What the hell is wrong with financial planning? (Part 2)

This is part 2.

Part 1 is here.

In part 1, we looked at some of the issues affecting financial planning in Australia, in particular, the small issue that financial advisers and their clients do not seem to be driving the agenda with regards to financial products.

The points that were raised were as follows:

1. Financial planning licensees and/or fund managers appear to be deliberately and mischievously aiming to discredit the Efficient Markets Hypothesis.
2. Financial planning licensees and their representatives are pushing active portfolio management as a benefit for clients.
3. Financial planning licensees and their representatives appear to also be pushing directly held assets as a benefit for their clients.

This article will look at some more specific problems - some of which follow on directly from the problems we identified in Part 1.

4. Marketing driven investment strategies

In the Fin Review of Saturday, 29 April, 2006, an article appeared that suggested that fund managers and not client needs drive the agenda with regards to clients' investment strategies.

Keith Ambachtsheer, a Canadian, has suggested that things may not be as they appear when it comes to personal investment.

Ambachtsheer, regarded by the Fin as one of the world's leading thinkers on pensions and retirement savings, publishes a monthly letter where he has contends that there may be more than meets the eye on this topic.

In short, Ambachtsheer's contention is that it is not client requirements that drive new financial product innovation, it's marketing.

Now, this is something of a change from what common sense would dictate is the situation.

Financial advisers should normally be recommending stuff to suit clients' needs. The simpler the better, where possible.

Not only that, but terms like "alpha" and "beta" should be meaningful expressions that demonstrate a concept that an adviser might use to address client requirements.

They should not be terms used to flummox clients unnecessarily.

For example - Strategy A has a better alpha than strategy B, all other things being constant. So adviser recommends strategy A.

Why has the adviser chosen this? And what does this mean? And why can't advisers refer to alpha as "outperformance"?

In the Ambachtsheer Letter (#243, dated April 2006), Ambachtsheer bemoans the proliferation of terms that have lost all meaning as fund managers drain all use out of them in order to portray their offerings as being more attractive than others.

The subtext of all this is that Ambachtsheer has strongly indicated that what we in Australia like to call 'Structured Investment Products' are nothing more than cynically marketed dumps for money.

5. A plethora of meaningless terms

Ambachtsheer picks up on just a few terms in the Ambachtsheer Letter that he dislikes.

These are not the only ones.

So many terms without specific nailed-down meanings are thrown around now that we may have actually lost sight of what terminology we should be using.

I happen to work at a master trust. I remember speaking to a former colleague of mine some time ago who told me that the product I work on, "Isn't a master trust. It's a wrap account."

What it actually is isn't important. What is important is that we have all this terminology in the financial world that is defined in quite fluid ways.

And this is simply crap.

The implications of so many words without agreed meanings is that personal investment itself starts to resemble some of the woo that I hate.

The thing about woo, is that pseudo-scientific terms are thrown about, partially to attempt to legitimise and partially to deliberately obfuscate.

And this is not what investment should be about. Investment should be a lot clearer than this and should never be considered even remotely woo-like. It is far too important.

6. Structured Investment Products^®

So what are these "marketing driven investment strategies"?

In the Fin of Saturday 24 June, 2006, reporter Chris Wright wrote an insightful article about the new breed of complicated investment products being promoted by financial advisers.

These started springing up in the nineties and involve much more complicated investing than your average managed fund.

First we had agribusiness schemes which were dodgy in the extreme. It's interesting to note that farmers are blaming these schemes for falling commodity prices.

I might even examine this claim in a future article - it's not as silly a claim as it appears.

These days, Wright writes (couldn't resist!), Structured Investment Products include the following:

• Capital-protected products
• Basket products
• Inaccessible asset classes
• Structured debt products
• Funds of funds

The issuer of quite a lot of these is Macquarie Bank, a company that has made a career out of making things as complicated as hell while stripping out a veritable treasure-trove of fees in the process. And each time they issue a new one, you get the usual positive spin about how "new" and "innovative" each product is.

Sure, some fund managers actually might have new and innovative ways to manage money, but are these methods actually any good?

Richard Capel, an adviser with Capel and Associates is worried that there is a new lack of transparency that is creeping in - the complexity is masking the actual act of investing itself.
Indeed, finding out how some of these work through the promotional material is really, really difficult. Product Disclosure Documents (PDSs), whilst meant to be standardised offer documents under the Corporations Act, appear to be nothing more than slickly produced sales tools.

The average PDS for a complicated investment is so opaque that you can't find out a lot of information. And the fees are quite high, despite what the fundies (fund managers, I mean) say.

Peter Lucas, executive director of the financial products division of Macquarie Bank says this:

"I understand the perception you've got there, that there are hidden fees and high fees. [But in many products there isn't a fee.] I can, hand on heart, say investors are not paying an MER on the Nikkei product [invested in via the ReFleXion product]."

Lucas is being economical with the truth when he says that investors are not paying an MER. What he is expected to disclose at this point if he is in any way, shape or form a good bloke is that the Nikkei product does not magically run itself. Somehow, somewhere the investor is paying for this. And common sense dictates that Lucas should mention precisely where this is.

(Unless, of course, Wright or a sub-editor at the Fin has selectively edited him)

What Lucas fails to realise, or realises too well, is that a product like Macquarie's ReFleXion is too bloody complicated by half.

And there is no track record in the same way there is with a conventionally managed Managed Fund. Capel alludes to this:

"I wonder whether these structured products will work as intended?"

Wright includes some wisdom at the end of his article from Warren Buffett, the Oracle of Omaha - he (Buffett) follows a strict maxim that he never invests in companies that he cannot understand.

Wise words indeed.

Financial advisers have lost sight of the little people. Their clients.

They've been blinded by the dog-and-pony show being thrown at them by cashed up institutions and are willing to buy these claims that their clients will benefit without due examination.

Advisers need to understand that their clients are people, too, and would do well to heed Buffett's advice on these matters.

And advisers should also be unafraid to bring this to their clients' attention. It is very much the exception that clients, given the choice, would not wish to know how their money is invested.

Advisers don't appear to know this, but they are there to keep institutions honest. Failure to exercise this power means that institutions will continue to walk all over the average investor.

Disclosure: This blogger owns shares in Macquarie Bank Ltd.

Standard but necessary disclaimer: This is not advice. Only a complete idiot would think that any of this constituted advice. Are you an idiot? I didn't think you were. If you are in any doubt as to the content of this, see a good, independent financial adviser immediately. They do exist.