Money Management (January 19, 2012)

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Vol.26 No.1 | January 19, 2012 | $6.95 INC GST

The publication for the personal investment professional

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FOFA PJC SUBMISSIONS: Page 4 | OUTLOOK FOR 2012: Page 12

Legal test looms if FOFA unamended

By Mike Taylor THE underlying legality of the Government's Future of Financial Advice (FOFA) changes will almost certainly be tested in the event the legislation passes the Parliament without amendment.

However, that legal test is likely to fall short of a High Court challenge.

While some sections of the financial planning industry are continuing to call for a High Court challenge to the FOFA legislation, mainstream opinion is that the sector should await the findings of the Parliamentary Joint Committee (PJC) reviewing the legislation and any resultant amendments.

Even if the PJC fails to deliver on the necessary amendments, Money Management understands the key financial planning organisations are unlikely to move to immediately support a High Court challenge and are more likely to at first obtain an opinion from high-

ranking legal counsel.

Only some elements of the FOFA bills are regarded as capable of legal challenge, with the most obvious being those which serve to retrospectively alter the contractual arrangements between planners and their clients.

While a survey conducted by Money Management in the middle of last year found respondents were strongly in favour of legally challenging the FOFA bills, there has been a general acknowledgement that the cost of pursuing such action is beyond the normal financial capacity of the organisations representing financial planners.

The PJC has received more than 70 submissions regarding the FOFA bills, with the majority expressing concerns about key elements of the Government's legislation and recommending amendments to avoid unintended consequences.

Those submissions have also served

Richard Klipin to underline the continuing deep divide between the retail segment of the financial services group and the industry funds and not-for-profit sector.

The PJC will begin its public hearings in Sydney next week, with the key planning groups expected to press not only for amendments but for a delay in the implementation of the legislation to

Plenty of buyer demand as practice valuations hold up

By Chris Kennedy THERE is plenty of demand in the market for quality financial planning businesses, as well as an increasing number of enquiries from those looking to sell in preparation for whatever Future of Financial Advice (FOFA) reforms may bring.

The managing director of practice sales consultancy Kenyon Partners, Alan Kenyon, said his business is seeing strong buyer sentiment, particularly out of Queensland, with offers for some businesses of 3.3 times recurring revenue and up to six times EBIT (earnings before interest and tax).

There are also more high quality businesses coming up for sale in the $2 million to $6 million range, he said.

“We’re seeing demand from those wanting scale and other business opportunities,” he said.

Lots of business owners are looking to diversify their revenue streams in the wake of the global financial crisis, he added.

FOFA is having the greatest impact in the area of client book sales rather than practice sales, as practice owners look to prop up businesses prior to the introduc-

Alan Kenyon tion of new reforms and add revenue to the top line in the hopes that it will filter through to the bottom line.

Sellers who would otherwise have been looking to come to market around the time of the GFC, but were able to defer, are gradually coming back to the market. However, they may still be waiting to see what the implications of FOFA will be, and are holding out for the right time to sell and looking at their succession options, he said.

Kenyon said valuations hadn’t really declined since the GFC, in spite of FOFA. “The revenues took a hit – not the multiples,” he said.

Plenty of businesses are still selling at or over three times recurring revenue, while client books are going for 2-2.75 times recurring revenue, he said.

Bendigo Wealth senior manager – Business Partners Program, Joshua Parisotto, said he is seeing a lot more enquiries at the moment, largely from those looking to prepare their businesses for sale once there is more certainty around FOFA. Most of the sales Bendigo Wealth has been involved in have been priced on EBIT rather than recurring revenue, and ranged from around four to six times, he said.

Both Parisotto and Kenyon said the key factor in preparing a business for sale is improving the back-end efficiency, where the biggest and easiest gains can be made – for example, getting all the back office systems in alignment.

General manager of independent dealer group Premium Wealth Management, Paul HardingDavis, said he also hadn’t noted any impact on prices due to FOFA. A number of practices may be coming up for sale where people are trying to get the transition done now, because they don’t want to go through another two years of change and regulation – although there may still be many adopting a ‘wait and see’ approach, he said.

allow for an orderly transition to the new regime.

As well, the Association of Financial Advisers (AFA) has argued that the disjointed manner in which the legislation has been handled warrants the Treasury conducting a study of the impact of the legislation in terms of both the cost of advice and the quality that will be delivered.

The AFA is also suggesting that a summit be convened involving all the relevant stakeholders to review the legislation and to deal with elements not covered by FOFA, including the taxdeductibility of advice and restricted use of the term ‘financial planner’.

AFA chief executive Richard Klipin said his organisation believed such a summit was justified in circumstances where the process around the development of the FOFA bills had been poor and had given rise to a number of poor outcomes.

‘Phoenixing Bill’ too tame on planners?

By Andrew Tsanadis

WHILE industry bodies support the Government’s proposed regulatory amendments to accelerate the wind-up of so-called ‘phoenix’ companies and claim the issue is not a major concern for financial planners, a senior lawyer has warned the Government move has not gone far enough in addressing financial planning issues.

According to the parliamentary secretary to the Treasurer, David Bradbury, the practice known as ‘phoenix activity’ allows insolvent companies to simply set up a new business using a similar company name, sometimes located in the same premises and with the same staff and clients.

The ‘Phoenixing Bill’, released for public consultation in December, will give the Australian Securities and Investments Commission (ASIC) the administrative power to wind up abandoned companies and to facilitate the online publication of notices and gazettes relating to external administrations, Treasury stated.

Directors involved in these activities exploit the concept of limited liability in the Corporations

Act 2001, which stipulates that when a company fails, those behind the company, including directors and shareholders, are not liable for the company’s debts.

Association of Financial Advisers chief executive Richard Klipin said such fraudulent activity is not something that he has come across among financial planning dealer groups. Although he believes the provisions in the current Act are sufficient to protect financial advisers, he supports the move to amend the Act. “Phoenix companies tend to leave a trail of devastation, from creditors to employees – [so] anything that goes to supporting the community is important,” he said.

In conjunction with the ‘Phoenixing Bill’, the ‘Similar Names Bill’ was also released for consultation and is intended to impose personal liability upon directors for the debts of phoenix companies.

Steve Harris, commercial general council with law firm Maurice Blackburn, argues that this bill is the real concern, as it does not go far enough in preventing phoenixing in the financial Continued on page 3

Editor

Reed Business Information Tower 2, 475 Victoria Avenue Chatswood NSW 2067 Mail: Locked Bag 2999 Chatswood Delivery Centre Chatswood NSW 2067 Tel: (02) 9422 2999 Fax: (02) 9422 2822 Publisher: Zeina Khodr Tel: (02) 9422 2198 zeina.khodr@reedbusiness.com.au Managing Editor: Mike Taylor Tel: (02) 9422 2712 mike.taylor@reedbusiness.com.au News Editor: Chris Kennedy Tel: (02) 9422 2819 chris.kennedy@reedbusiness.com.au Features Editor: Milana Pokrajac Tel: (02) 9422 2080 milana.pokrajac@reedbusiness.com.au Journalist: Tim Stewart Tel: (02) 9422 2210 Journalist: Andrew Tsanadis Tel: (02) 9422 2815 Melbourne Correspondent: Benjamin Levy Tel: (03) 9527 7392 ADVERTISING Senior Account Manager: Suma Donnelly Tel: (02) 9422 8796 Mob: 0416 815 429 suma.donnelly@reedbusiness.com.au Account Manager: Jimmy Gupta Tel: (02) 9422 2850 Mob: 0421 422 722 jimmy.gupta@reedbusiness.com.au Adelaide Agent: Sue Hoffman Tel: (08) 8379 9522 Fax: (08) 8379 9735 Queensland Agent: Peter Scruby Tel: (07) 3391 6633 Fax: (07) 3891 5602 PRODUCTION Junior Designer/Production Co-ordinator – Print: Andrew Lim Tel: (02) 9422 2816 andrew.lim@reedbusiness.com.au Sub-Editor: Marija Fletcher Sub-Editor: Daniel Winter Graphic Designer: Ben Young Subscription enquiries: 1300 360 126 Money Management is printed by Geon – Sydney, NSW. Published every week, recommended retail price $6.95 Subscription rates: 1 year A$280 incl GST. Overseas prices apply.

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Fitting the FOFA bills

A

ny reading of the more than 60 submissions to the Parliamentary Joint Committee (PJC) reviewing the Future of Financial Advice (FOFA) bills reveals that members of the committee are faced with some challenging decisions.

If those parliamentarians put aside their political affiliations and ideology and base their decisions upon the weight of arguments contained in the submissions, then they will back some key amendments to the FOFA bills. In particular, they will look to eliminate some of the contradictions and timing issues.

If the financial planning industry is lucky, the parliamentarians making up the PJC will adopt the same sort of objective approach to the issues being reviewed which informed the bipartisan report issued by the first Ripoll Review flowing from the collapse of Storm Financial.

However, the political factors influencing both the balance of power in the Parliament and the balance of power in the Australian Labor Party caucus make it much more likely that the committee will fail to find the common ground necessary to agree the basis for significant change.

In the absence of a bipartisan agreement

The planning industry “must accept that while a Coalition Government might seek to rescind elements such as the twoyear opt-in, the vast majority of the FOFA regime and the business models it dictates will remain intact.

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on the need for change, the Government will feel free to offer some token softening of its bills, but to act largely as it sees fit.

It is in these circumstances that planners – if they have not done so already – should pragmatically assess what it is they need to do to survive and thrive over the next 12 to 24 months. On the available evidence, most seem to have done so.

The Government may allow a transition period of up to 12 months, but this is by no means guaranteed and is a concession which has been openly opposed by a

number of the industry superannuation funds.

There is no guarantee that the ALP will lose the next federal election, but the polls have been unremittingly bad for the Prime Minister, Julia Gillard. Further, Australian political history suggests such deeply entrenched trends are rarely reversed.

Indeed, history suggests that even if the ALP were to again change leaders, it would be most unlikely to be able to change the ultimate outcome at the ballot box.

Nonetheless, the financial planning industry must accept that it faces up to 24 months of dealing with the FOFA regime which evolves out of the current Parliament – the amount of time it is likely to take before a Coalition Government might move for change.

Further, the planning industry must accept that while a Coalition Government might seek to rescind elements such as the two-year opt-in, the vast majority of the FOFA regime and the business models it dictates will remain intact.

One way or another, 2012 marks the beginning of long-term change for financial planners.

- Mike Taylor

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News

End-investor rebate risks in FOFA bills

By Mike Taylor THE Government's Future of Financial Advice (FOFA) bills, as currently drafted, carry with them the risk that platform providers may cease rebating volumebased benefits to the end investor.

Vanguard Investments has used its submission to the Parliamentary Joint Committee reviewing the FOFA bills to warn that the wording of the bills may give rise to unintended consequences with respect to volume-based benefits.

Pointing to the fact it had urged there should be a requirement to pass any volume-based benefit from product manufacturers to platforms through to end investors, the Vanguard submission said this was consistent with the current

“

There is a risk that platform providers that currently rebate these payments to investors will cease to do so.

- Vanguard Investments

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practice of some platform operators.

It said even rebates that were considered by platforms and fund managers to reflect reasonable scale efficiencies might influence the product options that an adviser gets access to through

platforms, unless the cost benefit was delivered through to the end investor.

However, it said that in the FOFA 2 Bill, the exemptions from the definition of a volume-based shelf-space fee had been broadened from the exposure d ra f t , re s u l t i n g i n t h e re b e i n g n o requirement to rebate any fee or benefit to the end investor. " T h e re i s a r i s k t h a t p l a t f o r m providers that currently rebate these payments to investors will cease to do so, as these reforms permit the platform provider to retain the payment," the Vanguard submission warned.

It said the legislation also provided ver y little guidance on what was a "reasonable fee" or "an amount that may reasonably be attributed to effi-

ciencies gained".

The submission said, on that basis, it was "difficult to see these refor ms bringing about any change in market practices, with such wide and undefined exemptions".

It said the Explanatory Memorandum suggested that platfor m providers should take into account the relative bargaining power between the product manufacturer and the platform operator in determining whether a payment represented the reasonable value for scale efficiencies.

However, it said this suggested that a product manufacturer might be able to continue to exert influence over the products offered to investors through platforms.

‘Phoenixing Bill’ too tame on planners?

Continued from page 1

planning industry.

Harris said the bill is strictly limited to similar names, but quite often the issue is that a phoenix company sets up under an entirely new name and continues the business of the failed company.

“It’s a serious failing of the bill. Quite often a rogue financial planner will use an entirely new name because the old name has been tainted by previous unlawful activities,” he said.

The amendments needed to take into account the directors, employees and clients of the new financial planning practice rather than just the credit history, he said.

Harris added that the debts of the failed company remain unresolved while the directors of the new company remain personally liable for the company that is

trading under a similar name.

Klipin said that breaches of ASIC’s regulatory guidelines and those set out in the Australian financial services licence were more prevalent than phoenixing.

All dealer groups must have a very extensive risk management framework before they allow advisers to come under their authority, and all advisers work to an approved product listing that operates to filter such companies, he added.

The Financial Planning Association of Australia has not made a submission to Treasury on the proposed amendments. It declined to comment on the effectiveness of such legislative changes, indicating that ‘phoenixing’ was not a major concern for the industry body given the debate over the Future of Financial Advice draft legislation.

Apology to David Huggins ON 28 October 2011 Money Management published an article in which various financial advisers expressed criticisms of persons and entities they believed were attacking the financial planning industry.

In the course of that article, reference was made to an article published by David Huggins in the West Australian newspaper.

We did not intend by the publication of those views to assert that Mr Huggins, who is a lawyer specialising in resolving disputes relating to financial advice, was involved in any campaign with others against the financial services industry. Further, we did not intend to suggest that Mr Huggins was an ‘ambulance chaser’ or would put his own interests ahead of his clients.

If any such meaning was inferred, we apologise to Mr Huggins. www.moneymanagement.com.au January 19, 2012 Money Management — 3

News

Law Council warns on FOFA deficits

By Mike Taylor THE Law Council of Australia has warned that the Government's Future of Financial Advice (FOFA) changes risk going further than is necessary to achieve their core outcomes.

In a submission filed with the Parliamentary Joint Committee reviewing the FOFA bills, a specialist superannuation committee within the Law Council said it was concerned that the likely impact of the legislation "will be much broader than is necessary to ensure that retail clients have access to unbiased financial product advice".

At the same time, the submission argues that the legislation introduces a significant degree of uncertainty for financial

advisers and product issuers and that if it is passed in its present form it will "have unintended and potentially negative consequences on superannuation funds and their members".

Among the core concerns cited by the Law Council committee were the breadth of the Australian Securities and Investment Commission's discretion to refuse to grant an Australian financial services licence, to cancel a licence and to make a banning order; the apparent “mislabeling” of the proposed best interests obligation and the associated provisions; the prospect that product fees will be included in ongoing fee arrangements; the breadth of the definitions of conflicted remuneration, platform opera-

tor and volume-based shelfspace fee; and the failure of the bill to address the issue of adviser fees being deducted from members’ interests in superannuation funds.

The Law Council submission also points to deficits in the drafting of the FOFA bills with respect to existing forms of remuneration for financial advisers, and the manner in which the legislation imposes expectations on licensees and their representatives.

"It should not be left to a licensee or a representative of a licensee to argue that a section of the Act or a Regulation is unconstitutional," the submission said. "It is incumbent on the Government to take advice and determine the extent to which it

must protect existing remuneration rights.

"It is not appropriate to leave it to individual action by licensees or their representatives," it said.

