A breakdown in investment research protocols can spell disaster for Australian Financial Services licensees, as demonstrated by the ongoing investigations into IOOF.
Conflicts of interest, including investment manager recommendations that lacked reasonable bases, are among some of the allegations leveled at IOOF, which employed its own research team. While the dealer group may have had a number of other issues, including ASIC breach reporting failures, it demonstrates the need for licensees of all sizes to have robust research governance.
Because of scale constraints, most non-aligned AFS licensees outsource research to one of the various research houses, a selection that includes the big brands of Lonsec, Zenith, Mercer and Morningstar along with a number of smaller players.
But how well does this work in practice? What internal systems should underpin the selection of investment managers, products and the research providers themselves?
Independently-owned financial planning licensee Paragem is the responsible manager of some 20 practices across Australia. Ian Knox, managing director, stands by the research selection protocols used across the group, which he says are employed without exception.
Paragem outsources its investment research to Lonsec, only accepting products onto its approved product list (APL) that are rated “recommended” or higher by this research house. Investment managers with similar ratings from other research houses are not permitted automatic entry to its APL.
“If the adviser can provide evidence of suitable public ratings and bring that to us, and it is equivalent to Lonsec [research], we would consider it, but it’s not automatic,” says Ian Knox, managing director, Paragem.
“So the obligation thereafter is that, if we agree to put that on the APL, we require the practice that wanted it, every year, to make sure it’s still being maintained at that level, or we make it a legacy product automatically.
“We put the emphasis on the practice itself. Our compliance makes the principal get the research, if it’s not our core research and if they fail to do it, we’ll drop it off [our APL],” he says.
Part-time research is dangerous
With around 20 years’ experience in the Australian financial planning sector, Knox allows his own judgement to colour his decision-making, but he doesn’t rely on it solely.
“My background, and time in the industry, allows me to have a little bit of a common sense ‘sniff’, if you like, around what’s right and what’s wrong…you get a few warning bells,” Knox says.
Instead, he relies on the expertise of the research specialists, filtering their recommendations with his own experience. “Part-time research is dangerous. Filtering it when you have suspicions about something is more sensible…I manage risks once [the products are] there.”
Despite Paragem’s firm stance on only relying on ratings from Lonsec, it is still regularly approached by investment managers that use other researchers.
When various other business development managers ask to talk with him about Paragem’s investment approach, his response is: “Why? Even if I love [your product] to death, I’m not changing our policy. I’ve got a rigid governance policy, and I never break my own rules.”
“As soon as I say, ‘Come and talk to me and I’ll see whether you get on the APL’, I’m some sort of god that knows more than the research firm. I don’t kid myself on that,” Knox says.
He also highlights the importance of such policies being entrenched within the business rather than being driven solely by an individual executive.
“A well run AFS licensee has policies, procedures and risk management that transcends managers. The policies are bigger than you and I, and that’s the whole idea,” Knox says.
Size does matter
There are a number of boutique researchers operating in Australia – in a market with only four big brand-name researchers, following the liquidation of Van Eyk last October.
While Knox notes that all have a part to play, he believes the greater reach and technology of larger players enables them to have “adequate bandwidth to do the necessary research across the market.”
“Research is a business. It’s not just intellectual capability…it’s the lifting up of the content of that and distributing it in a seamless way across multiple business channels.
“I don’t know how a one-man band does that…it isn’t all about being perfect in delivering research to a limited market, [but] about having adequate control and supervision through a broader market,” Knox says.
Across Paragem’s 20 practices, he says each will have its “idiosyncratic preferences” which the research firm must be able to allow for.