Back in the early 1990s it wasn’t considered savvy for a financial planner to champion the virtues of fee-for-service remuneration. Not surprisingly, the ranting and raving of Melbourne-based planner Kevin Bailey at the 1992 Financial Planning Association conference in Hobart, denouncing then recently-introduced trailing commissions, were like throwing an incendiary device amongst the masses.
A former SAS soldier, Bailey argued that the total cost to the client should have been half the average rate of 4% (for master trusts). Many contemporaries accused him of heresy.
Bailey recalls a prevailing industry view that while his fanciful notions were admirable, they were equally unrealistic.
In hindsight, Bailey says he was up against the assumption that unless the cost of advice was embedded in the product, planners would never get their money.
Over the past 15 years Bailey has successfully proved that this argument doesn’t hold water. In fact, he estimates that only 1 per cent of the company’s $10 million in gross revenue from 1000 clients comes from commissions, derived from what’s left of legacy products.
Bailey says products that don’t rebate upfront commissions are typically more expensive, and they’re unlikely to be used by his company, or by rival firms moving progressively into the fee-for-service space.
Bailey was convinced he could provide a better value to clients, for less than half the going price. In 1986 he gave two weeks’ notice to the dealer group he worked for. He recalls having irreconcilable differences with his dealer group over charging clients an up-front fee of around 4 per cent, on top of an annual management fee of 2 per cent – plus trailing commissions from various providers.
As a representative of the dealer group, Bailey only received 20 per cent of the total fees clients were paying. He was confident that providing a better value proposition on a fee-for-service basis wouldn’t erode his own profit margins.
“More importantly, I was uncomfortable with the conflict of interest that came from charging a service fee one minute then earning trailing commissions derived from recommending certain products the next,” Bailey says.
“I was equally concerned about being a price-taker instead of setting my own price.”
Having acquired his own dealer’s licence, posted a $20,000 bond and created a template for a financial plan, Bailey and his wife, Grace, proceeded to launch a financial planning service under the moniker of The Money Managers.
“I wanted to base the business on what I felt clients needed,” Bailey says.
“I also believed that within [what was] an environment of diminishing returns, fees to clients also had to be more cost-effective.”
Fast forward to 2007 and Money Managers now employs 47 staff, comprising 17 professional planners, with $1 billion of assets-under-advice spread across the Melbourne head-office and seven regional centres throughout Victoria and NSW. Much of the company’s fee-for-service model is based on independent research to build portfolios and create holistic wealth management by benchmarking client performance against fund manager and stockbroker performance.
To Bailey, moving to a fee-for-service model was all about being paid directly by the client as opposed to a third party. Instead of being a glorified sales rep for a product provider, he says being paid by the client meant he could truly act on their behalf. “Under the old model there’s no correlation between commission paid and what a planner actually does for a client,” Bailey says.
“If we want to be taken seriously as a profession then payment has to be separate to product.”
Bailey says many planners who claim clients don’t care whether they pay commissions or a fee-for-service are simply hiding behind inadequate disclosure. He says making planners responsible for good disclosure is a bit like putting Dracula in charge of the blood bank.
“The key is to educate people that there are alternatives beyond a commission structure and this requires full, not partial, disclosure,” Bailey says.
“Once they’re aware of all the options, clients really do care if they’re paying thousands [of dollars] more annually when a trailing commission is embedded in the product.”
The biggest challenge facing planners today, Bailey says, is to recognise that their value proposition is embedded in the advice they offer rather than being seen as a distribution cost.
He says it’s not difficult to convince clients that a fee-for-service is in their best interests once planners prove how and where they add value. To Bailey this means measuring what you do and being prepared to hold yourself up to scrutiny.
“Planners should add most value by efficiently capturing market returns, which means they’ll typically outperform most brokers and fund managers over time,” he says.
On a more pragmatic level, he says the daily tasks confronting planners include adding value to portfolio construction, relating risk to return and delivering the best tax and lifestyle outcomes in a cost-effective manner.
“How planners access independent research, administer portfolios efficiently, and ensure consistency of quality within their firms will determine whether they’re perceived to be offering trustworthy advice,” he says.
The key to ensuring clients are not getting more from a planner than their fees will cover is for planners to be very specific about what they will deliver for a stated cost.
“This comes down to experience and is typically based on a job cost – anything from a minimum amount of $500 – rather than an hourly rate,” says Bailey.
He says the best advice often comes down to reviewing the right asset mix as opposed to specific investments within each asset allocation. Sometimes, he says, the solution is as simple as correcting a concentrated risk arising from holding too few stocks, lower returns relative to volatility, or adjusting strategies for retirement or estate planning.
It’s not uncommon, Bailey says, to find that bad advice has led to an over-exposure to direct equities or debentures, especially within portfolios worth more than $1 million. “Sometimes the best solution is to turn off the capital gains clock by getting clients to hold shares within a super fund and having franking credits returned as cash from the Australian taxation Office [for those over 60],” Bailey says.
“Most portfolios should be re-balanced annually, and we’re in more regular contact via phone and newsletter throughout the year.”
According to Bailey, much of what makes a successful financial planner centres on having integrity, while staying flexible and eternally vigilant. To him that means keeping abreast of industry and regulatory changes and maintaining a wide network of local and international peers. It also means developing a strong viewpoint.
He says planners also have to learn to fashion their presentation and style to match the personalities of individual clients.
Bailey says planners also face the task of severing advice from distribution and product. Compulsorily separating advice from product, he says, would cause significant problems for institutions that have paid big money for distribution.
Bailey favours educating consumers on the remuneration options open to them. He says there is a commercial imperative to move to fee-for-service, as it helps develop better client/planner relationships.
He urges planners trying to move into the fee-for-service space to develop client contracts that highlight what they get for fees paid – even if some revenue still comes from commissions.
Bailey also urges every planner to seek a letter of appointment from their clients. It should, he says, ratify the relationship by highlighting what clients pay, and what they receive in return – for example, by measuring performance against certain industry benchmarks, tax savings, and lifestyle objectives that have been met.
Bailey says: “It opens the door to wean you off product commissions and provides a level of accountability that all planners need.”
Name: Kevin Bailey
Position: Managing director Money Managers, Melbourne
Years as a planner: 21
Qualifications: Diploma of Financial Planning, CFP, FFPA.
Member of the ASIC Business Consultative Panel, member of the FPA Conduct Review Commission, member of the FPA Professional Conduct Committee.