The Murray Committee Report on the Financial System — Part One

David Murray, the former boss of the Commonwealth Bank and former head of The Future Fund, has released a widespread report on the Australian financial system.

The Financial System Inquiry Interim Report is a weighty tome at about 400 pages. As it is an interim report, it contains observations on areas that can be tinkered with in the Australian financial system.

Sections of the report tie in with two topics we have covered this week — the CBA financial planning scandal and superannuation.

As I mentioned earlier this week, public confidence in the financial planning industry and superannuation is hardly effusive. Uncertainty is at the heart of the confidence issue — uncertainty over the quality of advice being offered by planners and uncertainty of what future governments may do to the rules governing superannuation.

First, we’ll look at the reports observations on the financial planning industry.

The Murray report recognised the disclosure requirements (that were originally designed to alert investors to the risks and costs of investing) are pretty much ‘bamboozling legalese’ (my term, not the report’s).

Murray’s more formal description of financial plans was, ‘Lengthy documents that often do not enhance consumer understanding of financial products and services.’ As I said, bamboozling legalese.

Everyone in the financial planning industry knows this. The Statement of Advice is more of a compliance document to mitigate the risk of being sued and/or to avoid having ASIC turn up on your doorstep. Consumer understanding took a backseat to the ‘crossing of t’s and dotting of i’s’ compliance requirements.

I distinctly recall a conversation I had with an ASIC compliance officer several years ago. He said to me, and I quote: ‘Your recommended investment strategy could be for clients to invest in concrete life preservers. As long as you have disclosed the risks, costs and complied with the legislation, the plan would be compliant.’ Whether the strategy literally sank or floated was irrelevant.

How you can legislate to make a financial plan simple and easy to understand in a litigious society is a miracle I am waiting to see. Don’t hold your breath on this one.

The Murray report also observed a need for an increase in the education standards to become a financial planner. This is certainly a step in the right direction provided the educational content is less ‘share centric’ and places a greater emphasis on how destructive excess debt can be.

If the added education is simply more industry brainwashing on shares and gearing (which just happen to be the products they so amply provide) as being the long term solution for wealth creation, then it’s a waste of time.

To emphasise the ‘share centric’ point: The investment industry idea of a ‘balanced’ fund is to have two thirds of the portfolio in shares and the remaining third in property, fixed interest and cash. In my opinion, this is totally unbalanced. It shows a distinct bias to an asset class that has performed well but there are no guarantees we will have a repeat performance of the past 25 years.

While the industry’s obsession with shares remains, then it is highly likely the education system supporting the industry will consciously or sub-consciously continue to present shares in a favourable light.

Don’t get me wrong, I am not anti-shares. They have a place in a portfolio. The problem is the investment industry was created and thrived during the greatest share boom in history — 1982 to 2007.

The Australian index rose a staggering 15 times in value over this 25 year period. The extended period of good fortune means the industry continues to worship at the altar of the share market without really questioning whether this period of prolonged sunshine will be followed by an equally long darkness.

The reality is there are periods within the share market’s history (the period before the boom began in 1982) when it was sheer torment being invested in shares.

A balanced approach to the education of future planners would be a good start to correcting the unhealthy imbalance in the industry’s love of all things share related.

The following chart comparing the asset allocation of Self Managed Super Funds (SMSFs) to APRA regulated funds shows individuals get it — ‘it’ being proper diversification. Those with individual control over their retirement capital have a far more ‘balanced’ view in comparison to institutional and industry funds.

My guess is individuals hold far more cash because they recognise the need to sacrifice return to ensure some certainty of capital. Institutions are so focused on the next quarter’s performance results they cannot afford the ‘luxury’ of being cautious with their investors’ funds.

Another of the report’s observations was to rename ‘general’ advice as ‘sales’. The notion behind the changed terminology was so prospective investors could distinguish whether they are being sold something as opposed to being advised.

This goes to the heart of the commission issue that continues to plague the industry and tarnish its reputation.