AustralianSuper urges against FOFA delay AUSTRALIA's largest industry fund, AustralianSuper, has urged against any delays to the implementation of the Government's Future of Financial Advice (FOFA) changes, arguing the financial advice industry has had sufficient time to accommodate itself to the regime change.

In a submission filed with the Parliamentary Joint Committee reviewing the FOFA bills, AustralianSuper chief executive Ian Silk said the financial services sector had had a long period of notice and consultation in relation to the reforms.

"We do not see it to be necessary, nor in the best interests of consumers of financial products, for these reforms to be delayed any further," Silk's submission said.

"We note that sections of the superannuation industry might have an interest in delaying these reforms so that they coincide with the Stronger Super reforms," he said. "This delay would allow another 12 months of financial advisers receiving commissions and volume bonuses on compulsory superannuation of Australian workers.

"It would also allow another 12 months of financial advisers receiving commissions and volume bonuses on investments made by consumers in a range of other financial products that have nothing to do with superannuation."

The AustralianSuper submission said the fund did not believe that a case had been made out "why consumers of all financial products should be

paying commissions and volume bonuses to financial advisers for another 12 months".

The submission also sought to argue that no link exists between Stronger Super and the provision of intra-fund financial advice.

"To consider delaying the commencement of the FOFA reforms because of the introduction of the intra-fund advice reforms as a component of the Stronger Super reforms would be illconceived and based on inaccurate information," it said.

"We suggest also that all aspects of intra-fund advice reforms need to take effect from 1 July, 2012, in order for them to work properly," the submission said.

FOFA bills fail to meet financial advice objectives – FPA THE Financial Planning Association (FPA) has warned the Federal Government its Future of Financial Advice (FOFA) bills, as currently drafted, are unlikely to reach their policy objectives of improving the quality of financial advice and strengthening investor protection.

In a submission to the Parliamentary Joint Committee reviewing the FOFA legislation, the FPA has referenced the policy objectives first outlined by the former Minister for Financial Services, Chris Bowen, and has pointed to the reasons why those objectives are unlikely to be met.

Further, the FPA said the formulation of a best interest

duty was "never going to be and neither should it be the avenue in which financial advice was going to be made more accessible and affordable".

"The Government had promised that this would be an outcome of FOFA but at this stage we agree with many in the profession that it is clear that Government is unlikely to meet this policy objective with the Bill as drafted," the submission said. "The FPA therefore submits that the FOFA reforms fail to deliver on the second guiding principle of increasing access to financial advice to more Australians."

The submission pointed to the official Regulatory Impact Statement (RIS) attaching to the

legislation which stated that "it is expected that adviser remuneration, as well as the number of advisers, will reduce over the long term".

It said the RIS had quoted figures produced by Rice Warner that financial adviser numbers will reduce from 15,400 to 8,600 in 2024, "which the FPA submits is actually counter-productive to the proposed guiding principle and therefore FOFA, as a result, has or will partly fail in its proposed objective".

While the FPA submission said the organisation welcomed the overall FOFA reforms, it made clear it remained strongly opposed to opt-in.

It said it was apparent that

4 — Money Management January 19, 2012 www.moneymanagement.com.au

the key objectives of 'improved transparency' and 'investor protection' could be achieved using just a few of the measures (proposed in the FOFA bills (tranche 1 and 2): that is, through the 'best interest' provisions and the 'removal of conflicted remuneration'.

"The FPA do not believe the client renewal 'opt-in' measure is necessary in the new world (that will be governed by the 'best interest' measure with no commissions) and merely poses risks to the client and duplicates administration (in the case of the disclosure requirements), leading to an increase in the cost of financial advice for all Australians," the submission said.

NAB/MLC warning on high cost of FOFA fee disclosure THE National Australia Bank and its wealth management arm MLC have warned that the annual fee disclosure arrangements contained in the Future of Financial Advice (FOFA) legislation could add millions of dollars to the cost of the financial advice process.

In a submission filed with the Parliamentary Joint Committee reviewing the FOFA legislation, MLC said it did not support the proposed annual Fee Disclosure Statement (FDS), "particularly given the amount of disclosure already required".

"However, if it is introduced, we consider it should only be required for new clients from the commencement of the FOFA reforms," the submission said.

"MLC conservatively estimates that the cost to implement FDS for MLC super (ie, excluding Managed Investment Schemes) will be between $3-6 million and $500,000 ongoing per annum," it said.

"MLC believes that this requirement was not intended by the original policy and is unlikely to deliver a superior customer outcome, yet imposes significant costs on the advice process," the submission said.

It said the FDS would be a duplication of the existing system and would require "extensive and expensive system changes, adding significant costs to the provision of financial advice to the industry and ultimately to consumers".

"It should be noted that existing product disclosure in superannuation and Managed Investment Schemes provide a dollar fee disclosure, with the exclusion of whole of life and endowment products," the submission said.

Elsewhere in submission, NAB/MLC said there should be an alignment of the commencement of the FOFA ban on conflicted remuneration with the introduction of MySuper as the mandatory fund (for contributions for employees who have not exercised a choice in relation to a fund); and a transitional two-year implementation timeframe for both FOFA and MySuper before sanctions apply.

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News Financial planning practice values stabilise: Radar Results

By Chris Kennedy FUTURE of Financial Advice (FOFA) reforms have not had as great a negative impact on financial planning practice valuations as anticipated, according to financial planning consultancy firm Radar Results.

Although valuations have been trending down since the onset of the global financial crisis, the impact of FOFA has been less than expected due to the Government’s watering down of reforms,

according to Radar Results principal John Birt.

Some financial planning practice principals have suggested that the valuations of financial planning businesses or client registers may even increase from now on, possibly due to the effects of grandfathering, but it is hard to see how as grandfathering has always been in place, Birt said.

There remains an expectation among those looking to sell that practices will receive three times recurring revenue, but this is totally unrealistic, according to Birt.

Each business is different and will consequently earn a different price, but on average valuations have trended down to around 2.5 times recurring revenue and levelled off, he said. While a year or two ago it was rare for a practice to go for less than three times recurring revenue, now it is rare for one to go for more than that, he added.

There had been no significant change in valuations in the last six months as the Government has announced concessions to the FOFA package, he said.

Opt-in to cost $95 per client per year

By Mike Taylor

THE cost of the Government’s two-year opt-in arrangements for financial planners would be $95 per client per year and not the "ridiculous" $11 cost adopted by the Federal Government.

That is the assessment contained in a submission to the Parliamentary Joint Committee (PJC) reviewing the Future of Financial Advice bills compiled by Matrix Planning Solutions managing director, Rick Di Cristoforo.

The Matrix submission argues that the proposed two-year opt-in arrangements are not necessary, but if they must be introduced should be extended to three years, and preferably five years with an annual fee statement.

It said this would recognise that advice strategies need the fullness of a business/market cycle to evolve and demonstrate long-term goal achievement.

The submission said that while Matrix had noted the commentary from Financial Services minister Bill Shorten around

Rick Di Cristoforo the proposed flexibility of the opt-in process, this had not been reflected in the legislation, which had proved quite prescriptive.

"We would ask that when legislation is presented to the house for vote, and if it is not amended to recognise previously stated formats such as recordable and other electronic forms of disclosure and renewal, that it is argued that it do so by the PJC," the Matrix submission said.

It said that as a matter of interest,

Light at end of the tunnel: IBISWorld DESPITE high levels of global debt there are signs of light at the end of the tunnel, according to the chairman of business research house IBISWorld, Phil Ruthven.

Although the world’s G20 nations account for 77.5 per cent of global debt they are mostly able to service this debt with a small share of taxes at the expense of social benefits, Ruthven said. The problem is Portugal, Ireland, Italy, Greece and Spain, but together they account for just 7.5 per cent of world debt – not really enough to wreck global markets, he said.

But the Australian economy should perform reasonably well this year, with the mining, infrastructure (engineering and construction), health, telecommunications, finance, professional services and the new information industries providing plenty of momentum to offset the slower

industries such as manufacturing, agriculture and hospitality, he said.

The Australian share market could even be poised in 2012 to take a big leap in 2013, with profits again on the rise and the price-earnings ratio coming off a subdued level in 2011. This all leaves room for a spectacular jump when confidence returns to London and New York – from where Australia takes its lead, he said.

There is still a lot of upside available, perhaps as much as a 50 per cent rise in the All Ords in the next few years, according to Ruthven.

The Australian economy would benefit from having a stable, more commercially realistic and far-sighted government and a better industrial relations scene, but these might emerge in the not too distant future, he added.

Matrix had estimated the cost of opt-in (including advice time, administration time, and system and process development costs) at approximately 40 to 45 minutes per client or a minimum of $95 per client per year.

"We thoroughly refute the ridiculous assertion of an $11 opt-in charge, as it in no way properly takes into account any part of the process other than the preparation of the opt-in notice and a brief contact between adviser and client.

"There is clearly more to the process and issues management around opt-in than this," the Matrix submission said.

The Matrix document also pointed to what it said was a clear case of double standards in that opt-in, transparent fee disclosure and scaled advice were proposed to prevent cross-subsidisation of clients within an individual adviser’s client book, regardless of whether it is in the clients’ best interest, yet it was seemingly acceptable that cross-subsidisation of advice was acceptable within certain financial products and providers.

ASFA concerned about director remuneration models

By Milana Pokrajac

THE remuneration of super fund directors should be publicly disclosed, according to the Association of Superannuation Funds of Australia (ASFA).

In its submission to a discussion paper released by the Australian Prudential Regulation Authority (APRA), ASFA noted this requirement should not focus on the person’s total remuneration, but rather on the component which pays them for carrying out their duties as a trustee director.

In September 2011, APRA proposed a requirement for all Responsible Superannuation Entity (RSE) licensees to establish and maintain a Board Remuneration Committee, which would put in

6 — Money Management January 19, 2012 www.moneymanagement.com.au

place a remuneration policy.

This Board would help trustee directors avoid conflicts of interests and socalled misalignments of duties.

“Our concern is that, unless directors of trustee boards are remunerated for being a trustee, then where they are appointed by virtue of a relationship between their employer and the RSE licensee, they will have conflicting priorities and will not be in a position to act with the required independence of mind,” ASFA stated.

ASFA said an effective remuneration policy should free up directors to maintain the necessary independence of mind when acting as the trustee in order to regard the best interests of members of the fund concerned.

Another Commonwealth Financial Planning adviser banned

THE Australian Securities and Investments Commission (ASIC) has accepted an enforceable undertaking from a Commonwealth Financial Planning adviser who failed to meet his professional obligations.

Commonwealth FP employee Simon L a n g d o n o f Mi n d a r i e, We s t e r n Australia, has agreed not to provide financial services for two years. He has also agreed to undertake professional education requirements, followed by 12 months of strict supervision, should he re-enter the financial services industry.

Between April 2008 and June 2010, Langton was found to have failed to meet obligations including: completing financial needs analysis documentation (and allowing clients to sign blank financial needs analysis docum e n t a t i o n ) ; m a k i n g re a s o n a b l e inquiries in relation to the personal circumstances of clients before implementing advice; providing clients with statements of advice; providing statements of advice within a reasonable time period; and disclosing fees in a statement of advice.

T h i s f o l l ow s l a s t O c t o b e r’s announcement that Commonwealth FP had offered an enforceable undertaking to ASIC in an attempt to improve its risk framework. This followed the highprofile case of former Commonwealth FP adviser Don Nguyen, who was last March banned for seven years by ASIC.

News

FSC urges disclosure of superannuation remuneration

By Mike Taylor SUPERANNUATION funds should be required under the new Stronger Super arrangements to disclose the remuneration of responsible persons such as trustee executives, according to a Financial Services Council (FSC) submission filed with the Australian Prudential Regulation Authority (APRA) last week.

The submission, responding

to an APRA discussion paper, argues that while the Government's Super System Review process indicated its support for remuneration disclosure, it ultimately did not make an explicit recommendation.

The FSC said that this was despite the fact that the remuneration of responsible persons by superannuation funds was one of the most relevant issues to members.

"Remuneration of responsible persons which is drawn

from the trust should be disclosed to members," it said.

"Remuneration which is not paid from trust assets should not be disclosed unless it is captured by other disclosure requirements."

The submission said that, for instance, where executives were required to disclose their remuneration under the Corporations Act 2001 or the ASX Corporate Governance Guidelines, this should continue to apply to listed entities

Australia worst of G10 currencies: HSBC

By Chris Kennedy

THE Australian dollar presents the least appealing investment opportunity of any of the G10 currencies this year, according to an HSBC report.

The report was produced assuming that the euro would not break up and no countries would leave the euro.

This belief was based on factors including a strong political will to make the euro a long-term success and a likelihood for the euro to continue showing resilience due to its strong external position, according to HSBC. The Australian dollar was rated the worst of the G10 currencies because it is strongly overvalued, and will likely average well below parity against the US dollar in 2012, according to HSBC. Global risks and slowing growth in Australia's Asian trading partners also recently resulted in easing policy, with

further rate cuts likely.

The currency has also been strongly correlated with the ‘risk on-risk off’ factor for some time, and once the eurozone news flow begins to stabilise the "risk off" dynamics will push the Australian dollar lower, HSBC stated.

The Norwegian Krone was one of the best rated G10 currencies. It is regarded as a true safe haven due to factors including "a large current account surplus, a low sovereign risk profile, and a budgetar y position which is second to none."

The Canadian dollar was also preferred as the best option when taking liquidity constraints into consideration. Although it is trading near fair value, it has a strong fiscal position and a stable financial system, with twice the turnover of the Swedish Krona, HSBC stated.

In Asia HSBC favoured China, Singapore and Malaysia while avoiding India and Indonesia. Columbia and Brazil provided the best opportunities in Latin America, with Argentina and Chile at the other end of the scale. In emerging Europe HSBC preferred Turkey and Hungary but avoided the Czech koruna.

Australian CFA members less pessimistic than global peers AUSTRALIAN members of the Chartered Financial Analyst (CFA) Institute are less pessimistic about the global economy than members globally, according to a large survey of members.

Excluding Australia, members from the Asia Pacific were the most pessimistic, according to a survey conducted in November 2011 that received almost 3,000 responses from around 60,000 invitations to complete the survey.

Results were weighted according to geography.

The survey aimed to measure the mood of CFA charterholders and members on the outlook for world capital markets and the ongoing struggles associated with the global credit crisis. It found Australian members were more confident about prospects for the global market outlook and their local market's potential for expansion.

Overall only one third of respondents expected the global economy to expand, while almost that many thought the global economy would contract. More than three quarters predicted no improvement in the current

sovereign debt crisis.

More than half of respondents expected equities to be outperformed by other asset classes throughout the year, although US respondents were the most optimistic about equities. For equity markets

8 — Money Management January 19, 2012 www.moneymanagement.com.au

within the Asia Pacific, less than one third of respondents thought equities would be the best-performed asset class.

Respondents largely predicted no improvement in the integrity of global capital markets. There was also a huge jump in the number of respondents who thought improved regulation and oversight of global systemic risk was the most needed regulatory action, up from 23 per cent in the previous survey to 38 per cent.

More than 20 per cent of respondents thought the most serious ethical issue facing global markets in 2012 was the "mis-selling of products by financial advisers", followed by the "disclosure and use of financial derivatives by financial firms" (20 per cent). Only market fraud such as insider trading (22 per cent) was deemed more serious.

which contained Registrable Superannuation Entity Licensees.

Elsewhere in its submission, the FSC also called for a narrowing of the 'responsible person' definition so that it solely captured trustee directors and responsible officers and excluded service providers.

It argued that responsible officers, as determined by the trustee, should be defined as having a degree of control over the superannuation entity.

AMP GID to remain standalone business under Suncorp

SUNCORP has announced that the recently-acquired AMP General Insurance Distribution (AMP GID) business has been established as a standalone subsidiary of Suncorp.

