FS Advice Journal vol15 is04

Volume 15 Issue 04

THE REAL DEAL

Dawn Thomas, Wealthwise

The hunt for yield Koda Capital

Elder financial abuse Bartier Perry

Published by

Outsourcing Work from home Handling complaints

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Contents

www.fsadvice.com.au Volume 15 Issue 04 I 2020

1

COVER STORY

THE REAL DEAL

Dawn Thomas, Wealthwise

16 NEWS HIGHLIGHTS

FEATURES

FASTEST GROWING AFSLS IN THE COUNTRY

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New research from Rainmaker Information shows which licensees added the

Welcome note Christopher Page

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most advisers in the 12 months to September end.

HUB24 ACQUIRES XPLORE

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HUB24 announced a series of significant transactions, including plans to

Whitepaper Why budget is not a dirty word

acquire Xplore Wealth and the sale of its financial advice business.

IOOF BUYS MLC WEALTH

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24

IOOF launched a $1 billion capital raising to fund its acquisition of MLC Wealth in a deal worth a total of $1.4 billion.

ANZ ADVISERS LAUNCH BOUTIQUE

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For news updates like this follow us on social media

Four former staff of ANZ’s financial planning business have started a new advice firm in Melbourne.

FS Advice

THE AUSTRALIAN JOURNAL OF FINANCIAL PLANNING•

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Contents

www.fsadvice.com.au Volume 15 Issue 04 I 2020

06 Published by a Rainmaker Information company.

A: Level 7, 55 Clarence Street, Sydney, NSW, 2000, Australia T: +61 2 8234 7500 F: +61 2 8234 7599 W: www.financialstandard.com.au Associate Editor Elizabeth McArthur elizabeth.mcarthur@financialstandard.com.au Production Manager Samantha Sherry samantha.sherry@financialstandard.com.au Graphic Designer Jessica Beaver jessica.beaver@financialstandard.com.au

Advertising Stephanie Antonis stephanie.antonis@financialstandard.com.au

VICTIMS FUME AT ASIC CALLS TO AXE TPB FOR FINANCIAL ADVISERS

w

07 09 10

Technical Services Roger Marshman roger.marshman@rainmaker.com.au

News

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News

THE PLATFORMS WITH THE MOST ADVISERS HENDERSON SENTENCED

News

ASIC TAKES ACTION AGAINST RI ADVICE MLC ADVICE FIRM EXITS

News

CLASS LAUNCHES NEW PRODUCT EW DEFINITION OF GENERAL ADVICE N CALLED FOR

News

FINANCIAL ADVICE FIRMS FACING FAILURE THE RACE TO $80 BILLION

Director of Media and Publishing Michelle Baltazar michelle.baltazar@financialstandard.com.au Managing Director Christopher Page christopher.page@financialstandard.com.au

FS Advice: The Australian Journal of Financial Planning ISSN 1833-1106 All editorial is copyright and may not be reproduced without consent. Opinions expressed in FS Advice are not necessarily those of Financial Standard or Rainmaker Information.

Financial Standard is a Rainmaker Information company.

ABN 57 604 552 874

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News

ASEA URGED TO CLARIFY IN-HOUSE F PRODUCT CONFLICTS COST OF ADVICE SOARS

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Opinion

WHO RULES THE WORLD? PARAPLANNERS!

Subscriptions hotline:

1300 884 434 Ask about our PLUS DEALS.

THE AUSTRALIAN JOURNAL OF FINANCIAL PLANNING•

For more news and updates, visit www.fsadvice.com.au

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Contents

WHITE PAPERS

www.fsadvice.com.au Volume 15 Issue 04 I 2020

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EHAVIOURAL FINANCE AND THE DESIGN AND B DISTRIBUTION OBLIGATIONS

By Simon Russell, Behavioural Finance Australia

Applied Financial Planning

This paper highlights barriers to consumer information processing and suggests how advisers can help clients in terms of better decisions, outcomes and understanding of products.

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Taxation & Estate Planning

LAIMING EXPENSES FOR WORKING FROM HOME DURING C COVID-19

By Lynne Gibson and Letty Chen, TaxBanter

This paper explains the differences between the fixed rate, actual cost and shortcut rates for deductibility claims.

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Technology

LEVERAGING THE TECHNOLOGY ECOSYSTEM

By Kylie Bryant, Bravura Solutions

Artificial intelligence is empowering consumers, and its capacity to deliver personalised offerings is ever increasing.

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Ethics & Governance

ELDER FINANCIAL ABUSE

By Jennifer Shaw, Bartier Perry

In cases where elder abuse is suspected the court may set aside ‘gifts’ from elderly relatives as unconscionable.

Compliance

THE IMPACT OF COMPLAINTS

By Angelique Aksenoff, Assured Support ASIC’s revised regulatory guidance has upped the ante on complaint handling for financial firms.

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Compliance

UTSOURCING: COMPLYING WITH AN OBLIGATION O WITHOUT PERFORMING THE FUNCTION

By Alexa Bowditch, Holley Nethercote

Outsourcing business functions is widespread, this paper summarises how to comply with the relevant regulatory requirements

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Investment

A LASTING BOND

By Paul Chin, Jamieson Coote Bonds

Even though yields are at historically low levels, there is still a place for high-grade bonds in a portfolio as they provide downside protection.

THE AUSTRALIAN JOURNAL OF FINANCIAL PLANNING•

FS Advice

Welcome note

www.fsadvice.com.au Volume 15 Issue 04 I 2020

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Christopher Page managing director Financial Standard

Farewell 2020 elcome to the final issue of FS Advice for 2020.

W What a year it’s been.

Those of us that are part of the financial advice industry in Australia started the year fretting about how many advisers would depart the sector as the FASEA educational requirements came into effect.

We also worried about the increasing cost of compliance and how the average Australian would be able to afford advice, as well as how advisers would rebuild after the reputational damage of the Royal Commission.

But, our problems in the industry were swiftly put into perspective by the bushfire crisis. A horrific bushfire season united Australia in respect for our fire fighters and brought us together to raise millions for those who had lost everything.

Little did we know what the year had in store for us.

The problems facing the industry didn’t go away, but they had to be pushed aside as advisers faced the immediate challenge of guiding clients through the most severe downturn Australia has experienced since World War II. Globally, the news has been full of uncertainty.

At home too, small businesses and whole industries have been pushed to the brink because of COVID-19.

More than three million Australians have taken up to $10,000 from their super funds to get through this down turn – and just under half of those went back to pull a second $10,000 out.

While a lot of us want to help, at times it has been hard to know how.

Now more than ever, Australians need financial guidance. It is plainly clear to see how many Australians could benefit from professional financial advice to get them through the fallout of COVID-19.

Perhaps, a silver lining of all this could be the average Australian having a deeper understanding of things like super? A whole generation of Australians had never experienced a recession before this. There’s every chance living through one will now make them prioritise financial security differently.

In this edition of FS Advice you will find our Power50.

These are the 50 most influential financial advisers in Australia, as voted by the public and their peers. They represent the bright future of this industry and its proud history.

One of the Power50, Dawn Thomas, is also our cover star. She is a relentless source of positivity in an industry that (at least recently) has had its fair share of gripes.

Thomas’ journey from a bank to redundancy to forging her own path outside the bank wasn’t smooth sailing, but she tells the story with a smile and a focus on the future.

We could all take a page out of her book after the year we’ve had. As the financial advice industry moves towards becoming a true profession, let’s focus on the future. Here’s to bigger and better things in 2021! fs

The quote

It is plainly clear to see how many Australians could benefit from professional financial advice to get them through the fallout of COVID-19.

Christopher Page managing director, Financial Standard

FS Advice

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News

www.fsadvice.com.au Volume 15 Issue 04 I 2020

Fastest growing AFSLs in the country

Victims fume at ASIC The Victims of Financial Fraud (VOFF) group have written to senators slamming ASIC chair James Shipton for ignoring their requests for help after it emerged he received relocation payments from ASIC above the salary cap.

VOFF secretary John Telford wrote to Senator Penny Wong informing her that VOFF’s activism in relation to the Trio Capital fraud had been ignored by Shipton.

He said that in 2018, the group wrote to Shipton and asked him to please inform authorities in Guernsey (an island in the English Channel) that a Guernsey citizen should be questioned in relation to managing one of the Trio Capital funds. Shipton did not reply.

“VOFF is angry because while Mr Shipton didn’t take five minutes to help 1000 Australians who are victims of the Trio Capital fraud, he had the time to submerge his own head in the trough allegedly at taxpayer expense,” Telford said.

“At no time during the ordeal surrounding the investigation into the Trio fraud did ASIC help the 1000 victims that were not part of the APRA-supervised funds that were covered by Part 23 of the SIS Act. ASIC’s unwillingness to help caused more harm than if there was no ASIC agent altogether.”

He said that ASIC had failed victims of fraud, while overseas regulators manage to see victims compensated. Telford pointed to the example of Bernie Madoff’s Ponzi scheme - victims managed to recover 78% of losses thanks to the actions of US authorities.

“That the financial cop on the beat, under the watch of allegedly a deceitful chair, James Shipton and deputy chair, Daniel Crennan, turned their backs on genuine victims of financial crime to benefit from ill-gotten gains,” Telford said. fs

Kanika Sood

N The numbers

2597

The number of advisers that left the industry one year.

ew research from Rainmaker Information shows which licensees added the most advisers in the 12 months to September end. And which AFSLs have the biggest market share.

Overall, there were 19,357 advisers attached to an AFSL at September end, down 2597 from a year ago. In the 12 months, 2832 new names were registered while nearly twice the amount of registrations ceased at 5429 - meaning a net drop.

Together, these advisers looked after about $932 billion in assets.

GWM Adviser Services picked up the most new adviser registrations in the period at 191. However 155 registrations ceased, meaning its total adviser headcount was 440 - an increase of 36 advisers.

In net terms, Lifespan Financial Planning was the winner with 62 additions. It ended September with 254

current advisers, after 101 new registrations and 39 ceasings in the period.

The big four banks saw the most adviser registrations cease: AMP Financial Planning (376), National Australia Bank (375), Commonwealth Financial Planning (247) and Australia and New Zealand Banking Group (231).

Despite the recent growth numbers, the largest adviser populations remain housed at older names.

AMP Financial Planning, with its 945 advisers and about $56 billion had the largest market share of advisers at 4.6%. It was followed by SMSF Advisers Network (907 advisers, $250 million, 4.4% market share).

Next up were five names with 2% to 2.6% market share: Synchronised Business Services (521 advisers), Morgans Financial (497), Charter Financial Planning (493) and GWM Adviser Services (440). fs

Calls to axe TPB for financial advisers Elizabeth McArthur

There are calls to stop financial advisers having to register for the Tax Practitioners Board (TPB) after a recent reshuffle of the board has seen the regulator without an advice representative.

Writing for FS Advice, Lifespan Financial Planning chief executive Eugene Ardino has said the TPB should be axed as a regulator for financial advisers all together.

Currently, financial advisers must pay an application fee of $560 to renew their TPB registration at least every three years.

“The Tax Practitioners Board should be removed as a regulator for financial advisers. Its responsibilities should be handed over to either ASIC or the disciplinary body, as it is unnecessary to have a separate regulator for one small area of financial advice,” Ardino said.

“Instead, some tax experts should be embedded within the main regulator. These are the core changes that need to be made to increase the accessibility of financial advice to more Australians.”

His views are in line with those of the Financial Planning Association of Australia (FPA).

THE AUSTRALIAN JOURNAL OF FINANCIAL PLANNING•

FPA chief executive Dante De Gori recently said that the establishment of a new single disciplinary body for financial advisers, as recommended by the Royal Commission, could be yet another agency that advisers had to fund which duplicates regulation.

“The single disciplinary body should have primary responsibility for government oversight of the conduct of financial planners, setting mandatory professional standards, investigating potential breaches of mandatory standards and law, and applying discipline,” De Gori said.

“A number of these functions currently exist in other government agencies, including FASEA, ASIC and the TPB. Rather than duplicate them, the single government body should assume these functions. “ Tax financial adviser Julie Berry recently departed the TPB, leaving the regulator without a financial advice representative on its board.

Financial advisers must be registered with the TPB, but there are now accusations that it duplicates regulation already applied to the industry by ASIC and the associations. fs

FS Advice

News

www.fsadvice.com.au Volume 15 Issue 04 I 2020

Henderson sentenced

HUB24 acquires Xplore Wealth

Elizabeth McArthur

Eliza Bavin

Sam Henderson was sentenced on 20 October 2020 in the local court after pleading guilty to three charges of dishonest conduct.

Henderson was fined a total of $10,000 and released without any jail time on the condition of good behaviour for two years.

The former celebrity financial adviser was fined $7000 on a charge of giving defective financial services and a further $3000 for dishonest conduct in relation to a financial service.

“As a financial adviser, Mr Henderson built a level of trust with his clients. However, by engaging in dishonest conduct, he broke that trust. His sentencing sends a strong message that ASIC will investigate and act against dishonest conduct, and that dishonest advisers will face the consequences,” ASIC executive director, financial services enforcement Tim Mullaly said.

The judge applied a 25% discount to the sentence due to Henderson’s guilty plea.

ASIC alleged that Henderson engaged in dishonest conduct while chief executive, director and senior financial adviser of Henderson Maxwell by claiming that he had a Master of Commerce when he did not.

The regulator found 115 PowerPoint presentations he gave to clients between 2010 and 2016 which allegedly contained false claims that Henderson had the degree.

Further, ASIC said the Master of Commerce claim was mentioned on the Henderson Maxwell website between 2012 and 2016 and in Henderson Maxwell brochures distributed between 2013 and 2017 as well as in an information memorandum dated May 2011. fs

H

FS Advice

The numbers

$60m

The amount HUB24 plans to acquire Xplore for.

UB24 announced a series of significant transactions, including plans to acquire Xplore Wealth and the sale of its financial advice business.

Paying $60 million for Xplore, the platform provider said the proposed acquisition through a scheme of arrangement will be funded by a combination of cash and HUB24 scrip consideration valuing Xplore at a share price of $0.20.

The valuation of Xplore represents a premium of 203% to the closing price of Xplore shares as at October 27.

Xplore’s board has unanimously recommended its shareholders approve the acquisition.

Xplore chair Alex Hutchison said the transaction is an opportunity for shareholders to receive a highly attractive takeover premium and to retain exposure to the platform industry.

He said clients and partners using its platform and MDA services will benefit from the continued development of the platform. The takeover process is anticipated to be completed in March 2021.

HUB24 announced the move as part of three strategic transactions which together aim to strengthen the company’s position as the “leading provider of integrated platforms, data and technology services”.

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The platform provider is also divesting its financial advice licensee, Paragem, in a move that will see it become a substantial shareholder in Easton Investments and Paragem managing director Nathan Jacobsen hold the same role at Easton.

HUB24 has proposed a subscription for new shares in Easton for $14 million cash and the divestment of Paragem to Easton for $4 million of new Easton shares. Following a share buyback, HUB24 will own 40% of Easton.

Easton said it has been conducting a strategic review for the last 12 months to identify a transaction that would transform the business’ earnings and growth potential, engaging with HUB24 due to its track record of growth.

“It became evident to the Easton board that HUB24 would make an excellent partner given its size, resources, capabilities and aligned culture on people and client servicing, as well as having complementary businesses with strategic overlap,” Easton said.

The Easton shares were issued at $1.20, representing a 38% premium to the company’s closing price.

According to Rainmaker data, Paragem is currently home to 76 financial advisers. Following the transaction, Easton - which already owns GPS Wealth - will be the fifth largest dealer services group in Australia, it said. fs

The platforms with the most advisers Kanika Sood

Colonial FirstChoice remains the platform used by the most advisers, with about 11% market share, according to latest Rainmaker estimates.

CBA’s platform is used by 9835 advisers and 1085 Australian financial services licensees.

It is followed by AMP Flexible Lifetime with 6.9% market share by advisers - 6240 advisers use it across 780 AFSLs. The third name on the list is Perpetual’s WealthFocus with 5853 adviser users and 6.5% market share. It is used by 777 AFSLs. Next up was Asgard with 5401

advisers, 6% market share and 739 licensees.

The results are based on AFSL-level data collected

by Rainmaker. It is estimated the average adviser uses about five different platforms.

Five platforms had 5-6% market share. This includes BT Wrap (5122 advisers and 5.7% market share), North (5019 advisers and 5.5% market share), AMP Flexible Super (4919 advisers and 5.4% market share), Macquarie Wrap (4709 advisers and 5.2% market share) and IOOF (4539 advisers and 5% market share).

BT Panorama was used by an estimated 3332 advisers giving it 3.7% share. fs

THE AUSTRALIAN JOURNAL OF FINANCIAL PLANNING•

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IOOF buys MLC Wealth, Geoff Lloyd departs Eliza Bavin, Kanika Sood, Jamie Williamson

O

n 31 August 2020, IOOF launched a $1 billion capital raising to fund its acquisition of MLC Wealth in a deal worth a total of $1.4 billion.

The agreement follows the announcement by NAB in 2018 to exit the business, saying the decision is in line with its strategy to simplify and focus on its core banking business.

IOOF chief executive Renato Mota said the opportunity to acquire the wealth business was compelling.

“MLC is a natural fit with IOOF and presents a unique opportunity to create value from synergies for the benefit of clients, members and shareholders,” Mota said.

“This is a once in a generation opportunity to create the leading wealth manager of the future.

“As the financial services industry reshapes, a much bigger and better IOOF will position it at the forefront of the industry transformation. In this new era, and in response to changing societal and technological needs, the new IOOF will have the ability to offer unmatched choice and accessibility of quality financial advisory and wealth management services to all Australians.”

IOOF will acquire 100% of MLC Wealth comprising its financial advice, platforms and asset management business for $1.44 billion.

The acquisition will be funded by a $1 billion fully underwritten institutional placement and accelerated nonrenounceable entitlement offer, $250 million of incremental senior debt via an underwritten syndicated debt facility, $200 million in a subordinated loan note issues to NAB and $40 million of existing IOOF cash.

IOOF confirmed it will not assume conduct or remediation liability for the MLC business.

IOOF said the transaction will transform the business into the largest retail wealth manager in terms of

funds under management (FUM) totalling $510 billion, the largest advice business with 1884 advisers and the second biggest super provide with funds under administration at $173 billion.

Mota said scale will be critical for success and ensuring both clients and shareholders benefit from the industry transformation.

“Merging two of the longest standing businesses in wealth management brings together a combined culture and common purpose of community spirit and supporting people to achieve their financial goals,” he said.

“The combination of IOOF and MLC brings wide-ranging capabilities, technical expertise and a purpose driven mindset to enable the new-era group to significantly enhance choice, accessibility and client experience.”

Following the acquisition, on 7 October 2020, MLC chief executive Geoff Lloyd announced his departure after two years at the helm.

MLC’s chief corporate services officer Andrew Morgan will oversee MLC’s day-to-day operations while the sale to IOOF is completed.

