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How banks may have saved their wealth businesses

When I go into a Toyota dealer, I expect to buy a Toyota. I don't want the sales person to act in my best interests and go through a check list and verify why I am not buying a Mazda. Or whether I should buy a car at all. Or whether I need two cars. Or give me a Statement of Car Advice to show they checked all my needs.

Let's also establish that wealth management businesses can be profitable. According to a PwC Report called Banking Matters released in November 2018, "Wealth management income was also up at $5.0 billion on a continuing basis, up 8.8% yoy (year on year) and 6.6% hoh (half on half), reflecting growth in average funds under management." PwC Australia's Banking and Capital Markets Director, Jim Christodouleas, said:

“It would be incorrect to suggest that banks divested wealth purely because of concerns about the profitability of these businesses.”

Why is wealth management different than cars?

Let's take a quick look at the law.

The Corporation Act 2001, Section 601FC(1), under ‘Duties of a responsible entity’, says:

“In exercising its powers and carrying out its duties, the responsible entity of a registered scheme must … (c) act in the best interests of the members and, if there is a conflict between the members’ interests and its own interests, give priority to the members’ interests.”

For example, Colonial First State (CFS) is the wealth management division of CBA and the responsible entity for the funds offered to retail clients. Currently it's within the group, but soon to be sold. CBA manages billions of dollars of assets across all sectors through Colonial First State Global Asset Management. This ‘vertically-integrated’ structure in the wealth industry has been subject to intense scrutiny and criticism by the Royal Commission.

CFS is a good example because, along with AMP and perhaps NAB, CBA and CFS came in for most criticism at the Commission. CFS even admitted to being the gold medallist among the Big Five in 'fees for no service'.

Did CFS take its role responsibly?

When I worked at CFS, from 2001 to 2012, the 'best interests' responsibility was taken very seriously. It was common for the in-house legal representatives in meetings to divert management from a preferred course of action because, in their view, the action was not in the best interests of clients. There was often a lively debate about how to structure a product or communicate with clients, but someone always made sure the fiduciary duty was front and centre.

That’s the irony for me. Wealth management is taking much of the culture blame, but in my personal experience, in product development and relationship management, the fiduciary obligation was well understood and respected.

How does this reconcile with the problems the Royal Commission has revealed? Much of it comes down to the economics of providing financial advice to a mass market. Only 20% of Australians have a financial adviser, and most people are unwilling or unable to pay for full-service advice. With a qualified adviser costing say $300 an hour, with onerous compliance obligations on client discovery and Statements of Advice, a decent plan costs say $3,000. That is 3% on $100,000 or 6% on $50,000 and beyond most people.

Advice versus sales

So the banks cross subsidised their advice with product margins, and this is where the sales culture advice model and best interests started to break down. Banks and wealth managers confused advice with sales. I believe there was an opportunity to remove the ambiguity and go directly and openly to the point. Just call it sales.

A good CBA product sold to a CBA customer could meet the best interests test of a reasonable fiduciary with the right design and disclosure process. Instead, CFS decided to lobby governments to retain commissions and tough it out and the rest, as they say, is history. At one stage around the implementation of FoFA, CFS could have tried the following:

1. A CBA customer who goes into a CBA branch to speak to a CBA teller and is directed to a CBA adviser will not mind being given a CBA wealth product. They are happy with a CBA loan and a CBA credit card, and for the vast majority, CBA funds are appropriate.  The 'vertical integration' model was not the problem.

2. However, CFS needed clients to understand what was happening to meet the fiduciary duty. A 'manifesto' could have been handed to every client. It would say something like:

"Our Financial Advice Undertaking To You, the Commonwealth Bank Customer

In meeting your investment needs, many of the funds recommended to you will be provided by related parties of CBA.

We make this undertaking to you:

1. The fund will be competitively priced for the quality of the product and overall service provided.

2. We will ensure the portfolio managers are highly experienced and skilled in funds management, and supported by the resources needed to do their jobs well.

CBA is confident investments in these funds are in your best interests because we provide the services, technology and capital for our fund managers to deliver a quality product. We understand our own products best. Few external fund managers can back up their products with this level of support. We will also ensure our financial advisers are trained to understand your needs and act in your best interests. By taking responsibility for all parts of the value chain provided to you, CBA can monitor the quality and deliver value to you."

In other words, CBA/CFS could have made greater merit of the vertical integration model and highlighted its strengths rather than apologising for it. And if that meant the staff in branches were no longer called 'financial advisers', I believe few Commonwealth Bank customers would have cared. They borrow from and lend to CBA without knowing the rates are the best. Although the Royal Commission has rocked the industry, this month's Roy Morgan Research survey shows rising satisfaction levels for Australian banks.

