For those inclined to question the value of financial advice, there are two important trends taking place right now that need to be reckoned with. Firstly, the federal government is committed to the scheduled rise in the superannuation guarantee, which will see the rate rise to 10% by 2021 and, if the government sticks to the schedule, to 12% by 2025. Workers are gearing up to have more of their retirement wealth exposed to financial markets in coming years, raising the stakes for the wealth management industry and making financial advice less a luxury and more a practical necessity.
Secondly, there have been some troubling signals coming from financial markets over the past six months. While the bull market trend in equities has held up since the start of 2019, the ‘recession dashboard’ is starting to light up, with leading indicators suggesting things might not be as rosy as the stock market suggests. Market turning points pose a real challenge for fund managers and have a way of pushing their process and discipline to their absolute limit. In times like these, product recommendations and manager selection really count, and advisers can quickly find their own processes exposed when things go wrong.
However, even as the value of advice is growing, the perception of advice has suffered through the trauma of the Royal Commission and the uncovering of illegal and unscrupulous practices. Regulatory changes and the shifting nature of advice will inevitably lead to some attrition in the industry, but for the rest there is an acute awareness that things won’t improve on their own. Clients need to be presented with a highly compelling value proposition that demonstrates how the advice process helps them. It also needs to address both the perception issues and the very real regulatory issues around conflicted advice and best interest duty. This is where having the right investment research becomes critical.
Quality investment research is essential to your value proposition
It’s tempting to see investment research as a cost of doing business. The reality is that research is not merely there to supply data, tick a compliance box, or support an established view on a particular product. Quality research is an essential part of the value proposition, because it enables advisers to deliver the things that clients expect from their financial advice: namely, to be able to take full advantage of the depth of Australia’s investment product market and be given recommendations that are most likely to satisfy their investment goals.
Achieving this requires advisers to conduct a full comparison of individual financial products covering a wide range of factors. For any recommendation to be meaningful, it must go beyond past performance to focus on the key qualitative factors that drive future performance and determine whether the product is in line with the client’s needs and preferences. To do this well, advisers must be able to draw on a full team of research specialists with experience across different asset classes, structures, and sectors. Having quality research means partnering with a team that can cover the breadth of products available in the market, and for each product perform the deep dive needed to truly understand how it works and how it can best be incorporated into the client’s portfolio. Having the right investment research means having the resources and capabilities to deliver on your value proposition.
This is why the regulatory challenge facing advisers should not be seen as something distinct from the value proposition. Meeting the highest regulatory and professional standards is something that clients expect, and it’s essential that advisers can demonstrate how they meet these standards. Advisers face a perfect storm of regulatory change, and the winners will be the ones able to adapt to the higher expectations set for them by the regulators and the community. Demonstrating a commitment to acting in the client’s best interest and an ability to avoid or effectively manage conflicts is key.
Tighter regulatory standards reflect the community’s desire for better investment outcomes
The Safe Harbour provisions of the Best Interest Duty state that, when recommending a financial product, an adviser must have conducted “a reasonable investigation into the financial products that might achieve those of the objectives and meet those of the needs of the client that would reasonably be considered as relevant to advice on that subject matter.” In practice, this means that the adviser has not simply looked at a product in isolation and determined if it’s likely to make their client better off but has actively compared it to other similar products and recommended the most suitable one.
In the case of super, there are specific requirements that relate to the due diligence advisers must undertake. Firstly, they must consider the client’s existing products and any products the client requests to be considered. Secondly, the adviser must show the benefits of a new fund, including qualitative factors such as the member servicing environment, the types of insurance the fund offers, the educational material it makes available, and the menu of investment options.
And the standards are getting tighter. The FASEA standards state that advisers “must not advise, refer or act in any other manner where you have a conflict of interest or duty.” This goes beyond the Corporations Act, which merely requires advisers to disclose a conflict and gain the client’s consent before acting for them. The FASEA standard is also broad in the sense that it isn’t limited to conflicts in relation to remuneration. The FPA’s view is that the primary ethical duty in this standard is: if you have a conflict of interest or duty, you must disclose the conflict to the client and you must not act. While these standards are tight, they reflect the community’s expectations that recommendations are free of conflict.
Partnering with a research provider gives you the resources and capabilities to conduct in-depth product comparisons and allows you to show the client how your expertise adds value. Having the right research means you’re better able to support product recommendations with in-depth analysis and detailed product comparisons. It puts you in a better position to meet the regulatory standards and it lets you have deeper conversations with your clients that directly address their needs.
Selecting the right manager involves looking at more than just past performance. It’s about delivering future outperformance based on an in-depth assessment of individual investment teams. This means understanding how people, strategies, and capabilities come together to position fund managers for success. When it comes to selecting for future success, qualitative research is not merely a filter or a heuristic, it’s the backbone of your entire research process.
While you might be able to get away with poor manager selection when the bull market is raging, the real test comes when the market reaches a turning point. Given the troubling signals from financial markets over the past six months, this is something many investors are starting to take very seriously. Market turning points pose a real challenge for fund managers and have a way of pushing their process and discipline to their absolute limit. In times like these, product recommendations and manager selection really count, and advisers can quickly find their own processes exposed when things go wrong.
Identifying future outperformance is an artform, not a science. Lonsec’s entire research process is built around understanding the range of qualitative factors that determine manager success and giving advisers the tools to select investment products based on individual client needs. Our analysis is based on an onsite assessment of investment teams, combined with a rigorous peer review process that safeguards the quality and integrity of our investment product ratings. Looking back over the past 10 years, our qualitative process has proven its worth. Lonsec’s Recommended and Highly Recommended managers have outperformed their respective benchmarks, even during a period where the long-running beta rally has pushed passive investment strategies ever higher, casting shade on many active managers who have struggled to offer value in this environment.