“This is a natural progression and reinforces the focus he brought to the process and to achieving the best outcome for customers, colleagues and shareholders. Having completed the task with distinction, he is now able to take some well-deserved time and consider his next role,” NAB chief executive Ross McEwan said in an email to NAB and MLC employees.

“In his time with us, Geoff has built the highest quality leadership team and set about building, communicating and driving a strategy that gave clarity to refocus, modernise and grow.”

In his letter to MLC staff, Lloyd thanked McEwan, the NAB board and executives and MLC’s boards.

“Having had the opportunity to lead MLC over the past two years, I feel a

THE AUSTRALIAN JOURNAL OF FINANCIAL PLANNING•

The quote

This is a once in a generation opportunity.

great sense of pride and gratitude,” Lloyd said.

“I am proud to have taken on this challenge. The level of change required was definitely larger than I first anticipated however you all quickly got behind the refreshed strategy, including those of you who preceded me and also those who joined to help reset and reshape MLC. Like me you all saw the opportunity in this great brand and the need for leadership in the wealth market.”

Following the acquisition, IOOF consolidated the leadership of its various dealer groups and announced another acquisition.

Revealing the next phase of its Advice 2.0 strategy IOOF has restructured its advice licensees into two core businesses, appointing two new chief executives to lead them.

The first group brings together integrated advice businesses consisting of Lonsdale, Millennium3 and IOOF Alliances and will be led by Millennium3 chief executive Helen Blackford.

The second group will comprise RI Advice and Consultum Financial Advisers and will be led by RI Advice chief executive Peter Ornsby. Ornsby will also lead Financial Services Partners until it is closed, as previously announced by IOOF. Terry Dillon will remain as chief executive of Shadforth Financial Group, and Nathan Stanton retains leadership of Bridges.

FSP head Geoff Kellett and Lonsdale chief executive Mark Stephen have departed the licensees with more changes to come. fs

FS Advice

News

www.fsadvice.com.au Volume 15 Issue 04 I 2020

ANZ advisers launch advice boutique

MLC advice firm exits group

Kanika Sood

F

Karren Vergara

A former MLC-licensed financial advice firm has left the dealer group following the IOOF takeover to join FYG Planners Group.

Queensland-based Designing Financial Solutions (DFS), led by principal and financial planner Kevin Redfearn, is now operating under the AFSL of independent group FYG Planners, which has over $3 billion in funds under management.

DFS was licensed with GWM Advisers, which was part of MLC. Redfearn has been in the financial advice industry since 2001 and founded DFS in 2014. Simone Halse works with Redfearn as client services manager.

FYG Planners general manager Andrew Wootton welcomed Redfearn, saying he shares a common alignment in terms of providing goals-based advice with FYG Planners.

“Interestingly, Designing Financial Solutions have joined us from an MLC entity, which is a clear theme we’re seeing right now, [as] we’re in discussions with several advisers looking at their options,” he said.

In early September, HFM & Partners announced it is leaving MLC-owned GWM Adviser Services in light of the acquisition

by IOOF. Managing director Scott Haywood said being part of the biggest group of advisers was one of the main reasons he decided to change licensees to Sequoia Financial subsidiary InterPrac.

FYG managing director Peter Mancell commented: “In discussions with Kevin we found him aligned with us philosophically, along with being the type of personality we want in FYG.” fs

FS Advice

9

The quote

The business sis looking to specialise in providing financial advice to clients who have been subject to a divorce or separation.

our former staff of ANZ’s financial planning business have started a new advice firm in Melbourne.

Park Lane Advice Group in Melbourne’s Cheltenham suburb is licensed via IOOF-owned Millennium 3 Financial Services.

It was founded by Evguenia Rutkowski, Jonathan Scukovic, Jason Bell and Peter Feddersen - all of whom worked for ANZ’s financial advice business until recently.

The firm is currently working with about 89 new clients.

It is offering broad-ranging advice to clients of all profiles, including those

in accumulation phase to retirement phase.

Rutkowski said the business sis looking to specialise in providing financial advice to clients who have been subject to a divorce or separation.

Rutkowski worked at ANZ as a financial adviser for about five years and says she services over 150 clients.

She, Scukovic and Bell are directors and principles at the firm. Feddersen is a director and a lending specialist.

In May 2019, ANZ decided to stop offering its Prime Access financial planning offering that was launched in 2003 and subject to a 2018 memorandum of understanding with ASIC. fs

ASIC takes action against RI Advice Elizabeth McArthur

ASIC has commenced proceedings in the Federal Court against RI Advice for failing to have adequate cyber security systems.

ASIC said its action is in response to a number of alleged cyber security breaches through authorised representatives of RI Advice.

One of those alleged incidents was at Frontier Financial Group, a trustee for the Frontier Trust, from December 2017 to May 2018.

RI Advice was previously owned

by ANZ but became a wholly owned subsidiary of IOOF in 2018.

ASIC alleges that Frontier was subject to a “brute force” attack whereby a malicious user successfully gained remote access to Frontier’s server and spent more than 155 hours logged into the server, which contained sensitive client information including identification documents.

The regulator also alleges RI Advice failed to implement adequate policies, systems and resources to manage cyber security risk.

ASIC is seeking declarations that RI Advice contravened provisions of the

Corporations Act, orders that RI Advice pay a civil penalty and compliance orders so that the group will have to implement appropriate cyber risk management.

ASIC named Anthony Hilsley, a financial adviser at Superannuation Advisory Service trading as Wise Financial Planning, in its concise statement. The regulator alleges RI Advice was informed in 2016 that Wise Financial Planning’s main reception computer was hacked by ransomware which encrypted files and made them inaccessible.

John Leslie Walker, a financial adviser at RetireInvest, was also named. RI Advice was informed in 2017 that its Circular Quay local network was hacked through a remote access port - impacting approximately 226 client groups.

Also in 2017, the regulator alleges an unknown malicious agent gained access to Frontier Financial Group’s file server.

“The malicious agent spent more than 155 hours logged into the server, which contained sensitive client information including identification documents. FFG did not detect the FFG breach until 16 April 2018, more than three months after it had commenced,” ASIC said. fs

THE AUSTRALIAN JOURNAL OF FINANCIAL PLANNING•

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News

www.fsadvice.com.au Volume 15 Issue 04 I 2020

Advice reforms to be legislated: Hume

FPA lobbies for change The Financial Planning Association of Australia (FPA) is once again calling on lawmakers to change the term ‘general advice’ to diminish client confusion and enhance confidence in the industry.

Instead of ‘general advice’, the FPA is recommending it be renamed ‘product information’ or ‘strategy information’.

FPA chief executive Dante De Gori believes future reforms to consumer protection should address problems in the law rather than add further regulation.

“While the recent reforms in regulation play an important role in protecting consumers, there has been an unnecessary level of duplicated red tape that will create a significant regulatory burden with no additional benefit to the consumers,” he said.

“There is a high level of confusion in the market, within industry, media, government and consumers about the definitions and roles of financial advisers and financial planners, and those that sell financial products.”

Further to replacing the term ‘general advice’, the FPA said consumers must be given a standard warning about the nature of the advice they are receiving.

Last year ASIC released a report Financial advice: Mind the gap which highlighted how consumers are unfamiliar with the concepts of general and personal advice.

The report echoed the recommendations of the Murray Financial System Inquiry and the Productivity Commission reports which suggested the term ‘general advice’ is likely to lead to false expectations about the value of advice received.

ASIC noted it would undertake additional research in 2019 to identify a more appropriate term. fs

Annabelle Dickson

A

The quote

I’m constantly looking for opportunities for red tape reduction, identifying obstacles to productivity and profitability and reducing the burden on your industry and participants.

THE AUSTRALIAN JOURNAL OF FINANCIAL PLANNING•

fter having previously been placed on hold, the single disciplinary body for financial advisers and the compensation scheme of last resort is set to be legislated by mid-2021.

Speaking at the 2020 Association of Financial Advisers Vision Conference, Senator Jane Hume said the government agreed with the Hayne recommendation for the single disciplinary body and believes it will encourage greater professional discipline in the industry.

“We are working through the detail and we intend to introduce the legislation by mid-2021,” she said.

Furthermore, Hume said the government’s forward-looking compensation scheme of last resort, is also set to be introduced in mid 2021.

“This is a substantial step in rebuilding trust in dispute resolution,” she said.

“I look forward to hearing from you all when consultation resumes on the single disciplinary body and compensation scheme of last resort measures.”

Hume went on to say financial advisers are a key part of the economy and will be critical in the recovery and that she and the government are listening to advisers’ concerns.

“I am working to address your biggest concerns. I’m constantly looking for opportunities for red tape reduction, identifying obstacles to productivity and profitability and reducing the burden on your industry and participants,” she said.

The single disciplinary body, Hume said, will assist with these opportunities and will be a “game changer”.

“We have been listening to what the AFA wants and what the community wants. We want to make sure there is far better alignment of the regulatory requirements and legislative requirements,” she said.

Hume referred to the current array of organisations and requirements as an “involuntary colonoscopy” as advisers are overburdened by compliance.

“We are hoping there a fewer of them and a clearer path for expectations,” she said. fs

Class launches new product Self-managed super fund administration and software provider Class has launched an accounting and administration product for the growing number of discretionary and unit trusts.

Class Trust is said to make the administration process easier for financial advisers and accountants by automating parts of the process from deed establishment and management through to closure.

Class chief executive Andrew Russell said the product comes from its existing customers’ wish to simplify trust administration.

“Class software product expertise is solving customer pain points through complex rule-based coding. The launch of Class Trust is a natural extension of our

product suite for our customers,” he said.

In a pilot of the product, Class Trust was able to save an average of three hours of administrative work and jobs could be processed in half the time after its research showed that Excel was used for trust administration.

“As we have seen through our in-depth customer research, managing trusts is complex and while we have used the components of the Class engine, our Trust product has been designed and built to address the specific challenges we know exist for professionals that administer trusts,” Russell said.

The launch of Class Trust comes after Class appointed two technology heads to assist in growth and innovation. fs

FS Advice

News

www.fsadvice.com.au Volume 15 Issue 04 I 2020

The race to $80 billion

Adviser sentenced to eight years’ prison

Karren Vergara

Elizabeth McArthur

Managed accounts assets continue to grow steadily, having hit nearly $80 billion despite setbacks caused by COVID-19.

The Institute of Managed Account Professionals’ latest census found asset growth for the sector was stable, reaching $79.71 billion at the end of June 2020.

Inflows comprised $3.54 billion of the total assets for the period.

Funds under management increased $420 million from the December 2019 figure of $79.29 billion.

Managed discretionary account services (MDAs) take the lion’s share of FUM with $35.28 billion followed by separately managed accounts (SMAs) at $28.06 billion.

Commenting on the market volatility for the period, Milliman head of capital markets for Australia Victor Huang said the value of the ASX/S&P200 Accumulation Index fell 10.42% compared to the 3.06% increase in the Accumulation Index.

“This helps explain the reason why overall FUM didn’t move when at the same time there was positive funds inflow and newly reported FUM,” Huang said.

IMAP chair Toby Potter said: “Advisers tell us, inflow is principally from migrating existing clients from advice only services to managed accounts to provide a better client outcome.”

Potter added that this has been a significant part of the managed accounts story as many advisers are keeping clients’ best interest front of mind and assessing if managed accounts are fit for purpose.

A client whose portfolio is subject to continual review and management is likely to be better off as opposed to a client who gets ad-hoc review, Potter said. fs

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The quote

The fact that he got sentenced to eight years, I think is good for the industry.

financial adviser has been jailed over using clients’ money to fund his lifestyle to the tune of $1.1 million, including $72,000 he spent on a boat, while licensed by AMP, NAB and Synchron.

Anthony Dick has been sentenced to eight years in prison with a non-parole period of two years and eight months.

He was reported to ASIC by Synchron, which also ceased his authorisation, in April 2018.

Between March 2006 and December 2017, Dick accessed and transferred about $1.1 million of clients’ superannuation, pensions and personal savings.

Dick was licensed by AMP’s Jigsaw Advice Services from 2004-2012 before joining GWM Adviser Services for two years. From there, Dick joined Synchron where he was an authorised representative from 2014 to 2018.

An ASIC investigation revealed that Dick used clients’ money to fund his lifestyle, including $72,000 which was used to purchase and maintain a boat.

Synchron director Don Trapnell told Financial Standard Dick’s authori-

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sation was ceased after he sent an email to Synchron admitting to wrongdoing.

Trapnell said the admission came during the Royal Commission and that perhaps Dick felt he would no longer be able to keep up his fraud.

Synchron’s compliance manager then flew to Townsville, where Dick was based, eventually escalating the issue to the police.

“The fact that he got sentenced to eight years, I think is good for the industry. It’s a little disappointing that the non-parole period is only two years and eight months,” Trapnell said.

He likened Dick’s behaviour to bank robbery, saying: “Instead of walking into the bank with a gun he walked in with a piece of paper, with a forged signature.”

Only a small portion of the misappropriated $1.1 million happened in the time Dick was at Synchron, Trapnell said.

He added that he personally knew Dick but that he had no idea of the fraudulent behaviour and felt shattered and betrayed when the information came to light. fs

Financial advice firms facing failure: Dynamic Asset Consulting Eliza Bavin

Dynamic Asset Consulting (DAC) has warned that financial advisers are putting their businesses and their clients at serious risk by implementing traditional strategic asset allocation (SAA) portfolios.

DAC portfolio manager Jerome Lander said most Australian financial advisers are still operating client portfolios based on a view that interest rates will continue to fall.

“The new reality is that rates are bottoming out and can’t fall much further in a historical context, and if they do then mainstream asset prices are probably in big trouble anyway,” Lander said.

“In the US we are seeing the effects of abnormal policies, including big tech names like Apple and

Tesla being thrown around on pure speculation in what is becoming an increasingly erratic asset pricing environment.”

Lander said portfolios need to be managed differently in an environment where major economic risks and crises loom large.

“Most portfolios recommended by financial advisers are based on a low inflation environment and falling interest rates,” he said.

“That is the benign environment we have had.

It is not the environment we are moving into and it increasingly unlikely to be the environment of the future. This is a key inflection point in markets and an opportunity for advisers to protect their clients and their business from what is coming. The world has changed.” fs

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News

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Ord Minnett acquires E.L. & C. Baillieu

Cost of advice soars With research showing the average cost for a Statement of Advice has increased 10% in 12 months, the Financial Planning Association of Australia (FPA) is warning of the detrimental impact ongoing reform is having on financial advisers and consumers.

The FPA said the establishment of a single disciplinary body must be used to reduce red tape and untangle an “unreasonably complex” regulatory framework that is stifling the industry and driving up the cost of advice.

The FPA said its research indicates the average cost for a statement of advice is around $2700, marking a 10% increase on the previous year and reflects the increased cost of operating as an adviser in the current environment.

FPA chief executive Dante De Gori said the current wave of reforms sweeping through the financial planning profession is creating significant risks.

“While we welcome reforms that improve the overall standard of financial advice, financial planners and their clients are paying an unreasonably high price for it,” De Gori said.

The FPA found that, when asked, 41% of Australians said they wanted to get financial advice.

“Many of them won’t proceed because of the cost or the complexity of getting that advice.

Without the government’s focus on this critical issue and the parliament’s support, we will resign ourselves to a future in which only the wealthy can afford to access financial advice,” De Gori said.

The FPA said the regulation of financial advice has become increasingly complex and costly, leading to many advice practices struggling to remain commercially viable. fs

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The scale benefits and self-clearing of the two businesses will allow us to be leaders in financial advice.

rd Minnett has acquired E.L. & C. Baillieu for an undisclosed amount in what it describes as “a highly welcomed strategic move”.

Ord Minnett said the acquisition will strengthen it as one of Australia’s largest, independent private wealth firms.

“We felt this acquisition was a strong strategic and cultural fit with Ord Minnett,” Ord Minnett chief executive Karl Morris said.

“The combination of E.L. & C. Baillieu’s brand heritage and history, private stockbroking business, its adviser network, its client-base and operational synergies will cement Ords as a respected Australian wealth brand.

“The scale benefits and self-clearing of the two businesses will allow us to be leaders in financial advice. This new amalgamation can only serve to benefit Australian investors and our clients for many more generations to come. We look forward to working with the E.L. & C. Baillieu team.”

Chair of E.L. & C. Baillieu Jo Dawson said, after running an independ-

ent and successful process since June this year, she is delighted to announce the shareholders of E.L. & C. Baillieu voted in favour of the transaction.

“The transaction will bring together two of Australia’s longest standing stockbroking firms, and provide many exciting opportunities for our clients and staff,” Dawson said.

“Having received strong interest from the stockbroking community, Ord Minnett were determined to be the perfect fit for our business and I believe that the combination of the two firms will position E.L. & C. Baillieu well for the structural changes transforming our industry. Our advisers and staff are looking forward to what will be an exciting time ahead.”

The integration of both firms is set to take place over the next 12 months and E.L. & C. Baillieu will continue to operate under its name, however will be a wholly owned subsidiary of Ord Minnett.

The news comes after Ord Minnett recently bought back IOOF’s 70% stake in its business for $115 million. fs

FASEA urged to clarify stance on in-house product conflicts of interest Elizabeth McArthur

The Institute of Managed Accounts Professionals (IMAP) has written to FASEA again, arguing that its latest guidance on the Code of Ethics leaves much to be desired.

IMAP’s main issue is with Standard 3, which seeks to eliminate conflicts of interest from financial advice.

In the latest guidance, FASEA clarified that where advice is in the best interests of the client, safe harbour has been followed, fees are reasonable and disclosure has been made, standard three is likely to have been met.

IMAP said while some of that guidance was clear, some of the information in the guidance was “misleading and confusing”.

“Conflicts are generally assessed as ‘potential’, ‘perceived’ or ‘actual’. In this and previous guidance,

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FASEA has suggested that Standard 3 only applies when there is ‘actual’ conflict,” IMAP said.

“However, the disinterested person test sets out a ‘perceived’ conflict and defines it as ‘actual’.

It states that if a ‘disinterested person’... ‘would reasonably conclude’... ‘that the arrangements could induce the adviser to act.’ This is a textbook definition of a ‘perceived’ conflict and it is not helpful in terms of achieving the intention of Standard 3, which is to ensure that adviser avoid all ‘actual’ conflicts.”

The association argued that advice should be assessed as it applies to each individual client, not in a bulk fashion.

“An adviser cannot fail Standard 3 in bulk any more than they can comply with Standard 3 in bulk,” IMAP said. fs

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Kate Fellows founding director, The Professional Paraplanner

Who rules the world? Paraplanners! tech and digital advice are Iof fgoing to rule the new world advice, who will run it? It is a question I ask of paraplanners regularly. Let’s put it another way.

If you are working in an advice practice, who is the tech champion? Who leads the software integration and migration when there is a change? Nine times out of 10 it will be the paraplanner.