The new managing director of AMP GID is Gerard McDermott, previously Suncorp Commercial Insurance's executive general manager, direct distribution, administration and servicing.

Brian Fulmer, the previous managing director of AMP GID, will remain on the board and has been appointed executive adviser AMP GID. "This acquisition gives us the opportunity to become the recognised leader in the authorised representative segment," said Suncorp's Commercial Insurance chief executive Anthony Day. "The authorised representative proposition can become market leading and achieve a strong growth trajectory. This business will enable us to more effectively grow our general insurance market and meet the needs of the agency channel."

McDermott said that under the new structure, by operating at arm's length from the insurance operations, AMP GID's ability to continue accessing products that are not offered by the Suncorp Group (such as CGU and NTI) is greatly enhanced.

The business will service a network of approximately 700 authorised representatives dedicated to selling general insurance products underwritten by GIO and other authorised insurers, according to Suncorp. The AMP brand will be withdrawn from January 2013 for new business and a new brand established, Suncorp stated.

News Financial planners more willing to recommend industry super funds

By Mike Taylor MORE financial planners are recommending that their clients direct their investments to industry super funds, according to new research released by Roy Morgan.

The research, contained in the Roy Morgan Superannuation and Wealth Management Report, found that in the 12 months to June last year, 10 per cent of all superannuation products that switched to industry super funds came through a financial planner.

It said this represented an increase from the 7 per cent recorded in the prior 12-month period.

The Roy Morgan research also revealed that most people choosing to switch superannuation funds were seeking financial advice before doing so.

It said that almost two thirds of those thinking about switching superannuation sought some sort of financial advice when doing so, with 42 per cent relying on a professional such as a financial planner or accountant, while 39

per cent sought advice via their employer.

The research also revealed the continuing importance of employers in the broader superannuation dynamic, with the research revealing that employers continue to be the primary channel that Australians rely on when deciding on their superannuation fund.

It found that over the past five years, approximately 85 per cent of superannuation products were obtained through the employer, while only approximately 11 per cent relied on a financial planner or financial adviser.

The research also revealed that while investors were generally happier with the performance of their managed funds, their satisfaction with the performance of their superannuation funds had not significantly improved since the global financial crisis.

It found the level of satisfaction amongst members who held a managed fund (excluding superannuation) had continued a

steady growth since the GFC, with 63.9 per cent satisfied with the financial performance in the six months to June 2011.

It said the proportion of those dissatisfied had also continued to decline, and in the six months to June 2011 was only 14.2 per cent.

The research found that superannuation satisfaction had improved since the GFC but remained low, with the result that in the three months to June 2011, the proportion of those satisfied with the investment performance of their superannuation was only 54 per cent – a small improvement from the low point of 48.9 per cent recorded in the first quarter of 2009.

It said current market conditions were likely to see this begin to decline.

Amongst the major wealth management brands, the research found NAB/MLC had emerged as the highest rated group, while AMP/AXA were the most likely to encounter switching by members.

Life risk sales continue to grow

By Chris Kennedy THE master fund market dropped $23.4 billion in funds under management (FUM) through the September quarter, resulting in an overall 2.9 per cent or $12 billion drop over the 12 months to September 2011, according to Plan For Life data.

The most recent figures show the masterfund market at $405.6 billion after being driven down by volatile global investment markets affected by European sovereign debt crises and US government deficits, according to Plan For Life.

Inflows into masterfunds in the 12 months to September 2011 were $111.6 billion, up from $102.6 billion in the prior corresponding period. Outflows also increased, however – up 17.5 per cent from $84.6 billion to $99.4 billion.

BT is the overall market leader in terms of FUM with $83.9 billion or 20.7 per cent, ahead of NAB / MLC (18.1 per cent), AMP (16.6 per cent) and Common-

wealth / Colonial (13.8 per cent).

BT experienced by far the greatest inflows for the year with a $41.8 billion (37.5 per cent) increase.

Next best was Commonwealth / Colonial with $17.3 billion (15.5 per cent). They were also the best performed in terms of net increase, up $7 billion and $3 billion respectively.

Wraps, which make up around one third of the masterfunds market with $140 billion in FUM, were down 4.3 per cent over the year. This was despite net inflows of $5.1 billion, according to Plan For Life.

The leading players in terms of FUM are BT ($29.3 billion), NAB / MLC ($25.2 billion), Macquarie ($21.6 billion) and AMP ($14.9 billion).

Platforms, which make up around half of the masterfunds market, were similarly down 4.2 per cent, again despite slight net inflows of $1.5 billion.

Master trusts actually increased by $5.6 billion due to $5.5 billion of net inflows, up to $65 billion.

www.moneymanagement.com.au January 19, 2012 Money Management — 9

News

Risk brokers resent FOFA’s ‘one size fits all’

By Mike Taylor THE risk insurance industry has been u n d u l y i m p a c t e d by t h e Fu t u re o f Fi n a n c i a l Ad v i c e ( F O FA ) c h a n g e s because the Government has adopted a ‘one size fits all’ approach, according to the National Insurance Brokers Association (NIBA).

In a submission filed with the Parliamentary Joint Committee (PJC) reviewing the FOFA legislation, NIBA claimed the FOFA reforms arose as a result of issues identified by the PJC in its inquiry into financial products and services in Australia (PJC Inquiry), which "were clearly focused on the investment and superannuation industries and financial planners".

"The general insurance and standalone non-investment linked life insurance industries (risk insurance) were never intended to be and were not a

focus of the Inquiry," the submission said.

It said that any of the recommendations arising out of the original PJC inquiry relating to risk insurance were limited in nature and arose in circumstances where an appropriately focused review of risk insurance and relevant stakeholders had not taken place. " T h e r i s k i n s u ra n c e i n d u s t r y i s distinctly different to the investment a n d s u p e ra n n u a t i o n i n d u s t r i e s i n significant ways. This has been shown in the insurance specific amendments made since the introduction of Chapter 7 of the Corporations Act which was originally enacted as a ‘one size fits all’ regime," the submission said.

It said such changes were all made once the reality of the specialised nature of risk insurance was understood by Government.

The submission said that it was on

this basis that NIBA was opposed to the ‘one size fits all’ approach to the regulation of financial services in Australia, "especially where proper analysis and consideration of the issues unique to the risk insurance industry has not been properly undertaken by Government".

The NIBA submission went on to say that the organisation believed the

perceived benefits for retail clients advised by insurance brokers in relation t o r i s k i n s u ra n c e we re l i k e l y t o b e outweighed by the detriments associated with the imposition of a statutory duty on insurance brokers.

"There is no evidence of any problem in the risk insurance market akin to that identified for financial planners on which the PJC Inquir y was actually focused and there are significant differences between the risk insurance market and investment products," it said.

The submission said no evidence has been provided by the PJC Inquiry or Federal Government of any fundamental or systemic problems with the provision of advice in relation to the risk insurance industry that were of a nature that would justify the introduction of a new suite of statutory reforms, and the resulting costs and market impact associated with it.

Three Storm Financial advisers banned

By Chris Kennedy THE Australian Securities and Investments Commission (ASIC) accepted enforceable undertakings (EUs) from three former Storm Financial advisers in the week before Christmas.

T h e E Us we re a c c e p t e d o n 2 2 December following an ASIC investigation, and will see one adviser banned for two years and the other two advisers banned for six months.

The three advisers recommended c l i e n t s a d o p t t h e St o r m m o d e l o f

investment, without considering whether any other strategy would meet their needs.

ASIC said it was also concerned that their advice involved the implementation of a gearing strategy, and they failed to advise clients that the advice provided to them was not necessarily appropriate or tailored to meet their financial goals and objectives.

Carey Fraser of North Ward, Queensland, has undertaken not to participate in the financial services industry for a period of two years. She must inform

ASIC if she obtains employment in the financial services industry within two years following the suspension period.

Tre v o r A l a n Be n s o n o f A s p l e y, Queensland, and David Robert McCulloch of Mount Louisa, Queensland, must complete specified professional education within six months and submit to a regime of supervision, review and audit of their financial services provided to retail clients by an independent senior financial planner (approved by ASIC) for a period of two years, ASIC stated.

Precious metals a good diversifier but timing crucial: CMC PRECIOUS metals such as gold, silver and platinum will remain useful ‘safe haven’ portfolio diversifiers in ongoing volatile markets in 2012 but the timing of entry will be crucial, according to CMC Markets chief market analyst Ric Spooner.

Factors supporting precious metals markets over the medium term include low international interest rates, which reduce the opportunity cost of owning gold; the ongoing potential for central banks to buy gold as countries such as China buy gold to diversify their US dollar exposure; and growing wealth in gold-owning nations such as India and China, according to Spooner.

But the timing will be

crucial for several reasons, he said. Silver and platinum are likely to outperform when the outlook for industrial production and economic growth is improving because of their higher usage in industr y

including in electronic conductors (silver) and catalytic converters (platinum), while the reverse is true of gold, he said.

Also, the international debt deleveraging cycle that has

10 — Money Management January 19, 2012 www.moneymanagement.com.au

now been embarked on means that business cycles may be shorter and shallower than in the past, leading to more frequent turning points in the price relationship between gold and the other two metals, he said.

This may benefit active management of precious metals, and traders can benefit via pairs trades in which they buy one precious metal contract for difference and simultaneously go short in another, Spooner said.

Precious metals are also quoted in US dollars, so Australian investors should also consider the impact of exchange rates because gold’s value as a hedge can be eroded by a rising Australian dollar, Spooner added.

GFC 2.0 to put portfolios on the defensive

By Andrew Tsanadis IN 2012, a conservative asset allocation is the best defence against a so-called ‘second round’ of the global financial crisis.

That’s according to Fidelity Worldwide Investment director of asset allocation Trevor Greetham, who believes the current financial crisis is based on uncertainty surrounding the value of Eurozone sovereign debt.

Despite this, Greetham believes that a bullish case can be made for 2012.

“It rests on a US-led economic upswing strong enough to offset anticipated weakness in the European economy, and it assumes the worst-case scenario of a messy Euro break-up can be avoided,” he said.

He added that the slowdown in global growth and peak in inflation will also enable central banks to ease sovereign policy with force.

At the moment though, Greetham argues policy responses are deepening the crisis in European and US markets, and because of this he favours bonds over equities in the new year.

“We favour the US; the market has relatively defensive attributes, and despite the fiscal deadlock, it is still the most likely to stimulate its economy,” he said.

“Diversification across a range of asset classes will remain an attractive proposition, and there will be lots of opportunities to add value through a sensible tactical asset allocation policy.”

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Will complexity overshadow objectivity?

Bill Shorten's mega-portfolio combining workplace relations with financial services will create a complex dynamic if the Government is to act appropriately on any Productivity Commission examination of default funds under modern awards. Mike Taylor reports.

MLC

$153.62m OnePath

$252.66m Tower

$1,064.75 TOTAL

R

ecent data released by Roy Morgan Research has served to underline the potential conflict created by the Prime Minister, Julia Gillard, in allowing Bill Shorten to remain in charge of financial services and superannuation while he takes on a higher duty as Minister for Workplace Relations.

The Roy Morgan Research confirmed that employers continued to be the primary channel relied upon by Australians when deciding on their superannuation fund.

It found that, over the past five years, approximately 85 per cent of superannuation products were obtained through the employer, while only approximately 11 per cent relied on a financial planner or adviser.

Why is this finding within the Roy Morgan Research so important in the context of Shorten's new mega-portfolio? Because it goes to the heart of default funds under modern awards.

In short, the Roy Morgan research confirms that most employees simply accept whichever default fund is selected by their employer.

What many employees do not know, however, is that these days their employers are obliged to choose their default fund from a narrow menu of mostly industry funds determined by Fair Work Australia in accordance with historic union-influenced industrial award coverage.

The default fund regime harks back to the superannuation regime which predated the superannuation guarantee and choice of superannuation fund – the era which gave rise to award superannuation and, over time, the evolution of industry superannuation funds.

It is axiomatic of the regime around default funds under modern awards that there exists continuing disagreements, even between industry funds, about how it works. Certainly, there have been misgivings expressed about the industrial relations judiciary having a role in determining superannuation investment decisions.

A Rudd challenge has the “capacity to either stall Shorten’s career or accelerate his own leadership ambitions.

”

Then, too, there has been the as yet unfulfilled promise on the part of the Government to have the entire default fund regime reviewed by the Productivity Commission – something which the Federal Opposition and many in the financial services industry have argued should have occurred well before the implementation of the Future of Financial Advice (FOFA) changes.

The Federal Opposition, together with a number of financial services organisations, have claimed that neither the Government's Stronger Super regime nor its FOFA changes should be pursued in the absence of the Productivity Commission dealing with the default fund regime.

They claim the Productivity Commission's findings will have significant implications for arrangements around MySuper which, in turn, has implications with respect to elements of the FOFA changes.

The Productivity Commission is, of course, independent and impartial, and comprised of people who are experts in their fields. It follows that its examination of the default funds regime will be objective and uncover any of the anomalies or distortions which may have been created.

However, by being both the Minister for Workplace Relations and the minister responsible for financial services and superannuation, Shorten will not only be the person responsible for initiating the referral to the Productivity Commission, but the minister responsible for dealing with the implementa-

tion of any of its recommendations.

He will be doing so in circumstances where the Federal Opposition has already suggested that he has shown undue sympathy towards the interests of industry superannuation funds and has deliberately delayed a reference to the Productivity Commission to serve those interests.

Given the Government's timetable for the implementation of the FOFA changes and its Stronger Super package, it seems unlikely that the Productivity Commission's findings on default funds under modern awards will significantly alter its underlying policy agenda.

It seems likely that the Productivity Commission's findings will emerge too late to influence FOFA and too close to the next Federal Election to make an immediate difference.

In those circumstances, the more interesting issue for the financial services industry in 2012 may well prove to be the recommendations which flow from the Parliamentary Joint Committee reviewing the FOFA legislation, and how they are ultimately treated by the Government.

On the available evidence, some bipartisan support appears to exist for some minor amendments and clarifications, but dissenting reports seem likely on the major issues such as "opt-in".

Perhaps equally important for the financial services industry will be the broader political mood in Canberra and the performance of the Prime Minister, Julia Gillard, in the public opinion polls leading up to the Federal Budget, and the manner in which that influences the internal dynamics of the Parliamentary Labor Party.

If, as has been rumoured in the Canberra press gallery, the Foreign Minister, Kevin Rudd, makes a play to regain the Parliamentary leadership of the ALP this will, in turn, impact the fortunes of Shorten.

A Rudd challenge has the capacity to either stall Shorten's career or accelerate his own leadership ambitions.

Source: DEXX&R Life Analysis Tables September 2011

What’s on The Superfund Reform Summit 2012 7 February 2012 CQ Functions, Melbourne www.superfundreform.com.au

Effective Business Forecasting Conference 2012 14 February 2012 Park Royal Darling, Sydney www.cpaaustralia.com.au

ASIC Summer School 2012: Building Resilience in Turbulent Times 20-21 February 2012 Hilton Hotel, Sydney www.regodirect.com.au/asicss2 012

SMSF Essentials 2012 27 March 2012 Doltone House, Sydney www.moneymanagement.com.a u/eventlist

CFO Strategy Resources Summit 20 May 2012 Burswood Intercontinental Hotel, Perth www.cfostrategy.com.au

www.moneymanagement.com.au January 19, 2012 Money Management — 11

Outlook for 2012: Markets

Rough ride ahead – for some World markets are in for a rough ride in 2012, but Australia is well positioned to survive another potential global recession, according to Dr Shane Oliver.

UNCERTAINTY hanging over Europe, and to a lesser degree the US and China, suggests a very uncertain outlook for the year ahead.

