The articles have been flying back and forth over whether financial advisers can accept commissions for selling LICs/LITs to their clients. If you haven’t been following this so far, Graham Hand wrote a well-rounded article recently, with Jonathan Shapiro and Christopher Joye also leading the charge in The Australian Financial Review.
I’m not going to rehash the main points here but want to bring three additional points to the discussion.
1. Financial advisers shouldn’t be keeping any commissions
Whilst some are arguing that LIC/LIT commissions must go, they are supporting the continuance of commissions for other listed product types. There’s no decent argument for this. If any commission is viewed as biasing an adviser’s decision, they must pass the commission to their client or refuse it outright. Saying that an adviser has a conflict if the commission relates to a LIC/LIT but doesn’t if it relates to a hybrid or equity investment is nonsensical.
For those struggling with the concept of selling hybrids or equities on their merits and without an adviser commission, look to the institutional debt markets. These have long functioned without the need for commissions. If the bond is considered poor value it receives little interest, but if it is good value, it is many times oversubscribed. There’s no reason that hybrids and equities can’t be distributed in the same fashion.
2. Brokers can keep commissions, subject to disclosure
Those dealing with clients need to choose whether they are sales people (brokers) or financial advisers. Whilst a financial adviser needs to adopt a best interest/fiduciary duty position and consider the wider client position, I don’t see that a broker should be subject to the same restrictions. A broker should however, be clearly disclosing that they are a broker being paid for the sales they make. This could be as simple as a verbal statement such as;
“I am a salesperson not a financial adviser which means that I earn commissions by selling products and services to you. The products and services I am selling may not be in your best interest and you may want to seek independent financial advice before agreeing to purchase.”
Some might argue that this is overkill and retail investors are smart enough to know who is a broker and who is an independent adviser. I think the Royal Commission showed that not only were clients confused about the distinction but many so called ‘advisers’ were as well.
3. LICs/LITs are an appropriate structure for illiquid investments
Some of the arguments against LICs/LITs come from a viewpoint that open-ended managed funds are the best solution for retail investors as they always offer a quick exit at close to the net tangible asset (NTA) calculation. This is fair for the most liquid sectors such as large cap equities or vanilla investment grade bonds.
However, for more illiquid assets such as sub-investment grade debt, private equity, some hedge funds and direct property, history is littered with examples of funds that ran out of cash and locked their investors in. If the assets take substantially longer to sell than the redemption period on the fund, investors and managers are playing with fire.
Given this, unlisted closed ended funds (e.g. direct property syndicates, private equity funds), individual mandates or LICs/LITs are the most appropriate vehicles for illiquid assets. As many retail investors insist on having some form of liquidity, a listed fund is likely to be their best avenue to access these sectors.
Critics of listed funds often point to the higher fees (from listing and governance costs) for these funds compared to their unlisted equivalents. This isn’t always true, with fees running at over 1% per annum for retail investors on some open-ended unlisted funds. It also ignores that higher fees could be more than offset by higher returns as listed funds do not have to hold large cash positions to offset the risk of a run on the fund that open-ended unlisted funds face.
Jonathan Rochford, CFA, is Portfolio Manager for Narrow Road Capital. This article is for educational purposes and is not a substitute for professional and tailored financial advice. This article expresses the views of the author at a point in time, which may change in the future with no obligation on Narrow Road Capital or the author to publicly update these views.