So if the paraplanner is the tech champion, the software implementor, the process automation consultant and template manager, it’s pretty hard to see how we are going to transition to the world of digital advice and automation without them. In fact, they should be leading the charge.

Take a step back to the infancy of the paraplanning role.

Paraplanners were wannabe advisers who were getting a foot in the door or didn’t have the client engagement skills to cut it as an Adviser.

Paraplanners would be trained by the person who was leaving to become an adviser and they were probably sent off to a software training course to teach them how to get an SoA out of the software package in use.

Fast forward 10, 20 years and although paraplanning is now a profession in its own right, and

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We need paraplanners to take a leadership role in the progress of, and content in, these new tech opportunities.

they are often as qualified as advisers, many paraplanners have still learnt the practical aspect of their role from software trainers and ‘how to’ videos.

For many, it’s hard to imagine a time when they had to change software to produce SoAs. They have used the same software for their whole career.

From where I see it, this is all set to change and we are not quite ready for it. Why? Because the skillset of many paraplanners is intrinsically linked to the software they use. This means they only know how to be a paraplanner if they are using Xplan/Midwinter/AdviserLogic. In my paraplanning business with an operating model of contract paraplanners, I was often told, ‘I only do SoAs in X software’. Really?

I have spent years now working with paraplanners to separate their knowledge and skillset from the software to be transportable. This reduces the friction in changing software and it is critical to the success of new software vendors but also to the development and progression of our advice industry in the future.

We need more paraplanners that can think about how to use the software to support advice rather than moulding their advice process to suit the

software. Yes, this is what has been happening for years. When you have dominant software vendors they tend to dictate how you operate. But not anymore.

In recent years, we have seen the launch of new providers, specialising in parts of the advice process that have previously been neglected or we’d just resigned ourselves to it being ‘too hard’ to change. Nod is one of those new entrants that has looked at the document generation part of advice and said, ‘We can do this better, we can do it faster and it will cost less’.

They are not alone. And the trajectory is exponential if you look to other markets such as the US and UK that we tend to lag in tech adoption and development.

The challenge then becomes adaptation and development of this new technology. If we want to see them in advice practices and support their development, we need paraplanners on board.

We need paraplanners who can critically evaluate how these solutions will work in the Australian advice industry.

We need paraplanners to take a leadership role in the progress of, and content in, these new tech opportunities.

If you are a new or growing software vendor in the Australian advice industry and you are not actively engaging or educating the paraplanning community, you will not have the success you desire. And we will all miss out on the opportunity to progress advice on our shores. fs

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The financial advisers featured in this guide are a diverse group: some specialise in responsible investment advice, some provide financial advice to specific professions, and some focus on addressing market gaps, with many finding themselves on the list for the very first time.

But they all have one thing in common: they all wield influence that can create the blueprint for the future of financial advice in Australia.

Not all of them are familiar names but just because they are not making a lot of noise doesn’t mean they are not making waves. Meet our Power50.

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Cover story

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THE REAL DEAL Dawn Thomas, Wealthwise

Wealthwise senior financial adviser Dawn Thomas believes in authenticity above all else and is becoming the spokesperson for a new form of financial advice – one that’s warm, approachable and not all about the money.

Elizabeth McArthur writes.

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ealthwise financial adviser Dawn Thomas is no shrinking violet. Her hair is often dyed a bright shade of purple or pink and she’ll occasionally wear a suit to match.

Thomas’ hair is naturally grey, but she’d been covering up the grey with “natural” hair dye for years when one day she had a moment of self-reflection.

“I asked myself ‘Who am I dying my hair for? Why am I dying my hair black and brown every time?’ I didn’t know why I was doing it. And if clients judge me for having grey hair then they’re not the clients I want,” she says.

One day she tried putting a bit of purple hair colour through it at home and it stuck. And, instead of clients judging her like she was worried might happen – they loved it.

She jokes that her retired clients seem to enjoy the hair colours the most. “We talk about our grey hairs,” she says.

On social media, Thomas is the antithesis of the professional business influencer. Instead of stylised inspirational speeches and photoshoots, she offers her followers the kind of mishmash of content you might see from a friend on your Facebook feed.

While there’s a temptation in styling a social media feed into a “brand”, Thomas has done the opposite. She’s found power in being a real person.

Alongside videos of her explaining financial concepts and posts

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about business achievements, you’ll find Thomas cooking with her children and sharing what her drive to work looks like or a holiday experience.

Finding a voice on social media was something of a natural fit for Thomas. She originally graduated with a degree in media studies and wanted to be a journalist.

Growing up in Singapore, Thomas’ father spent 30 years as a radio broadcaster and at university she found her own love of broadcast media.

Having moved to Australia from Singapore to pursue her university education, Thomas found it more difficult than she anticipated to get a job in Australia’s small media industry without permanent residency.

So, her pragmatic side kicked in. Thomas managed to secure a role at Bankwest and was pleasantly surprised by the doors it opened up for her, how much she enjoyed the culture of working there and by how interesting she found the work itself.

“I found that the bank was actually open minded in hiring me and within a few months I found out they had a graduate program for financial planning and that was it, really. Once I started the program I was hooked,” she says.

It was interesting turn of events for Thomas. Her mother was a maths and science teacher and in school Thomas had been encouraged to focus on “practical” science and maths subjects. But, she had fought to embrace her creative side and her parents had supported her in pursuing an arts education.

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Unfortunately, Thomas joined the bank just before the global financial crisis hit and she had no idea how rocky her career trajectory was about to get.

Bankwest was owned by the now defunct HBOS at the time Thomas joined. HBOS was the result of a merger between Halifax and Bank of Scotland in 2001 and was acquired by Lloyds in 2009.

At the time Thomas was getting started as a financial adviser, Bankwest’s international owners had a vision of an adviser in every single bank branch.

“Then, of course, the global financial crisis came and that changed very quickly. And the Commonwealth Bank bought Bankwest,” Thomas says.

Suddenly, that vision of a financial adviser in every bank branch was gone and the graduate program was radically cut.

“So that was my first experience of redundancy,” Thomas says with a laugh.

“We had to reapply to be on the new form of the graduate program. That was my first inkling that being a financial adviser was really important to me. We were given the option of taking up other roles in the bank if we wanted to, but I knew by that point that I was hooked.”

What drew her in was the experience with clients. Training in financial advice, Thomas found that the career she had stumbled into actually offered the kind of fulfilment and satisfaction that some people spend a lifetime searching for.

“What really connected with me was the fact that people handed over their trust to you. That’s always something I’ve held in high regard,” she says.

“When someone’s able to give you their trust, I think that’s one of the most important gifts they can give you and you have to honour that.

“I felt it was a very privileged position to be in, to be able to help someone and get them to their goals. It’s not just skill-based, it’s the fact that you’re being tasked with something really important.”

Thomas was a Bankwest adviser for nine years, eventually managing a team of advisers. She still speaks fondly of the mentoring and support she received during this period of her career.

But, then came Thomas’ second brush with redundancy.

Commonwealth Bank was finding it wasn’t feasible to continue with BW Financial Advice because it was a much smaller business than Commonwealth Financial Planning.

“It was very interesting being the last woman standing in my department and helping people transition to their new roles. There was a long transition period for me to think about what I wanted to do,” she says.

Thomas says her move away from a big bank, something many in the industry will relate to, wasn’t all smooth sailing.

“I almost wasn’t prepared for the outside world. You become quite insulated when you’re within the banking space – you almost think your whole world is in the bank. And I did have advocates in the bank who were really invested in my professional development,” she says.

By that point, staying in Western Australia had become important to Thomas and her family, but the financial advice opportunities in Perth were not exactly abundant.

Then in a stroke of good luck, Wealthwise principal Jamie Luxton reached out to Thomas. She says she still doesn’t know why

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Luxton sought her out specifically to work at the business. But she soon saw that their values aligned.

“The client is the centre of everything. I needed to see that for him that was the case as well. I think it’s hard in financial planning, you don’t want to chop and change where you work too much because there’s always clients at the end of it,” Thomas says.

Leaving the bank was hard for Thomas for this very reason.

She’d already had to give up her clients once when she moved into a managerial role, so as appealing as the Wealthwise offer was, Thomas felt cautious.

She wanted her next move to be to a place where she could stay long term, so that her clients could have long term consistency in their best interests.

The move away from the bank also brought another big shift for Thomas. For the first time, she found her voice on social media.

“I think this journey after the bank has helped me realise that what I have to say has value to people and social media has become the platform to represent the kind of advice that I see as valuable.

While I don’t expect the whole industry to reflect my ideals, I can tell my side of the story,” she says.

“It’s my content. I can explore and do what I want. I know who my audience is and they don’t mind if it’s a bit of a hodgepodge.”

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Day to day, what’s being asked of an adviser is a lot. If I’m feeling drained I ask myself, what can I do to fill up that well?

The compliance culture at the bank made advisers reluctant to express themselves online and build a following.

Once Thomas started sharing her thoughts and ideas though, she saw dividends. Not just in client engagement, but from her peers too.

“I’ve had advisers reach out to me and tell me they appreciate the messages I put out. When someone reaches out from our industry, I really appreciate it. It makes me feel like I should continue this trajectory I’m on,” she says.

Thomas has been licensed to provide financial advice for a decade. However, she hasn’t stopped furthering her education during that period.

“I know people say that experience trumps qualifications, but I think there’s something to be said for having both,” Thomas says.

“I knew I was dedicated to the career and that’s why I started the Masters of Applied Finance. I’ve been committed since day one. And, I think the journey of being the best for your clients has to continue.”

Thomas’ belief in education has continued. She’s currently doing a PhD with superannuation as her academic focus.

On the integrated PhD program Thomas is undertaking, her topic is superannuation with a working thesis title of: The retirement labyrinth: Superannuation and the financial literacy of Australians.

It will see her focus on a subject she is relentlessly passionate about – financial literacy, education, engagement and empowerment.

“I’m dedicated to this industry long term,” she says.

“Whether I have the influence to bring about change, I’m not sure. But I’m taking the opportunity to do a PhD out of passion, purely out of passion. I believe that financial advisers do have so much power to change things for Australians.”

As Thomas’ career in financial advice has taken twists and turns, something that has remained consistent is her belief that financial advisers can effect change on a micro and macro scale.

While each client’s journey with a financial adviser is an opportunity to change their lives for the better, on a bigger scale Thomas sees that professional advice can contribute to a more prosperous, equitable and informed society.

“I really do believe our job can bring about change. I see so much inequity that happens, I just want to change it. I want to contribute to that movement to change it,” she says.

It’s this belief that spurred Thomas on to undertaking her PhD. As anyone who has tackled further study while working full-time and caring for a family will understand, it’s no small feat.

“It is overwhelming. The imposter syndrome sneaks in and you start thinking ‘How can I do this?’ You have to talk to yourself though and say to yourself ‘I’ve got this’. I did my Masters with three children, so I need to remind myself that I’ve had it harder before,” Thomas says.

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“This is going to be my big writing project. I didn’t quite become a journalist, I’ve taken another route.”

Thomas’ drive to continue her education and her passion for financial literacy is insatiable. As it turns out, a lot of people have boosted her confidence along the way.

She refers to these people as both mentors and advocates. Thomas credits Joseph Meawad, a mentor she met through the Association of Financial Advisers (AFA), with teaching her about focusing on herself before trying to please everyone else, Commonwealth Bank’s Chris Jones for helping her with job interviews and development plans and mentions Quyen Truong from WA Super (now Aware Super) as being a structured, helpful mentor. Joseph Hoe is also her “in-house” mentor at Wealthwise.

There’s also Brendan Hendry, who was Thomas’ manager at Bank West and now works at Bendigo and Adelaide Bank, who she says will often take the opposite view to her, allowing for “robust” conversations, and executive general manager of Commonwealth Private Marianne Perkovic.

Support from Perkovic, Thomas says, means a lot.

“When someone of that calibre gives you a line of encouragement and believes in you, you’ve got no reason not to believe in yourself. You should always have self-belief, that’s what I try to start off with, but sometimes you can get such a boost from people you admire,” she says.

Through 2020, as we’ve all been forced to find new ways to connect, Thomas has found support from these people and from her online community.

But, she’s also found the silver linings in 2020’s challenges.

“This has been a year with a lot of challenges for people at different degrees but it’s also provided opportunities to step into new ideas, to connect with people I haven’t before and it’s given me the gift of studying,” Thomas says.

Asked how she stays so positive Thomas says her secret is simple. Focus on what you can control.

“I mean, I’m already tired. Day to day, what’s being asked of an adviser is a lot. If I’m feeling drained I ask myself, what can I do to fill up that well? Maybe it’s talking to clients or writing an article or making a video – something that makes me happy,” she says.

“It doesn’t take away that there’s tough things going on but I think dwelling on the hurdles is tiring. I prefer to focus on the things that energise me.”

Focussing on the things that energise her is what makes Thomas’ mishmash social media content work so well, and it’s what her clients love too.

She says she’ll often find herself connecting with clients over food they like to cook or Thomas’ latest hair colour choice, and she thinks this is something to celebrate.

“An old school financial advice approach is thinking you need the sharp suits and the multi-million dollar clients and the pretty offices,” Thomas says.

“I think the new form of advice that is emerging is more engaging, more connected financial advice.” fs

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EARN 5 CPD HOURS

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RETIREMENT INCOME Video on Demand Series The Best Practice Forum on Retirement Income seeks to assist advisers and investment professionals in navigating through the array of strategies and considerations that are required for clients that are transitioning to or are already in retirement.

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All presentations from the Best Practice Forum on Retirement Income will be CPD accredited.

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Applied Financial Planning:

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Why budget is not a dirty word

By Jules Knox, Evalesco Financial Services

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Behavioural finance and the design and distribution obligations

By Simon Russell, Behavioural Finance Australia

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: People often think of budgets as constrictive. However, budgets are the cornerstone of wealth management and an essential step to financial freedom. They can also reveal hidden and surprising things about clients’ finances and where their money is going.

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Why budget is not a dirty word

A Jules Knox

fellow advice professional I met recently said he avoids the term ‘budget’ when meeting with clients as they see it as a dirty word. He went on to explain that if you ask clients to complete a budget, they will think that they are going to have to give up the things they love or their lifestyle will suffer. For instance, they will not be able to buy the kids the Christmas presents they want or have their annual family holiday, and baked beans will be a regular event at mealtime.

I was shocked. How could anyone possibly think that budget is a dirty word? It may sound a little nerdy, but I believe that budget is a beautiful word, and I often discuss the importance of budgeting and cash flow management with clients and colleagues.

Creating balance and opportunity Many clients believe that budgeting is all about sacrifice. In other words, they will have to cut back and forgo the lifestyle they enjoy now so that they can have the lifestyle they want in retirement, or some other future date.

I would argue that effective budgeting is actually about balance and opportunity.

First, it is about finding that balance between the lifestyle that clients want now versus the lifestyle they aspire to have in the future. By knowing how much to budget for their current living expenses, we can start planning and setting aside funds for their goals or other things they tell us are important to them. These could be

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short term—like having the Christmas they want for their family, or the annual holiday—as well as longer-term goals like paying off the home loan, buying an investment property, or enjoying a comfortable retirement.

A means for client reflection and engagement Budgeting gives clients the opportunity to review their current expenses. By taking stock of all their outgoings, they can often find ways to save money or look for opportunities to negotiate the ‘fixed’ expenses down (such as home loan interest, insurances, phone plans, etc.).

Completing a budget also assists clients to stop and think about how much they want to be spending, in contrast to how much they are spending, on various discretionary expenses. Often there is a mismatch between what clients value as important for their quality of life compared with how much they are currently spending on other not-so-important items.

After accounting for these fixed and discretionary expenses, the budget can often reveal surplus money that could be used for important goals or wealth creation rather than just ‘disappearing’ through unconscious spending.

Completing a budget before the initial meeting

Before meeting with a new client, part of their ‘homework’ prior to the first meeting is to complete a client snapshot and a budget.

This is for two reasons. First, rather than being a ‘data collection’ meeting, I’d much prefer to spend my time getting to know what is truly important to a new client, learn more about them than just the

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numbers, and, by having some initial data, be able to tailor the meeting based on their circumstances.

The second reason I ask new clients to complete a budget before the first meeting is that it provides them with some tangible value right from the beginning of the relationship. Clients who spend some time to fully complete a budget always say what a valuable exercise it was, are usually ‘shocked’ at how much they spend, and come to the meeting more motivated to make some changes to their spending habits or to establish some structure.

Helping clients stay within their means I met with prospective new clients a busy working couple with two kids, a mortgage, good incomes, and lots of expenses. They commented that, sure, completing the budget was hard, but that it had already changed the way they thought about their spending.

Further, they had already commenced tracking the actual spending from their bank statements against their budget, and found that there was quite a lot of ‘spending without purpose’ that did not add to their lifestyle. They said they would much rather have this surplus removed from their spending bucket and directed into a savings or investment bucket instead.

They commented, “If it’s not there, we won’t spend it.”

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Keeping something in reserve

This is where a budget works hand in hand with the right cash flow and account structures. With the right structure, funds are set aside so that all the budgeted expenses are provisioned for, as well as funds for the client’s shortto-medium-term goals (for instance, holidays, milestone birthdays, renovations, a new car), longer-term goals (such as children’s education, paying down the home loan sooner, semi- or full retirement) and an emergency buffer. A client knowing that they have provisioned for all their outgoings and are on track to achieve their goals, means that whatever is left over can be spent guilt-free.

I firmly believe that our ability to create wealth is not a factor of what we earn, or even how we invest our money (although we need to be smart about this), but it is to what degree we can spend less than we earn. In other words, it is our ability to save that determines our end wealth position.

When discussing financial plans with clients, I like to make sure they understand that I cannot predict the future—indeed, projections regarding their plans are for modelling purposes, and assumptions are based on past trends. I will never be able to affirm to them that ‘now’ is the right time in the sharemarket to buy up big, or conversely the right time to sell down shares to cash in on recent gains, or even answer the question; ‘Should I buy shares or property?’ I’ll always say you should own both for different reasons.

Jules Knox, Evalesco Financial Services Jules Knox is a director and financial adviser at Evalesco Financial Services, a Sydney-based advice firm whose purpose is to empower clients to be healthy, wealthy and happy. As a financial adviser, Jules develops plans to help her clients achieve their goals and provides ongoing advice to ensure they stay on the path, adapting their strategies as life changes, always commencing with a budget.

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A foundation for investment strategies

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD 1. What does the author request from clients when they meet for the first time? a) Review their goals b) Consider cash reserves c) Complete a budget d) Complete a risk profile questionnaire 2. What can a budget most importantly reveal? a) The difficulty in completing one b) A bank statement is enough for a budget c) Where a client’s money is spent d) The need for a client to earn more money 3. What would be the reason for keeping cash reserves? a) To meet short-to-medium term goals, such as holidays b) To meet longer-term goals, such children’s education c) To meet any unexpected expenses d) All of the above 4. In the author’s experience, clients who prepare a budget for the first time often find that: a) The process is easier than anticipated

As an adviser, I believe that a substantial part of my role involves educating and guiding my clients to make the right financial decisions for the right reasons, and formulating a long-term wealth creation plan incorporating a range of strategies depending on their goals, life stage and risk tolerance, among other things.

