12 minute read
INVESTMENT COMMENTARY
from ASSET Spring 2022
by ASSET
Independent vs in-house: why are we still competing?
David van Schaardenburg looks at vertical integration - dead in other developed countries but alive and kicking in New Zealand – and what independent advisers can do about it.
This column may be old news to many independent financial advisers, but nevertheless it’s an issue worth reviewing to see what options or solutions exist to resolve it.
What am I talking about? Competition for clients.
In particular, competition for clients between 1) the increasing number of vertically-integrated funds-management firms and 2) independent financial advisers.
I’ve got many professional friends and former colleagues working at verticallyintegrated firms in so-called ‘advice’ roles.
None will appreciate a focus on the constraints on the investment recommendations they can give clients - but it’s time we had a decent debate on the issue.
A uniquely Kiwi problem
This competition seems to be a uniquely New Zealand problem. Across the Tasman, and in other developed markets, regulations or market pressures have forced funds-management firms to be solely managers of portfolios - and for financial advisers to focus on providing individualised advice, client by client.
Hence, if you’re seeking personalised financial advice, say in Australia, should you call ABC Funds Management seeking financial advice they’ll steer you down the road to talk first with a local, licensed, financial-advice firm.
Do the same exercise in New Zealand and increasingly you’ll find yourself speaking to an in-house ‘adviser’.
I put speech marks around the word ‘adviser’ as while in-house advisers are licensed, and for the most part technically wellqualified, their advice is usually limited to investing in their own funds. Pretty limited!
More than ever, New Zealand fund managers are building their own ‘advice’ teams, either by way of acquisition, adding new advice offices, or simply continuing to add to the number of ‘advisers’ in their in-house private-wealth teams (numerous Auckland-based funds-management firms).
Sticky business
Having formerly managed the development of an in-house advice team, the business logic is pretty familiar to me.
Growth in in-house advice-team funds under administration (FUA) not only equates to growth in FUA for their fundsmanagement arm, most importantly it’s sticky business.
An independent adviser using a ‘best of breed’ approach will allocate a portion of a client’s portfolio to a well-performing fund manager, but this sum is always ‘on notice’ and may be redeemed if the fund manager doesn’t perform to expectation or undergoes a negative personnel or corporate event.
In contrast, the portfolio recommended by an in-house adviser employed at a funds-management firm is inevitably fully or substantially comprised of inhouse funds solutions.
At a future point in time, should a fund manager not be delivering, the independent adviser will be looking for potential replacement - and may effect termination of a fund manager in the best interests of the client.
In contrast, the in-house adviser is motivated to retain the client. Even if their investment arm is not doing a particularly good job.
Conflict of interest
This clear conflict of interest is why in-house advice functions in fundsmanagement firms have been competed or regulated out of existence in other developed market, but not yet in Aotearoa.
Many of the funds-management firms who have built in-house ‘advice’ teams owe their existence in their early years - or at least a decent chunk of their revenues - to the support provided by independent financial advisers placing clients with them.
So it’s rather galling to see those same fund firms increasingly competing with their external adviser supporters.
In addition to the ‘client retention’ driver, the substantial and projected further growth in New Zealand household savings held via fund solutions, principally KiwiSaver (growth of 787%, or $72.4 billion in the 10 years to 2021), means an in-house ‘advice’ function can be potentially very profitable for a fund manager.
Growth in FUA for in-house advice teams can come through new client signings, client-base acquisitions from retiring independent advisers, higher client-retention rates, or the regular drift of the fund manager’s clients - possibly with a nudge - away from an external adviser to the cosy embrace of an inhouse one.
This latter, insidious trend seems to be fair game, often without compensation, in the relatively laissez-faire competition for clients between in-house and independent advisers.
Not in the clients’ best interests
Is this paradigm in the best interests of the investing public – interests our regulators appear keen to protect? No.
Unlike independent advisers, inhouse financial advisers are not free of investment-recommendation conflict. This means most clients of in-house advisers are likely to be receiving lessthan-top-quality investment solutions.
Not that fund managers with in-house advisers can’t do a good job, and not that that some independent advisers won’t have weaknesses, but on balance a ‘best of breed’ solution should win out.
This is increasingly relevant, as many New Zealand-based fund managers also manage global-securities portfolios in addition to the domestic-securities portfolios they’ve managed for a considerable period.
In doing so, they move from competing to be the best amongst the relatively small set of New Zealand-based asset managers to competing with a wide range of funds-management groups with far larger research resources and globalasset management experience.
Fair to say, I struggle to believe an Auckland-based firm with five to ten staff members allocated to global-portfolio management can offer a superior investment solution relative to global giants such as Capital Management or Wellington Management. But their in-house private-wealth advisers will tell you otherwise.
Redraw the landscape
So if our regulators are reluctant to put up a ‘WARNING!’ sign – “Using an in-house adviser may not be best for your future returns” - how can the independent-adviser community start to redraw the landscape in the competition for advised clients?
First, ensure all adviser/fund-manager agreements have protective/punitive clauses with respect to the marketing to, and possible transfer of, mutual clients.
Second, avoid working with firms which compete with you. There are plenty of quality funds-management firms out there which focus on what they do best, especially in the global arena.
Third, make it clear to current and prospective clients that independence is important - as is a lack of.
Fourth, it’s time the advisers industry body (FANZ) picked this issue up, both in an educative sense and by lobbying regulators for a distinction for consumers between in-house (tied) advisers and independent ones. I didn’t see any in-house private-wealth advisers at the recent FANZ conference. A
CEO of the Ignite adviser network, David van Schaadenburg is independent of any funds-management firm
OPINION
Time for another look at non-bank deposit takers
Goldband chief executive Martin Brennan says it is time investors and advisers took a new look at non-bank deposit takers.
