The issue of vertical integration has raised its head again (as if it ever really went away), as submissions to the government’s Financial System Inquiry (FSI) focus on planners being coerced to place clients’ funds into investment products manufactured by the same institutions that own the financial planners’ licensees.
Vertical integration is a rational and understandable, if regrettable, response to the economics of the financial planning industry, and it’s not a structure limited to the big financial institutions. But vertical integration is just a symptom of a much deeper disease.
The central issue with vertical integration is not that a client’s money finds its way into an investment product owned by the same institution that controls the AFSL; the issue is why a client’s money has to find its way into an investment product at all.
A conflict of interest exists when money is pumped into an associated investment product, and just as significant a conflict of interest exists when a financial planner’s livelihood depends on aggregating client funds in investment products of any sort. If that’s what they have to do to get paid, then that’s what they’ll do.
Efficiency of conflict
All a vertically integrated business model does is improve the efficiency of the conflict – it makes the conflict more profitable. The bigger issue is why financial planning as a service cannot be structured, priced and valued so as to be profitable in its own right. Why does it have to be propped up?
At the recent Professional Investment Services conference in Shanghai, which Professional Planner attended, more than one adviser made the point that financial planning is all about service – strategy, structuring, planning, coaching – and not about product.
But it sends a massively confusing message if a business says it does one thing but gets paid for something else. A business model that sells service but is paid for product says the service has no value – because customers and clients do not pay for it.
It’s not surprising that the public then does not value financial planning, because the industry is consistently telling them that service has no value. If it had value, a client would be asked to pay for it.
Financial planners have to find some other source of revenue to survive, and vertical integration is the structural solution.
Criticised again
Professional Planner has spoken out about the conflicts inherent in a revenue model that relies on aggregating and charging a fee on clients’ assets, and been criticised for it. We’ll be criticised again, and again most of the criticism will miss the point.
“Skin in the game” is a common defence. (Like putting your professional reputation on the line isn’t “skin in the game” enough.)
“Hourly-based fees are conflicted too.” (As if it’s OK for one thing to be conflicted because another thing is conflicted as well.)
“Asset-based fees can be agreed with the client.” (Perhaps the percentage can, but the dollar figure can’t. How will a client’s portfolio vary in value – precisely – during the coming 12 months, and what’s X per cent of that figure?)
“Professionalism is a mindset, it’s not about how you charge.” (That’s true if your mindset is that the value of your professional experience, education and expertise rises or falls depending on what happens in financial markets.)
The point is that unless and until financial planners themselves treat their service as valuable in and of itself, clients also won’t value their service. The value of financial planning will continue to be undermined, and vertical integration will persist as a necessary and conflicted solution for subsidising advice.