Increasing contributions into superannuation, investing regularly into a professionally managed share portfolio, buying the right investment property, paying down the home loan sooner through additional repayments (and the right loan structures) are all great strategies to create wealth, depending on the client’s given situation and goals. Some of these may also have some tax benefits along the way.

However, if you do not know how much you have available to create wealth, how can you commit to any of these strategies, let alone ensure that you have a range of options in your plan to offer diversification and flexibility to adapt should your circumstances change?

Choosing an investment strategy is only possible if you know how much you have to work with.

The way forward If you do not like the word ‘budget’, call it whatever else you want, whether it be ‘cash flow management’, ‘savings plan’, ‘spending plan’, or something else, but we need to make clients more aware of where their hard-earned money is going, and how it is (or is not) working for them towards achieving their goals.

Once clients have a budget that they are happy with, they feel more in control and motivated knowing they are on track to achieving what is important to them. And as their advisers, we know that our financial plan and investment strategies are manageable and sustainable, have the client’s buy-in and commitment, and can enable them to have the lifestyle they want, both now and in the future. fs

b) They are spending without purpose c) Their motivation to reduce fixed expenses diminishes d) The effectiveness of savings buckets is questionable 5. C hoosing an investment strategy is only possible if an adviser knows how much the client has to spend. a) True

b) False

6. In the author’s experience, the ability to create wealth is not a factor on what we earn, but the degree we spend less than we earn. a) True

b) False

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: The design and distribution obligations go beyond disclosure and consumer consent. This paper highlights barriers to consumer information processing and suggests how advisers can help clients in terms of better decisions, outcomes and understanding of products.

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Behavioural finance and the design and distribution obligations Considerations for a successful implementation

T Simon Russell

he product design and distribution obligations are due to come into effect in October 2021. If an organisation issues or distributes investment or credit products, now is the time to prepare. This paper examines what you need to know about behavioural finance and associated decisionmaking research to implement these new requirements successfully.

Background The product design and distribution obligations are the latest attempt to remedy poor consumer outcomes. Broadly, the new obligations require that products are distributed to consumers for whom they are suited. The obligations will apply to a range of financial products, including investments, superannuation, insurance and various credit products. The obligations are particularly relevant for superannuation funds, investment product providers, banks, credit unions and insurers, among others. They appear

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to indirectly impact financial advisers and mortgage brokers too.

Within these organisations, the new obligations are relevant for people in roles covering: • sales, marketing, client engagement and advice (who might need to change their promotional and explanatory materials, call scripts and websites) • product design (who might need to redesign products and their features) • technology, data and customer insights (who might help to implement changes to products or the way they are presented, or use data to assess consumers’ needs) • leadership, governance, legal and risk management (who might need to assess the adequacy of their organisation’s product governance arrangements).

The broad approach taken by the Australian Securities and Investments Commission (ASIC), as evidenced by its Consultation Paper 325 Product design and distribution obligations and accompanying draft regulatory guide, aligns with the behavioural finance and associated decision-making research in several ways.

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Example Consistent with this research, ASIC suggests that product issuers and distributors should not just rely on disclosure or obtaining a consumer’s informed consent as a path to good consumer outcomes. Further, ASIC recognises that people’s decisions and actions can be influenced by behavioural biases, choice architecture, and conflicts.

The remainder of this paper looks at five specific psychological issues product issuers and distributors need to consider.

1. Creating the appropriate choice architecture

Simon Russell, Behavioural Finance Australia Simon Russell is the founder and director of Behavioural Finance Australia.

He provides specialist behavioural finance training and consulting to financial advisers, fund managers and major superannuation funds. Simon’s most recent book, Behavioural finance: A guide for financial advisers, is intended to help financial advisers prepare for the behaviouralfinance-related components of the FASEA exam, and improve their client engagement skills.

ASIC mentions the importance of ‘choice architecture’ 16 times in its draft regulatory guide. By ‘choice architecture’, the regulator refers to “features in an environment, noticed and unnoticed, that influence consumer decisions and actions. These features are present at every stage of product design and distribution.”

ASIC’s emphasis on the role of choice architecture is consistent with a resounding finding of behavioural research that people’s decisions can sometimes be influenced in important ways by how information is framed and presented to them.

My own research demonstrates this too—people’s choices can be influenced by the order in which information is presented, the number of options they are given, and the categories used to describe their options.

Their choices and subsequent behaviour depends on: • the complexity and uncertainty they face • the amount of information they receive and how it is layered and chunked into meaningful pieces • the ease with which they can make appropriate comparisons • the frictions they encounter in processes • a product’s default settings.

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The problem is that to a product designer or distributor who is not familiar with the relevant research, these things can sometimes seem inconsequential. In an entirely logical and rational world, they would be. In such a world, people would make appropriate choices regardless of how information happened to be presented. However, in a behavioural world populated by human beings, these things can significantly influence peoples’ choices, actions and outcomes. Product designers and distributors therefore need to be aware of how choice architectures can influence consumers’ decisions, and factor that into their approach.

2. Using questions to understand consumers’ needs According to ASIC, the design and distribution obligations will require issuers to “design financial products that are likely to be consistent with the likely objectives, financial situation and needs of the consumers for whom they are intended”.

But how can issuers know what consumers’ objectives, financial situations and needs are, or what they like or dislike, or what they understand or do not understand?

Perhaps the best approach is simply to ask them.

Unfortunately, as ASIC points out and the decisionmaking research confirms, there can be severe limitations in attempting to do this. You cannot simply ask people if they understand a product and expect to get a reliable answer. For a start, they might not be aware whether they understand it, resulting in them saying ‘yes’ when the real answer is ‘no’. And, as ASIC points out, if the consumer purchased the product previously, that is not a sufficient indication that they understand the product.

Further, you cannot ask how satisfied a consumer is either. ASIC’s research demonstrates that this too is an unreliable guide to whether a product is suitable. As ASIC puts it, “Consumer detriment may be apparent to consumers or be hidden.” Neither can consumers be asked to self-certify that they are in the ‘target market’ for the product—ASIC says that is not sufficient either. Asking about their risk

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preferences and their goals and objectives is also a tricky business that is beset with psychological traps.

So, what can be done? The short answer is to choose any questions put to consumers carefully, and consider relevant psychological factors when interpreting their responses.

Tip To assess whether a consumer understands a complex product, having them articulate a key component of it can allow an adviser to gauge whether the consumer truly understands the product, rather than relying on the consumer's own (less-reliable) selfassessments.

3. Using data and technology to understand consumers’ needs Rather than asking questions, an alternative approach is to use data and technology. This is a possibility for which ASIC specifically allows. Measuring consumers’ actual decisions and behaviours can mitigate the risk of their fallible memories and self-assessments.

Moreover, the data does not even have to be perfect—ASIC will be satisfied so long as the issuer has made a reasonable assessment of consumers as a group, not an assessment that is necessarily correct for every one of them.

However, while data presents opportunities, it also creates its own range of decision-making challenges, one of which is how to deal with uncertainty. When making an inference about a consumer based on particular demographic information (for instance, their postcode), great care needs to be taken to avoid straying too far from what psychologists refer to as relevant ‘base rates’ (that is, what applies for most people most of the time).

In psychological experiments and in my own workshop demonstrations, people often fail to properly account for this uncertainty.

People find beguiling patterns in the ‘noise’. They naturally and often unknowingly ‘overfit’ a narrative to fit the patterns they find, thereby creating an apparently compelling story about a customer they actually know very little about.

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the shift is not absolute; a role for the consumer remains. To give the consumer the best chance to fulfil this role requires, at least in part, making sure they are not misled.

One of the problems of communicating with consumers about products is that they can easily get the wrong impression. One of my favourite demonstrations of this is where I present workshop participants from across the financial services industry with text labelled ‘Important information’. Despite the label, typically a large proportion of people ignore it—assuming that the text was, ironically, unimportant. When given the same test, more than three-quarters of individual investors did the same.

The problem is that when faced with complexity and information overload (which pertains to much financial decision-making), people often look for simple decision-making shortcuts to reduce their cognitive load. In the case discussed in the preceding paragraph, the shortcut might have been, ‘This information is important to the product issuer, but not to me as a consumer’. No doubt, this interpretation is formed from investors’ experience reading disclosure documents. For these investors, ignoring the ‘important information’ seems entirely logical.

So, how might consumers be misled?

One way that ASIC specifically identifies is if consumers are deliberately or inadvertently led to believe their personal circumstances have been taken into account when only some aspects have been. Or, that the product has been assessed as being suitable for them when in fact they have only been identified as being a member of a target market for whom it might be suitable.

ASIC also discusses how consumers can be misled by specific words (such as ‘cash’ when discussing mortgage-related investments), or promotional materials that make inappropriate comparisons between products.

Consider When an inference is beset with uncertainty, it is easy to feel you know more about a customer than you do.

Factoring decision-making research into consumer data analytics is one way that product issuers and distributors can mitigate the risk of apparently sophisticated statistical predictive models leading to the very consumer harms that they are intended to avoid. A psychological lens needs to be applied somewhere between the data analytics people and the client engagement or marketing people. Without it, each party may incorrectly think that they have benefited consumers when they have not.

4. How to avoid misleading consumers While many of the product design and distribution obligations shift the onus of ensuring product suitability away from the consumer,

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CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD 1. According to the author’s findings, people’s choices can be affected by the: a) Order of information presented b) Number of options provided c) Categories used to describe their options d) All of the above 2. What role does the author see for data and technology to better understand consumers’ needs? a) It largely mitigates the problem of dealing with uncertainty b) It helps mitigate memory and self-assessment risks c) Sophisticated statistical predictive models help avoid consumer harm d) It nullifies the need to rely on ‘base-rate’ inferences 3. What observation does the author make in terms of consumer decisions and information processing? a) The design and distribution obligations need to be more absolute to ensure product suitability b) Consumers often overcomplicate decision-making c) Consumers may readily believe that particular information is not relevant to them d) Consumers too readily believe the literal meaning of words 4. What is suggested by the author to help achieve better consumer outcomes? a) Have consumers articulate a key component of a complex product b) Focus on product issuer-distributor relationships c) Use decision-making research as a guide d) All of the above 5. A SIC suggests that product issuers and distributors avoid relying solely on disclosure or informed consent for robust consumer outcomes. a) True b) False

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How can these risks be mitigated? Sometimes, problematic words can be changed or removed. Research suggests that sometimes it is the order in which information is presented, making some things seem more important than others, or making it seem that some things lead to others. Sometimes, it is the headings that are used, or the way information is presented in a pie chart—the number of segments can be critical. And, as ASIC discusses, sometimes it is the presenter of the information that matters.

If information is presented by a financial adviser, the consumer might be more inclined to believe that their personal circumstances had been taken into account.

Given that consumers can sometimes believe the exact opposite of the literal meaning of the words they read or hear, we cannot always rely on information to be interpreted as intended. If we do not use the decision-making research as a guide, we should not be surprised when misunderstandings occur.

5. Ways for product issues and distributors to work together ASIC points out the need to focus on the relationships between product issuers and distributors.

Example To assess compliance with the new rules, ASIC intends to assess what steps have been taken to eliminate or manage the risk that incentives may influence distribution behaviours.

Psychological research is highly relevant in making this assessment. As was discussed in the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, that research shows that conflicts of interest can have a more pervasive impact than many people expect. Conflicts do not need to be financial, but can be conveyed by relationships. For instance, if an employee’s boss is conflicted, because they are accountable to their boss, the employee is likely to be conflicted too.

Further, conflicts do not just cause intentional wrongdoing, but can also impact well-meaning people beyond their conscious awareness. And, as ASIC points out, detriment can be caused not just by actions that are intentional, but also by ones that are ‘reckless or inadvertent’. Given this, eliminating only explicit conflicts and managing only intentional behaviour is not going to be sufficient.

Factoring in the relevant decision-making research requires product issuers and distributors to think more broadly about the impact of conflicts. It might also require product issuers to provide training to their distribution partners, not just on the features of their products, but on the relevant accompanying psychological issues. fs

6. ASIC believes removing explicit conflicts and managing intentional behaviour will control consumer detriment. a) True b) False Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

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Taxation & Estate Planning:

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Claiming expenses for working from home during COVID-19

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By Lynne Gibson and Letty Chen, TaxBanter

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: This paper explains the differences between the fixed rate, actual cost and shortcut rates for deductibility claims.

Further, it demonstrates these methods in practice, and clarifies what the ATO allows regarding claimable expenses for working from home.

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Claiming expenses for working from home during COVID-19

E

Lynne Gibson and Letty Chen

xpenses associated with the running of an individual’s home are usually private and domestic in nature. However, deductions for ‘home office expenses’ may be available under section 8-1 and Div 40 of the Income Tax assessment Act 1997 (ITAA 97) (general deductions and depreciation respectively) where: • an area of the home is used as a ‘place of business’ • a room is used as a ‘study’, ‘home office’ or other ‘work area’ as a matter of convenience, or

• no particular area of the home is used, but work is performed at home.

Types of home office expenses Home office expenses fall into two broad categories, namely: • Occupancy expenses—relating to the ownership or use of a home which are not affected by the taxpayer’s income earning activities • Running expenses—relating to the use of facilities within the home.

Table 1 (on the following page) provides examples of various occupancy and running expenses.

ATO guidance Australian Taxation Office (ATO) guidance on home office expenses can be found in: • Taxation Ruling TR 93/30 Income tax: deductions for home office expenses —which considers when: an area of a home is considered to be a place of business or a private study; and deductions are allowed in each case, and how to calculate them.

• Practice Statement Law Administration PS LA 2001/6 Verification approaches for home office running expenses and electronic

device expenses—which sets out guidance for ATO officers on acceptable verification approaches for certain home office expenses.

• Practical Compliance Guideline PCG 2020/3 Claiming deductions for additional running expenses incurred whilst working

from home due to COVID-19 —which provides a simpler alternative to the approach in PS LA 2001/6 in relation to calculating additional running expenses incurred while working from home due to the coronavirus (COVID-19).

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Table 1: Types of occupancy and running expenses Occupancy expenses

Running expenses

Rent

Electricity charges for heating/cooling and lighting

Mortgage interest

Cleaning costs

Municipal and water rates

Depreciation (e.g. for furniture fittings)

Land taxes

Leasing charges

House insurance premiums

Cost of repairs to furniture and furnishings

Source: TaxBanter

Table 2 sets out when occupancy costs and running expenses may be deductible.

Table 2: Deductibility of occupancy costs and running expenses

Type of expense

An area of the home is a place of business

Dedicated room used as a study or home office

Work done a home not in a specific area

Running expenses







Occupancy costs







Source: TaxBanter

The legislation does not prescribe specific methods for calculating home office expense deductions.

The amount of occupancy costs which can be claimed depends on the taxpayer’s individual circumstances. In the Commissioner’s view, in most cases, the apportionment of the total expense incurred on a floor area basis is the most appropriate method (see TR 93/30 for more details).

The remainder of this paper outlines the ATO’s alternative methods for calculating deductions for running expenses.

Claiming running costs for 1 March to 30 September 2020 The three alternative methods of calculation

For calculating a deduction for additional running expenses incurred as a result of working from home from 1 March 2020 to 30 September 2020, the ATO allows a choice of three standard methods: 1. Claim the actual work-related portion of all additional running expenses, calculated on a reasonable basis (the actual cost method).

2. Claim using a fixed rate of 52 cents per hour (the fixed rate method). a) This covers: • home office electricity (lighting, cooling, heating, running electrical items such as a computer) and gas expenses • cleaning expenses • the decline in value of home office items such as furniture and furnishings. b) It does not cover: • computer consumables • stationery • phone, internet expenses

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• the decline in value of a computer, laptop or similar device.

Note: The types of expenses in b) are to be claimed using the actual method.

3. Claim using a new ‘shortcut’ fixed rate of 80 cents per hour (the shortcut method), which covers all additional running expenses, namely: a) electricity (lighting, cooling, heating, electronic items used for work, e.g. a computer) and gas expenses b) t he decline in value and repair of capital items such as home office furniture and furnishings c) cleaning expenses d) phone expenses including the decline in value of a phone handset e) internet expenses f) computer consumables g) stationery h) t he decline in value of a computer, laptop or similar device.

Note: Unlike the fixed rate method, under the shortcut method, the taxpayer cannot also claim a separate deduction for other running costs, for instance, depreciation.

To claim a deduction under the actual cost method or the fixed rate method, the taxpayer needs to establish the work-related portion of expenses incurred. Methods include: • the actual proportion of deductible use for the whole year (e.g. itemised supplier records) • an estimate for the year based on a diary record for a four-week representative period, showing the taxpayer’s usual pattern of working at home • a reasonable estimate. However this will only be accepted in limited cases where the claim is small and the taxpayer can demonstrate that their estimate was reasonably likely (PS LA 2001/6).

The shortcut method only requires the number of hours that the taxpayer worked from home.

Regardless of the method adopted, taxpayers must still satisfy the deductibility requirements in order to claim the expense, namely: • the expense was incurred and not reimbursed • the expense was incurred in earning income • records must be kept in order to substantiate the expense. These may include a record of the number of hours worked, a diary record for the four-week representative period, receipts for asset purchases, and phone accounts.

Applying the shortcut method Why did the ATO introduce the shortcut method?

Due to COVID-19, many taxpayers started to work from home for the first time during 2019/20. Given the speed of developments and federal government restrictions, many taxpayers did not have the time or knowledge to prepare adequate record-keeping systems

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Lynne Gibson, TaxBanter Lynne Gibson is senior tax trainer at TaxBanter.

With over 25 years’ experience in chartered accounting firms, she has worked at a senior level for a number of organisations, including a ‘Big Four’ accounting practice, advising a diverse range of clients.

Letty Chen, TaxBanter Letty Chen is a technical tax writer at TaxBanter. Her experience includes business services and tax advisory roles in various public practice firms, and as a senior specialist at a tax professional association. Letty is a chartered accountant and a chartered tax adviser.

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to establish the work-related portion of additional running costs under the actual cost method or the fixed rate method. The shortcut method—set out in PCG 2020/3— reduces the record-keeping requirements while giving taxpayers a reasonable amount to claim for the period that they work from home due to COVID-19 public health concerns.

Example 1. Calculating running expenses deduction using the shortcut rate Ephrem is an employee and, as a result of COVID-19, he is working from his home office. In order to work from home, Ephrem purchases a computer on 15 March 2020 for $1,299. He intends to use the shortcut rate to claim his additional running expenses.

During the entire period he is working from home as a result of COVID-19, Ephrem notes in the calendar on his computer when he starts and finishes each day, along with a note about any breaks he has and how long those breaks were.