BY MARTIN BRENNAN
In the 15 years since the Global Financial Crisis, New Zealand’s non-bank deposit taker (NBDT) sector has been transformed, with new levels of oversight, a tightening of rules and consolidation of participants.
Many of these changes have gone largely unnoticed in the wider sector, as new products and technology compete for investors’ attention. But with increased pressure on capital, Gold Band Finance (GBF) chief executive Martin Brennan says it might be a good time to pay attention to the opportunities the sector offers as part of a diversified portfolio.
When inflation hit 7.3% in July this year, it marked the largest annual rise in the cost of living since 1990. With one year term deposits across the major banks having just reached 4%, after the latest 50 basis point increase in the OCR, and five-year rates barely adding another half a percent, for many Kiwi investors that represents a significant erosion in capital.
As readers will be all-too aware, investment propositions across the board in 2022 have been increasingly fraught. The share market closed the first half of the year down 18% – following overseas trends, which saw Wall Street have its worst half since 1970. The high-profile collapse of crypto investments, with marquee currency Bitcoin losing half of its value over the last six months, have also shaved millions from the local market. Even our ‘forever increasing’ property market has come off the boil quickly, with local house prices seeing the largest drop in over a decade.
While the establishment of KiwiSaver has greatly increased the investor savvy of New Zealanders, it has also made fluctuations in those investments much more obvious, and the impacts of a falling market more widespread. By their nature, Mum and Dad Kiwi investors tend to be conservative. In this environment – confronted by bad news at seemingly every turn – they will be seeking advice on how to protect their assets.
A well-governed sector
For anyone who experienced the GFC, it might seem counterintuitive to be recommending the non-bank sector as the sensible option for diversification in a market where negative sentiment dominates. But that would ignore the enormous changes that have taken place across the industry and the regulation and oversight which now controls the sector.
Chief among those is the Non-bank Deposit Takers Act of 2013. This legislation governs a small number of organisations that, like registered banks, offer debt securities and borrow and lend money. It's a small group of local businesses – around 15 in total – and includes building societies like the Nelson Building Society, credit unions, such as those operated for the Police and the NZ Firefighters, and established businesses like GBF.
The Act was introduced with the aim of raising standards and improving the sector’s overall resilience to adverse market conditions. With benefits of the lessons learned from the GFC, this level of oversight has been established in recognition that, as the Reserve Bank itself states, “The NBDT sector is an important component of the broader financial system because it assists with providing funding to wider sectors of the economy, and provides alternative investment options for individuals and organisations.”
As further outlined by the Reserve Bank, the sector is subject to the Financial Markets Conduct Act 2013 (the FMC Act), which requires them to have a trust deed (and therefore be supervised by a trustee) and a product disclosure statement. They are also required to comply with prudential requirements outlined in the relevant Act and associated regulations, which include twice-yearly independent audits in almost all cases.
In reality, this means regular contact with their supervisors, and clear and transparent processes for investors to see how the business is acting and operating. It also means strict penalties for businesses, and their Boards and management, if they fail to comply with the requirements of the Act.
Protecting investment value
In a market like the current one, having an alternative option that provides higher interest rates than the banks (in the case of GBF, between 4.90% for one year fixed and 6.15% over five years) can make a major difference. This is particularly true for those on fixed incomes – still a major class of local investor – for whom the rise in inflation has put real pressure on their supplementary earnings.
Of course, like any investment, the sector is not without risk. However, with careful oversight by a prudential regulator (RBNZ) and conduct
regulator (FMA) these risks have been substantially reduced over the last decade, and the sector should now be viewed in this context.
If we look at GBF as an example, we have a track record of prudent operation over more than 35 years. During that time, we have never failed to pay back the full value of an investment on maturity. In fact, we have consistently provided good returns for every month over the past three and a half decades.
Perhaps as a measure of how much things have changed in the sector, my latest update to investors was a discussion on why – in comparison to the more ‘exciting’ investments in cryptocurrency, app-driven share trading or even NFTs – an investment in our company was so boring. And why in the current market, boring was good, if it meant investors still had the full value of their capital, while receiving a fair market return through robust, licensed non-bank funders meeting requirements set by the Reserve Bank.
Even our own investment portfolio is one that would hardly stir the heart rate. The vast majority of our loan book is focused on investments in residential property – something the average Kiwi investor understands very well. But that conservative approach is one that has continued to serve our local investors well – allowing them to achieve higher interest than offered by the banks, without erosion of their capital.
At a time when there are growing concerns about the use of wholesale investment schemes to secure investment funding for property development, the option of a prudent and well-regulated option that still pays higher than bank interest may well be a good path for local investors.
A changing market
With the lingering impacts of the COVID-19 pandemic, a disrupted supply chain and uncertainty in the world’s major economies, it is unlikely that markets will become any less volatile in the near future. At the same time inflation is proving a particularly intractable problem. New Zealand is certainly not getting the worst of it, with the UK predicted to see inflation top 18% this year off the back of high energy prices. But our increasingly connected world will continue to see those impacts spread around the globe.
In this kind of market, finding the right balance between risk and return is extremely important. The NBDT sector has a role to play in that as part of a diversified portfolio, especially as they offer returns which can reduce the impact of inflation on local Mums’ and Dads’ investment principal.
The fact that the Government has chosen to create a framework of legislation for the sector reinforces that they see value in the role it plays. There is even discussion at present about including NBDTs within the deposit compensation scheme, offering stillfurther protection to local investors, and potentially completing the transformation of the sector.
With all this in mind, it would be prudent for investment advisors and local investors to take another look at the options available within the Nonbank Deposit Takers sector, especially established local organisations with a considerable track record, like GBF. A
