Approved product lists, restrictive barriers and cozy relationships with business development managers are restricting the ability of fund managers to reach retail investors according to research conducted by Deloitte at the request of ASIC.
The Competition in Funds Management final report, which was commissioned by the regulator in early 2020, continues a line Deloitte rolled out in its March interim report – that the “long and complex” value chain between fund managers and retail investors creates issues around incentive alignment, transparency and conflicts of interest.
Of particular concern, Deloitte told ASIC, is the proclivity of advisers to be sweet-talked into abandoning their ethical duties by the BDMs who operate as sales and support leaders for fund managers.
“Under the Financial Planners and Advisers Code of Ethics 2019, financial advisers are required to comply with a core set of standards, including acting in the best interests of clients and not deriving benefits from any third-party relationship,” Deloitte states.
“However, if overly influenced by BDMs when making recommendations, advisers may not act in the best interests of investors, creating a principal-agent problem.”
Deloitte highlighted similar concerns in its March interim report when it said advisers weren’t incentivized to negotiate discounts between providers.
While only around 6 per cent of the $2.5 trillion dollar domestic fund management industry is funnelled to retail investors, 86 per cent of that is currently invested at the direction of financial advisers.
Product list barriers
Deloitte identifies APLs as another element restricting providers from reaching retail investors in the final report.
“The APL process undertaken by advisers can be effective at screening funds and ensuring that they are appropriate for investors but can also affect the ability of fund managers to compete by restricting access to investors,” the report states.
It can take around six months for a fund manager to get onto an APL, Deloitte continues, with only “smaller financial advice groups” given flexibility to recommend funds that are not on APLs.
For new funds management firms the barrier to entry is even higher as advisers “will sometimes require funds to have a track record of multiple years”.
If the BDM in question isn’t friendly with the adviser, Deloitte advises, the job gets even harder.
“Quality funds can receive a positive rating from a research house, get listed on a platform, and be placed on a dealer group’s APL, but then struggle at the adviser stage where BDMs convince financial advisers to recommend funds. As this final step is strongly relationship-based, this process can be a significant barrier to new, unknown funds without connections in the industry.”
Conflicts of interest
The report does highlight one positive trend; the divestment of financial advice businesses by large banking institutions.
Responsible for the egregious vertically integrated practices ASIC uncovered in its January 2018 report – which found that 68 per cent of funds invested by advised clients went to in-house products – the big banks have subequently left advice in a mass exodus from wealth management originally coined by this publication as WEXIT.
The banks’ collective retreat from advice “may reduce the potential for conflicts of interest in advisers’ recommendations of managed funds”, the report notes.
This development could be offset by conflicts of interest that arise when advice firms charge clients a fee to place their investments in managed account structures, Deloitte continues.
“In principle, the management fee paid to advisers for managed accounts can represent a conflict of interest resulting from vertical integration,” Deloitte states, referring back to ASIC’s own 2016 regulatory guide (RG 179).
“Conflicts could potentially emerge where [managed discretionary account] providers put clients into their own investment model portfolio rather than external products, as advisers receive a management fee for doing so. This reflects a principal-agent problem related to information asymmetry, with the adviser acting in their own best interests rather than in the interests of the investor.”
The report notes, however, that the issue was dealt with in the Hayne royal commission which stopped short of recommending a separation of product and advice.
According to feedback Deloitte received from its interim report, existing legislation sufficiently covers these potential conflicts.
“Despite the opportunity for these conflicts to occur… industry consultees were satisfied that the risks and conflicts are appropriately managed by existing regulation, particularly for MDAs. MDA providers must be licensed by ASIC and, like any advice service, are subject to best interest obligations.”