However, it’s worth noting, to borrow from Paul Keating, every pet shop galah is saying the same thing – Europe, Europe, Europe! So maybe it’s all factored in and perhaps after an initial messy period, it won’t be so bad.

There are several reasons for a bit of cautious optimism.

First, Europe appears to be heading towards a resolution of sorts, which is likely to involve much greater European Central Bank (ECB) intervention, helping to limit Europe’s growth contraction next year to around -1 per cent. The task is beyond the scope of various bailout funds (which aren’t big enough and are under ratings pressure) and the International Monetary Fund does not have enough funds.

The only organisation that can bring the debt contagion under control is the ECB. Our assessment is that it is likely to move into top gear in the next six months – and buy bonds in troubled countries more aggressively. A move towards fiscal union is likely to provide it with more confidence to act; the deepening European recession provides justification for aggressive monetary easing and bond buying in order to achieve price stability; and German opposition to a more aggressive ECB is likely to fade as its economy weakens too.

Second, the US economy looks like it will continue to simply muddle along, perhaps even with another “double dip” worry around mid year, but growth being held up around the 1.5 per cent level by more quantitative easing and solid profits supporting employment and business investment.

Third, China looks like it could slow further in the short term, possibly taking growth to a low point of 7 per cent year on year. However, with the property market and inflation cooling and the authorities

not willing to tolerate a hard landing, policy easing is likely to become aggressive, resulting in overall 2012 growth of 8 per cent in China. This is pretty much the story in the emerging world as a whole: ie, short-term weakness but plenty of scope to provide policy easing as inflation subsides, which should support growth.

Pulling all this together suggests: • Global growth somewhere around 2.53 per cent next year, composed of 0.75 per cent in advanced countries and around 5 per cent in emerging countries, albeit looking worse earlier in the year before improving in the second half; • Falling inflation as commodity prices remain benign and spare capacity builds in advanced countries, leading to a bout of deflation in Europe; • More monetary easing with falling interest rates in the emerging world and commodity countries, but aggressive quantitative easing in the US, UK and to a lesser degree Europe (ie, just enough); • Intensifying currency wars as quantitative easing sees the US dollar, euro and sterling remain weak; and • Constrained earnings growth reflecting the soft overall economic backdrop.

For Australia this means a difficult environment initially, before risks recede later in the year. Our base case is for 3 per cent growth over the next year – ie, better than 2011 which was affected by the drought, but it probably will require more monetary easing with the cash rate expected to fall to 3.75 per cent by the end of 2012 to help protect growth.

So what does this all mean for investors?

• In the short term it’s hard to feel confident about shares and related risk assets, as much uncertainty hangs around Europe and global growth could first get worse before it gets better. However, against this, shares are now very cheap (particularly against bonds), monetary policy is easing further and everyone is

12 — Money Management January 19, 2012 www.moneymanagement.com.au

bearish. So while shares may have a rough start to the year, there is good reason to expect them to be higher by year’s end.

That a lot of bad news is factored into share markets is indicated by forward price to earnings (PE) multiples which are now 10.2 times for global shares compared to 12.4 times a year ago. In Australia, the forward PE is now 10.9 times compared to 13 times a year ago. In the emerging world and Europe, the forward PE is now just 8.5 to 9 times.

• Share markets to focus on are those with strong fundamentals and monetary easing (Asia, emerging markets and Australia) or those with weak currencies and monetary easing (eg, the US, where monetary easing is likely to be more aggressive over Europe). We expect the Australian ASX 200 to rise to around 4800 by end 2012.

• Commodity prices are likely to rebound after a possible initial soft patch once it becomes clear the global economy is not going into free fall and as quantitative easing (QE) ramps up in advanced countries. Gold is likely to rise through $US2000 an ounce on QE. • The Australian dollar is likely to have a few rough patches, but is likely to remain strong overall, ending higher in response to more QE in the US and Europe – Australia being one of the few countries with a stable AAA rating – and as investors start to anticipate better commodity prices.

• Cash and term deposits are likely to become less attractive as cash rates continue to fall, pulling down term deposit rates with them.

• Very low starting point bond yields suggest low returns from sovereign bonds, unless of course global recession looms.

Australian bonds are more attractive than global bonds given higher yields and less risk if things fall apart. Corporate debt is a better bet, but favour investment grade if you are worried about equities.

• Unlisted commercial property returns

are likely to remain reasonable, reflecting yields around 7 per cent and requiring only modest capital growth to generate a decent return.

• Australian house prices are likely to fall another 5 per cent or so in the first half as buyers hold back on economic uncertainty, before rate cuts reach a critical mass and greater confidence leads to a recovery in the second half.

What are the risks?

The main risk is that Europe does not act quickly enough to prevent a major financial meltdown and deep recession.

If so, this would drag the global economy back into, or very close to, recession.

There is also a risk in China that the leadership transition and a desire to quash property speculation sees the a u t h o r i t i e s re a c t t o o s l ow l y t o t h e slowing economy, allowing a move to a hard landing (ie, 6 per cent growth or less) to become entrenched.

If the world really does go back into recession, fortunately Australia has plenty of ammo to fight it off – rates have a long way to go to zero, the Australian dollar will fall if things fall apart globally, there is more room for fiscal stimulus if needed, the corporate sector is cashed up, the household sector has a strong savings buffer and mining projects impart a degree of resilience. This would all suggest a 1-2 per cent growth locally, but not recession.

Conclusion Expect a rough ride, with potential weakness in the first part of the year. Conditions are likely to improve as monetary authorities in Europe and the US step up to the plate. Overall, what many fear could be a disaster could turn out to be much better than expected.

Dr Shane Oliver is head of investment strategy and chief economist at AMP Capital.

Outlook for 2012: Financial Advice

Same old,

same old

Future of Financial Advice reforms well and truly dominated the financial planning industry during 2011 and the year ahead looks set to bring more of the same, writes Nicolette Rubinsztein.

WITH 2011 behind us and the new year now underway, the question on everyone’s lips is “what will 2012 hold for the financial advice industry?” The Government’s Future of Financial Advice (FOFA) reforms dominated the landscape during 2011, with both tranches entering parliament and the legislation being referred to the Parliamentary Joint Committee on Corporations and Financial Services and the Senate Economics Legislation Committee for inquiry.

After almost two years of work on this issue, ‘FOFA fatigue’ and ‘FOFA frustration’ are becoming commonly cited expressions. Although the terms are largely used in jest, the start of a new year provides a pertinent opportunity to reiterate the importance of these reforms for both the industry and the consumer.

These reforms are intended to increase confidence in the financial planning industry and make it easier for Australians to access quality advice.

With that in mind, it’s no real surprise that FOFA is set to dominate again in 2012.

It’s easy to get caught up in the shortterm issues, such as the lack of certainty over start dates and grandfathering, which are key aspects of FOFA. Ironically, it’s the longer-term impacts that are easier to predict, with four key trends expected to characterise the market in 2012: - The end of ‘one-size-fits-all’ advice; - A shift towards big or boutique licensees; - Business model specialisation; - A focus on cost reduction and income diversification.

The end of ‘one-size-fits-all’ Client segmentation, pricing and alignment of services are becoming increasingly important as advisers continually seek to better match their offering to the needs

of their clients. Over the next six to 12 months it’s expected this trend will accelerate, resulting in a clearer delineation between comprehensive and scaled advice. The primary consequence of this shift will be a decline in comprehensive advice, probably down to less than a quarter of clients. That is, those clients who have the propensity to pay the cost required to prepare this type of counsel.

Rapid growth in scaled advice is also expected. Whilst many envisage large call centres delivering scaled advice, we believe it will primarily benefit traditional face-to-face models because it should allow planners to reduce some of the costs in the advice process: in particular, the fact-find and the statement of advice.

However, there remain some roadblocks to this becoming a reality. For example, many lawyers argue strongly that the current definition of ‘best interests’ does not support the delivery of scaled advice.

Should the reforms permit, it’s anticipated the majority of new clients will limit the advice received, seeking additional assistance only when a life event requires it. This shift to a single-event advice relationship will impact advisers and consumers. For the adviser it will mean reviewing practice models and future revenue growth assumptions, while for the consumer, decisions to opt for limited, event-specific advice may detrimentally impact outcomes by removing the holistic perspective the comprehensive advice model enables.

Big or boutique Consolidation is common in mature industries such as financial services. It’s a trend that has been in play for the past five years and one that will continue in 2012. However, the key driver this year is likely to be FOFA. Mid-sized financial planning licensees will seek access to the

“

The consolidation trend will not hinder the continued success of the boutique licensee market.

”

resources needed to comply with the legislative requirements. In addition, the potential ban on the flow of payments from platforms to licensees is encouraging some firms to consider the sustainability of their current business model in a post-FOFA environment.

The consolidation trend will not hinder the continued success of the boutique licensee market, but significant business model transformation among this group is anticipated. This will involve redefining their client proposition and engagement models to ensure their offering remains relevant to their market. In addition, practices will actively seek to acquire new clients, shore up revenue streams through offer diversification, and plan for business succession and value realisation.

Business model specialisation Success in the post-FOFA environment will require advisers to very clearly demonstrate the value of their advice. As a consequence, business model specialisation is likely to increase. Some practices will opt to focus on a particular demographic or a specific area of advice such as self-managed super funds or business insurance, rather than seeking to offer advice across a broad spectrum of areas.

Cost reduction and diversification Cost pressures have been a global theme since the onset of the global financial crisis and like all sectors the financial advice industry has been impacted by the continuing uncertainty. Many businesses have sought to manage these pressures by reducing costs and diversifying their income base – a trend that is expected to continue in 2012.

FOFA is likely to be a key driver of cost pressures as practices invest in systems, processes and training so they can meet the requirements set out in the legislation. These requirements will also necessitate extra man hours. Advice practices will need to take their efficiency to a new level and many will seek the assistance of platform providers in meeting these challenges. To provide this assistance, platform providers will need to deliver in critical areas, including pricing, and in functionality that suppor ts new adviser remuneration models and the opt-in regime.

FOFA, FOFA, FOFA There is no doubt FOFA will continue to dominate the industr y landscape in 2012.

Over time, the changes will lead to an increase in confidence in advice and we welcome the current form of many of the proposed changes. However, there is one exception: opt-in. We are of the view that the opt-in provisions need to be amended to avoid an excessive administrative burden for clients and advisers.

Furthermore, we believe the substance of the refor m can be retained, but changes can be made which would make it significantly less costly for the industry to implement.

Nicolette Rubinsztein is Colonial First State’s general manager of strategy.

www.moneymanagement.com.au January 19, 2012 Money Management — 13

Outlook for 2012: Insurance

Enter the dragon 2012 will be the year of the savvy consumer – and the financial services industry is preparing for this new trend, writes Jim Minto.

THE Chinese Zodiac tells us that 2012 is the Year of the Dragon.

Our dynamic financial services world is preparing for a new force to enter – the well-educated, all-powerful consumer.

Highly selective, value driven, transacting online, thinking independently, price and service savvy, this new consumer presents a bigger challenge than any our industry has yet encountered. With the momentum of recent Government reforms and the media focus, the customer of 2012 will also be quick to sense risk and seek out the bright light of transparent engagement with our industry’s brands, products and services.

Already the industry has experienced clear evidence that the new age of consumerism brings with it profound change. Change of a magnitude that will, long term, transcend all of the past 12 months of government regulatory intervention served up to our industry.

Rather than string all the potential risks, opportunities, challenges and roadblocks together, this article proposes to discuss just three simple changes. Each represents a new tool currently being forged in the furnace of our rising consumer society.

How these tools are applied will depend on which hand seizes them first.

Let me explain:

1. The tool of first-mover advantage Government called the shots in 2011. But 2012 will be the year when consumers take the controls. Our industry – through its products, services and distribution models – must heed that call in order to build a sustainable future. First movers who meet this head-on will be best placed to prosper.

Take financial advisers as an example.

Many advisers have already done the hard thinking and have acted to clarify their value proposition and remuneration models to clients. The underlying business of advice has also shifted markedly. Historically, advice businesses changed hands based on the quantum of remuneration received by advisers – including some that consumers were not fully aware of.

The situation has changed, drawing the client relationship and business underpinnings further out into the open.

Such unprecedented transparency is a game changer.

What will this lead to? First movers may

begin to offer simple, specialised approaches to niche advice areas. The holistic ‘one-stop shop’ may no longer work for the educated consumer who seeks advice on just a select part of their wealth, and is happy to act as their own ‘central caretaker’ with select inputs from a number of specialist advisers.

Pricing power for advisers will rest with the adviser’s ability to offer a clear, wellarticulated value proposition that meets the consumer on their terms. One clear opportunity is the area of personal insurances – Australia remains grossly underinsured as a nation. And while life insurance can be bought anywhere, at any time, it is largely an advised sale. In other words, people need the advice. The product decision and access lies much more with the individual.

Another pocket of opportunity might well include the provision of self-managed super fund (SMSF) services and truly tailored advice. What do I mean by tailored advice? Advice that acknowledges that clients now have a far deeper appreciation of risk, and thus more refined ‘risk appetites’. Preservation of capital is quite clearly a dominant consideration as retail and institutional investors ask: “How do I avoid losing money?”. That question will remain central to advice conversations throughout 2012. We can expect to see continued strong growth in the SMSF sector as many consumers distrust collective super schemes and take control of their investment risk.

2: The tool of branded distribution, refashioned for 2012 We may be driving at breakneck pace towards a reasonably uncertain consumer dynamic. Ironically, however, many industry strategists have thrown their ideas generation into reverse, going back to past models in search of future viability.

Anyone who has been around long enough to remember the ‘allfinanz’ model of the 1990s will see that it is expected to have a mini-resurgence in 2012. It would indicate that many financial services brands believe the only way to remain viable in the new environment is to create vertically integrated silos.

The regulatory changes to the open architecture of the industry’s underlying business structures have actually created a fresh round of product manufacturers

14 — Money Management January 19, 2012 www.moneymanagement.com.au

building higher walls around their product, service and distribution models.

Is ‘silo thinking’ a good idea? It remains to be seen if going back to the future will pay off. Frankly, the consumer will choose which brand he or she connects with in terms of financial products and services.

It is up to each organisation to adapt to consumer demand as a primary lever – not necessarily to engineer their business around underlying payment issues.

The consumer expectation is that they will either go to a brand expecting to be delivered the house products or they will

advisers may feel “theirMany choices are limited to operating within a vertically integrated structure.

Personally I’m not so sure, and believe that alternative models can flourish in a post-reform world.

”

seek advice that is product neutral and focused on their interests. The past 10 years have seen advice models built around the latter – and it is the industry and government walking away from this rather than consumers themselves. Many consumers still want independent advice and rejected vertical models 20 years ago.

At the institutional end – is vertical integration smart strategy or pure survival?

Many advisers may feel their choices are limited to operating within a vertically integrated structure. Personally I’m not so sure, and believe that alternative models can flourish in a post-reform world.

Such models would have strong brand, strong value proposition, and strong alignment with consumer demand. The rise of silo institutions – from bank account to loans, investments and insurance to advice – may be unstoppable after the Future of Financial Advice changes, but is this good for consumers or what

consumers want? It remains to be seen.

Back to the future – we go for the present.

3: The tool of eyeballing your future Whether we like it or not, Australians are increasingly going online to transact.

Recent data (CBA Equities: Online retail data) indicates online retail spending had increased by a staggering 36 per cent over the 12 months to October 2010. In other words, a $12.3 billion spend during that year. To me, such data underlines the importance that Australians place on their online experiences.

Does the propensity for more Australians to purchase online threaten our sector? No. Does it change the way we do business? Absolutely.

