Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 250

Royal Commission 3: A ban on all percentage-based fees?

In Round 1 of the Royal Commission mortgage broking interviews, the Commissioner asked why the industry does not operate on a flat administration fee paid by the client. This would address the broker incentive to push the borrower into the largest loan and potentially fudging financial statements. Brokers are paid a commission by the bank based on the size of the loan, normally about 0.6% up front. There is usually no cost to the borrower of using a broker.

The idea immediately gained traction. Westpac CEO Brian Hartzer suggested mortgage brokers should charge clients directly, and Westpac would “tighten up” on its processes and transparency on commissions, fees and costs. The Commission found that CBA CEO, Ian Narev, had noted in February 2017 that broker incentives “lead to poor customer outcomes”.

A ban on commissions paid by banks to brokers (similar to the FOFA ban on product manufacturers to financial advisers) would have an enormous impact on mortgage broking and banking, as brokers originate half of all home and investment loans. The industry is already under stress as the banks tighten their lending criteria, with implications for house and apartment prices across the country.

Across a range of financial services, the Commission will make recommendations on fee calculations, who pays them and what incentives are created. How much further could this extend into wealth management?

Fees for fund administration platforms

What’s the equivalent in financial advice and asset management? There was a revealing moment which the media has overlooked in its excitement about charging fees to dead people.

Linda Elkins (LE) is an Executive General Manager at Colonial First State. She was examined by junior barrister Mark Costello (MC) who asked about platforms and their fees. This is a long extract to show how issues sneak up during questioning. Make a note at the point when Commissioner Kenneth Hayne interrupts.

MC: All right. So all consumers that invest through a Colonial First State platform will pay, as a general rule, an investment fee and an administration fee?

LE: Yes.

MC: And the fund manager’s fee would ordinarily be calculated by reference to funds under management?

LE: Yes.

MC: And is the administration fee calculated in that way?

LE: Yes, it is.

MC: And what’s the relationship between funds under management and the administration expenses that the platform operator might incur?

LE: So the main relationship between those things is the – I guess the risk we carry in relation to the unit pricing function that we carry out, and there can be a relationship, although it will vary, between the amount of service that would be required on the account if  the account balance is higher, there can be additional servicing needs, but I would say it’s predominantly the risk in relation to the higher amount.

MC: All right. So you’ve mentioned risk and servicing. Can I deal with risk first. What’s the risk that you’re exposed to?

LE: If we get – the unit pricing is incorrect, then we would be responsible for the remediation of that.

MC: Does that happen often?

LE: No, it doesn’t. We – we – we are – obviously, there is audit functions that are carried out with our external auditors, and we perform at – or we believe we’re at industry best practice.

MC: And explain to me the other vagaries that create the pricing risk?

LE: If we made an error, if we got it wrong.

MC: In the division?

LE: Or in – you know, things like the withdrawal of the administration fee or in the recouping of expenses, wherever it might be.

THE COMMISSIONER: You charge more against the prospect that you might do something wrong? 

LE: We – the question you asked me was what’s the relationship, so no I wouldn’t – I wouldn’t say that that is the relationship. And I would also agree that it is industry practice that these fees are asset-based.

MC: But you would also agree that you’re pricing in your risk of miscalculation which might result in a requirement for remediation, and that affects the price the consumer pays?

LE: Yes.

MC: And that’s the risk component. And the other component was the serving component?

LE: And, again, that’s not necessarily a direct relationship, but it is a factor that it can be. And I would agree that using asset-based fees is the common method that’s used in the industry.

MC: What type of services are contemplated by the servicing fee?

LE: So the servicing fee covers the administration of the account. So the application process, any redemption process, call centre activity reporting, and so on.

MC: All right. And the administration fee will generally be charged by reference to funds under management?

LE: Yes.

MC: And is there any relationship between the administrative tasks that Colonial would undertake and the amount of funds under management?

LE: As I said, it would – it would vary. I mean, no, this is the standard method that the industry uses.

Are platforms a likely target?

The two reasons given for charging administrative fees – possible costs of remediating the client and to cover the services provided – are not the major reasons for the fees. Remediation is minor, and services provided are generally a fixed cost and do not vary materially according to size. Someone with $10,000 on a platform receives the same reports and service as someone with $100,000, so why should the latter pay 10 times as much?

The main reason is to make money. As account balances grow, so do fees. A person with $500,000 at an administration fee of 0.5% pays $2,500 each year (in addition to the investment and advice fees). It’s a scale business where profits are highest on large balances.

Kenneth Hayne is focussing on how financial advice and funds management can address problems with product sales and commissions. He may argue administration in its many forms across the industry should be charged at a flat rate to remove the incentive to grow the account when it might be preferable, for example, to pay off debt.

