Does it matter who pays your adviser?

Recent publicity here and in Australia has focused on what has been an age old debate within the industry since its foundation, should advisers be paid fees or generate their income from brokerage?

There is a wide variance in the business models used in the delivery of personal financial advice. Some are purely investment transaction businesses which generate their income from commissions, yet others charge fees, while a significant number generate their revenue from a combination thereof.

Much emphasis has been placed on the connection between those who sell products to investors and are paid commission by the product provider, and failed investments. Most noticeable has been the failure of high commission earning fixed interest products which are often cited as an example of where commissions have influenced the advice given.

There has been speculation that the recently released Ripoll report would look to ban financial advisers being paid commissions in Australia. Moves are afoot in the UK to look at whether such a ban is possible to achieve by 2012.

In 1998 we ran a pilot program with a selected group of clients before deciding to take the step to transition to a fee for service model in 1991. So I have worked in both environments and it is with that experience that I am concerned about the quality of the current public debate on these matters. Of primary concern to me are the following points:

1.            the first principal in consumer rights is that the consumer should have the freedom of choice.

2.            the state should never dictate the pricing model used by the private sector when providing services

3.            there is an underlying assumption that the banning of commissions will prevent people from losing money when investing

4.            arguably the largest generators of commission and brokerage are the sharebroking fraternity, yet they seem to be exempted from this discussion. Why?

While I have a deep personal connection with the advantages provided for consumers by the fee for service model, I find much of the logic around removing choice deeply flawed and misguided.

The most telling example is that 77% of investors in finance companies invested directly. No brokerage was paid and they lost money just as those directed by commissioned sales agents.

So clearly, simply dealing with the payment terms of advisers is not going to prevent such losses. Advisers have no control over how markets price risk, investors however do.

One of the few useful points made in the deeply flawed mystery shopping of Financial Advisers by Consumer was to highlight the lack of transparency in the way stockbrokers report to clients on the full amount they are paid in the numerous capacities in which they operate. This example highlights for me what the real issues in this debate are:

1.            consumers should have the freedom of choice but also take responsibility for the outcomes of that choice.

2.            the issue is not how advisers are paid, but the transparency of that payment. The consumer has the right to know and in detail. If multiple margins are being paid, they should all be declared to consumers prior to them investing and as they occur. This is the only way consumers can make truly informed choice.

3.            there are currently disclosure requirements under the Investment Advisers Disclosure Act. These need to be enforced. They are adequate now and do not need further regulation in order to provide protection to the consumer.

4.            consumers will be aided greatly if all participants in the personal financial advisory sectors are required to comply with the same standards. The view that NZX members are somehow superior in their compliance and that their clients enjoy superior outcomes, belie the facts. Consistency of standards will allow consumers to be fully informed and undertake more direct comparisons between various offerings.

So to answer the question, does it matter who pays your financial adviser?, I would suggest yes, but not as much as knowing how they are remunerated, the quantum of that remuneration (at all levels) and the personal benefits to the financial adviser in giving said advice.

Consumers should be treated with respect. Nothing less than full disclosure will allow that respect to be given.

Craig Myles, Director

Certified Financial Planner^CM,

MInstD.

Myles Wealth Management Ltd

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