Over the weekend, former Commonwealth Bank Chief Executive Sir Ralph Norris (he succeeded Murray at the CBA) was questioned on the financial planning scandal that occurred on his watch. Here’s a couple of quotes:

Large organisations are always at risk of having these sorts of things happen. You deal with it. Certainly there is no way this is some form of conspiracy. It is just some deceitful people did some things that they should not have done.

…sad that there has been a situation where there have been some rogue people that have not done the right thing by the customers.

Deceitful. Rogue. Hardly the adjectives to be used for those entrusted by Australia’s largest institution to provide customers on how best to manage their finances.

As mentioned in Markets and Money earlier this week, the Achilles’ heel in the financial planning industry is the investment process — the inducement to place funds into institutionally owned products.

Why else would institutions want to employ or have a shareholding in 80% of financial planners if it didn’t mean a funds flow into their products? Changing the title from ‘sales’ won’t alter the fact the business model is all about directing funds flow into the parent’s products.

According to The Australian Financial Review on 14 July 2014, ‘Commissions will persist under Matthias Cormann’s changes.’The report’s observation on re-labeling ‘general advice’ as ‘sales’ is likely to be just that — an observation.

Sales targets, bonuses, commissions, brokerages and other incentives have all been part and parcel of the remuneration structure in the industry, and will remain so.

Senator Matthias Cormann has been trying to defend the indefensible — commission payments within the financial planning industry — by twisting the definition and scope of what constitutes a commission.

Why? Because the major institutions don’t want the apple cart upset too much. They have a very lucrative business model that starts with the bank teller being under pressure to meet referral targets and ends with dollars flowing into their investment and insurance products.

In the middle is the financial planner with sales targets to be met. Obviously, they are incentivised to meet these targets. What if the planner is only one or two clients away from a lucrative bonus? Is there a temptation to skew the advice to ensure the target is met?

According to a recent report in the Sydney Morning Herald a Finance Sector Union (FSU) survey of 800 tellers at the Commonwealth Bank in May 2014 found:

‘Pressure on bank tellers to push customers into Commonwealth Bank financial products such as insurance and managed funds is causing stress, depression and bullying, according to an explosive new survey of staff.’

Perhaps the FSU ‘cherry picked’ the survey respondents — I don’t know. But having spoken with some bank tellers over the years, the report reflects the experiences they’ve shared with me.

For a couple of ‘old-time’ bankers I know, the pressure to meet targets became unbearable and they resigned.

This is the problem with the system: The drug companies own the majority of the medical practices.

The system needs to be completely changed — as outlined in Markets and Money earlier this week — but realistically that is not going to happen. There are billions of dollars at stake, and the institutions would resist the proposed changes to the bitter end.

Evidence of this opposition to change was apparent in a recent SMH column on the CBA’s ad on Seek for a new Government Relations Chief. The qualities required for the position are (emphasis mine):

Advances and protects CommBank’s interests by engaging with federal and state politicians and senior bureaucrats to adopt policies that are aligned with CBA’s strategic and commercial interests and to minimise the risk of adverse regulatory change.

Now there a job description that has some pressure attached to it.
As I mentioned above, Murray’s report is an observation only, but even if it’s implemented in full (and it won’t be), it really does only tinker at the edges.

The recommendations of my own one page review would be:

  • Institutions should be banned from owning financial planning divisions or firms. Full stop.
  • Commissions should be banned. Full stop.
  • Financial planners should be remunerated by on a hourly fee basis. Full stop.
  • Education courses need to be vetted by an independent panel, which includes investors who have incurred substantial losses due to erroneous advice.

These four simple steps would go a long way to cleaning up the industry’s image (and actually turning it into a profession).

Don’t hold your breath waiting for these changes to be implemented by government or a government-appointed body that includes persons with institutional backgrounds.

The only way real and substantive change is going to occur is via people power.

The financial advice industry is ripe for change. It just needs a disrupter to facilitate this change. Like Uber has done for the taxi industry.