But if I were a betting man I would wager that no amount of 24/7 clickthrough connectivity will ever replace the value of the eyeball when it comes to advice. Advisers acting as the trusted partner making eye contact with their client, guiding and counselling them, and working in partnership, will almost certainly prevail as a business case. Wealth is building and as superannuation grows the needs of consumers become greater. A huge opportunity is before a provider of quality advice.

As our industry orients towards the customer, both the institutions and the individual adviser need to keep improving communication – talking about the value of advice, the value of long-term savings matched to risk profile, and the value of protection through insurance, regardless of markets.

In summary, to return to my opening about the Year of the Dragon, a quick Wikipedia search tells me the dragon represents a symbol of good fortune and immense power.

I can think of no more apt description for the new age of consumerism we are entering in 2012.

The good fortune for our industry will come for those prepared to return to fundamentals. This means a renewed focus from advisers, banks, fund managers and insurers on the basics: the real value of our services for consumers who are ever-more self-directed and demanding.

As they should be.

Jim Minto is the managing director of TAL Limited (formerly TOWER Australia).

Outlook for 2012: Superannuation

A chance to make it look super Pauline Vamos believes it is time for the rebranding of the superannuation industry.

THIS year will bring an opportunity for the super industry to rebrand itself. It will be a year with significant and unique opportunities as well as challenges.

The first opportunity will come with the continuation of the debate around the appropriate tax, social policy and legislative settings for delivering income streams in post-retirement – and how this policy area should link in with social security, pension and health policy settings. This is a live debate that started before the tax forum last year and I believe we will see some announcements in the May Budget.

The industry clearly has a significant role to play here both in terms of advising on policy settings and in delivering those policies. These conversations will be linked to increasing productivity and encouraging people to work longer, as well as ensuring there is greater flexibility in workplace laws to cater for older workers. This will be made easier with the revised and combined portfolio now with the Financial Services Minister, Bill Shorten.

Opportunities for funds to provide greater variety in post-retirement products will emerge out of this, and funds will need to look at investment strategies that take members through retirement. New offerings will be backed by research produced last year on the buying behaviour of retirees and the growing knowledge of market, inflation and longevity risk. Closely linked with this will be the deepening relationship between super funds and insurers as competition drives the need to retain members in the fund when they retire.

The second opportunity for funds will be access to greater diversity in the fixed interest and unlisted asset space. There will be the continued escalation of funding shortages for Australian banks and funding shortages for infrastructure.

Again, both conversations were started last year but must be resolved and put into action this year. Thinking and initiatives to increase the corporate bond market and fund infrastructure are escalating across the Government, Treasury and the superannuation industry, including the work being done by the

Infrastructure Finance Working Group and Infrastructure Australia.

It is a year where there will be more recommended changes in terms of coverage of the super system – leakage from the system by the self-employed, contractors and casuals will need to be revisited as the percentage of these types of workers increases and the nature of their work changes.

It will be a year of increased scrutiny on net performance: this is inevitable with market volatility and an ageing population that is more engaged with retirement and their superannuation.

Financial literacy is again on the agenda with Financial Literacy Week, and no activity around financial literacy can ignore super. This could be the year when super is finally part of our schooling, apprenticeship programmes and immigration induction.

Year 2012 will also bring legislative certainty, the new MySuper default, the Australian Prudential and Regulation Authority standards, account consolidation and electronic data standards.

New governance requirements and new reporting standards mean that every aspect of a fund’s operation will need to be reviewed and possibly changed.

With this certainty will come more mergers, but also increased competition as new players enter the market with new products.

Part of this legislative certainty will also deliver intra-fund advice and scaled advice, providing many funds with the opportunity to review their advisory services.

Year 2012 is not a year of ‘business as usual’ for the superannuation industry, as every aspect of its working environment is under pressure. We will see a significant maturing of the industry as it responds to changing demographics, the digital age, volatile markets, regulatory change, increased competition and a growing recognition that the superannuation pool is a key economic driver in the Australian economy.

Year 2012 is not a year of ‘business as “usual’ for the superannuation industry, as every aspect of its working environment is under pressure. ”

Pauline Vamos is the chief executive officer of the Association of Superannuation Funds of Australia (ASFA). www.moneymanagement.com.au January 19, 2012 Money Management — 15

OpinionFOFA

An evolution of advice?

Bryan Ashenden tries to find resemblance between current developments in the financial advice industry and Charles Darwin’s Theory of Evolution.

D

o the Future of Financial Advice (FOFA) changes represent an evolution of financial advice? The answer to this question may depend on whether or not you subscribe to Charles Darwin’s Theory of Evolution. While the main FOFA measures have now been introduced into Parliament, there are still a number of issues and concerns arising within the industry about how these new measures apply and in what circumstances. In this article, rather than doing a deep dive into the current FOFA Bills and all the issues they raise, we will look at a few of the key issues and changes that have arisen since the two tranches of draft legislation were released for comment in August and September 2011.

Slowly (but surely?)

Darwin’s Theory of Evolution is a slow, gradual process. Darwin wrote that natural selection “acts only by taking advantage of slight successive variations; she can never take a great and sudden leap, but must advance by short and sure, though slow steps.”

While some may be of the view that the proposed FOFA reforms are a great and sudden leap forward, another view is that they are perhaps just the next stage in the development of financial planning in

Australia. Financial planning, or the need for advice, has been around for decades, and change has always accompanied this.

Whether it be from a straight tax management view with the first Income Tax Assessment Act in 1936 or the introduction of the current superannuation legislation in 1993 and the reforms implemented through the Financial Services Reform Act at the beginning of this century, financial planning and the environment in which it has been delivered has been constantly evolving.

Certainly, there is no argument that the current process feels slow. The reform process commenced back in February 2009 when the Parliamentary Joint Committee (PJC) launched its inquiry into the collapse of Storm Financial and Opes Prime, and the financial services industry generally.

That inquiry delivered its findings and 11 initial recommendations in November 2009. The Government announced its planned reforms five months later in April 2010 and made further announcements a year later. Draft legislation was released for comment in August and September 2011, and quickly followed with the introduction of the two FOFA Bills into Parliament in October and November.

The Bills have now been referred through to the PJC (perhaps reflecting the “circle of life”) and to a Senate Economics

16 — Money Management January 19, 2012 www.moneymanagement.com.au

Committee (SEC). The PJC is not due to hand back its report until 29 February 2012. The House of Representatives only sits for eight days following the release of this report before it breaks over Easter. The SEC follows with its report due to be delivered on 14 March 2012. If the SEC recommends any further amendments to the FOFA Bills, Parliament only sits for a total of five days before rising for the Easter break. Parliament then doesn’t resume until Tuesday, 8 May 2012, which is the commencement of the Budget sittings.

As a result, the FOFA Bills are unlikely to be enacted until late March at the earliest.

Interestingly, this timeline aligns with the original dates forecast by Treasury at the beginning of the consultation process in April 2010, when they forecast the Bills would be passed through Parliament around Easter 2012.

The timing of the passage of the Bills raises the often asked question – will there be a deferral of the FOFA measures for 12 months? Many in the industry are requesting a deferral and many are expecting that it will be forthcoming. Indeed, the latest news (as reported in the Sydney Morning Herald on 19 December 2011) is that the announcement around deferral may come from Minister Shorten’s office some time in January 2012. However, until any such deferral is announced, it’s impor-

tant that advisers and licensees start preparing for these reforms now, rather than waiting until the legislation is ultimately passed or a deferral is announced.

While not ruling out the possibility of a deferral, here are some reasons why this may not occur (or may not be as significant as many have requested): • After the FOFA reforms, the next major set of reforms coming to the financial services industry are those from the review of the Australian superannuation system (Stronger Super reforms), including the introduction of MySuper from 1 July 2013.

Up to 11 tranches of legislation to give effect to the Stronger Super recommendations are expected, and with many of these changes due to commence from 1 July 2013, it may be difficult for products, platforms, systems and advice process to evolve and include these changes on top of changes required for FOFA. • In the Cabinet reshuffle announced in December 2011, Minister Shorten retained carriage of the financial services and superannuation portfolios.

If a new Minister had been appointed, they may have been in a position to announce a deferral while they were personally brought up-to-speed on the history and context of all the FOFA reforms.

With Minister Shorten retaining this responsibility, there is no longer a need for this.

• On 13 December 2011, the Australian Securities and Investments Commission (ASIC) issued a media release in which it announced that it would issue regulatory guidance on the best interests duty, scaled advice, and conflicted remuneration before 1 July 2012.

In the same release, however, ASIC also stated that for the first 12 months (ie, through to 30 June 2013) of the FOFA regime it will adopt a facilitative compliance approach – that is, provided industry participants are making reasonable efforts to comply with the FOFA reforms, ASIC will adopt a measured approach where inadvertent breaches result from a misunderstanding of requirements or systems issues.

However, where ASIC finds deliberate and systemic breaches they will take stronger regulatory action.

ASIC’s approach was expected, and is consistent with the approach it took with the introduction of the Australian Credit Licensing regime at the beginning of 2011.

However, it’s important to remember that this announcement by ASIC does not prevent consumers from taking legal action where, for example, they believe advice received is not in their best interests.

However, we need to be cognisant of the breadth of proposed relief provided from ASIC as it is restricted to the misunderstanding of requirements or systems issues.

With all of the discussion and engagement that has occurred (and continues to occur) in relation to FOFA, it may be more difficult to argue a misunderstanding of requirements.

A process of natural selection?

Darwin’s other main argument in his Theory of Evolution was the introduction of the concept of natural selection.

Natural selection acts to preserve and accumulate minor advantageous changes

“

While some may easily adapt to this new environment, others must be willing to change in order to survive, or face the significant risk of being forced out of the industry.

”

over time. In essence, those that are stronger and adapt to the changing environment will survive. The weaker, or those unwilling (or perhaps unable) to adapt, will gradually die out. Put differently, natural selection is about preserving those advantages that enable you to compete better in the world.

FOFA certainly represents a change to the world in which advisers operate. While some may easily adapt to this new environment, others must be willing to change in order to survive, or face the significant risk of being forced out of the industry – either through the inability to comply with the new requirements or being left with a business model that relies heavily on any potential grandfathering relief. Such business models run a significant risk of losing value over time to the seller (rather than the purchaser), given that any grandfathering relied upon would presumably be lost on a change in adviser or licensee.

The three main areas of the FOFA reforms that advisers will need to focus on are the best interest duty, the so-called opt-in regime and the ban on conflicted remuneration.

Best interests duty The FOFA Bills introduce a very broad ‘best interests’ duty, requiring the provider of the advice to act in the best interests of the client in relation to the advice.

However, a significant change in the FOFA Bills before Parliament (compared to the draft legislation released for consultation) is that the current version contains what could be regarded as a defence mechanism for advisers.

Increasingly referred to as the “seven steps defence”, the Bill states that if the provider of the advice can prove they have fulfilled seven requirements, they will be taken to have satisfied the broad best inter-

est duty. The seven steps can be summarised as follows: 1. Identify the objectives, financial situation and needs of the client; 2. Identify the subject matter of the advice sought by the client (and the above, as relevant to that advice); 3. Make inquiries to obtain complete and accurate information if it’s reasonably apparent that the information is incomplete or inaccurate; 4. Decline to give the advice if you don’t have the required expertise; 5. Conduct a reasonable investigation of products that might achieve the client’s objectives; 6. Base all judgements on the objectives, needs and financial situation of the client; 7. Take any other steps that would reasonably be regarded as being in the best interests of the client.

While some of these steps are relatively straightforward and consistent with advice processes and obligations today (such as step 1), other obligations still raise questions as to the breadth and intent of their operation. Such difficulties will hopefully be resolved by the time the duty becomes effective.

For the majority of advisers, the concept of acting in the best interests of the client should not be of concern, as this is what they do today. The duty, as drafted, only focuses on the activities undertaken by the adviser at the time the advice was provided – not the end result of the advice, eg, whether it was successful or not.

In order to commence preparing for the introduction of the duty, advisers and advice businesses should be reviewing their current advice processes and testing whether they believe the processes would stand up to a best interests scrutiny today.

Continued on page 18

www.moneymanagement.com.au January 19, 2012 Money Management — 17

OpinionFOFA ensure that the right value propositions and valued relationships are in place for all clients, whether existing or new.

Conflicted remuneration bans

Continued from page 17 A comprehensive and consistent advice process, supported by relevant documentation of discussions, will be important to provide a defence against future potential claims. Indeed, maintaining clear records of why certain recommendations or actions were not made to a client will be as important as the recommendations actually made.

not be an unreasonable conclusion to expect “thatIt would through its own natural evolution, without Government intervention, the upcoming regulatory environment is one that the industry would have gravitated towards in any event.

”

The final area of importance is the ban on conflicted remuneration. Conflicted remuneration broadly covers the provision of any form of benefit to a licensee or representative that could reasonably be expected to influence the advice that is provided.

An important change from the initial draft legislation now reflected in the Bill is that while any form of volume benefit is presumed to be conflicted remuneration, scope has been provided to rebut this presumption. In order to fall outside the definition of conflicted remuneration, you will need to prove that the payment/receipt of the benefit could not reasonably be expected to influence the advice provided.

While there is no guidance on how this proof may be given or in what circumstances, it does provide some possible relief, particularly for the ban on employers paying conflicted remuneration to employees. Where the benefit is paid to someone who is a number of steps removed from the actual provision of advice to a client and the amount of the benefit is not significant, the Explanatory Memorandum to the FOFA Bill indicates this may be an example of where the presumption can potentially be rebutted. However, this is in the Explanatory Memorandum only – not the Bill itself.

Some grandfathering relief has been catered for in the FOFA Bills, particularly in relation to commission arrangements in place before 1 July 2012, but no grandfathering relief has been provided at this stage for payments from platform operators.

Opt-in measures Much has been made of the proposed opt-in measure intended to apply to new clients (ie, those who haven’t been provided with personal advice prior to 1 July 2012) every two years, and whether it should instead be an opt-out approach.

The debate over opt-in versus opt-out, however, really misses the importance of this measure. The opt-in requirement, at its essence, simply requires the client to sign off every two years that they wish to continue their ongoing advice relationship with an adviser. While there are potential difficulties in getting people to sign and return documents generally or situations where clients are overseas, these can be addressed by introducing the opt-in document earlier than every two years and/or doing it in face-to-face meetings with clients that occur regularly, such as annual reviews. Ultimately, this is about being closer to your clients, which is a positive outcome.

The more important piece around these measures is not the opt-in itself, but the annual fee disclosure requirement.

Firstly, it applies to all clients that are in an ongoing fee arrangement, which essentially covers those who have received personal advice – both existing and new clients. It also covers situations where the payment received is in the form of a commission, even though non-ongoing personal advice is being provided. While there has been some speculation that the

Bill will be amended so that only new clients are covered by this requirement (as was the case in the draft legislation), there have been no positive announcements from the Government to this effect at this point in time.

Secondly, with a proposed start date of 1 July 2012 and current application of the definition of “disclosure day” to existing clients, taken literally, there may be a need for advisers to send out annual disclosure notices to clients immediately after the commencement of the legislation. As a result, advisers should consider what information they need to capture now that will be needed to complete these notices, such as the actual services that the client received for the year.

However the legislation may be amended to clarify that the first notices for existing clients aren’t required to be sent until 1 July 2013 (ie, a year after commencement). If amended in this way, the potential risks that many will not be in a position to meet the legal requirements of the notices on 1 July 2012 will be avoided. It also means that the first time existing clients will need to be sent a notice will align with the first time a new client would potentially need to be provided with similar information (ie, assuming the ongoing fee arrangement for the new client commences on 1 July 2012).