Furthermore, there is an incentive for a vertically-integrated model to refer larger clients to a platform with a percentage-based fee than one with a fixed fee or a lower cap. There are wrap platforms available which cap the fees or have a low 0.1% fee above a certain amount. Many independent, fee-for-service financial advisers use these wraps to force down the client cost, but an adviser in a large integrated business would be less likely to offer this option.

Or maybe the Commission missed this target. Mark Costello moved off the subject quickly, did not raise the issue of the availability of cheap alternatives, and did not question the two reasons given for charging asset-based fees.

Although the capped or low-cost platforms are already available, it would be a massive change if commissions and asset-based fees were replaced by fixed fees or low caps. Investors paying hefty platform fees on large amounts should shop around now, not wait for the change.

The argument that the industry has not passed on the benefits of scale is not new in funds management. Fiona Trafford-Walker, director of consulting at Frontier Advisors, has been arguing for changes in fee structures for a decade. For example, in an article called Alignment of Interest, written in 2016, she said:

“As the Australian superannuation industry has grown, there has not been enough capture of that scale through reduced costs. We also know that fund manager margins remain very, very high (and if anything, many have expanded since the GFC), especially when compared to any ‘normal’ industry. This desire to capture the benefit of scale is now a significant focus at many funds.”

The Royal Commission will lead to a greater separation between how financial advisers are paid and their choice of products, and there’s a potential for this to extend into other parts of the value chain.

 

Graham Hand is Managing Editor of Cuffelinks.

 

10 Comments
Toby
April 30, 2018

I can't understand why there wasn't a mention the need for institutions to be compensated for the capital employed. Ms Elkins may have covered this but not been reported. We all want well resourced financial service providers and the technology and human resourcing required means substantial capital and a requirement for it to achieve an adequate return.

Michael
April 30, 2018

Thanks for the summary regarding % of assets based admin fees - I wonder if the Royal Commission will be interested in the fact that many (if not virtually all) super funds (including industry funds) now also charge admin fees that are based on a % of money invested? This means that SG contributions are effectively being charged on this basis - is this a good look for a compulsory system? The only large funds that do not do this (to my knowledge) are HostPlus and AustralianSuper.

Many years ago I looked at this issue for super funds and concluded that no more than only a few basis points could be justified and this was because the only admin costs that related to % of assets were some trustee insurance costs (eg trustee liability) and the APRA levy. All other costs have no relationship to funds under administration. This may have changed since then, but I doubt it has changed much if at all.

It will be interesting to see if the grilling that CFS received will also be applied to any super funds.

Jimmy
June 02, 2018

I read through an industry fund PDS the other month and its running costs are at least 1% p.a. from what I could see, however you had to read three different documents and put it all together to work it out.

Paul
April 29, 2018

Many wrap platforms have caps on total
Admin fees already. Generally around the $3500 mark. We are a 16 yo planning practice and a client with a million will pay approx 0.7% for advice platform fee and manager fee with our model portfolio, less than many industry funds AND with advice built in. We run on asset based advice fee and it has worked fine. Every part of the advice chain is reducing costs except for the fund manager . At one thousand or one million fund managers charge the same ICR. It’s about time that they share the load. ....

Phil
April 30, 2018

I agree you can run that pricing model Paul. And agree the active fund managers must come down. My question with your pricing model and it's a genuine question, something I grapple with - for the most part I would prefer active management, but the pricing you've indicated which I agree is a good target, sort of forces you to index costs. I find this makes you almost persuade yourself that index is ok, even if your philosophy is active. i.e. it's another conflict really that drips down to your investment process, sometimes by stealth. Hence, the problem that comes with all forms of vertical integration, you can end up forming a policy to suit the business model.

Peter C
April 29, 2018

Thanks for a great summary regarding the recent events of the Royal Commission. Hopefully it will remove commission based remuneration for financial advisors where there is a clearly a conflict of interest. No wonder genuine financial advisors have had difficulty separating themselves from second hand car salesman.

As an individual trying to find quality information, I had a lot of difficulty getting much regarding wrap platforms. Most google searches turned up websites marketing to financial advisors - I was suspicious. Reviews from the government’s Money Smart and Choice were not particularly supportive of wrap platforms for the indvidual investor. Rather it seemed a technology to make the job of the advisor easier while inconspicuously taking a percentage of assets under management.

I eventually moved everything to Vanguard. My advisor still charges a percentage but has reduced it and gives me a bill. While the difference in fees I pay is probably minimal, it is transparent and I think the financial advisor now has to justify the fee rather than hoping I just leave things as they are.

I am more than happy to pay for quality unbiased advice and hopefully changes from the Royal Commission will be the start for professionals from the financial industry earning back the trust from their clients!