Perhaps in the not too distant future there will be a ‘virtual planner’ that enables investors to go online for a fraction of the cost of a financial plan. The attractiveness of the ‘virtual planner’ will be its independence from institutional ownership.

For instance, the share recommendations could be to invest in listed exchange traded funds (ETFs) and/or listed investment companies (LICs). Investors can simply facilitate these recommendations with an online broker at minimal cost and know with absolute certainty there will be no kickback or trailing commission to a financial planner.

The Murray report and superannuation
Earlier this week we asked whether superannuation was worthwhile or not. We observed that the further you are away from retirement, the more certain it is the access to a lump sum will be withdrawn.
According to The Australian Financial Review (emphasis mine):

The [Murray] inquiry wants to explore whether rules should be introduced to encourage retirees to buy retirement income products, introduce a default “investments” option for retirees or mandate the use of certain retirement income products such as annuities.

This is one observation the Government is almost certain to use to ‘have a dialogue with the community’. This is code for softening us up to the concept of superannuation eventually providing a pension only with no access to a lump sum.

This debate has been a long time coming. Australia is one of the only countries in the world that allows access to the capital that provides retirement income. At some stage, we’ll move in lockstep with the rest of the developed world’s policy on private pensions.

As with all major changes to superannuation, there’s likely to be a phase-in period before the change becomes reality (political sensitivities dictate this approach). My guess is those under 40 are most likely to be the ones affected by the transformation of superannuation to pension only.

We also observed the need to bring more fee competitiveness into the management of superannuation funds. No one (other than the institutions) would argue with this recommendation.

For example, the average SMSF, with a portfolio of cash and exchange traded funds, can contain its investment and administration costs to well under 1%. Yet a lot of institutional funds — when you drill into all their costs — charge well in excess of 1%.

Surely, they have the economies of scale to pare back some of the fat in the fees? Obviously, Murray thinks so as well. I hope the government acts on this one.

The report also looked at the increased use of borrowing to invest within SMSFs. The following is an extract from the Report:

The general prohibition on borrowing in superannuation was introduced for sound reasons. Although levels of direct leverage in the superannuation sector are low, they are increasing. Removing direct leverage in superannuation is consistent with the concept that superannuation tax concessions should apply to funds that have been saved and not borrowed. There are ample opportunities — and tax benefits — for individuals to borrow outside superannuation.

The report is canvassing the prospect of removing direct leverage in superannuation. This is one observation I support wholeheartedly. As the report correctly notes, there are ample opportunities to borrow to invest outside of superannuation.

Why do we need to gear everything up we own? Surely, leaving superannuation debt free is a good thing. If, for arguments sake, we go into a deflationary spiral, debt will be an anvil around the necks of investors. Having one asset — and an important one at that — unencumbered would hedge our bets against such a scenario. This is prudent.

You can bet your bottom dollar the real estate industry will fight this observation tooth and nail.

Disclosure — here’s a sales pitch

The investment newsletter business of Port Phillip Publishing is the most independent, transparent, unbiased and low cost form of investment advice in the industry.

For what really is the price of a coffee or two a week, investors have the ability to access a variety of information on investment markets and the economy in general. There is no sales pressure to proceed with any recommendation. You are free to weigh up the merits of each recommendation yourself and transact with the broker of your choice.

Is every recommendation correct? No. But only a naive investor would expect a 100% track record. The difference is you have control over whether to exit an investment you are no longer comfortable with, as opposed to having to argue the toss with a planner who may have an incentive to keep you invested.

That’s my two-bobs worth on the merits of the investment newsletter business.

Vern Gowdie,
Editor, Gowdie Family Wealth

Editor’s Note: Tomorrow, in Markets and Money weekend edition, Vern will follow on from his analysis of the Murray Report and the market. He’ll share his conclusions, drawn from his 27 years in the financial planning industry, and his core principles of how sound investments should be made. Look out for that in Saturday’s Daily Reckoning.

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Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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