Finally, for those advisers who operate in the corporate superannuation market,

18 — Money Management January 19, 2012 www.moneymanagement.com.au

questions have arisen as to whether the fee disclosure notices will be required to be sent to all members of the relevant employer funds. If a requirement, thousands of notices may be required to be sent. What is important in these situations is to determine whether the member is in an ongoing fee arrangement with the adviser, as these notice requirements only apply where there is an ongoing fee arrangement.

The initial requirement for an ongoing fee arrangement to be in place is that the client has been provided with personal advice. In the corporate superannuation market, this will be the important question.

Many corporate fund members may only be provided with general advice (ie, their personal circumstances have not been taken into account), and as such, the optin and fee disclosure notices will not apply.

Ultimately, it is the development of a strong and trusted relationship between an adviser and their clients that is important. Arguably, clients are likely to pay little regard to the content of fee disclosure notices as they already know the value of their relationship with their adviser. Similarly, the clients will be ready and willing to opt in for continued services, as they are aware of the risks of continuing in an unplanned and unguided environment.

While the opt-in and fee disclosure measures don’t commence until 1 July 2012, the groundwork needs to happen now to

Conclusion The FOFA reforms certainly represent the next step in the development of the financial services industry in Australia.

Arguably, the reforms are more evolutionary than revolutionary. Indeed, the financial services industry itself had already commenced some of this journey prior to the announcement of the FOFA reforms by the Government back in April 2010.

On this basis, it would not be an unreasonable conclusion to expect that through its own natural evolution, without Government intervention, the upcoming regulatory environment is one that the industry would have gravitated towards in any event, albeit over a longer period of time.

The FOFA reforms shouldn’t be viewed as the big storm on the horizon, but really as the opportunity or impetus to re-engage (where relevant) with clients, cement the value of advice with your clients and the community more broadly, and set everyone up on the journey towards their goals, whether personal or business related. The reality of not accepting this evolutionary process and preparing now, is that the process of natural selection will force the unprepared out unwillingly, as FOFA hits with a big bang.

Bryan Ashenden is a senior manager, technical consulting at BT Financial Group.

OpinionManagement

Top 10 tips for 2012 Fiona Mackenzie presents the top 10 tips for 2012 focusing on client relationships and value propositions.

F

or many financial planning firms around the country, 2011 was another challenging year marked by market volatility and regulatory uncertainty. While advisers have shown resilience and are optimistic about the future, as we begin the new year it is a good time to reflect and decide what to focus on in 2012. There are some small steps that every financial planning practice can take to help improve business performance during the year ahead.

1. Be true to yourself Focus on your strengths and those of your business. There is much discussion in the industry about diversification, but if you have established a niche and you do something well, keep doing it. If it is something you are passionate about and good at, your clients will pick up on this, helping to confirm that their decision to engage you was the right one. Whatever it is you do well, do more of it and keep the momentum going.

2. Focus on being interested, not interesting Be curious and go that extra step to get to know your clients in order to strengthen your relationship with them.

The same goes for referral partners.

Consider taking a new approach to getting to know your clients: for example, using a personality tool to help you understand their approach to decision-making and investing.

3. Develop the art of storytelling It can be difficult to articulate to clients the value your business adds. Build a

connection with the listener and use examples of success stories that your clients can relate to, to demonstrate how you have helped someone achieve their goals. It is the service you are providing, not the product, which is of real value, so the ability to articulate this is what can set you apart.

constructive task for most people, taking their attention away from the day-today tasks and encouraging them to think about what changes they need to make to reach their goals. For example, do you need to update technology to increase your workflow? Do you need to invest in new talent?

4. Accept the new norm

7. Step outside the box

We do not always want to accept reality, but the fact is the world has changed as a result of the global financial crisis.

Clients’ confidence, like the share market itself, is more volatile and clients are keen to understand more about their investments and the value they get from financial advice. Client sentiment typically reflects where the share market is, so expect your clients to ask questions about what is happening in the market and what this means for them.

What are you doing to actively manage your ageing client base? Are you talking to them about their changing needs and discussing their estate planning and aged care needs? Importantly, are you talking to their children? Educating adult children about how their parents’ needs will change and how to prepare for this will also demonstrate the value of financial advice and could help you attract new clients too.

8. Start networking 5. Keep talking to staff Make sure you keep communication channels with your staff open. If you are feeling under pressure, the chances are your staff will be too, so it is important to keep them motivated and engaged through communication. Ensure your staff understand what is important to your clients and set key performance indicators around this so you are all working to achieve a common goal –for the business and clients.

6. Get clear on what your vision is Many people get asked what their fiveyear and 10-year plans are, but it can often be difficult to look that far ahead.

Asking where you see yourself in three years is a much more manageable and

Having the ability to meet your clients’ financial needs does not necessarily mean you have to diversify your own services: instead you can partner with other specialists, while you focus on what you do best. Building a stronger and broader network of referral partnerships with accountants, mor tgage brokers and risk specialists means you can offer your clients access to experts across a broad range of areas, while maintaining the relationship with your client. Establishing a referral partner program and agreeing referral targets can be a good way to formalise these relationships.

9. Measure results When it comes to marketing and busi-

ness development, have a plan, but more impor tantly, make sure you measure the results. Most businesses have a plan, but the key to finding out whether it actually worked and how it should continue to evolve is to ensure you are using an effective method to measure what went well and what still needs attention.

10. Set new goals It’s a new year and a time to reflect on both past experiences and future opportunities. It can be easy to lose sight of why you first went into business and what you hoped to achieve, so now is a good time to reflect and consider if your goals are still relevant. It is also a good time to set new goals and make practical resolutions. Choose something which is achievable: for example, schedule a value-add meeting with each of your referral partners every fortnight.

Improving business performance does not have to be about making one big change. Making a series of smaller changes that are easier to implement can often make a more significant impact on the broader business. At the beginning of each New Year, many of us re-evaluate where we are and where we want to be in life and make New Year’s resolutions to achieve these new goals.

As financial planning firms look towards the year ahead, the first step towards achieving success in 2012 is to set goals that are realistic, but more importantly, to stick to them.

Fiona Mackenzie is the senior practice consultant at Macquarie Practice Consulting.

www.moneymanagement.com.au January 19, 2012 Money Management — 19

OpinionMarkets Nowhere to

go up ? but

All the signs are showing that the market is reaching its low point, argues Dominic McCormick.

I

t has been hard to miss the extreme pessimism about the share market from both professional and unsophisticated investors in the lead-up to Christmas 2011. Confirming this pessimism there was little sign of any ‘Santa Claus’ rally last year, although 2012 has begun slightly better.

However, the surprise is not just that there is so much pessimism around.

Rather it's that some widely followed investment professionals and commentators have become even more bearish recently in the midst of such extreme pessimism – sometimes with 180-degree turnarounds from more bullish views.

Long-standing and increasingly scarce bulls such as the Australian Financial Review’s Market Monitor, Glen Mumford, have recently recanted the bullish stance held through most of 2011 and gone bearish. Alan Kohler recently communicated to his subscribers that he planned to move his equities allocation down sharply, possibly to zero. Even Shane Oliver of AMP Capital, who this time last year was calling the S&P ASX 200 to 5500 by end 2011, is now expecting the index to fall as low as 3800 within the first half of 2012.

The point is that these dramatic moves to the bearish side are the sort of recommendations commentators would normally aim to make at a market top, before a major fall of at least 20-30 per

cent. However, if looked at objectively I believe such recommendations are part of an environment with characteristics more like a market bottom than a market top. This capitulation may be indicative of the widespread investor frustrations that typically occur around a market bottom.

One of my favourite books on the stock market that virtually no-one has ever heard of is by Kiril Sokoloff – The thinking investor’s guide to the stock market. It's a bit dated (originally 1978), out of print and quite US-centric, but it is excellent at explaining the psychology of market movements and what to look for in determining where we are in the stock market cycle.

Toward the end of the book Sokoloff provides a checklist of factors/questions to consider separately in determining major market tops and bottoms. A sample of the first nine (there are 15) for a market top include: - Have interest rates moved up?

- Is business activity booming, and is it as good as it possibly can be?

- Have stock prices been rising for so long that investors have thrown caution to the winds?

- Are the newspapers full of optimistic news? Are the major concerns of the previous bear market totally forgotten by one and all?

- Are you very confident in the future

20 — Money Management January 19, 2012 www.moneymanagement.com.au

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Investors certainly seem to be getting more pessimistic even while the market is showing considerable resilience in a difficult environment.

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and totally optimistic about buying and owning stocks?

- Is enthusiasm feeding on itself? Is this enthusiasm widespread and pervasive?

- Is it now generally accepted that the stock market is a superior place for investment funds? Is this view now so widespread that it is no longer a subject for debate?

- Are you so sure about the upward direction of the market that you feel confident about buying stocks on margin?

Does everyone else feel the same way?

Does this sound like today's environment? Clearly not. Yet in getting out of, or recommending getting out of shares, many amateur and professional investors are currently acting as if we are now at a major top and the appropriate course of action is to dramatically reduce their exposure to equities.

Conversely, Sokoloff also provides a list of factors/questions indicative for a major bottom. Here is a sample of them.

- Have monetary conditions started to ease? Are utilities and bond averages and the government bond market all advancing nicely (yields declining) after the previous declines?

- Is the economic news starting to get bad? Are major publications devoting cover stories to the forthcoming decline in economic activity?

- Are all stocks declining together, especially the high flyers of the previous bull market? The sharper and more pervasive the declines the closer the bottom is.

- Are professionals who had been waiting to buy stocks now convinced that the market will go lower still? Is that conviction now so widely held that it’s no longer even a subject for debate?

- What’s happening to volume? Has it slowed dramatically from the previous peak?

OpinionMarkets

- Are you so turned off by stocks that you want to hide your money under a mattress?

- Has the market made a ‘test’ of its bottom? Has it come back to the low and proved that it wants to bottom? Do investors get even more scared at this test?

If so that’s a good sign.

- Have most of your acquaintances who own stocks liquidated some or all of what they hold?

- Is the brokerage business consolidating and going through a major contraction and elimination of the previous period’s excesses?

- Do stocks show resistance to further decline?

- Is it easy to make money by shortselling stocks? Can you indiscriminately pick a high-multiple stock, short it, and quickly make money?

- Have interest rates begun to decline, thereby confirming the slackening in business activity?

Clearly, this seems a pretty good description of the current environment.

Interestingly, in terms of the Australian market the common investor perception seems to be that the market is making new lows on a monthly or even weekly basis. However, the reality is that in early January 2012 the S&P ASX 200 index is actually around 10 per cent above its early August 2011 intra-day low, plus more than 2 per cent has been paid in dividends in the subsequent five months. Investors

certainly seem to be getting more pessimistic even while the market is showing considerable resilience in a very challenging environment.

At a pre-Christmas (working) lunch for our broader investment team we went through each of the above indicators and tried to get a team view on each of the questions/issues relating to market tops and bottoms. A couple of them were ambiguous, but the majority agreed that almost all the elements Sokoloff describes as being indicative of a major market top did not currently exist – and almost all of the characteristics of a major bottom were currently present.

The essence of Sokoloff’s approach is contrary thinking and investing. The simple premise is that when the crowd is extremely positive financial assets will likely fully reflect this optimism and there will be few potential buyers left to drive prices higher. In contrast, when the crowd is extremely negative, prices will be discounted and there will be a large supply of potential buyers to take prices higher at some point. Warren Buffet puts it this way: “be greedy when people are fearful and fearful when they are greedy”.

No one can doubt that the prevailing mood of the investing crowd today is fear and pessimism. To further highlight this, below is a list of article headlines from just two pages of The Australian’s business section from 4 January, 2012.

“Tremors shatter old paradigm” “Growth outlook cloudy for island nation” “Investors batten down the hatches” “Asian exports feeling the heat” “It’s a make or break year for Europe as economic woes threaten to engulf the world” “It’s all gloom and doom at Bridgewater” “Winter of discontent for Britain’s retail sector”.

Of course none of this suggests that the market has definitely bottomed or will do so in coming months. The bottoming process can sometimes take years and 2012 could still be another tough year with high volatility. Further, there is some validity to the view that this is not just a cyclical bear market but a secular one associated with the end of a 30-year leveraging cycle that may have many years to run. Still, even if this is the case, there are likely to be strong rallies and opportunities arising out of periods of excessive pessimism. Even Japan has had numerous rallies of 20 per cent or more in its 20year bear market.

But what about today’s major macroeconomic challenges that can easily be translated into more extreme ‘Armageddon’ scenarios (eg, a disorderly collapse of the euro, a major crash in China)? As noted in previous articles, I have long believed it makes little sense to bet one’s portfolio on just one scenario. Therefore it can make perfect sense to consider

some of the more extreme or Armageddon scenarios and try to include some ‘tail hedges’ or investments that can perform in these extreme environments. However, given the extent to which these scenarios are at least partly priced in; that valuations in equity markets currently look reasonably attractive; and the low probability of these scenarios occurring, it hardly makes sense to build a total portfolio with a version of Armageddon as your core and only scenario.

If I had to take a best guess at how 2012 is going to pan out, it is for a significant multi-month rally in the early months of the year in which many investors (especially retail) largely sit on the sidelines with high levels of cash only to eventually begin to come back in towards mid-year as frustration and the sense of missing out grows. Only then when some of the current pessimism dissipates are we likely to be hit by a renewed fall from mid-year and renewed frustration and pessimism.

However over the course of the year I see more risk of upside surprises overall given the extreme pessimism around – and even if the market makes little overall progress this is still a far cry from the 20-30 per cent fall that various ‘get out of equities’ calls imply, particularly with the attractive dividend yields available in many markets.

Having said this, investors and advisers need to stop searching for the guru who will successfully tell them exactly when to buy and when to sell. They don’t exist. Instead, try answering the above questions/issues raised by Sokoloff for yourself. While it doesn’t help with precise timing, it does suggest we are closer to a major bottom than a major top. Professionals who are suggesting the opposite to this by suggesting selling most or all equities (particularly if they have recently done a 180-degree turn) should probably be ignored and will likely turn out to be good contrarian indicators.

If indeed we are closer to a major bottom than a major top, then these are the times true investors should be considering buying equities, not selling.

If you are still selling now and/or refusing to even consider buying into current or future weakness, then you are not an investor but simply a follower of the current pessimistic fashion. It may make you and your clients feel better in the short term but it won’t do much for their wealth in the long term.

Economist and investor John Maynard Keynes emphasised that individual investment success is largely determined by how investors behave at market tops and bottoms. This is where price volatility concentrates and where the big investment mistakes are made.

It’s a time for rational thinking and assessment, not emotional kneejerk responses to widespread negative news or hyperactive recommendations. We may be at that time.

Dominic McCormick is the investment officer of Select Management.

chief Asset

www.moneymanagement.com.au January 19, 2012 Money Management — 21

OpinionEstate Planning Pig in the python

As baby boomers reach retirement and their latter years, intergenerational advice might be the answer to continued business growth in the future, according to Paul Singh.

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ike most developed countries, Australia is facing a conundrum – an ageing population. In a not too distant future (2020), thenever-grow-old baby boomers will be in their 60s and 70s and the oldest of Gen Xers will be in their 50s and beginning to exit the workforce. It is estimated that one fifth of the Australian population will be over 60 by year 2020.

Putting the turmoils of the recent past (credit crunch, global financial crisis, Storm Financial collapse) aside – over the past two to three decades, growth in the financial planning industry has mainly been dr iven by the baby boomers. As this generation commences its descent from the peak, financial planning businesses around Australia will face some difficult questions regarding their own mortality, in particular those considering an exit strategy in the next five to 10 years.