When it comes to lodging his 2020 tax return, Ephrem works out that during the period he worked from home as a result of COVID-19, he worked a total of 456 hours.

Ephrem calculates his deduction for the 2020 income year for additional running expenses as: 456 hours × 80 cents per hour = $364.80 As Ephrem has claimed his additional running expenses using the shortcut rate, he cannot claim a separate deduction for the decline in value of his computer. Ephrem keeps a record of the calendar entries he has made to demonstrate how he calculated the number of hours he worked from home. Ephrem also keeps the receipts for his computer purchase in case he will need to claim depreciation in future.

When he lodges his 2019/20 tax return, Ephrem includes the notation ‘COVID-hourly rate’.

Source: Example 5 from PCG 2020/3

The shortcut rate does not cover occupancy costs. Occupancy expenses are not deductible where the taxpayer is being required to work from home temporarily as a consequence of COVID-19 and where no part of the home is a place of business. However, where the taxpayer has created a place of business within their home as a result of COVID-19, they may claim occupancy costs under established rules.

The shortcut method is available to all taxpayers working from home during this period, whether as a result of COVID-19 or not, including any business owners who now carry on their business from their home or continue to carry on their business at home. However, the ATO introduced the method as a direct response to taxpayers’ changed work arrangements arising from COVID-19, and this is reflected in the limited applicable period of 1 March 2020 to 30 September 2020.

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Note: The end date of the shortcut method was originally 30 June 2020, however, has now been extended to 30 September 2020. PCG 2020/3 states that the ATO will give further consideration to whether the date may be extended further.

Taxpayers eligible to use the shortcut method

Eligible taxpayers are employees and business owners who: 1. work from home to fulfil their employment duties or to run their business during the period from 1 March 2020 to 30 September 2020—this work must be substantive and directly related to the taxpayer’s income-producing activity. Minimal tasks such as checking emails or taking calls will not qualify as working from home; and 2. incur additional running expenses that are deductible under section 8-1 and Div 40 of the ITAA 97 as a result of working from home. Note that: a) employees or business owners must be paying or liable to pay additional running expenses that are deductible b) non-deductible private expenses such as depreciation on a home computer may become deductible due to a change in use.

The taxpayer does not have to have a separate or dedicated work space. If they do, multiple people can be using the space.

Record-keeping

Taxpayers using the shortcut rate must keep a record of the hours they have worked at home in order to calculate their additional running expenses. This could be in the form of timesheets, rosters, a diary or similar document that sets out the hours they have worked.

Tax return description

Taxpayers who use the shortcut rate to calculate their additional home office expenses and lodge their tax return through myGov or through a tax agent must include the notation ‘COVID-hourly rate’ next to their deduction for home office expenses—at label D5 Other work-related expenses—in their 2020 tax return and/or 2021 tax return.

Taxpayers who worked from home before 1 March 2020 Many taxpayers already had work from home arrangements in place before the COVID-19 crisis. They may have increased their work from home hours due to COVID-19 or there may have been no change to previous arrangements. Running expenses incurred prior to 1 March 2020 should be calculated using the actual cost method or the fixed rate method.

Implications

This means that affected taxpayers will have to perform two separate calculations to work out their total 2020 deduction—one for the period 1 July 2019 to 29 February 2020 and one for the period 1 March 2020 to 30 June 2020. This is likely to also be the case for their 2021 claim.

The ATO has recently advised that one of the top three lodgement issues for tax time 2020 is taxpayers claiming multiple working from home methods for the same period. Specifically, for the period 1 March to 30 June 2020, some taxpayers have deliberately

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Example 2. Existing arrangement

CPD Questions

Duyen is an employee of an online trading business. Up until the end of February, Duyen spent two days working from home and three days working at the office of her employer. As a result of COVID-19, she starts working from home five days per week from 1

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March 2020. For the period from 1 July 2019 to 29 February 2020, Duyen uses the current fixed rate of 52 cents per hour to calculate

1. As permitted by the ATO, running expenses include: a) Water rates b) Home insurance premiums c) Depreciation for fittings d) Rent 2. Claims made using the fixed rate method of 52 cents per hour include: a) Phone expenses b) Home office electricity c) Stationery d) Computer consumables

her additional running expenses including electricity expenses, cleaning expenses and the decline in value and repair of her office furniture. She also calculates her work-related phone and internet expenses using the itemised phone bill for one month on which she has marked her work-related phone calls and the four-week representative diary of internet usage that she kept.

As Duyen is working from home, she can rely on PCG 2020/3 to claim her additional running expenses for the period from 1 March 2020.

3. Which of the following can be used to establish the workrelated portion of expenses incurred? a) The actual portion of deductible use b) An estimate based on a four-week period c) A reasonable estimate for small claims d) All of the above 4. Di works from home for 320 hours post -March 2020 due to COVID-19. How much can she claim for 2020/21 under the shortcut rate? a) $166.40 b) $320 c) $256 d) None of the above 5. R unning expenses incurred before 1 March 2020 must be calculated using the actual cost method. a) True b) False 6. Occupancy expenses are deductible if a taxpayer is required to work from home temporarily due to COVID-19. a) True b) False

Duyen ends up working from home for five days per week until 30 June 2020 as a result of COVID-19. Rather than continuing to use the current fixed rate and working out the actual expenses she incurred on her phone and internet expenses from 1 March 2020 to 30 June 2020, Duyen decides, for simplicity, to calculate all of her running expenses using the shortcut rate. Duyen uses the timesheets she is required to provide to her employer to calculate the number of hours she works from home in the period from 1 March 2020 to 30 June 2020 and keeps those timesheets as evidence of her claim.

Source: Example 3 from PCG 2020/3

or accidentally claimed a deduction under the shortcut method as well as depreciation on assets such as laptops or desks. The ATO is reminding taxpayers that the 80 cents per hour rate is an allinclusive rate. fs

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Technology:

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Leveraging the technology ecosystem

By Kylie Bryant, Bravura Solutions

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: Artificial intelligence is empowering consumers, and its capacity to deliver personalised offerings is everincreasing. It has also made financial services businesses more efficient and agile through consumable microservices and partnering opportunities with technology providers.

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Leveraging the technology ecosystem Delivering intelligent and sustainable financial services

T Kylie Bryant

he coronavirus (COVID-19) pandemic is reshaping the global business landscape, giving rise to new consumer attitudes and behaviours that are expected to have a lasting impact. In particular, there has been rapidly accelerating consumer reliance on digital interactions and experiences, with McKinsey & Company reporting in its ‘Reimagining marketing in the next normal’ article of July 2020 that consumer adoption of digital has advanced by five years in just eight weeks.

Forced to move online, more people have become accustomed to digital engagement and service delivery, finding it is often more efficient, less expensive and more convenient. While many regulators have granted businesses a short-term reprieve on compliance requirements in response to the pandemic, it is anticipated that heightened consumer reliance on digital interactions will bring a new wave of regulation around fraud, data security and cyber-resilience.

Simultaneously, the economic impact of the pandemic is leading to high levels of uncertainty, with the loss of business and consumer confidence posing significant challenges for companies across all sectors. The pursuit of sustainable competitive advantage in the

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financial services industry is likely to drive a further convergence of existing providers and the emergence of disruptive new players.

In the financial services industry globally, savvy providers are responding to these tectonic shifts by adapting proactively and focusing their efforts on the wide-ranging opportunities they present.

Progressive wealth management businesses had already initiated digital transformation journeys to create more flexible technology environments, to bring their offerings in line with growing customer expectations for more personalised digital experiences and reduce their cost-to-serve.

The most successful of these efforts have been guided by ongoing strategic partnerships with innovative and experienced financial services technology (fintech) companies.

However, it is clear that its greatest impact on the financial services sector is the fast-tracking of the global megatrends that were already well underway. At the heart of these trends lies a new way of working that leverages strategic fintech partnerships and dynamic technology ecosystems to achieve financial services that are truly intelligent and sustainable.

The emphasis is on: • Building new and expanded competencies that support data-driven and customer-led digital-first offerings

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• Agile and cost-effective operations (Accenture, ‘COVID-19: 5 priorities to help reopen and reinvent your business’, May 2020) • Best-of-breed technologies and competitive regulation.

This new approach is enabling providers to respond effectively to rapidly evolving change—both environmental and customer-led. By significantly improving customer experience and outcomes, providers can genuinely empower their customers’ financial wellbeing.

This whitepaper explores the five key global megatrends being supercharged by the pandemic and examines the key strategies that financial services companies can use to remain relevant, fend-off disruption and thrive.

1. Customer empowerment Delivering hyper-personalised, digital-first customer experiences that support choice, control and financial wellbeing

In recent years, most financial services organisations have focused on delivering customers more personalised and accessible digital offerings, when and where they want. Not surprisingly, research cited in Salesforce’s second annual State of sales report found that a majority of consumers today (61%), felt significantly more empowered than they did five years ago.

The pandemic is accelerating this trend by increasing customer familiarity with, reliance on and demand for digital channels. IBM’s Beyond the great lockdown: emerging stronger to a different normal report of August 2020 showed that 84% of executives expect more customers to interact online more often in the future.

Within the financial services sector, customers are seeking greater knowledge, choice and control over their financial circumstances in the face of economic uncertainty.

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Many customers are looking for real-time, personalised support and guidance around deferring retirement, changing drawdown strategies and reviewing insurance coverage, as well as effectively managing their finances and investments, both now and into the future. They expect their financial providers to understand their changing needs, goals and expectations, build relationships with them and utilise their individual data to deliver seamless, holistic customer journeys that are intelligent and sustainable.

Successful financial services providers will offer simple, relevant and real-time digital interactions and experiences that heighten customer choice and control over their finances.

Savvy providers will increasingly leverage artificial intelligence (AI)—virtual agents and digital-advice solutions supported by data-driven adviser insights— as well as financial dashboards, self-service capabilities and goals-based products that offer flexibility when circumstances change.

More than ever, customers will expect their providers to make it easy for them to interact through smart, intuitive and seamless omni-channel experiences that can evolve to meet their needs during various life stages.

2. Powerful partnerships Establishing and growing strategic partnerships with financial technology providers to maximise differentiation and secure competitive advantage

As competition within the global business landscape reaches new heights, forward-thinking financial services organisations are increasingly forming strategic partnerships with technology companies to innovate and maximise opportunities for differentiation. This trend has seen a growing number of traditional providers join forces with fintechs to build dynamic technology ecosys-

Kylie Bryant, Bravura Solutions Kylie Bryant is country manager for Bravura Solutions’ New Zealand division.

Her role includes identifying emerging needs and opportunities and overseeing the delivery of Bravura’s professional and support services in the region.

She has over 20 years’ financial services industry experience, including working for a number of leading global institutions.

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tems that can leverage best-of-breed technology, business models and industry expertise to deliver new and innovative offerings and solutions.

The financial services sector can expect to see a significant increase in these formidable strategic alliances, particularly as pressure mounts from digital disruption and margin squeeze. PwC’s Redrawing the lines: fintech’s growing influence on financial services report of 2017 found that that 82% of global banks, investment managers and insurers plan to increase their partnerships with fintech companies in the next three to five years. The report also found that the primary impetus for the partnerships was concern that standalone fintechs represent a genuine threat to traditional provider revenue streams.

Looking ahead, fintech partnerships will provide a significant opportunity for financial services providers, enabling them to leverage global technology trends and pioneer their own digital-first experiences and solutions.

Fintech partners bring to the table speed, enterprise agility and operational resilience, as well as considerable industry expertise and proficiency around customer experience—key competencies needed to keep up with rapidly changing customer expectations for hyper-personalised digital-first offerings that empower financial wellbeing.

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By coupling with an innovative and experienced fintech partner, forward-thinking wealth providers can transition to dynamic enterprise ecosystems that support intelligent solutions and deliver a sustainable competitive advantage over fintech disrupters and traditional players.

3. Consumable microservices Employing flexible, needs-based technology components to improve business agility, scalability and performance

The recent emergence of dynamic technology ecosystems has been accompanied by a new flexible approach to software development known as ‘consumable microservices’. Microservices are small, selfcontained and independently deployed technology components that provide the flexibility to deliver specific business capabilities anywhere across the business value chain to add value.

Fully scalable, microservices can exist as satellite applications around the existing core system, be built up over time to gradually replace the core system, or be adopted as the core system from the outset.

Many providers test the water with satellite applications.

For example, a bank might employ one microservice to handle automated loan applications and another to handle loan contract management.

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US-based software company DreamFactory in its ‘Microservices Examples: Amazon, Netflix, Uber, and Etsy’ post explained that Tech giants such as Amazon, Netflix and PayPal have led the way with this trend, transitioning their core systems to microservices infrastructure to substantially enhance customer experience and boost profitability.

This global megatrend is expected to gain pace as financial services providers seek capabilities that solve business and customer pain points in much smarter and more cost-efficient ways.

The adoption of microservices leads to greater innovation, better tools and functionality for end-users, and increased speed-to-market. Microservices make extensive use of automation across testing, deployment and monitoring, leading to higher quality, more scalable architecture, with minimal support costs.

To make a change, providers can simply replace, update, test and introduce a new microservice without impacting the rest of their enterprise ecosystem. This approach eliminates the need for software release cycles, whereby one simple change might have knock-on effects across an entire core platform.

Microservices are becoming an indispensable tool for financial service providers seeking to meet heightened demand for digital-first experiences and lower costs.

Task-specific microservices can be employed by wealth managers and financial advisers to make their financial services significantly more intelligent and sustainable.

For example, they can be used to track, analyse and report on investment portfolio or pension/superannuation fund performance with ease, carry out large volumes of accurate calculations at high speed, and support specific, often complex, aspects of regulatory compliance and reporting.

In the immediate future, the availability and diversity of consumable microservices within financial services will continue to grow, giving providers the ability to ‘pick and mix’ from best-of-breed technology solutions to achieve smarter, more cost-efficient offerings, greater business agility and resilience, scaling advantages and increased profits.

4. Cognitive technology Harnessing AI to elevate customer experience and capitalise on intelligent automation

In the years ahead, the use of cognitive technology across businesses will become widespread. Already, forward-thinking financial services organisations have been using AI (most commonly, machine learning) to drive customer engagement, improve offerings and reduce costs. IBM’s Beyond the great lockdown: emerging stronger to a different normal report found that 97% of financial services executives say their organisation will deploy more AI tools in the next two years.

Cognitive technology will play a pivotal role in customer-facing operations. Dynamic AI-backed engagement tools such as chatbots, virtual assistants, robo-advice solutions and chatbot call centres will replace scripted, static offerings. Powered by machine learning and voice recognition technology, these tools enable intelligent, intuitive and responsive interactions that effectively meet customer needs at lower cost.

According to Accenture’s Banking technology vision: technology for people report of 2017, more than 70% of global banking execu-

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tives believed that AI can become the face of their organisation.

Amid unprecedented economic uncertainty, savvy providers will seize the opportunity to provide integrated financial advice and education through seamless, end-to-end advice capabilities. New cloud-based financial planning software is allowing providers to offer customers high-quality self-directed digital and face-to-face advice that is experience-led and data-driven.

In the middle office, machine learning will enable forward-thinking financial services companies to unlock key insights from customer and business data. It will require customer-centric business models capable of capturing and maintaining large high-quality datasets from omni-channel interactions, including social media.

Further, Bravura Solutions’ Artificial intelligence and machine learning in financial services: where might we go next? report of July 2019 found that although larger firms have an advantage, smaller firms can access the data they need from third parties.

Providers with sufficient data and flexible technology ecosystems will be able to leverage consumable microservices that specialise in machine learning and data analytics. These microservices deliver AI expertise on demand, enabling providers to conduct more intelligent and detailed customer profiling that anticipates needs, and drives individually tailored experiences and journeys, at mass scale.

Retention risks can also be identified, enabling proactive measures to be taken to stem defections.

There is also opportunity for greater automation within financial services administration. As cost pressures continue to mount, successful providers will employ intelligent automation within their back-office operations to significantly lower cost structures and maintain profitability, ensuring sustainability.

Driven by AI, smart technology provides the means to streamline and largely automate administration processing. This can deliver exceptional operational efficiencies, substantially reduce cost-toserve and enable resources to be redirected to activities that improve customer experiences and outcomes.

5. Competitive regulation Leveraging the regulatory agenda to drive better customer outcomes

In recent years, regulatory scrutiny and pressure across the global financial services sector have focused on fees, product suitability and customer engagement, as well as culture and conduct. In response, astute businesses have been making genuine changes to their business ecosystems to embed customer wellbeing at their very core.

KPMG, in its ‘COVID-19 insights—emerging risks: financial services sector is having to adapt rapidly’ post, explained that in response to COVID, financial regulators across most jurisdictions have taken steps to alleviate compliance pressures on the sector in the short term, including extending some implementation dates, postponing selected activities and delaying non-essential reviews, where possible.

However, providers should guard against a false sense of security.

It is inevitable that the brakes on compliance will be lifted and new regulatory measures will be needed. The pandemic is accelerating digital disruption and rapid changes in financial markets and consumer behaviours like never before.

Far greater consumer reliance on digital interactions, such as ecommerce, virtual engagement and robo-advice solutions across

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CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD 1. From the article, how has the digital landscape changed in relation to financial services? a) Consumers have increased their digital interactions b) Opportunities for differentiation have fragmented c) Microservices and companies’ broader technological ecosystems are more entwined d) Consumers want face-to-face and digital interactions 2. What observation does the author make in terms of technology and consumers? a) Consumers are more empowered than five years ago b) Consumers can feel ‘chained’ to digital interaction c) The ‘personalisation’ of digital interactions is often oversold d) Self-service offerings are often a ‘flick pass’ offering to consumers 3. What does fintech offer financial services providers? a) Speed b) Agility c) Resilience d) All of the above 4. Why should financial services adopt ‘consumable microservices’ into their business? a) They can enhance profitability and customer experience b) It means they do not have to partner with other providers c) It is what the regulators want them to do d) They give wealth managers more time to build their business 5. A ccording to research cited, smaller operators can still leverage the advantages of AI. a) True b) False 6. Due to COVID-19, financial regulators have taken steps to strengthen compliance obligations for fintechs. a) True b) False

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multiple channels 24/7, will provide the catalyst for a further review of regulatory settings and additional compliance obligations that focus on fraud, data security and cyber-resilience.

In the years ahead, the global megatrend towards competitive regulation will be supercharged, as savvy financial services providers seek to prepare their operations for change. It is expected that more providers will partner with fintechs to adopt highly configurable and customer-centric enterprise ecosystems capable of supporting competitive compliance solutions.

These intelligent solutions enable wealth management companies to modify, update and introduce new regulatory measures quickly with limited costs. They support automated, auditable ‘manage-by-exception’ workflows that ensure compliance issues are quickly identified and resolved. They also enable the use of big data and analytics to enhance compliance management and improve customer experience.

This approach involves collecting customer data beyond what is required by regulation and applying it to support customer wellbeing.

