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Financial advisers not allowed to advise

In the recent article by author and lecturer, Peter Thornhill, he made the case for a long-term asset allocation of all Australian shares. His main argument was the long-term superior income backed by capital growth, but it requires investor tolerance of the inevitable short-term fluctuations in the market value of their portfolio. Peter argued investors should focus on income, and dividends are less volatile than market prices.

The article was a response to a piece on life-cycle investing by an equally well-credentialed expert of long-standing, Don Ezra. We have also published Don's further contribution this week.

Some comments on Peter's article highlight another serious issue. Financial advice as a profession has taken a beating over recent years, most notably in CBA-aligned licencees, with millions of dollars of compensation paid to clients. There is no doubt that some poor advice was given including cases of fraudulent activity, leading to ASIC investigations, the Future of Financial Advice (FoFA) legislation and the current Royal Commission. Clients argued they did not understand the risks in their portfolios when entering the GFC, and cases such as the elderly lady invested in a geared listed property fund are high profile examples of advice failure.

What is rarely acknowledged, however, is that many people took advantage of the media and regulatory focus on financial advice and made ambit claims, even when they knew the risks they were taking. The Australian share market ran strongly in the five years to 2007, and investors wanted a piece of the action and enjoyed the hefty gains. When it went bad, many saw an opportunity to claim innocence. I was working at Colonial First State at the time, and amid the obvious problems, a lot of appropriate advice was also targetted by clients simply because exposure to shares had resulted in losses. It was a chance to recover some money, what some called a 'put option' back to the bank. As the media hype became hysterical, CBA virtually waved the white flag and made payments in cases where internally, it was strongly felt clients knew exactly what was in their portfolios, and had knowingly signed their Statements of Advice.

Advisers started ducking for cover and banks such as ANZ have stepped back from the advice business. In fact, CBA and Colonial First State have lost confidence in defending their rights and the merits of financial advice given, and would rather write $100 million in cheques than face further slamming of their reputations.

Many advisers do not give the advice they believe in, faced by a potential legal liability and the worry that clients will panic amid the media whipping up fear.

Comment by Andrew Rowan

"As an adviser for 25 years, my career commenced in 1993, and shortly after that, I came face to face with the Bond Crash of 1994, when even 'safe' investments fell in value (collapsed), and obviously every 'crash' since that time.

When I was younger, I compiled possibly too many spreadsheets to prove theories such as yours (ie Peter Thornhill's) for myself using actual client situations; nowadays I am happy just to know the truth.

My observation over time is that volatility has never really mattered in client portfolios provided that they have had sufficient cash to meet their income and 'emergency' needs.

In theory, I would like all clients to say hold near 100% in equities in their portfolio. However in the real world as advisers, we have to contend with the media setting expectations and trying to scare the daylights out of the public whenever the sharemarket undergoes repricing from time to time (what they call Australians losing 'billions').

Coupled with this, is the concept of 'Risk Aversion' where some people simply do not have the appetite for any volatility, such is their fear that they will lose their hard earned.

In such cases, and as advisers we are under an obligation to 'know' thy client and invest their funds accordingly. I know that when I invest a client’s money in a 'conservative portfolio', I am setting up the client to earn less over time.

If on the other hand, I were to do the right thing by the client and invest in a way that we know the client will be better off (i.e. shares), then when next the market falls, my conservative client will in all likelihood complain. This could then cause them to sell their investments of their own volition and crystallise the 'loss'. This scenario would likely end up with me meeting the lawyers.

In my experience volatility for our clients is a concept until it becomes real, and the portfolio report shows a 'loss'. That is when the real test is applied, and then when they listen to the media, they panic.

My question then is how in the face of knowing what is right, how then do we deal with the reality of fear, risk aversion, misinformation and prejudice in clients."

Comment by Phil Brady

"Excellent summary of the problem Andrew and sums up the dilemma of managing multiple clients, not just your own portfolio, or Peter’s in this case, on which you can manage your own emotions or not. Much more difficult to manage other’s emotions. Part of the answer is education, but in my experience as well, the education may not actually sink in, or it is abandoned when fear becomes real, hence we revert to the ‘safe’ approach. The no win no fee lawyers would have a field day with portfolios 80% in Australian equities, no matter the theory. That’s why some choose to be educators and theorists I guess, and not personal advisers!"

Comment by Rob

"I once considered very seriously becoming a financial adviser (I was already involved in the finance industry in another capacity) however I was unable to reconcile my own firm views on high ASX asset allocation and the importance of income above all else, to the 'standard' approach of the 'balanced' portfolio and the much lower outcomes that must occur as a result.

So I just stayed where I was and in the end was able to personally retire some 10 years ahead of most, if not all, of my colleagues and peers. This is not to 'brag', I actually state this with a sense of disappointment for the missed opportunities of the majority caught up in the mire of the bog standard asset allocation world."

Concluding note

The increasing amount of compliance and legal obligations faced by advisers is one reason many are leaving the large advice groups and becoming Independent Financial Advisers or setting up themselves. Every adviser faces significant paperwork obligations each time they hand out personal financial advice, including the 70 page Statement of Advice, the Approved Product Lists, the Professional Indemnity Insurance, the administrative platform and the model portfolios. It limits the scope for individual advisers to follow their instincts and accumulated knowledge as they fear the backlash from advice that goes wrong. Michael Kitces argued that the future of financial advice is specialisation, not these generic responses and institutionally-based rules. In the meantime, financial advisers will give the advice they've been told to give.