Example of a competitive retail fund available to all investors

CFS spent considerable resources selecting the best fund managers and designing products to meet investor demand. Without wanting this to sound like a promotion for CFS or retail funds, let me illustrate with one CFS fund from the FirstChoice Multi-Index Series of six funds designed to match different risk appetites. Briefly, the Diversified Fund invests in eight different asset classes across Australian shares, global shares, infrastructure, emerging markets, bonds and cash. Its total management fee (with no performance fee) is 0.65%, with CFS handling rebalancing, manager selection using smart beta (not cap-weighted indexing) and access to a call centre, complete tax reporting, online transactions and regular newsletters. The minimum investment parcel is only $5,000 with none of the weekly administrative fees charged by industry funds. It's a competitive product.

In fact, there is even a so-called 'A Series' available with a minimum of $25,000 and a management fee of 0.47%, yet the public perception of retail funds is they are all too expensive.

Along with other funds in the Series, the Diversified Fund is a good in-house solution to offer to CBA customers.

Now, in the wake of the damning Royal Commission, CFS will be sold and the bank will exit wealth management. And who will provide financial advice to the millions of people who need it?


Graham Hand is Managing Editor of Cuffelinks.


Graham Hand
February 10, 2019

For those who think advisers could not meet a fiduciary duty by recommending in-house products, Hayne says: (page 190)

"advisers may be expected to know more about the products manufactured by the licensee with which the advisers are associated than they know about a rival licensee’s products. Advisers will often be readily persuaded that the products ‘their’ licensee offers are as good as, if not better than, those of a rival. These types of conflicts direct attention to the structure of the industry."

February 05, 2019

Firstly, in your metric about wealth management income, which I assume is revenue, have you adjusted for the past, present and expected compensation and remediation costs arising from poor financial advice? For many wealth managers the compensation has wiped out a decade's worth of profit and made financial planning unsustainable as a business for retail clients. Which is why you will see this shrink eventually into the wholesale/sophisticated investor space.

Secondly, in terms of the value of financial planning, I recently saw a client who in wanting to close down their SMSF sought advice and was charged around $6,000 to be recommended into that adviser's preferred retail fund, which is owned by the licensee. The fund is in the bottom quartile of performance over short and long terms. Where is the best interest there?

February 05, 2019

Except that products like this [run by banks] fail to disclose the margin they make, versus the lower fee margin charged by the external fund managers they get into bed with. A good low disclosure business, while you beat up on what planners & mortgage brokers earn, to keep the focus off yourself.

Graham Hand
February 05, 2019

Hi Casual Observer, I'm sure you're far more than casual based on your good comments. My main point is that CFS and the advice businesses had a strong case that they could meet a fiduciary responsibility by explaining to customers the quality and design of the products and the overall service. It could then have sold in-house funds to bank customers.

Casual Observer
February 05, 2019

Hi Graham,

While I too see merit in the agent vs adviser model, there a few points in your article that require review.

1. CFS is not the primary advice giving vehicle for CBA. CFS operates platform + investment and CFS GAM operates investment product only There is vertical integration there and also integration in the investment + platform + advice combination. The advice arms are very distinct from these businesses.

2. The advice industry lost the agent vs adviser argument long ago. It chose to argue that all advisers are professionals and fiduciaries (not car salesmen) and thus the 'I sell product and happen to give free advice with it' model is dead and gone (for the foreseeable future).

3. Regulation did not bring in 5% advice costs, that level of fees and commissions existed long before FSR and FOFA.

4. "We will ensure the portfolio managers are highly experienced and skilled in funds management, and supported by the resources needed to do their jobs well." This largely only applies when selecting the multi asset options. A huge portion of CFS FUM is directly controlled by adviser portfolios and thus the above statement could never be made.

5. The multi index option is indeed an interesting, lower cost retail alternative. But the overwhelming majority of customers walk in already holding at least 1 super fund. A professional advisers responsibility is to consider these relative to the various CFS (and other) viable options. A salesmen's responsibility is to simply 'sell' the client on the benefits of their product over all others. Advice has always done the later, its the former that remains the challenge.

6. Lastly, I'm not sure if you are referring to what 'could have been' with a best interest test/FOFA outcomes but under current rules, there is no way that the process described could ever meet a fiduciary duty and that's the whole point, the client doesn't know (or care) but a fiduciary does.

There is still merit in the vertical model, but most of that was captured by product providers and licensees/advisers, now it must demonstrate how it benefits consumers vs other models.


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