Investing Your Client's Money - Does Your Licensee Have Your Back?

The wild share market gyrations we saw with the onset of COVID-19 has inspired a wave of DIY-ers into the market, for better or worse. This has been facilitated by the latest digital platform like Superhero, Stake and even Robinhood, although the latter is not yet available in Australia despite tens of thousands of local registrations since 2015.

For advisers, even those endorsing long-term set and forget investment strategies, many have experienced an unprecedented volume of calls from clients about cashing out, going short, topping up, doubling down, or just “throw all my money into Afterpay”. Hopefully, there have also been crickets from those who truly understand investing is a long-term pursuit.

But it begs the question – how well placed are advisers to implement and maintain an overarching investment approach for their business? One that can withstand the shocks from global market-moving events like COVID-19 and accommodate clients of many persuasions, biases and emotional responses during moments of crisis. And recognising that advisers are not or should not be investment experts, how is it informed by investment experts or expert third party firms?

That means putting in place appropriate governance mechanisms, in many cases established by and rented from the licensee. The best of breed approach to such governance is typically multi-layered:

1. An investment philosophy that defines the firm’s overarching approach to economics, markets, asset classes, product classes and investment styles.
2. An investment committee to manage the investment philosophy, approved product list, model portfolios, MDAs if relevant, and external expert engagements.
3. An approved product list (APL) that aligns with the philosophy to provide risk management and control over the investments available for advisers to recommend.
4. Use of research and investment consulting, internal and/or external, to support the activities of the investment committee in carrying out their duties.

These governance structures may seem elaborate and can be expensive, but they are important to demonstrate an effective level of science and control over how clients are advised. Meeting best interest duty provisions demands that, and the new Design & Distribution Obligations (DDO) legislation to come into force in October 2021 will further compel it – not just for advisers and licensees, but also for the financial product manufacturers who will share in the responsibility that clients are only in invested in products that are suitable for them.

So how are licensees positioned? Our recent survey of the Top 300 licensees showed some remarkable differences and encouraging commonalities in Figure 1 between the smallest licensees (< 10 advisers) and the largest (> 10 advisers).

Figure 1: Top 300 Licensees Approach To Investing

Source: Adviser Ratings survey of Top 300 licensees, Nov 2020 (n=71)

On the positive side, it was encouraging to see that a high proportion of both groups (80-95%) have an investment committee. However, only 35% of the smaller licensees were using third party experts versus 85% of the larger licensees. Compounding that, only 25% of smaller licenses had internal experts versus 55% of the larger licensees. To be most effective, investment committees have to be resourced with the right number and type of experts, and with a sufficient degree of independence and objectivity.

For the smaller licensees, affordability goes a long way to explaining these shortcomings. One mitigating factor in their favour is their unwillingness to provide flexibility around the APL. Only 30% of smaller licensees allowed this versus 63% of larger licensees. Most large licensees allow investments “off the APL” provided there is a solid business case, sufficient demand, and are approved by the investment committee. These exception processes add further cost to a business and invariably introduce more risk to the business.

Lastly, with less than 35-43% of both groups ascribing to goals-based investing, it looks like this philosophy will take some more time to penetrate. It’s a salient message for those financial planning software providers, particularly the newer players, that are committing substantial resources to incorporate into their designs.

How effective are the investment services that your licensee or practice provides?

Article by:

Adviser Ratings

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