Leaving the last words for Peter Thornhill:

"I have always felt for advisers. Know your client? What a joke. You know many of them only until things don't go their way and then it is your fault. The GFC was a great opportunity for many 'clients' who signed off on their plans to activate a 'put' option."


Graham Hand is Managing Editor of Cuffelinks.


Raymond Page

March 15, 2018

Hi Ashley, Further to Geoff Walkers comment, in the 1992 recession dividends as a general rule collectively leveled off - but on average they didn't fall!


March 15, 2018

We have also had another recent example where media hysteria and misrepresentation has resulted in worse outcomes for the broader majority of financial services consumers. Has anyone noticed how much premiums for TPD and income protection insurance have increased in recent years? Part of this is due to insurers paying out dubious claims rather than risking further media beat ups.

Insurance claims are primarily funded from the premiums of other policy holders (that's how insurance works) so if insurers are paying dubious claims due to fear of an irresponsible media, it's the other policy holders who wear most of the cost.

Mal Hutton

March 15, 2018

What's missing in much of the discussion is the notion of financial planning i.e. the plan which sets out precisely where a client's income is coming from over a period of years, and how they will fund their capital expenses like overseas trips, car replacements, major house maintenance etc. If a portfolio of income producing shares is of sufficient size to fund the required income then that settles one aspect of retirement funding, but almost all clients I had did not have that much to invest. Thus other investment products like annuities were needed, and you can view them as structured drawdowns of capital if you like. For capital expenses it was almost always necessary to set aside cash amounts for access when needed. A clear projection then showed how financial needs would be met.

Gary M

March 15, 2018

It feels like "all hail" for advisers who just put all their clients money into equities. Consider what many advice groups do through active asset allocation rather than a Hail Mary on Aussie shares. There's a good reason advice is structured this way.


March 14, 2018

Dividends have fallen by 50%+ several times after the big crashes (1890s ,1930s, mid 1970s, early 1990s, etc) – so dividends can fall by as much as share prices! The fact that divs have semi-annual volatility whereas shares have daily volatility is not the issue – both fall by 50%+. Arguably dividend falls are more important to retirees than share price falls because retirees are living on income, not share prices! So the semi-annual div variability is actually more important than daily share price variability. But too often people dismiss dividend risk with statements that ‘divs are less volatile than share prices’.

Geoff Walker

March 15, 2018

Hi Ashley. What's the source for your intriguing claim that "Dividends have fallen by 50%+ several times after the big crashes ..."? I'm interested because it accords with neither my personal investing experience nor the market records that I keep.


March 12, 2018

Another Adviser...

I have more than 32 years experience as a financial adviser, (i.e. pre 1987 stock market correction). My business runs its own AFSL, we manage bespoke portfolio's, some big, some small. Use a lot of direct equities (no bonds as per Wayne above), LIC's, and ETF's in recent years.

We developed 9 different risk profiles (and the appropriate underlying asset allocations to match) and a risk questionnaire that actually helps the adviser and client to select the appropriate asset mix based on their risk tolerance. The client signs off on the risk profile (with adviser comments), and the completed questionnaire is embedded in our audit trail.

One of the profiles is simply call ''Áustralian Equity'' - 65 to 75% ASX listed shares, some fixed interest (no bonds), cash, international equity, listed property, etc.etc.

While I acknowledge its easier with your own AFSL... not that hard really!

Wayne Barber

March 12, 2018

Thank you for this forum in airing this 'elephant in the room'. As a Financial Planner (30yrs) and as a business owner, the sequence of events, (through Legislation, Regulation and Political expediency) playing out reminds me of the US TV series FARGO. Where a series of initially unrelated events leads to a single fatal outcome (event). The Future Of Financial Adviser. No not FOFA , although the intention was well founded the resulting outcome (through the framed regulation) has missed the mark to the detriment of the both the Adviser and the client.
The saving grace in my practice with a number of my clients is an establishment (with time) a deep trusting relationship. Where assets under consideration 100% of the time include Equities (domestic & International) and Property (direct & syndicated).
Bonds are rarely discussed and not included in the portfolio. The clients (with means) are not at all interested in Bonds. It is hard to mount an argument to include.
Yet when a new client wishes to enter into an arrangement, my documentation must consider a bond exposure, although I am not totally comfortable.
Personally I have never invested in bonds and never will. Equities & Property.

Neil Dearberg

March 11, 2018

Could it be that, if ASIC actually knew and understood what 'financial advice' and 'financial strategy development' truly was, the Storm Financial model of double gearing, especially amongst retirees, was not a valid strategy? Isn't ASIC's failure to understand 'strategy' the problem, not the banks who held up their hands and capitulated? Whose job is it to protect the consumer once the Adviser has completed the "know your client" rule - the bank or the Regulator? Storm was squeaky clean in ASIC's compliance methodology, right? If ASIC fully understood the financial advice concept, asset class behaviour, volatility -v- risk (they are completely different animals), portfolio construction to meet genuine client needs - then maybe we wouldn't need the ridiculous and unhelpful (to anyone, especially the client) compliance burden that simply increases a client's cost and is making the industry untenable?


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