John Ashton
April 27, 2018

In 1231The King of Sicily, Ferdinand II, legislated in the Edict of Salerno to make illegal the physician and the apothecary being the same. He could see the clear conflict of interest.This separation became the model for Europe and the rest of the world. The financial industry has some catching up to do.

Jimmy
April 26, 2018

"There are wrap platforms available which cap the fees or have a low 0.1% fee above a certain amount"

Most wrap platforms now have caps on the maximum fee and offer family fee aggregation across couples & some associated entities. I'm interested to understand if Graham means that the platform only charges 0.1% of the entire balance or if it's only 0.1% once the balance gets above a certain level...

Graham Hand
April 26, 2018

Hi Jimmy, without knowing the fee structure of every wrap, I mean only 0.1% once the balance rises above a certain level. One genuine IFA told me he has negotiated a full-service wrap for his clients with a cap even for multi million dollar accounts, and an upper tier cost of 0.1% before the cap. His business then charges an hourly fee-for-service with no additional percentage-based fees. So my question is: how many aligned financial planners will put clients into a structure like this?

Phil
April 30, 2018

Hi Graham,

I think there are quite a few Wrap's with fee caps, and quite a few without them. It's probably more a question of whether the cap is too high. I think you would need quite a bit of FUM to negotiate a special price with a platform.

 

Leave a Comment:

     

RELATED ARTICLES

Royal Commission 1: How the tone was set

banner

Most viewed in recent weeks

10 reasons wealthy homeowners shouldn't receive welfare

The RBA Governor says rising house prices are due to "the design of our taxation and social security systems". The OECD says "the prolonged boom in house prices has inflated the wealth of many pensioners without impacting their pension eligibility." What's your view?

House prices surge but falls are common and coming

We tend to forget that house prices often fall. Direct lending controls are more effective than rate rises because macroprudential limits affect the volume of money for housing leaving business rates untouched.

Survey responses on pension eligibility for wealthy homeowners

The survey drew a fantastic 2,000 responses with over 1,000 comments and polar opposite views on what is good policy. Do most people believe the home should be in the age pension asset test, and what do they say?

100 Aussies: five charts on who earns, pays and owns

Any policy decision needs to recognise who is affected by a change. It pays to check the data on who pays taxes, who owns assets and who earns the income to ensure an equitable and efficient outcome.

Three good comments from the pension asset test article

With articles on the pensions assets test read about 40,000 times, 3,500 survey responses and thousands of comments, there was a lot of great reader participation. A few comments added extra insights.

The sorry saga of housing affordability and ownership

It is hard to think of any area of widespread public concern where the same policies have been pursued for so long, in the face of such incontrovertible evidence that they have failed to achieve their objectives.

Latest Updates

Strategy

$1 billion and counting: how consultants maximise fees

Despite cutbacks in public service staff, we are spending over a billion dollars a year with five consulting firms. There is little public scrutiny on the value for money. How do consultants decide what to charge?

Investment strategies

Two strong themes and companies that will benefit

There are reasons to believe inflation will stay under control, and although we may see a slowing in the global economy, two companies should benefit from the themes of 'Stable Compounders' and 'Structural Winners'.

Financial planning

Reducing the $5,300 upfront cost of financial advice

Many financial advisers have left the industry because it costs more to produce advice than is charged as an up-front fee. Advisers are valued by those who use them while the unadvised don’t see the need to pay.

Strategy

Many people misunderstand what life expectancy means

Life expectancy numbers are often interpreted as the likely maximum age of a person but that is incorrect. Here are three reasons why the odds are in favor of people outliving life expectancy estimates.

Investment strategies

Slowing global trade not the threat investors fear

Investors ask whether global supply chains were stretched too far and too complex, and following COVID, is globalisation dead? New research suggests the impact on investment returns will not be as great as feared.

Investment strategies

Wealth doesn’t equal wisdom for 'sophisticated' investors

'Sophisticated' investors can be offered securities without the usual disclosure requirements given to everyday investors, but far more people now qualify than was ever intended. Many are far from sophisticated.

Investment strategies

Is the golden era for active fund managers ending?

Most active fund managers are the beneficiaries of a confluence of favourable events. As future strong returns look challenging, passive is rising and new investors do their own thing, a golden age may be closing.

Sponsors

Alliances

© 2021 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. Any general advice or ‘regulated financial advice’ under New Zealand law has been prepared by Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892) and/or Morningstar Research Ltd, subsidiaries of Morningstar, Inc, without reference to your objectives, financial situation or needs. For more information refer to our Financial Services Guide (AU) and Financial Advice Provider Disclosure Statement (NZ). You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.

Website Development by Master Publisher.