a sale and I know what it is. But in the end I must take the decision and I must accept the responsibility of my actions. Surely ASIC (and maybe the press) is more capable that is being brought out here?

Raymond Page
January 09, 2020

So, as a a financial adviser of 30+ years standing I take exception to the statement "..I struggle to see where there is any more conflict that say a real estate salesperson or a car sales person..''

That's exactly the conflict we (advisers) have been accused of over the years - we are just 'sales people' - its not just a perspective either, until FOFA the corporations law enshrined the transactional nature of the ádvice' industry.

I use LIC's (generally trading in the secondary market) and ETF's extensively. Don't need a stamping fee to make it work.

Time to sought this S*** out so we can all move on.

Emma
January 09, 2020

Well done Randall K for putting forward an alternative side or way to look at the LIC space...finally.

Richard Brannelly
January 09, 2020

As a professional financial planner with almost 20 years experience in helping clients I cannot think of a single valid justification an adviser could use to accept the "stamping" fee. I believe a very large percentage of my colleagues would feel the same, but I would like to know how many licensees and advisers are accepting such fees. A true profession will call out such behaviour in the interests of consumers. The time for such conduct has well and truly past and if individual advisers cannot do the professional and ethical thing then legislation to remove the exemption is the only recourse.

Frank
January 09, 2020

What if an adviser genuinely believes the issue is in the best interests of the client?

Richard Brannelly
January 09, 2020

If so by all means recommend the IPO - the quality and suitability of the investment and the payment of stamping fees are very separate issues. In fact the payment of stamping fees could well create the perception that the investment is of inferior quality by the very fact that a fee gets paid by the product issuer to the adviser making the recommendation.

John Flynne
January 09, 2020

Disappointing that the traditional lics get branded in a generic way with all others . I think the press are very lazy on this issue .

 

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