As baby boomers commence drawing on their retirement resources and consumption of financial products (eg, life insurance) diminishes, the impact

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Recent research has indicated that $600 billion will change hands between baby boomers and the X and Y generations over the coming 10-15 years.

22 — Money Management January 19, 2012 www.moneymanagement.com.au

”

of the ageing population will be truly evident in dwindling book values and declining funds under management (FUM). Though, if some of the recommendations of FOFA are anything to go by, businesses planning to exit in the short to medium-term may argue that the mutiny of planning businesses in Australia has already begun...no need to wait till 2020.

Without a doubt, to compensate for the impact of the ageing population, now more than ever planning businesses need to think ‘outside the box’ and realign their business strategy with emerging markets to ensure continued growth and a successful exit strategy in the future. One such emerging market that boasts significant value is ‘intergenerational advice’. Recent research has indicated that $600 billion will change hands between baby boomers and the X and Y generations over the coming 1015 years.

Put simply, ‘intergenerational advice’ involves, amongst other things, planning and advice to facilitate transfer of

family assets from one generation to another, more commonly referred to as estate planning. This will often require involving other specialists such as solicitors and accountants. Assuming that the legalities of setting up wills, powers of attorney, etc. have been given appropriate consideration, from a practical point of view clients will often look to their financial advisers to formulate and implement strategies to meet their goals and objectives.

In the majority of cases, a client’s goals in relation to estate planning can be summarised simply as “ensuring that assets pass on to the intended beneficiaries tax-effectively with minimum delay”. Where estate assets are easily divisible or where sufficient liquid assets are available, the task may be relatively simple. However, in circumstances where equal distribution of estate assets is required and assets comprise of mainly indivisible assets, it may be problematic to distribute the estate equally because: - Assets may not be easily divisible

- Particular assets may be valuable to some beneficiaries and worthless to others, and - Capital gains tax (CGT ) may be payable in some circumstances.

The need to distribute the estate equally must be carefully weighed against the desire to see family businesses continued by future generations. For instance, in a family situation, it may be possible that some children are capable of continuing their parents’ business whereas others may have no interest in it whatsoever. Or the business size may not be big enough to provide for all the children.

Generally, CGT does not apply upon disposal of assets by a person due to death. However, subsequent disposal of those assets either by the beneficiaries or by the legal personal representative will crystallise the CGT liability, if any.

Let’s consider these issues in an example.

Derek is single, age 56 and operates a successful dental business. He has two children. Travis, age 25, is single and currently pursuing a Bachelor of Dental Science. He has been assisting Derek in the management and operation of the business on a regular basis. Damien is a qualified IT engineer, age 29 and married. Damien has no intention of being involved in his father’s business.

The dental business is the only real asset that will form part of Derek’s estate and Derek would like both of his sons to receive his estate in equal shares. Let’s assume that the business is currently valued at $500,000. The business was originally purchased in the 2000/01 financial year and the cost base is $100,000.

It is clear that Travis is being groomed as the heir of the family business in the event that Derek passes away. In the case where the business was split evenly between the two sons upon Derek’s death, the tax implications would be as follows:

Travis Share in the business: $250,000 Cost base: $50,000

Since Travis intends to continue the business, CGT will only crystallise at the time of actual disposal if there was to be one in the future.

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Care must also be taken to ensure that adequate financial provision is made for all dependants.

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Damien Share in the business: $250,000 Cost base: $50,000 Nominal capital gain: $200,000

Since the business was purchased post-1999, the indexation method does not apply. However, Derek held the business (a post-CGT asset) for longer than 12 months prior to his death, therefore Damien will be eligible for the 50 per cent CGT discount.

Discounted Capital gain: $100,000 Assuming a marginal tax rate (MTR) of 46.5 per cent, a tax liability of $46,500 will ar ise. In other words, the net amount received by Damien will be $203,500 as opposed to his actual inheritance of $250,000.

It should be noted that depending upon the circumstances it might be possible to eliminate some or all of the capital gain by accessing small business CGT concessions. For reasons of simplicity it is assumed that Damien is not eligible to claim these concessions.

For tax purposes, Travis will be deemed to have acquired Damien’s share of the business and the cost base for that share will be the market value of Damien’s share of the business at the time of the CGT event.

In addition, prior to embarking on a strategy, Derek should consider the following issues and their impact on his estate planning goals and objectives:

- Does the business have enough cash flow to fund the borrowing cost?

Assuming that Travis has sufficient resources to acquire Damien’s share of the business, a simple solution to equalise the estate would be a life insurance policy on Derek’s life to cover any crystallised capital gains tax exposure.

An alternative strategic approach can be taken where Travis does not have the resources to purchase Damien’s share in the business. In this case, 100 per cent of the business can be passed on to Travis and a life insurance policy equal to the value of the business may be purchased to compensate Damien in lieu of a share in the business.

Care must also be taken to ensure that adequate financial provision is made for all dependants. Family law legislation in most states empowers the courts to provide recourse to certain dependants and also to determine what amounts are deemed to be adequate provision for the proper maintenance and support of the applicant. Depending upon the facts of the case, a court may award certain amounts to applicants or rule that the estate be settled in equal proportions – regardless of the deceased’s intentions as stipulated in the will.

Conclusion

- Would Damien readily sell his share to Travis?

- Would Damien demand immediate settlement upon sale?

- Does Travis have enough resources to buy out Damien’s share?

- Would it be possible to take out a loan against the business to buy out Damien’s share?

The benefit of intergenerational advice is two-fold: a) It ensures value-based advice to clients during the most important stage of their lives, and b) It creates a self-sufficient referral resource by tapping into generation X and Y through the current client base.

This should lead into continued growth and new business opportunities that are vital for the survival of financial planning businesses in Australia, given the consequences of ageing population.

Paul Singh is a technical consultant for practice development at Suncorp.

www.moneymanagement.com.au January 19, 2012 Money Management — 23

OpinionGFC

Will US housing steady the economy it wrecked?

While experts expect more glum US housing statistics for 2012, the normal motions of economic cycles indicate there is a recovery on the way, writes Michael Collins.

T

he United States housing market, with the help of financial wizardry, laughable credit standards and low interest rates, triggered the global financial crisis by bubbling over. The troubled sector might, though, help push along the US economic recovery that has now entered its third year.

There’s scant sign of that rebound yet, though, when you look at the latest data on the US housing market, which is experiencing its worst crash since the 1930s. Residential investment has dropped to an alltime low of just 2.2 per cent of gross domestic product these days, well below the long-term median of 4.4 per cent.

Housing starts for 2011 are only running at a 592,000 pace, according to Bloomberg calculations. This is well under the record high of 2.1 million starts recorded in 2005, even if the number exceeds last year’s total of 587,000 and 2009’s tally of 554,000 – the lowest annual total since records started in 1959.

Recent declines on stock markets and (linked) concerns that the US and global economies could re-enter a recession have led to a drop in applications for mortgages and building permits. Not even record low mortgages are generating demand for housing as home prices are falling.

Overhanging the housing market is the excess supply from years of foreclosures, as people broken by mortgage payments walked away from their homes that are often worth less than the debt owed on them. Lender Processing Services estimates there are 2.5 million vacant houses in the US, and this number could jump, given that 4.1 million loans were in the foreclosure process – or at least 90 days delinquent – as of July this year. CoreLogic (a provider of business analytics) said that at the end of June, 10.9 million – or 22.5 per cent – of US residential properties had bigger mortgages than the properties were worth.

Government attempts to revive the

housing market have largely failed so far.

Among the disappointing programs is the Home Affordable Refinance Program that was introduced in 2009 to free borrowers from risky loans and to prevent foreclosures. Most of the US$8 billion that the US Treasury allocated to its Hardest-Hit Fund (which was designed to prevent foreclosures) is yet to be spent.

Add on tougher lending standards blunting the benefit of low interest rates and unemployment at 9 per cent and it’s little wonder that house prices are still floundering. According to the Case-Shiller 20-city index, prices as of August 2011 were almost a third lower (31 per cent) than their July 2006 peak; moreover, the index is only a few percentage points away from its April 2009 low.

Falling home prices and the prospect of foreclosed properties returning to the market give builders little incentive to invest in new housing. Confidence among builders of single-family homes in November stood at 20 on the NAHB/Wells Fargo Housing Market Index.

The neutral level – where pessimists match optimists – is 50.

The cycle at work Ironically, it’s these grim statistics that could lead to a bounce-back in housing that is big enough to give the US economy a noticeable push.

To understand this may occur, it’s worth reflecting on how recessions slow recoveries (just as robust times set up downturns). Amid the gloom of tough times, when consumer spending and business investment are low, equipment wears out or becomes obsolete and people run down savings. Eventually, the build-up in demand for new equipment (whether it be factories, machinery, offices or transport) is so great that businesses are forced to invest in new capital stock.

Low interest rates make this easier to do.

More people are employed and they

24 — Money Management January 19, 2012 www.moneymanagement.com.au

spend the money they earn on postponed purchases. Thus, in many cases, the greater the build-up of demand, the more sustainable the recovery.

The US housing market appears to have created such a backlog of demand which will eventually be unleashed.

Housing starts have been at an unprecedentedly low level for five years – about four million new homes have been built from 2007 to 2011 (using an estimate for this year), versus 9.4 million new homes in the preceding five years. Since 2007, the stock of housing has aged (especially those abandoned, foreclosed homes) while the US population has grown.

The unleashed demand angle is that household growth has lagged population growth because children are staying with parents longer or more people are sharing in order to save money. The Economist magazine estimates that, based on figures from the Census Bureau and Bureau of Labor Statistics, there are two million fewer households in the US that population growth since 2007 would suggest should be the case at present.

At some point – and it may be a while off – the demand-supply dynamics of new housing in the US will shift in favour of demand as rundown homes need replacing and household growth catches up to population growth. Zelman & Associates (a US housing consultancy) expects household growth of 11 per cent this decade, compared with only 8 per cent population growth. This should translate into housing starts of about 1.5 million a year.

Builders will notice a pick-up in demand as 35-year-olds decide they can no longer live with their parents. Construction companies will oblige by investing and hiring again, and the virtuous spiral of recovery will kick in. While the NAHB/Wells Fargo Housing Market Index of building confidence might only be at 20 – that’s its highest level since May 2010.

Zelman is forecasting housing starts to

reach 745,000 next year, 940,000 the year after, and 1.12 million in 2014. The forecast for 2014 is almost double the 590,000 Zelman expects for 2011.

One sign of a build-up in demand for housing is that rents are rising in the US. Mortgage rates near record lows are making rental yields on properties positive again as rents are 1.5 times mortgage payments. Higher rents encourage people to invest in property and push renters to buy their own home – and homes have rarely been more affordable, according to the National Association of Realtor’s index that measures such things.

As gloomy as consumer confidence is overall in the US, according to the University of Michigan Consumer Sentiment Survey, 72 per cent of respondents believe that now is a good time to buy a home as house prices and interest rates are low.

Another hopeful sign is that housing starts jumped a more-than-expected 15 per cent in September to a 658,000 annual rate – the most since April 2010. Builders are competing with foreclosed properties by building smaller homes that are obviously cheaper to sell.

It must be said that housing investment, at just 4 per cent to 5 per cent of the US economy in normal times, is not big enough by itself to rejuvenate the US economy. But its indirect effects can be widespread as new owners need appliances and furniture for their homes.

Any recovery of sorts in home prices will help consumers, overall, regain confidence to spend, even if low house prices reduce this effect to some extent.

Optimism about the US housing market in coming years might seem misplaced as more glum housing statistics are released in 2012. But the normal motions of economic cycles say otherwise.

Michael Collins is the investment commentator at Fidelity Worldwide Investment.

OpinionStrategy

A new index of success Damien Frawley maintains index investing is still fresh after four decades.

I

t is widely accepted that the phrase 'May you live in interesting times' is an ancient Chinese curse. Actually, it is neither Chinese nor ancient in origin, but is instead recent and Western.

Regardless of the origin of the words, there is no doubt that investors do indeed live in interesting times.The global financial eruption of 2008 and continuing aftershocks have jolted investors in a fashion not experienced for many decades. As a result, long-standing beliefs are under question, including the conviction that equities offer higher returns than other conventional asset classes over the long term.

In 2011 investors have been de-risking their portfolios by flooding into cash (including term deposits) and fixed interest, and this trend will probably continue in 2012.

Index investing has also benefitted from changed investor attitudes. According to Rainmaker, index funds as a whole represented 13.2 per cent of total investment industry funds under management at the end of June 2008. By the end of June 2011, the index funds market share had climbed to 15.8 per cent1.

Intriguingly, Australian and global equity indexing enjoyed something of a bull run over those three years. Index Australian equities represented 15.4 per cent of the total industry funds under management at the end of June 30, 2011. Three years earlier, this figure was just 11.2 per cent2.

Global equity indexing has received even more support, capturing 23.1 per cent market share by June 30, 2011 compared to 15.4 per cent three years earlier3.

We see this migration of funds into indexing as something more complex than all-out de-risking. Instead, we believe it

implies investor sophistication.

Rather than retreating by taking shelter in cash and fixed income, a large number of Australian investors have positioned their funds in a way that underlines a belief in the importance of maintaining some equity exposure. They may be cautious about the outperformance potential of equities at this time, but have not given up on the conviction that equities are worthwhile in their portfolios.

So indexing may be a kind of parking bay, a place from which funds will flow back into active investments when greater confidence about the global economy returns.

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Discussion these days is about index as well as active. Together, they can potentially achieve better outcomes for clients than either can in isolation.

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Not glamorous, but effective Senator Ron Boswell made a name for himself during the 2001 Federal election with billboards and television ads saying, “He’s not pretty but he’s pretty effective”.

As it turned out, he was successful in winning senate re-election on that note of self-deprecation.

Similarly, indexing as an investment approach may lack the panache of high alpha-seeking strategies. However, it has carved out a large slice of the global and Australian investment pie because its attributes are as compelling as they are simple.

Hard as it may be to believe today, the advent of indexing in 1971 was a breakthrough. Making the world’s markets accessible in a cost-competitive way was a significant boost to the diversification cause for investors everywhere.

Advocates of indexing and active investing were at loggerheads for some years.

Each side substantiated their views, trying to demonstrate that their opponents’ arguments were flawed. Thankfully, the industry has moved on. Discussion these days is

about index as well as active. Together, they can potentially achieve better outcomes for clients than either can in isolation.

Barbelling puts indexing front and centre ‘Barbelling’ has brought an end to the index - active wars. Today, high conviction strategies at one end of the portfolio barbell are being complemented by lower -risk index strategies at the other end of the barbell.

By separating beta from alpha in this fashion, advisers can now define risk budgets as well as performance targets more transparently. They are also better able to gauge manager skill.

The emergence of barbell investing also

reflects a re-examination of the fundamental law of active management 4, which describes the relationship between an active manager’s risk-adjusted return (or information ratio), their skills or insights and breadth of the strategy, or how many times their insights can be applied.

Wider and deeper In recent times, breadth — which can also be thought of as investment decisions driven by many independent sources of active return — has been the predominant focus of attention, and for good reason. Greater attention on the skill element of the fundamental law is opening up a world of active strategies, such as long-short investing, where risk is only spent on unique, high-confidence insights.

The same approach can be applied to manager selection. Rather than investing in active managers with modest alpha targets, barbelling is premised on employing high outperforming-seeking managers with low correlations. Risk and cost budgets can be managed by combining high alpha managers with index tracking, or low risk, lower cost funds.

As we kickoff 2012, barbelling promises to be one innovation that may be as long lived as indexing.

Damien Frawley is head of BlackRock Australia.