With the help of an experienced fintech partner, the cost burden associated with regulatory change is shared across their entire client base, significantly reducing compliance expenditure for each provider. In this way, compliance is being turned from a regulatory burden into a compelling and sustainable competitive advantage.

The way forward In the years ahead, the financial services providers that survive and thrive will be those who place their customers at the very heart of everything they do. They will join forces with innovative fintech partners to build dynamic enterprise ecosystems that will enable them to better respond to the rapid pace of change, and turn this into a considerable advantage.

These strategic partnerships will provide financial services providers with access to innovation, agility and resilience by capitalising on the benefits of advanced technologies such as cloud-computing, microservices, AI and automation. In addition to their technical knowledge, fintechs will also bring a deep understanding of the market and extensive industry expertise.

This approach will provide the means to meet heightened demand for hyper-personalised, digital-first, real-time experiences, as well as achieving exceptional operational efficiencies and cost savings. It will also underpin the ability of providers to capitalise on new opportunities and solve business and customer challenges in much smarter and more viable ways.

Progressive providers that build fintech partnerships proactively to leverage dynamic technology ecosystems will be rewarded with an enduring competitive advantage—the ability to deliver truly intelligent and sustainable financial services. fs

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Ethics & Governance:

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Elder financial abuse

By Jennifer Shaw, Bartier Perry

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: Elderly people are at risk of financial abuse, often by adult children, through threats, undue influence or manipulation to gain ‘consent’. If advisers see happen to their older clients, there are legal precedents to determine and remedy unconscionable dealings.

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Elder financial abuse

When the court will set aside ‘gifts’ from elderly relatives as unconscionable

T Jennifer Shaw

ime and again, the courts hear cases concerning vulnerable elderly people who have been taken advantage of financially by their own family members. This paper examines the circumstances in which the court will set aside ‘gifts’ from elderly relatives as ‘unconscionable’.

Financial abuse Sadly, elderly people are vulnerable to being taken advantage of financially. Adult children and other adult relatives have been known to persuade elderly parents/relatives in their care to part with property or significant sums of money without any independent legal or financial advice in circumstances where the elderly parents/relatives are left with no security in return for the funds advanced and insufficient funds for their own care and maintenance including future nursing home care.

What can be done to put things right?

The court has the power to set aside unconscionable dealings. In Hewitt v Gardner [2009] NSWSC 1107, Justice Ward stated [at paragraph 106] that an unconscionable dealing involves the following: “(a) the weaker party must, at the time of entering in to the transaction, suffer from a special disadvantage vis-à-vis the stronger party;

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(b) the special disadvantage must seriously affect the weaker party’s capacity to judge or protect his or her own interests; (c) the stronger party must know of the special disadvantage (or know of facts which would raise that possibility in the mind of any reasonable person); (d) that party must take advantage of the opportunity presented by the special disadvantage; and (e) the taking of advantage must have been unconscientious.”

Once the points in (a), (b) and (c) above have been established, there is then a presumption at law that the improvident transaction was a consequence of the special disadvantage and that the stronger party has unconscientiously taken advantage of the opportunity presented by the disadvantage. The onus of proof then shifts to the stronger party to prove that the transaction was fair, just and reasonable.

Some examples Transfer of a house from elderly uncle to nephew set aside

In Hanna v Raoul [2018] NSWCA 201, a transfer of a house from an elderly uncle to his nephew was set aside. The New South Wales Court of Appeal held that the elderly uncle was at a special disadvantage due to his age, frailty and state of health and that the nephew had taken “unconscientious advantage” of the elderly uncle by entering in to the transaction. The nephew sought to argue that the transaction was fair and reasonable. One point that he put forward was

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that he was not the instigator of the proposal. However, the court held that this was not the point in determining whether the transaction was unconscionable.

In this case, the court summarised some earlier cases with regard to unconscionable transactions and said that an unconscientious transaction in respect of which equity would intervene (that is, to set it aside) is one: “… ‘whenever one party to a transaction is at a special disadvantage in dealing with the other party because illness, ignorance, inexperience, impaired faculties, financial need or other circumstances affect his ability to conserve his own interests, and the other party unconscientiously takes advantage of the opportunity thus placed in his hands’.”

Daughter and her partner required to refund money to late mother’s estate

In Grant v Grant [2020] NSWSC 760, the Supreme Court of New South Wales ordered a daughter and her partner to repay funds back to the estate of the daughter’s late mother.

The court found that even if the late mother had intended to make a gift of the funds, she did this in circumstances that made it unconscionable for her daughter and her daughter’s partner to retain the benefit of those gifts.

Those circumstances included: • the late mother’s age and frailty • her dependence on her daughter • the fact that she received no independent advice concerning the transactions

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• the fact that the late mother believed that payment of the funds was the only way to ensure she had a roof over her head if she was to avoid going in to a nursing home, as her daughter had threatened would occur.

Given the court’s finding that the late mother was at a special disadvantage, the onus fell on the daughter and her partner to demonstrate that the transactions were fair and reasonable, and they failed to do so. In fact, the court held that they were not fair and reasonable and set them aside.

The court held that since the money that the late mother had transferred was to be put towards the daughter and her partner’s property, it accorded with the “solid and substantial justice” of the case that there be imposed on the property an equitable lien [a claim or right against the property to satisfy a debt] to secure the judgment, including interest.

Adult son required to transfer funds back to elderly mother

In Johnson v Smith [2010] NSWCA 306, the New South Wales Court of Appeal upheld a decision of the primary judge to require an adult son to transfer funds back to his elderly mother together with damages for losses.

The court held that the adult son had ascendency over his mother, given: • her age • her dependence upon him as her carer • the bonds of love and affection • the fact that the son instigated the transaction.

Jennifer Shaw, Bartier Perry Jennifer Shaw is a partner in Bartier Perry’s Dispute Resolution & Advisory team. She acts and advises in relation to disputes including professional negligence, contracts, construction, intellectual property, estates, debt recovery, windups and bankruptcy. She is a member of the Law Society’s Professional Conduct Advisory Panel and has acted for and advised peak professional bodies in relation to the prosecution of disciplinary matters before specialist tribunals in NSW and the ACT.

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CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD 1. Elderly people are more likely to be taken financial advantage by: a) Their own children b) Family ‘friends’ c) Paid service providers d) Their siblings 2. What precedent was established in the Hewitt v Gardner [2009] case? a) The weaker party doesn’t have to be suffering from a special disadvantage at the time of transaction b) The stronger party doesn’t need to be aware of any special disadvantage to be culpable c) The stronger party must prove that gifts were transacted in a fair manner d) The weaker party must prove that gifts were transacted in an unfair manner 3. According to the commentary, which of the following statements regarding unconscionable transactions is correct? a) The stronger party must be the instigator b) The stronger party doesn’t have to be the instigator c) The ‘bonds of love and affection’ often nullify such concerns d) Case law findings and ethics are often at odds

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Further, given the relationship of influence and the lack of independent advice as to the improvident transaction, the court upheld the primary judge’s finding of undue influence. The court stated that the son: “… was aware of his mother’s position and was or ought to have been aware of the potential for real disadvantage to her if the transfers were to be by way of outright gift with no legally enforceable protection to have the moneys used for her benefit”.

The difference between undue influence and unconscionable dealing The High Court of Australia has held that the equitable doctrines of undue influence and unconscionable dealing are distinct. Undue influence looks to the quality of consent or assent of the weaker party, whereas unconscionable dealing (or conduct) looks to the conduct of the stronger party in attempting to enforce, or retain the benefit of, a dealing with a person under a special disability in circumstances where it is not consistent with equity or good conscience that they should do so (Commercial Bank of Australia Ltd v Amadio [1983] HCA 14 & Bridgewater v Leahy [1998] HCA 66).

Considering whether to bring court proceedings It is an unfortunate reality that some elderly people are vulnerable to financial abuse, even from those closest to them. However, if the points outlined earlier in the ‘What can be done to put things right?’ section of this paper can be proven, then it is possible to apply to the court to seek orders for any monies obtained to be repaid. The receiving party will then have to prove that the transaction was fair, just and reasonable; or risk orders being made setting aside the transaction. fs

4. Which of the following situations should be on an adviser’s radar as an unconscionable transaction? a) A frail client gifts $350,000 to one of their children, and you know this was instigated by pressure from the child b) An elderly client is dependent on her daughter, and transfers the house to her without your advice c) A child tells their elderly father that the only way to avoid a nursing home is to hand over his estate, and the father obliges d) All of the above 5. T he High Court has held that there no distinction between undue influence and unconscionable dealings. a) True b) False 6. Undue influence looks to the weaker party’s assent rather than consent. a) True b) False Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

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Compliance:

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Outsourcing: Complying with an obligation without performing the function

By Alexa Bowditch, Holley Nethercote

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The impact of complaints

By Angelique Aksenoff, Assured Support

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Compliance

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: Outsourcing business functions is widespread. This paper summarises how to comply with the relevant regulatory requirements, particularly AML/CTF obligations; highlights pre-outsourcing considerations and suggests best-practice strategies for managing outsourced service providers.

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

Outsourcing: Complying with an obligation without performing the function

I

Alexa Bowditch

n times like these, can a business be confident that it will continue to comply with its obligations where it has outsourced certain functions?

This paper explores strategies that a business can implement to ensure it complies with its obligations while outsourcing a particular function. These start from the preengagement phase and extend throughout the relationship.

Why is it important?

Outsourcing itself is not the problem. Even regulators outsource functions. The Australian Securities and Investments Commission (ASIC) mentions this four times in the ASIC Corporate Plan 2019–23.

If a business outsources functions that relate to its Australian financial services (AFS) licence, the business remains responsible for complying with its obligations as an AFS licensee.

Similarly, if a business outsources any anti-money laundering and counter-terrorism financing (AML/CTF) functions, the business remains responsible for complying with its AML/CTF obligations.

If a business is regulated by the Australian Prudential Regulation Authority (APRA), there are prudential standards that it needs to

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comply with when it comes to outsourcing (depending on which regulated industries it is in).

Further information can be found in APRA’s prudential standards: • CPS 231 Outsourcing • SPS 231 Outsourcing • HPS 231 Outsourcing.

While some businesses are not APRA-regulated, the prudential standards can provide a good benchmark in terms of good governance practices. Even if a business is not APRA-regulated, if it does not have appropriate arrangements in place, this will increase the risk that it will be in breach of its regulatory obligations.

(Other legal regimes may also impose further obligations on a business where it outsources key functions, for example, privacy and derivative trade reporting regimes. This paper focuses on the financial services and AML/CTF regimes.)

Regulators’ expectations Both ASIC and the Australian Transaction Reports and Analysis Centre (AUSTRAC) have similar expectations regarding businesses.

As per its Regulatory Guide 104 AFS licensing: Meeting general obligations (at 104.36), in relation to financial services obligations, ASIC expects businesses:

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1. to have measures in place to ensure due skill and care is taken in choosing suitable service providers 2. can and will monitor the ongoing performance of service providers 3. will appropriately deal with any actions by service providers that breach service level agreements or one’s obligations as a licensee.

In relation to AML/CTF obligations, AUSTRAC’s Insights from compliance assessments report of 2017 explained that AUSTRAC expects businesses to: 1. consider the impact of outsourcing on the ability to meet their obligations 2. ensure the roles and responsibilities of each party are clearly documented in a contract 3. proactively monitor and test AML/CTF systems and processes provided by the third party.

As noted previously, APRA-regulated entities have specific obligations relating to outsourcing (CPS 231, SPS 231 and HPS 231), including: 1. maintaining a board-approved policy relating to outsourcing material business activities 2. assessing options for outsourcing material business activities to a third party 3. having sufficient monitoring and supervision in place to manage outsourcing material business activities 4. having a legally binding agreement in place for outsourcing all material business activities with third parties 5. consulting with APRA prior to entering into outsourcing agreements in relation to offshoring outsourcing material business activities 6. notifying APRA after entering into agreements with Australian service providers for material business activities.

Of course, if a business is an APRA-regulated entity, it will have already considered what a “material business activity” is. In summary, an activity is a material business activity, if the activity has the potential, if disrupted, to have a significant impact on matters including the regulated entity’s business operations or ability to manage risks effectively. (For further details, see the relevant prudential standards CPS 231, SPS 231 and HPS 231.)

Strategies when outsourcing a function Pre-engagement

Prior to outsourcing a particular function, a business should clearly identify the scope of services to be outsourced and its relevant legal responsibilities. This enables it to consider the materiality of the function and risk-assess the arrangement. This determination will have a flow-on effect throughout the relationship. The higher the risk, the greater the due diligence that should be performed.

For example, heightened due diligence should apply to: • liquidity, platform and bridge providers for the contracts for difference (CFD) sector • bank and technology providers for the payments and money remittance sector

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• template software and research providers for the personal advice sector • transaction monitoring technology providers (for all sectors).

Sometimes, regulators expect extra due diligence at this stage.

For example, ASIC’s Regulatory Guide 227 Overthe-counter contracts for difference: Improving disclosure for retail investors (at 227.51) requires CFD providers to publicly document factors they take into account when determining if hedging counterparties are of sufficient financial standing.

Engagement

When engaging outsourced providers, the risk assessment at the pre-engagement phase will determine the rigidity of the engagement process followed and the due diligence required for a business to satisfy itself that the outsourced provider will be able to perform the function on an ongoing basis.

For example, if the outsourced service provider is an overseas entity, it may be more difficult for a business to satisfy itself that the overseas entity will be able to provide the services in compliance with Australian laws on an ongoing basis.

Although all outsourcing arrangements must be documented in a legally binding agreement, the detail required within the agreement should vary, depending on the materiality of the outsourced function and risk of the service provider.

The agreement assists with risk management/controlling the risk of the relationship, setting out the scope of the services and the roles, responsibilities and expectations of each party throughout the relationship (including how the outsourced service provider will be monitored and supervised) and what will happen if things go wrong.

The specific risks of any particular relationship and circumstances should be considered before entering into an outsourcing arrangement.

For example: • AUSTRAC commented in its Australia’s mutual banking sector: money laundering and terrorism financing risk report of 2019 (p. 5) that high levels of outsourcing of customer-facing AML/CTF processes and limited oversight or influence over the operations of third-party service providers is a factor exposing the banking sector to financial crime.

• ASIC recently commented in its Report 651 Cyber resilience of firms in Australia’s financial markets 2018–19 (p. 3) that the trend towards outsourcing non-core functions to third-party providers has created difficulties in the management of cybersecurity risks. Further, ASIC’s Markets Liaison meeting of 5 March 2020 noted a higher incidence of cybersecurity breaches reported to ASIC during the COVID-19 outbreak. So, cybersecurity is an important risk to consider and control.

Alexa Bowditch, Holley Nethercote Alexa Bowditch is a financial services, financial crime and commercial lawyer at Holley Nethercote, assisting financial services clients manage their legal and compliance risks.

Her expertise is particularly focused in the virtual assets (cryptocurrency), money remittance, fintech, OTC derivatives, and financial advice sectors.

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Monitoring and supervision

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD 1. If a business does not have appropriate governance in place for outsourcing, it will increase the key risk of: a) Breaching its regulatory obligations b) Handing over too many core functions to external parties c) Being reclassified as an APRA-regulated entity, with stricter regulation d) Breaching its best practice requirements 2. In relation to AML/CTF obligations, AUSTRAC expects business to: a) Notify APRA before agreements with overseas outsourced service providers are set up b) Proactively monitor and test third parties’ AML/CTF systems and processes c) Exhaust all in-house alternatives before outsourcing AML/ CTF reporting d) Notify ASIC after agreements with overseas outsourced service providers are set up 3. W hy is pre-engagement so important for a business’s outsourcing process? a) It identifies what services will be outsourced b) It confirms legal responsibilities in relation to the services c) It enables the opportunity for assessing risk d) All of the above 4. I f a business does not outsource any AML/CTF-related functions, they should be overseen by: a) APRA b) Its board and senior management c) ASIC d) Its board, APRA and ASIC 5. M onitoring and supervision are primarily concerned with whether the terms of the agreement can be met in the present, as opposed to the future. a) True b) False 6. If a business outsources functions relating to its AFS licence, it is still responsible for complying with its outsourcing obligations as an AFS licensee. a) True b) False

When we conduct AFS licence or AML/CTF reviews, we ask for evidence that the business has actively monitored and supervised the outsourced provider. Sometimes, we receive a blank look, or an agreement that does not set out any detail in what is expected of the third-party provider in terms of monitoring and assurance. This is a problem. Some legal regimes (such as the derivative trade reporting regime) include a safe harbour if one makes regular enquiries that are reasonably designed to determine whether the third party is discharging their obligations under the terms of their appointment (Rule 2.2.7 of the ASIC Derivative Transaction Rules (Reporting) 2013 & ASIC Regulatory Guide 251 Derivative transaction reporting at 251.31).

To ensure a business has adequate controls in place to manage the risk of the outsourced provider and outsourced function, it must have appropriate monitoring and supervision processes in place. This should be risk-based. Accordingly, the frequency and due diligence required will depend on the materiality of the outsourced function and the risk-assessment of the outsource provider. Monitoring and supervision should not just consider whether the terms of the agreement are met, but also whether they can be continue to be met in the future.

Oversight of the relationship

Appropriate governance arrangements are also essential.

For example, as per Rule 8.4.1 of the Anti‑Money Laundering and Counter‑Terrorism Financing Rules Instrument 2007 (No. 1), when it comes to AML/CTF, the board must approve a business’s AML/ CTF program, and the program must be subject to ongoing oversight of the board and senior management.

If a business does not outsource any AML/CTF-related functions, this should be captured in its AML/CTF program, over which the board and senior management have oversight.

If a business is an APRA-regulated entity, APRA has far more stringent requirements around governance of outsourcing arrangements and expects that the board (CPS 231 at paragraphs 22–24 & SPS 231 at paragraphs 13–15): 1. is ultimately responsible for outsourcing a material business activity 2. approves the outsourcing policy 3. ensures that outsourcing risks and controls are taken into account as part of the business’s risk management strategy.

Senior management and the board play an essential role throughout the entire relationship. They must be able to make timely and well-informed decisions in relation to the arrangement. To do so, they must: • be involved in the materiality and risk-assessment • approve the agreement before execution • be provided with reports of monitoring and supervision • be engaged, question and challenge the reports which they are provided. fs

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: ASIC’s revised regulatory guidance has upped the ante on complaint handling for financial firms. This paper highlights ASIC and AFCA’s key findings on the nature of complaints against financial firms and explains what firms must do, and what clients should expect, in terms of resolution.

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

The impact of complaints New requirements, new challenges

A Angelique Aksenoff

s at 30 June 2020, the Australian Financial Complaints Authority (AFCA) had received 80,546 complaints, of which 78% were closed, and $258.6 million paid in compensation.

Complaint areas and associated numbers were: • banks: 28, 411 • general insurers: 15,748 • credit providers: 9,857 • superannuation fund trustees or advisers: 4,732 • debt collectors or buyers: 2,607.

Drilling down to those providing investment advice, complaint areas and associated numbers related to: • misleading product and/or service information: 757 • inappropriate advice: 585 • failure to follow instructions/agreements: 575 • failure to act in clients’ best interests: 469 • service quality: 380.

Guide 165 Licensing: Internal and external dispute resolution.

With the new and improved regulatory guide on IDR due to commence on 5 October 2021, how will these statistics, clearance rates and customer satisfaction levels be affected? Will the new definitions, compressed timelines, increased policies, processes and allocation of resources see a different result in June 2022?

I’m not complaining, but …

In July 2020, the Australian Securities and Investments Commission (ASIC) released updated requirements in its Regulatory Guide 271 Internal Dispute Resolution (RG 271) in relation to how financial firms deal with consumer and small business complaints under their internal dispute resolution (IDR) procedures. RG 271 will replace Regulatory

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Compliance

Angelique Aksenoff, Assured Support Angelique Aksenoff is a senior compliance consultant at Assured Support.

Her areas of expertise include risk, competency, capability and conduct. Previous roles and projects include head of compliance training for Macquarie Bank, designing an Operational Risk and Compliance Capability Framework and Capability Assessment for CBA, and managing a large regulatory reform project for ASIC— Financial Adviser Professional Standards.

Despite catching many unawares, the IDR policy consultation has been long and protracted. It commenced in December 2018 with ASIC Report 603 The consumer journey through the Internal Dispute Resolution process of financial service providers.

The investigation undertaken by ASIC at the time found that: • four in five complainants experienced difficulty, decreased satisfaction and formed a negative impression of the financial firm in question • one in two people whose complaint was not resolved in their favour did not receive an explanation.

• one in seven people found it difficult to find the relevant financial firm’s contact details • four in five people whose complaints took more than 45 days to conclude were not told about external dispute resolution schemes • one in three people spoke to too many contacts over the course of the complaint • one in seven people withdrew from the complaint process due to an inadequate response from the financial firm.

The majority of these suggest process failures, which a competent licensee should have identified.

However, the updated guidance contains more significant response obligations, including: 1. an introduction of reduced timeframes for responding to complaints, including superannuation complaints 2. enhanced disclosure in terms of the information financial firms must include in written IDR responses to allow customers to decide whether to escalate their complaint 3. new timeframe requirements for consumer advocate reviews of appeals against IDR decisions 4. guidance about how firms can deal with representatives who are not acting in consumers’ best interests.

Financial firms have until 5 October 2021 to comply with the new IDR standards and requirements. This paper provides some practical suggestions regarding possible changes to processes, policies and systems to accommodate the new requirements.

The first few steps Policy

New definition Consumers can now use a financial firm’s IDR processes to complain about its IDR processes, the outcomes of the IDR process and its remediation program.

With the broadened scope, and obligations to uncover and facilitate complaints, a financial frim may need to consider the adequacy of its current resources.

Public complaints policy A financial firm will need to have a public complaints policy that explains: • how consumers may lodge a complaint (e.g. online, email, phone, in person)

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• options available to assist complainants who might need additional help to lodge their complaint • key steps for dealing with complaints • response timeframes • details about accessing AFCA in instances where a complaint is not resolved.

Financial firms will also need to develop (or refine) their public privacy policies.

Process and record keeping

Outsourcing IDR processes: Financial firms outsourcing, all or part of, the IDR process, must: • have measures in place to ensure that due skills and care is taken in choosing suitable service providers • monitor the ongoing performance of service providers • deal appropriately with any actions by service providers that breach service level agreements or fall short of their obligations.

Further, financial firms will need to review their outsourcing policies, selection and performance criteria, and contractual clauses.

Complaint acknowledgement: In terms of complaint acknowledgement, financial firms: • now have to acknowledge a complaint within 24 hours or one business day of receiving it, or as soon as is practicable • must take into account the method used by the complainant to lodge their complaint and any preferences they may have expressed about communication methods (e.g. email, post or social media channels) • need to look at the systems in place to effectively monitor their social media footprint.

Written response for partial or full rejection of complaints For those complaints rejected by a financial firm, its response must clearly set out the reasons for the decision by: • identifying and addressing the issues raised in the complaint • setting out the findings on material questions of fact and referring to the information that supports those findings • providing enough detail for the complainant to understand the basis of the decision and to be fully informed when deciding whether to escalate the matter to AFCA or another forum.

Financial firms will also need to review their complaints correspondence and templates to ensure they can meet the new requirements.

Compressed timeframe to provide IDR response As a general rule, RG 271 will require a financial firm to provide an IDR response no later than 30 calendar days after receiving the complaint.

In some cases, a different timeframe applies: • Traditional trustee complaints—no later than 45 days • Superannuation trustee complaints— no later than 45 days

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• Superannuation death benefit complaints—no later than 90 days • Credit-related complaints involving default notices—no later than 21 days.

Financial firms will need to consider resourcing requirements and ensure they have adequate capacity to deal with these new timeframes.

In addition, financial firms will need to ensure that their IDR staff: • are capable and adequately resourced • are appropriately authorised (with appropriate delegations) to resolve complaints • have an awareness of cultural differences that should be reflected in their position descriptions.

Complaints closed within five business days of receipt Financial firms will not need to provide an IDR response to a complainant if they: • resolved the complaint to the complainant’s satisfaction • gave the complainant an explanation and/or apology when the firm could take no further action to reasonably address the complaint.

However, financial firms will need to look at their record-keeping processes to ensure adequate notes are maintained to support any closed nil-IDR responses.

Tools for staff

People

Employees of a financial firm will have an obligation to proactively identify those who may need additional assistance.

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Financial firms will need to ensure their IDR staff have: • knowledge of the regulatory guides, consumer protection laws relating to financial products and services, AFCA approaches and relevant industry codes of practice • an understanding of the products and services officered by the firm • empathy, respect and courtesy • an awareness of cultural difference and the ability to identify and assist complainants who need additional assistance.

Further, financial firms should develop health and safety policies to support staff involved in complaints management.

It is recommended that financial firms review or develop these policies and train and develop IDR staff to be able to satisfy ASIC’s requirements.

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Data and analysis

CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD 1. The updated RG 271 is mandated for: a) Australian financial services licensees b) Trustees of regulated superannuation funds c) Australian credit licensees d) All of the above 2. Which of the following statements regarding AFCA’s findings on investment advice complaints is correct? a) Failure to follow instructions attracted the least complaints b) Service quality attracted the most complaints c) Best interests failure attracted the least complaints d) Misleading product information attracted the most complaints 3. The timeframe for a financial firm to respond to a superannuation-related complaints and traditional trustee complaints is: a) 90 days b) 30 days c) 45 days d) 21 days 4. ASIC Report 603 found that approximately: a) 50% of people whose complaint was not resolved in their favour received no explanation b) 50% of consumers formed a negative impression of the financial firm in question c) 60% of consumers were ‘stuck’ with the same contact over the course of the complaint d) 70% of people found it difficult to find the relevant financial firm’s contact details

Metrics and monitoring Firms will need to monitor key metrics for complaints management on an ongoing basis.

Extensive information regarding complaints will need to be documented, tracked and monitored, including: • number of complaints received and closed • nature of complaints • time taken to acknowledge complaints • time taken to resolve complaints • complaint outcomes • possible systemic issues • number of complaints escalated to AFCA. Quality assurance ASIC will expect financial firms to carry out regular and ongoing quality assurance.

Complaint audits Firms should conduct regular compliance audits to identify and address issues of non-compliance.

Reporting data internally and publicly IDR staff should regularly provide detailed reports about complaints data to senior management and the licensee’s board. In addition, complaints should be included in annual reports.

It is recommended that financial firms review their data and recording capability.

The (increasing) cost of doing business Better complaints management does not come cheap. RG 271 has been estimated to cost the industry approximately $5.087 million per year, according to the ASIC regulatory impact statement. In reality, the cost of non-compliance may be significantly higher. fs

5. A FCA is responsible for overseeing the operation of Australia’s financial services dispute resolution framework. a) True b) False 6. Consumers must now use an external dispute resolution scheme to complain about a financial firm’s IDR processes. a) True b) False Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

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Investment:

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A lasting bond

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By Paul Chin, Jamieson Coote Bonds

Hunt for yield during COVID-19

By Sabil Chowdhury, Koda Capital

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: Even though yields are at historically low levels, there is still a place for high-grade bonds in a portfolio as they provide downside protection, low correlation to risk assets, efficient returns and portfolio diversification.

Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

A lasting bond High-grade bonds and their long-term role in a well-balanced portfolio

H Paul Chin

igh-grade sovereign (or government) bonds remain as relevant as ever in an uncertain and complex market environment.

Today’s bond yields are indeed low, and some investors may be finding it difficult to justify a portfolio allocation to high-grade bonds. However, research and experience shows that in periods of market stress, the inclusion of high-grade bonds in a portfolio can provide investors with the opportunity for balance given their defensive characteristics, the mitigation of risk through low correlation with risk assets, and relatively robust returns over time.

In current times, central bankers’ range of liquidity and accommodation measures in response to the coronavirus (COVID-19) pandemic have undoubtedly been enormous. Most notably, a number of policymakers have chosen to cut their policy rates to even lower levels (including the US, Canada, UK and Norway), and of course in Australia, policy rates have fallen to 0.25%. With the Reserve Bank of Australia (RBA) target cash rate reaching historic lows, many multi-asset investors are questioning the role of highgrade bonds in portfolios. That is, how much more can yields fall and can they still be relied on as a defence against risk assets?

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High-grade bonds have historically diversified against shares Australian high-grade bonds have proven to be effective diversifiers for balanced portfolios, especially during stressed market environments. A look at the history of Australian shares and their drawdown (the maximum drawdown measures the lowest point of an investment after its most recent high value of an investment achieved) episodes since 1976 shows there have been 22 such cases. With five material equity market drawdowns in each decade, the cushioning effect of high-grade sovereign bonds (represented by the Bloomberg AusBond Treasury Bond Index) is evident throughout this time (see Figure 1 on the next page).

While it is true that high-grade sovereign bond returns are not spectacular relative to growth assets, their role as a diversifier and counterweight to major falls in the Australian sharemarket is. In all of the 22 sharemarket drawdowns, Australian Government Bonds outperformed their risky exposure counterparts and offered a valuable shock absorber.

On one occasion in 1994, the defensive exposure recorded its softest return—even so, the exposure still outperformed the sharemarket.

In financial market terms, this event was extraordinary, marked by a rapid rise in rates by the RBA of 2.75% within a brief six-month period (the official Australian target cash rate grew from 4.75% in July 1994 to 7.50% by December 1994, which was a 2.75% rise within six months.

The RBA locked in low inflation when interest rates were lifted in 1994

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ahead of a strengthening economy and a hawkish US Federal Reserve)—as the RBA followed the US Federal Reserve’s lead in an effort to tame inflation once and for all.

In contrast to modern times, the past decade’s inflationary pressures have been modest, even in a low-interest-rate environment. The reality is that the world, in particular the US, is currently more concerned about deflationary pressures.

Looking at this historical view where interest rates were much higher than today and inflationary pressures were mounting, high-grade bonds have been an effective diversifier. However, in evaluating how the asset class has performed in conditions more similar to our current environment (that is, low prevailing interest rates), can they still be relied upon today?

Performance of high-grade bonds in low (or even negative) policy rate environments Low (and even negative) rate environments have been employed by central banks across a range of developed market countries, including most notably Japan, Germany, Denmark Sweden and Switzerland (see Figure 2).

We need to look at a range of real-life and tangible episodes from around the world to assess the low rate policy effects on the ability of high-grade sovereign bonds to defend and protect portfolios against equity risk. Further, we have access to a long history of low-rate policies (zero to negative official rates) across a range of developed market countries (as illustrated in Figure 2).

Consistent with the earlier analysis, Table 1 on the next page shows the maximum drawdown events for each nation’s local shares (that is, less than –5%) versus the performance of the local treasury index (that is, high-grade sovereign bonds). Table 1 also shows that local high-grade sovereign bonds have dampened local sharemarket drawdowns, even with low yields.

Figure 1. Australian sharemarket drawdowns and Australian Treasury Bond market performance during uncertain times

Source: JCB team analysis, using data sourced from Bloomberg

High-grade bond and equity positioning: a strong counterbalance

The sharemarket declines (or left-tail events) illustrated in Table 1 have been fairly frequent and, as with financial market stress, other risk asset classes also suffered losses— including international shares and listed property, which can provide limited diversification during periods of extreme volatility, as there is correlation between risk assets.

With more than 25 years of Japanese policy rates at 0.50% or lower, and low to negative rates since 2012 across key developed markets such as Switzerland, Germany, Sweden and Denmark, local treasury bond markets have provided solid accretive returns coupled with continued muted volatility. Low yield levels alone are not necessarily a reason for investors to ignore highgrade bonds.

Figure 2. Selection of developed markets that have employed zero to negative interest rate policies

Source: JCB team analysis, using data sourced from Bloomberg

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Paul Chin, Jamieson Coote Bonds Paul Chin, SF FIN, is Jamieson Coote Bonds’ director and head of investment strategy and research.

Previously, he worked at Colonial First State, Advance Funds Management, Barclays Global Investors (now BlackRock), and Vanguard. Paul holds a Bachelor of Commerce and a Masters in Applied Finance & Investments.

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Table 1. Maximum sharemarket drawdowns, alongside treasury bond market performance

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Duration and the risk/return payoff for portfolios Some investors believe that a bond benchmark with a longer duration should be avoided. The reality is that a longer benchmark duration does not necessarily lead to greater risk. A 1% increase in yields will result in a higher capital loss relative to a lower duration (as it was during much of the 1990s)—this is mathematically true. However, there is more to bond risk than just this single metric. To understand this, consider both the duration level (that is, the weighted average time to receive all cash flows—coupons and principal), and the chance of a shift in yields.

With potential signs of an overheating global economy around 1994, the probability of yields increasing over a 12-month period were much greater than they are today. Policymakers were concerned with managing rising inflation and the potential for economic overheating. Today’s policymakers are busily trying to raise and maintain a reasonable inflation trajectory via significant stimulus and policy accommodation. The world is a far different place to the mid-1990s.

Asset class behaviours since the global financial crisis have long conditioned investors to expect more of the same (that is, elevated returns partnered with dampened risks, linked to central bank/government moral hazards) (see Figure 3).

February and March 2020 reminded investors of the need to appropriately assess risks, changing economic conditions and the potential for real market drawdowns. Investors relearned that when markets turn, they turn quickly.

Against this backdrop, it is no surprise that investors now lean toward defensive exposures and look to position portfolios for a sober forward-return environment.

Figure 3 shows the rolling three-year p.a. returns of Australian and international shares, and Australian and international real estate investment trusts.

For a variety of reasons, bond yields have declined across the globe, providing investors with much lower coupon rates. This implies that compared with higher yielding environments, cash flows from fixed income are more dominated by the capital return at maturity. Even with duration levels rising, and yields falling, high-grade sovereign bonds still retain their defensive properties.

Do not fear zero or negatively yielding bonds in a portfolio As illustrated, high-grade sovereign bonds have broadly moved in the opposite direction to shares—even at very low yields—displaying low to negative correlation to risk assets.

High-grade bonds as a classic defensive exposure are income-producing assets, meaning that unlike shares (which primarily rely on capital appreciation to drive Figure 3. Where will future returns come from?

30%

ROLLING 3YR P.A. RETURNS

20%

COVID-19

10% 0% -10%

Aus Shares Intl Shares H Aus REITs I-REITs H Linear (Aus Shares)

-20% -30%

Source: JCB team analysis, using data sourced from Bloomberg. Dates to 23 July 2020

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GFC overhang

Source: JCB team analysis, using data sourced from Bloomberg

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The prospect of a rise in inflation and future interest rates By the end of 2019, the world was already showing signs typical of a late-cycle phase. Material structural imbalances were unfolding, including spluttering regional and global demand, over-indebtedness in major pockets, and weak inflationary impulses. The onset of COVID-19 has dramatically devastated the world, and central banks and governments have quickly implemented large-scale emergency liquidity and accommodation measures to prevent the world from descending into deep recession and potential depression.

Meanwhile, three key megatrends have conspired to temper worldwide growth and inflation.

1. Ageing demographics—the older generation increasing in proportion to many countries’ populations, meaning rising public financing obligations, and changing workforce dynamics.

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2. Technology innovation (resultant increasing industrial efficiency, decreased production costs) and the altering of the human/physical capital balance—producing headwinds for global spending levels, economic growth and inflation.

3. Massive (and ever-growing) debt burdens, which traditionally lower additional credit creation, spending and investment—incentivising central banks to keep rates lower for longer.

To be sure, inflation could become an issue down the track. The enormous fiscal and monetary easing alongside with re-emerging supply chains and disillusionment with globalisation in favour of local independence could all provide the impetus for rising prices.

One possible scenario sees a global economic recovery brought about by vaccine development and widespread distribution, lockdown removals and the effects of stimulus combining to resemble the periods following World War II. Figure 4. Rolling three-year correlations: Australian shares and high-grade sovereign bonds 1.0

ROLLING 3YR CORRELATIONS

0.8 0.6

Aus Shares & Aus Govt

Aus Shares & Global G7 H

Aus Shares & Global G7 Govt H

0.4 0.2 0.0 -0.2 -0.4 -0.6 -0.8 -1.0

Top line: Aus Shares & Global G7 H, middle line: Aus Shares & Aus Govt, bottom line: Aus shares & Global G7 Govt H Source: JCB team analysis, using data sourced from Bloomberg

Figure 5. Rolling three-year correlations: international shares and high-grade sovereign bonds 1.0 0.8

Intl Shares & Global G7 Govt H

Intl Shares & Aus Govt

Intl Shares & Global G7 H

0.6 ROLLING 3YR CORRELATIONS

returns), they derive the majority of their returns from income, and the income on their income. Far less defensive assets such as corporate credit, illiquid or speculative exposures are often allocated to portfolios for defence, income and liquidity, but often fall short of these qualities.

A global bond allocation can provide the additional country/regional, currency and security diversification, alongside currency yield pickup. Global sovereign bonds receive their returns from coupons (income), changes in bond values from term structure shifts and—often neglected—the currency hedge yield pickup (in effect, the forward premium from the difference between Australian and offshore cash rates in the currency that is hedged).

Correlation measures between shares (domestic being the Australian Treasury Bond Index and offshore, the G7 Treasury Bond Index as shown in Figures 4 and 5) highlight the benefits of this defensive asset class.

Rolling correlations remain relatively low (or even negative) over extended periods. Even with low interest rates, these metrics have not spiked, contrary to some market beliefs. Simply, if high-grade sovereign bonds were to lose their protective properties, correlations would also dramatically increase in poor sharemarket periods, and approach 1.0. This, however, is not the case in Australia, or globally in the markets we have identified as having low to negative rates.