1 Rainmaker Roundup (Edition 55) June 2011 (printed September 2011) 2 Ibid 3 Ibid 4 Grinold and Khan 2001. A manager’s value-added (information ratio) is a function of his selection skill (information coefficient) and the number of opportunities (N) he has.

www.moneymanagement.com.au January 19, 2012 Money Management — 25

Toolbox

SMSF borrowings and property development Before diving headlong into improving a property that is held under a limited recourse borrowing arrangement, caution must be exercised, Fabian Bussoletti claims.

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ollowing the Australian Taxation Office’s (ATO’s) recent release of Draft SMSF Ruling SMSFR 2011/D1, SMSF trustees now have the ability to not only borrow money and purchase property, but also the opportunity to subsequently undertake improvements to that property.

However, while these developments have resulted in a heightened level of interest by property investors, it is important to remember that making improvements to properties will only be permitted under limited circumstances.

So caution needs to be exercised before diving headlong into improving a property that is held under a limited recourse borrowing arrangement (LRBA).

The first of these limitations applies to the actual source of the money used to carry out the improvements. To that end, while borrowed money can be used to undertake repairs or maintenance, it cannot be used to carry out improvements.

As such, the money required to finance the improvements must come from existing cash holdings of the fund, or from additional contributions. With some careful planning, this first hurdle should be a manageable one.

The second limitation is a little more complex and relates to the ATO interpretation of section 67B and what is a replacement asset. This limitation requires that the extent of any improvements cannot be so significant that they change the character of the property.

Should this occur, the property could no longer continue to be held under the borrowing arrangement – as it would not be recognised as the asset originally acquired by the self-managed superannuation fund (SMSF) – albeit via the holding trust.

On a positive note, the ATO’s earlier

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It should be noted that this SMSF Ruling is currently still in draft form, therefore potentially subject to change.

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this means the addition of a new pool or garage to an existing house, or a kitchen extension will be recognised as an allowable improvement to an existing house. However, it will not result in the ATO viewing the house as a different asset, as the character of the asset has not been fundamentally changed (ie, it is still a house).

What is considered a new asset?

view – that any improvement would effectively result in the creation of a different property – has been softened somewhat through the draft ruling.

In fact, the draft ruling specifically tells us that a mere improvement to a property will not by itself result in the creation of a new asset. Instead, the “replacement” of an asset will now only be considered to have occurred where the character of the asset has fundamentally changed – either in terms of its physical attributes and/or the proprietary rights attached to the asset.

When one considers that an allowable improvement may now involve the addition of new and substantial features that make the property more valuable or desirable, it is this significant shift in thinking that has raised interest levels.

In a nutshell, according to the ATO view expressed through the draft ruling,

26 — Money Management January 19, 2012 www.moneymanagement.com.au

Well, consider a LRBA entered into over a vacant block of land on a single title.

Should the fund trustees later decide to subdivide this block of land, the subdivision will result in one asset being replaced by several different assets (ie, the single block of land is replaced by a number of separate titles). As a result, the draft ruling indicates that the character of the asset will have been fundamentally changed, giving rise to a new asset.

Or similarly, if a residential house (or any other form of building) was erected on the vacant block of land (still on single title), the character of the asset will be fundamentally changed. In essence, it will go from being vacant land to residential premises – and will be considered a different asset from the original asset.

By way of a seemingly obvious observation, based on the views expressed in the draft ruling, the ATO’s current interpretation of the replacement asset definition continues to prohibit the development of property that is directly held under an LRBA – whether by subdivision or by physically developing vacant land.

This is regardless of whether the development activity is conducted using borrowed money or other resources of the fund.

The draft r uling also clar ifies a number of other potential replacement

asset scenarios: • A replacement asset arising from an insurance claim covering the loss to the original asset will no longer be considered to be a different asset.

For example, if a four-bedroom house that is destroyed by fire is rebuilt using the insurance proceeds, this will not result in the creation of a different asset – instead it will be treated as a restoration of the original asset.

However, if the insurance proceeds resulting from the same four-bedroom house destroyed by fire are used to build two two-bedroom units instead, this will be considered a new asset as it would fundamentally alter the character of the asset that was originally purchased under the LRBA. • Buying a completed property off the plan may be undertaken with money borrowed under an LRBA. However, the LRBA can only be entered into with respect to the final payment required to complete the purchase.

The fund trustees will need to use existing fund money to secure the purchase of a property ‘off the plan’ – the initial deposit. However, once the apartment has been completed and strata titled, the trustees can enter into an LRBA to facilitate the acquisition of the property.

Finally, it should be noted that this SMSF Ruling is currently still in draft form, therefore potentially subject to change. Until the ruling is finalised, any tr ustees who may be consider ing improvements to property held under a LRBA would be well advised to seek SMSF-specific advice directly from the ATO to avoid breaching section 67B. Fabian Bussoletti is a senior technical analyst at AMP.

Appointments

Please send your appointments to: andrew.tsanadis@reedbusiness.com.au

Following the appointment of Pa u l Cr a m e r to the role of group executive – product and distribution in October, Plan B Group Holdings (Plan B) has appointed Matt Nile as group executive – operations, IT, risk and governance.

The company said Nile has significant experience in the operations, information technology, risk and advice space, with particular expertise in project management.

Plan B chief executive officer Andrew Black said Nile has demonstrated skill in bringing together the mission-critical streams of a growing business, ensuring strong governance while driving organisational performance and efficiencies.

The addition of Nile reflects the company’s commitment to move the business for ward amid regulatory change.

Nile’s previous roles include managing the risk integration of the wealth management businesses of Westpac and St George, and most recently, serving as BT Financial Group head of program management – advice.

Nile commenced his duties with Plan B on 9 January 2012.

Ian Richards Threadneedle Investments has announced the appointment of Iain Richards as head of governance and responsible investment.

Leading a team of three, he w i l l b e re s p o n s i b l e f o r t h e environmental social and governance (ESG) research and policy.

Richards joins Threadneedle a f t e r s e r v i n g a s Av i va Investors’ regional head of corporate governance since 2003. Before that, he was head of corporate governance at Schroder In ve s t m e n t Management.

“Iain’s appointment, which increases our governance and responsible investment team to three, reflects our belief that

governance and responsible investment are key aspects of our stewardship responsibilities, and an essential part of protecting and enhancing our clients’ long-term investment interests,” said Threadneedle chief investment officer Mark Burgess.

Richards will commence duties from 20 February 2012, and will report to Threadneedle head of equities Leigh Harrison.

Gen Re has appointed Eddy Fabrizio as managing director (MD) of General Reinsurance Life Australia following the d e p a r t u re o f p re v i o u s M D Michael Molesworth.

As Gen Re’s previous deputy general manager and actuary, Fabrizio has been with the insurer since 1992. The company has subsequently announced that James Louw, who has more than 10 years experience working at Gen Re, will move into Fabrizio’s position.

Commenting on Molesworth’s departure, regional manager for Gen Re Life/Health Asia-Pacific Wolfgang Droste commended the former MD on his ability to

Move of the week MLC has announced the appointment of John Brakey to the role of MLC head of private equity.

The former head of private equity at Macquarie Bank most recently worked with global alternative asset manager KKR, where he was responsible for investor relations and fundraising for private equity in the Australian and New Zealand market.

MLC executive general manager, asset management, Garry Mulcahy said Brakey’s addition will help to build its private equity business and enhance MLC’s previous success in the private equity investment market.

build a profitable franchise in a challenging market environment.

BetaShares Capital Limited has appointed Vinnie Wadhera a s d i re c t o r, p o r t f o l i o a n d national account sales.

In his new role, Wadhera will be responsible for distribution t o f i n a n c i a l a d v i s e r s, a n d educating them on, the specialist provider’s suite of exchange traded funds (ETFs).

Wa d h e ra h a s 1 7 y e a r s o f experience in the investment management industry, most recently as head of distribution

Opportunities AMP HORIZONS ACADEMY Location: Australia-wide Company: AMP Horizons Academy Description: AMP is accepting applications for its 2012 AMP Horizons Academy 12month training program.

The paid traineeship begins with a 10week course at the AMP’s academy in Sydney. Graduating as a competent financial planner, you will be provided with a position in your home state and receive additional on-the-job training for nine months in an AMP Horizons practice and be mentored by experienced financial planners throughout the year.

The successful applicants will have a Diploma of Financial Services (Financial Planning) or be RG146 compliant.

You will be rewarded with a fast-tracked career in the company and a competitive training salary.

To find out more and to apply, visit www.moneymanagement.com.au/jobs, or contact AMP on 1300 30 75 44.

For more information on these jobs and to apply, please go to www.moneymanagement.com.au/jobs

dealer group is currently looking to hire a financial adviser for its newly created financial planning department.

The company provides management, administration and consulting services to industry superannuation and eligible rollover funds.

The position allows for training, support for ongoing study and professional development.

The successful candidate will report directly to the financial planning services manager, as you provide clients with high quality investment and strategic financial planning advice. You will also provide ongoing advice services to clients, including ongoing portfolio monitoring services.

Ideally, you will have a Diploma of Financial Services with a minimum of three years experience as a financial planner.

To find out more and to apply, visit www.moneymanagement.com.au/jobs, or contact the manager, human resources, at IFAA – humanresources@ifaa.com.au.

SENIOR FINANCIAL ADVISER FINANCIAL ADVISER Location: Brisbane Company: Independent Fund Administrators and Advisers (IFAA) Description: A Queensland-based boutique

a t T h i rd L i n k In ve s t m e n t Ma n a g e r s . B e f o re t h a t , h e worked with ING Australia as head of funds management – d i s t r i b u t i o n , ov e r s e e i n g wholesale market segment s a l e s a n d re s e a rc h h o u s e ratings.

BetShares managing director Alex Vynokur said Wadhera will be a key figure in promoting to business and education advisers the benefits and role of ETFs in a portfolio.

B e t a Sh a re s c u r re n t l y p r ov i d e s n i n e E T F s t o Australian investors, seven of which were launched in 2011.

Location: Adelaide Company: Terrington Consulting Description: A leading financial institution is seeking an experienced financial adviser to work with a portfolio of high net worth

clients.

In this role, you will have the opportunity to develop your own referral networks and portfolio. You will also have access to an unlimited product and platform range.

The successful candidate will have several years experience as an adviser, with proven sales and networking capabilities.

The successful applicant will be offered a competitive salary package and career development opportunities.

To find out more and apply for jobs, visit www.moneymanagement.com.au, or contact Myra at Terrington Consulting, 0404 853 895/(08) 8423 4466, myra@terringtonconsulting.com.au.

FINANCIAL ADVISER – RISK SPECIALIST Location: Perth Company: Terrington Consulting Description: A Western Australian business advisory firm is seeking a highly-trained individual to join its wealth management team as a risk specialist.

In this role, you will deliver detailed risk insurance advice for the firm’s business clients. Knowledge of tax structures, entities, estate planning and SMSFs is essential.

To be successful in this role, you will

possess the skills to identify and capitalise upon business growth opportunities for the firm.

You will have the opportunity to utilise state-of-the-art facilities and be offered an attractive salary package.

To find out more and apply for jobs, visit www.moneymanagement.com.au/jobs, or contact Myra at Terrington Consulting, 0404 853 895/(08) 8423 4466, myra@terringtonconsulting.com.au.

BUSINESS DEVELOPMENT MANAGER Location: Melbourne Company: Terrington Consulting Description: A commercial firm is currently looking for a business development officer to drive growth, build brand equity and provide holistic and tailored solutions to a diverse client base.

Reporting to the regional manager, your responsibilities will include developing and managing key relationships.

The successful candidate will possess a solid understanding of credit risk, the ability to manage long-term relationships, and have experience in the SME market.

For more information and to apply for jobs, visit www.moneymanagement.com.au/jobs.

www.moneymanagement.com.au January 19, 2012 Money Management — 27

Outsider

ISSN 1322-7254

01

9 771322 725001

A LIGHT-HEARTED LOOK AT THE OTHER SIDE OF MAKING MONEY

“

Gone fishin’ JUST one week into the New Year and Outsider found himself back at his desk at Money Management Central, seeking to glean whatever news he could about the financial services industry.

But it seemed the most startling news was how few other financial services types were back at their d e s k s o n Mo n d a y, 9 January.

As Outsider’s colleagues at Money Management dialled number after number seeking comment on this or that, it became obvious that many of the industr y's thought leaders weren't even thinking about getting back in harness.

Out of context

Among the few exceptions was Association of Financial Advisers (AFA) chief executive, Richard K l i p i n , a n d Pre m i u m Wealth Advisers general manager, Paul HardingDavis.

Indeed, the AFA CEO's presence in the office defied Outsider's prediction that "Klippo" would most likely be found wearing board shorts and thongs while sitting next to a swimming pool.

Gi v e n Ha rd i n g - D a v i s resides on the NSW Central Coast, Outsider would have completely understood if he had been working from home.

“In these markets, window dressing can be more dramatic.”

AXA global fund manager Mark

Tinker argues that the seemingly

strong start to global markets in 2012 is a ruse coming on the back of strong selling at the end of 2011.

All you can donate tax buffet FREQUENT readers of Outsider will know that he is a long-time admirer of US investment guru, Warren Buffett.

Outsider's admiration of Buffett is not only owed to the man's undoubted investment expertise, but to the fact he combines it with a good deal of intellectual quirkiness and an undoubted social conscience.

Thus, as the US political spotlight shines on the Republican Party primary’s process and the views of groups such as the Tea Party with respect to the levels of taxation paid by the wealthy, Outsider notes the distinctly different message being sent by Buffett.

Indeed, Buffett has sought to cajole wealthy Republicans into paying more tax by saying he will match them one dollar for every dollar they donate to help pay down the nation's debt.

Where the Senate Republican leader, Mitch McConnell is concerned, Buffett says he's prepared to go $3 to $1.

Of course, given the size and rate of growth of US national debt, Outsider reckons that even if the Republican politicians were to meet Buffett's challenge, it would represent only a drop in the ocean.

To Outsider's knowledge, none of the Republican politicians have seen fit to meet Buffett's challenge.

If you’ve got it, flaunt it OUTSIDER did a fair job of putting the world’s turbulent financial markets as far from his mind as possible over the holiday period, to the extent he was able to resoundingly enjoy Australia’s newly rediscovered dominance on the cricket field.

But having now returned to the daily grind, it seems there is no way of avoiding buzzwords such as “European crisis”, “sovereign debt”, “contagion”, “GFC mark II”, and so on. Things are all looking decidedly glum, really.

One man who seems to be less distracted than most by the debacle

in Europe is popular US rapper 50 Cent.

News sources recently reported that “Fiddy” (as Outsider has been instructed to refer to him) had posted a series of photos to his Twitter account showing him posing in a hotel in Las Vegas with large wads of cash balanced up and down each arm and dangling from his somewhat-askew headwear.

Outsider thought it to be rather reminiscent of Scrooge McDuck diving into his money bin.

Depressingly, reports indicate that Mr Cent owes a significant chunk of his personal fortune not

28 — Money Management January 19, 2012 www.moneymanagement.com.au

only to the largesse of the American music industry, but to astute investing. Apparently, he got on board with a large stake in Vitamin Water before the product was bought out

by Coca Cola in 2007, earning him a more than tidy sum.

We’ve all been through a few stockmarket downturns since the last time Outsider clearly remembers large numbers of financial services getting about with large wads of cash decorating their person. Given the unpredictability of the stockmarket lately, maybe it's time we all started taking investment advice from rap stars?

“It goes without saying that companies that disappoint on earnings will get taken to the woodshed.”

Tinker again, on the sentiment that will be afforded to major companies that underperform in global markets in 2012.

“A tax policy only a Republican could come up with.”

Berkshire Hathaway chairman Warren Buffett on the Republican’s proposed “Buffet Rule Act” which would allow the rich to make voluntary tax contributions to pay down US national debt.