As shown in Figures 4 and 5, high-grade sovereign bonds have done an effective job in diversifying sharemarket risk.

The countries with low-interest-rate policies show the same type of rolling correlation outcomes between their respective local sharemarkets and local treasury markets.

In some instances (such as Denmark), persistent negative correlations have become marginally positive in recent times—but very weak. This means that the diversifying properties of high-grade sovereign bonds have largely remained intact.

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0.4 0.2 0.0 -0.2 -0.4 -0.6 -0.8 -1.0

Top line: Intl Shares & Global G7 Govt H, middle line: Intl Shares & Aus Govt, bottom line: Intl Shares & Global G7 H Source: JCB team analysis, using data sourced from Bloomberg

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CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD 1. Which country has a long history of low-rate policies (even negative official rates)? a) Japan b) Germany c) Denmark d) Sweden 2. Which country is more concerned about deflationary measures today? a) Australia b) Japan c) The US d) Germany 3. I n 1994, policymakers were more concerned with managing: a) Rising inflation b) Economic overheating c) Both the above d) Only A 4. T he author highlighted a possible global economy recovery through: a) COVID-19 vaccine development b) More government stimulus c) More bonds within portfolios d) The US election 5. D iversification does not insure against client loss, but it can help decrease their overall portfolio risk and improve the consistency of returns. a) True b) False 6. Historically, Australian high-grade bonds have proven to be less-effective diversifiers for balanced portfolios. a) True b) False

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Such an optimistic scenario differs markedly from where the world is currently. We have witnessed the sharpest fall in US growth expectations and the fastest collapse in the US labour market of all time.

Treasury yield curves in Australia and the US at the time of writing remain decidedly flat, with the market concerned about a prolonged global recession (or even depression) from the fallout of the COVID-19 shock. The pathway to recovery from here may be potentially longer than broadly expected.

Strengthening portfolios through high-grade sovereign bonds There can be no argument—bond yields are indeed at historically low levels, an indication of the emergency settings in place to keep the world from descending into a bleaker alternative.

Based on our assessment, in both rising and falling interest rate environments, high-grade bonds can play a critical role in portfolios— even more so in the current environment of poor global growth, low inflation and falling yields, which look set to remain.

Five reasons to consider an allocation to high-grade bonds

1. Downside protection—high-grade bonds perform vastly differently relative to risk assets and other debt instruments. They can be a source of genuine and evergreen liquidity and portfolio defence.

2. Low correlation to risk assets—throughout history, high-grade bonds have provided portfolio protection, especially against more risky exposures (albeit potentially tempered as a function of lower yield levels).

3. Efficient returns—while an exposure to high-grade bonds will likely deliver more modest returns compared with long-term trends, this needs to be viewed relative to a set of traditional asset class returns which are likely to be more muted. Each basis point of return— especially looking ahead— will matter (and be harder to come by).

4. Asset quality matters—March 2020 provided investors with a valuable reminder that ‘asset quality’ matters—especially in times of stress. Many asset owners have been soured by the experience of widening fixed income sell spreads, limited withdrawal windows, and for pre-retirees the occurrence of a sequencing risk event.

More attention is likely to centre on higher-quality assets.

5. Portfolio diversification—a defence exposure to balance out other defensive exposures and provide further portfolio diversification in a world where volatility is here to stay. fs

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CPD Earn CPD hours by completing the assessment quiz for this article via FS Aspire CPD. Worth a read because: This paper explains the applications of particular investment classes which offer potentially higher yields. Further, it evaluates the effects of COVID-19 on markets, particularly those considered less risky; and suggests ways to construct portfolios to best withstand the pandemic’s impacts.

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The hunt for yield during COVID-19

T Sabil Chowdhury

he search for yield is proving to be an endless challenge for investors during the market crisis brought on by the coronavirus (COVID-19) pandemic. Finding attractive yield has become more difficult than ever as central banks around the globe have coordinated simultaneous interest rate cuts, and companies have reduced dividend payouts due to the economic impact of the lockdowns.

Prior to COVID-19, historic bond yields were already subdued as central banks kept interest rates at ultra-low levels to support the economic recovery after the global financial crisis in 2008.

On 10 June 2020, US Federal Reserve (Fed) chair Jerome Powell stated, “We’re not even thinking about thinking about [sic] raising rates … we are strongly committed to using our tools to do whatever we can for as long as it takes.” Statements like these reinforce the notion that ultra-low interest rates are here to stay for some time.

Self-managed superannuation funds and not-for-profit organisations that rely on yield to distribute income now face a dilemma. That is, as cash rates and bond yields have been compressed to all-time lows, should they chase yield and move up the risk curve?

This paper discusses how COVID-19 has impacted certain securities which many investors have previously relied upon for income generation, and explores different investment options that offer yield with consideration to the risks involved. Further, it argues that di-

FS Advice

versification and a focus on strategic asset allocation are essential for generating a sustainable income stream, and considers other asset classes for diversification and reliable income generation.

The great dividend crunch One of the main advantages of investing in Australian shares is the access to high-dividend-paying companies as well as the benefits of franking credits. Domestic dividend-paying shares can provide substantial yield, especially to retirees and charitable trusts that require yield to generate ongoing income.

Another benefit that makes Australian shares even more attractive includes the tax benefit in the form of franking credits. Dividends for Australian resident companies are paid out of profits which have already been subject to Australian company tax. This means that shareholders receive a rebate for the tax paid by the company on profits distributed as dividends.

The lockdowns brought on by COVID-19 have caused a sudden decline in sales and revenue across most industries, directly impacting profits and the ability of companies to pay out dividends to shareholders. A Bloomberg article ‘Australian investors set for biggest payout cuts in a decade’ of 15 July 2020 reported that approximately a third of S&P/ASX 100 stocks have already reduced, deferred, suspended or cancelled dividends since the February reporting season.

COVID-19 has not only impacted dividend payouts in Australia but also across the world. Earlier this year, the European Central

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Bank recommended that companies in Europe cease dividend payments in order to keep sufficient cash buffers in place. The Fed stopped US banks from increasing dividends or resuming share buybacks through the third quarter of 2020, given the economic uncertainty brought on by COVID-19.

How do income-seeking investors protect themselves from this great dividend crunch? Sound investment strategies involve investing in quality companies with strong balance sheets and sustainable cash flows. Companies with low levels of debt and high cash reserves can weather market turmoils as they can continue their business operations, remain profitable and pay dividends to shareholders.

In order to minimise the risk of drawdowns (which is the peak-to-trough decline during a specific period for a portfolio), it is crucial for investors to diversify their portfolios and reduce concentration risk that comes with holding a single asset class such as Australian shares.

Are hybrids the answer?

Sabil Chowdhury, Koda Capital Sabil Chowdhury is an adviser and partner at Koda Capital. His specialisations include customised investment mandates, strategic/tactical asset allocation, alternatives, managing liquidity events, structuring and tax strategies.

Previously, Sabil was an investment adviser at Macquarie Private Bank and held advisory roles at Perpetual Private Wealth and KPMG Risk Advisory.

Given the uncertainty and volatility in sharemarkets, some investors are considering moving up the capital structure into hybrids. ‘Hybrid’ is a term used to describe securities that combine elements of fixed interest securities and equity securities. They include preference shares, convertible notes and capital notes.

Hybrids can pay relatively reliable distributions like bonds, however, they often have complex features including options to convert into equity, and uncertain maturities. These features can result in them behaving like equities in some circumstances.

Hybrids usually rank above common equity in the capital structure, but can rank below other forms of fixed income and debt should a company default on its debt obligations (see Figure 1). Unlike fixed income securities such as government or corporate bonds, most hybrids are

subordinated and unsecured, meaning that repayment is not collateralised over any asset.

Hybrid securities do not offer the same level of security or ranking in the capital structure compared with other fixed income securities, so it is important for investors to determine if the additional risk is being rewarded through sufficiently higher returns.

Some hybrids may convert to ordinary shares or be written off completely if the issuer experiences financial difficulty. Hybrids may also include terms that allow the issuer to exit the deal or suspend interest payments when they choose. When considering hybrids, investors must look carefully at these terms.

Hybrids should not replace defensive fixed interest securities such as government and corporate bonds as they do not have the same risk-reward characteristics. This is not to say that hybrids should be entirely dismissed.

A lower allocation within a well-diversified portfolio can be implemented, provided that the risks and returns of hybrids are well understood.

Higher yield = higher risk?

Ten-year Australian Government Bond yields dropped from 1.30% at the beginning of 2020 to below 0.90% in July 2020. With yields starting low and falling to even lower levels, investors are seeking yield elsewhere by moving up the risk curve and investing in ‘high-yield’ debt such as non-investment-grade corporate credit and junk bonds.

Corporate credit securities are non-treasury fixed interest investments issued by companies to raise capital in the form of debt. Investors holding corporate credit benefit from having priority of payment above equity investors for payment of coupons and repayment of principal.

Corporate credit can offer higher yields than cash and term deposits with less volatility than shares and can help diversify a portfolio.

Figure 1. Hybrids: risk and capital structure ranking

Source: Koda Capital, Investing for non-profits; Hybrids are not fixed income

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Example To be considered an investment-grade issue by Standard and Poor’s, the security must be rated ‘BBB–’ or higher. Similarly, for Moody’s, the security must be rated ‘Baa3’ or higher to be considered investment grade (see Table 1).

Figure 2. Virgin Australia: corporate bond price 120.0

100.0

Bond Price (AUD)

Credit agencies such as Standard and Poor’s and Moody’s assess the credit quality of companies and provide a rating to reflect their creditworthiness. Credit agencies use different designations, consisting of the uppercase/lowercase letters, numbers and plus/minus signs to classify the credit quality rating.

80.0

60.0

40.0

20.0

0.0

Nov '19

Table 1. Standard and Poor’s and Moody’s credit rating scales Grade

Standard and Poor’s

Moody’s

Investment grade

AAA Aaa

AA+ Aa1

AA Aa2

AA– Aa3

A+ A1

A A2

A– A3

BBB+ Baa1

BBB Baa2

BBB– Baa3

Non-investment grade

BB+ Ba1

BB Ba2

BB– Ba3

B+ B1

B B2

B– B3

CCC+ Caa1

CCC Caa2

CCC– Caa3

CC Ca

C

D C

Source: Standard and Poor’s Global Ratings Definitions (2020); Moody’s Rating Symbols and Definitions (2020)

Non-investment-grade corporate credit can offer investors higher yields compared with investment-grade bonds, however, they have a higher risk of default and missed debt repayments. Credit risk can be mitigated by considering the security’s ranking in the capital structure, the company’s credit rating, level of gearing and ability to service its debt.

Case Study: Virgin Australia Airlines

In November 2019, Virgin Australia raised $325 million in debt by offering its unsecured notes to investors as the company was seeking to purchase back its own frequent flyer program. Both Standard and Poor’s and Moody’s rated the Virgin Australia Corporate Bond as non-investment grade from the time of issuance. During the market crisis brought on by COVID-19, these notes plunged in value (see Figure 2) before being suspended from trading when Virgin Australia went into administration.

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Dec '19

Jan '20

Feb '20

Mar '20

Apr '20

May '20

Jun '20

Source: Bloomberg; Virgin Australia Corporate Bond VAHAU price from Nov 2019 to June 2020

It is difficult for private investors to mitigate risk by holding onto single direct corporate credit positions such as the Virgin Australia corporate bond or even a handful of direct corporate credit positions.

Instead, investors can achieve an appropriate spread of risk and return by investing in a diversified managed fund or exchange-traded fund (ETF) that provides exposure to investment-grade corporate credit securities.

Sovereign risk with emerging market bonds Investors seeking higher yields can also invest in emerging market (EM) bonds. EM bonds are debt securities issued by governments and companies in developing countries. They tend to have higher credit risk and, therefore, offer higher yields than investment-grade government bonds in developed markets. Potential threats include political uncertainty, socioeconomic instability and sovereign default risk.

Returns from EM bonds are generally uncorrelated to other traditional asset classes such as shares and investment-grade bonds.

However, the increased debt burden from emerging countries as a result of increased borrowing costs could increase a country’s likelihood of default.

Argentina, Brazil, Greece, Russia, and Pakistan are illustrations of countries that have defaulted over the past two decades. More recently, Argentina missed a bond payment in May 2020. This meant that Argentina technically entered default for the ninth time in its history. The perceived credit risk can severely affect a bond’s price movement and volatility as shown in the performance of the Argentina 15-year sovereign bond (see Figure 3 on the next page).

During a sovereign default, where a country fails to make an interest or principal payment, the value of the bond does not necessarily disappear overnight. The bonds often continue to trade at sharply reduced prices; the steep discount is often referred to as a ‘haircut’. Some of the debt can be written off, and governments often negotiate with bondholders to delay payment.

When investing in EM bonds, investors must consider the likelihood of the country defaulting and perhaps invest in a diversified managed fund or ETF to spread the risk rather than taking concentrated positions in any given EM. Moreover, if investing in EM bonds, a lower allocation should be applied relative to other fixed interest securities.

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Figure 3. Argentina 15-year sovereign bond price

120.0

100.0

Bond Price (USD)

80.0

60.0

40.0

20.0

0.0

Dec '16 Mar '17

Jun '17

Sep '17

Dec '17 Mar '18

Jun '18

Sep '18

Dec '18 Mar '19

Jun '19

Sep '19

Dec '19 Mar '20

Jun '20

Source: Bloomberg, Argentina 15yr Sovereign Bond price from Dec 2016 to June 2020

Real assets and the liquidity premium Liquidity premium refers to the additional yield demanded by investors when any given security cannot be easily converted into cash for its fair market value. When the liquidity premium is high, the asset is deemed to be illiquid, and investors will want compensation for the additional risk of investing over an extended period.

If income-seeking investors can afford to take on liquidity premium, they could consider adding real assets to their portfolios.

Real assets such as direct commercial property and unlisted infrastructure have traditionally provided investors with steady, predictable income streams as well as capital appreciation from growing populations.

However, with the COVID-19 lockdowns, rental income from commercial properties is tumbling as business tenants struggle to pay their leases. When investing in commercial property, investors should look at the property’s vacancy rate, lease expiries and tenants’ ability to pay rent. For instance, are tenants exposed to sectors facing significant headwinds from COVID-19?

For diversification benefits, investors could consider investing in unlisted property trusts rather than purchasing physical commercial property directly.

This eliminates the concentration risk of being overly exposed to a single illiquid asset, and an unlisted fund can offer exposure to several properties in different regions.

Like commercial property, unlisted infrastructure can offer attractive yields and capital appreciation. Direct infrastructure assets include road networks, airports, rail and ports. Some infrastructure assets such as airports face severe headwinds due to travel bans and low tourism numbers.

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When considering unlisted infrastructure, investors should look at investing in funds that offer predictable cash-flows through economic cycles. For instance, some infrastructure funds are investing in broadcast towers, cable and wireless networks and data centres which benefit from an increase in demand for online services.

COVID-19 has structurally changed the way people work and purchase goods and services. When investing in real assets, investors must be selective and choose specialist investment managers with access to unique deal-flow, proven track-records, and who invest in high-quality assets that can weather cyclical market drawdowns.

Private debt: An alternative source of yield The Australian private debt market was traditionally dominated by the big banks. With stricter regulatory and capital requirements, banks have decided to exit this sector. Bank disintermediation has caused wider funding gaps for capital-deprived businesses which has opened opportunities for investors seeking higher yield.

The power imbalance between borrowers and lenders has meant that lenders can ask for favourable terms and high interest rates. This market inefficiency provides income-seeking investors opportunities to capture high yields through private debt funds. Private debt funds hold several private debt positions with different terms and maturities, and provide investors diversification.

Private debt funds can lend to small-to-medium businesses, property developers and consumers through a broad range of debt instruments across the capital structure, including senior, mezzanine and junior debt. Private debt can also be secured or unsecured and is generally unrated by credit agencies.

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Private debt investments are not risk free, as borrowers can default on their loans. For this reason, it is important for investors to select private debt investments that are senior ranked in the capital structure and secured against assets to mitigate default risk. In addition, investors should assess the quality of the borrower’s balance sheet, credit history and loan-to-value ratio.

The catch with private debt is its illiquidity and lack of access to quality deal-flow. Most private debt funds have lockups of approximately two years. As a result of this lockup, the capital invested is not readily accessible if other investment opportunities present themselves. For this reason, private debt funds may suit long-term investors who can afford the ‘liquidity premium’ and do not need immediate access to their funds.

Conclusion For income-seeking investors, capital preservation is essential since the invested capital is relied upon for generating future income. With greater market uncertainty from the economic ramifications brought on by COVID-19, investors should be aware of the different options for generating income and consider a combination of investments that align with their income objectives, liquidity requirements and risk profile.

Cash-flow forecasting can be helpful for investors to determine whether a portfolio’s weighted average yield is enough to cover future income distributions. Investors can rebalance portfolio weightings where necessary to achieve income objectives while being cognisant of the risk-reward trade-offs.

During times of great uncertainty, diversification is more important than ever. The best defence against large market drawdowns is to have a well-diversified portfolio with a mixture of uncorrelated asset classes. This way, investors can protect their capital which will allow them to generate steady streams of income over the long term. fs This content has been prepared without consideration of any client’s investment objectives, financial situation or needs. Before acting on any advice in this content, Koda Capital Pty Ltd recommends that you consider whether this is appropriate for your circumstances.

While this content is based on the information from sources which are considered reliable, Koda Capital Pty Ltd, its directors, employees and consultants do not represent, warrant or guarantee, expressly or impliedly, that the information contained in this content is complete or accurate. Koda does not accept any responsibility to inform you of any matter that subsequently comes to its notice, which may affect any of the information contained in this content.

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CPD Questions Earn CPD hours by completing this quiz via FS Aspire CPD 1. In terms of countering market drawdowns in the COVID-19 environment, the author recommends that investors: a) Increase their holdings of a strong single asset class such as Australian shares b) Have a well-diversified portfolio with a mixture of correlated asset classes c) Have a well-diversified portfolio with a mixture of uncorrelated asset classes d) None of the above 2. As discussed by the author, hybrids: a) Have higher risk than senior unsecured debt b) Have lower risk than senior unsecured debt c) Offer the same risk-reward characteristics of corporate bonds d) Cannot convert to ordinary shares or be written off completely 3. Investors holding corporate credit securities: a) Take on more volatility compared with shares b) Are secondary to equity investors for payment of coupons and repayment of principal c) Have priority over equity investors for payment of coupons and repayment of principal d) Nearly always achieve higher yields than cash 4. Which of the following considerations does the author flag regarding private debt? a) Illiquidity b) Lack of access to quality deal-flow c) Borrowers can default on their loans d) All of the above 5. A key risk of emerging market bonds is sovereign default risk. a) True b) False 6. The author found that Australian dividend payouts have been quite resilient to the effects of COVID-19. a) True b) False Visit www.financialstandard.com.au and click ‘FS Aspire CPD’ in the menu or call 1300 884 434 to gain access to the platform.

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