Financial Planners - Independents vs Banks

So you've decided to see a Financial Planner. Good for you.

Next decision, who do you see? Do you see a Financial Planner associated with the Bank that you transact with? Do you go with the Financial Planning arm of one of the large Fund Managers/Insurers? Or do you go with the completely impartial totally 'independent' Financial Planner?

Each has their advantages and disadvantages which I plan to discuss.

1. Bank Financial Planner

The Bank Financial Planner most probably sits in a bank branch. Most of his customers are clients that walk in the door of the bank branch, asking investment questions to the front of house 'tellers' and being referred on to the Financial Planner in that branch. The approved list of products is generally limited to the products administered by the Fund Manager arm of the Bank. Advisers are remunerated with a salary, with the potential for bonuses based on the revenue that they generate if they meet targets. This can often be the training ground for new advisers, therefore, advisers might not have large amounts of experience.

2. Fund Manager / Insurer Financial Planner

These breed of planners generally market themselves as an 'independent' practice. However, independent they usually are not. They sit under the umbrella of a large fund manager or insurance agent. The simplest way to describe them would be a 'Franchise' type approach. They use the large organisation they work with to provide all the administration, research, etc support, however, all the costs of running their business are with them, similarly, all revenue they receive from you ends up in their pockets. The products available to them generally are more widespread than the 'Bank Planner', however, there are often incentives to recommend those products administered by their 'dealer group'. Typically, these Financial Planners have been in the industry for a long time, starting out years ago as a Life Insurance agent and their client base is from these clients and referrals from existing clients. Alternatively, they may have purchased a client base from someone else.

3. Truly Independent Financial Planner

These practices really are independent, with no allegiance to any Banks, Fund Managers or Insurers. Quite often they are attached to an accounting practice, with most of their clients coming from the accountant. They might do their own research and admin, or outsource this to someone else. Generally their range of available products is large and the Financial Planners may be Accountants who have realised there's plenty of money to be made in Financial Planning!

So, there you have it. As a rule, the Financial Planner you see will fit into one of these categories. But, who should you see? It depends on what you're after really.

Fees & Costs

The costs of advice can vary remarkably. Even within the same practice, you could see two different advisers and they will charge a totally different set of fees. Different businesses will have different ways they charge their fees. Most charge based on a percentage of the total dollars invested. Some (but not many) charge on an hourly basis like an accountant or solicitor would. Most receive ongoing commissions for the funds that are invested through them, some (but not many) rebate these commissions to the client.

Generally, bank planners fees will be lower than number 2 & 3 advisers (from above list). This is because the bank planner is not paying the bills themselves and because they are only receiving a portion of their fees in bonus/commission. However, bank planners generally have less scope in reducing fees and rebating ongoing commissions. They are likely to have strict limits on minimum fees payable, and as the ongoing commissions are helping line of the pockets of shareholders, it is unlikely they will be allowed to rebate them.

Product Lists

The question that has to be asked here is, who cares how big the product list is? Does it matter if I have the option of investing in 50 funds or 5,000 funds? Not really. A managed fund is a managed fund. Generally most planners, whether they're from 1, 2 or 3, will use "model portfolios" anyway, which involves using a predetermined list of funds, allocated according to the investor's "Risk Profile". Therefore, from the list of 50 or 5,000, only 10 funds are being used.

The advantage that the banks have here, is their research is likely to be very conservative. Therefore, a fund or product has to be top notch to be on the approved list. They don't want their name dragged in mud because they had another Westpoint in their approved list of products. However, your independant practice might have all sorts of wacky, generally high commission products in their approved list. Macadamia farms come to mind.

Conclusion

There's only one question to this debate. Shop around. Spend the money to have plans presented by different companies. Examine the advice. Is one remarkably cheaper? Why? Are there products in there you don't really understand? Stay away! Don't tell the planners you are shopping around. The independents will rubbish the banks, and vice versa. Each type of planner has their advantages and disadvantages. The most important thing is to find an adviser who knows what they are saying and are truly meeting your needs.

The Long and the Short of things

As the market currently on what seems like a day by day basis hits record highs, one has to wonder how long this record breaking bull run can last.

This chart plots the Australian All Ordinaries Index for the last 12 months (to 23 Feb 07). Apart from a couple of small blips, it's been all up hill since late September!

Now, if you're one of the increasing numbers who believes that there is only so long a run like this can go for and we're due for a correction, you might stick all of your money in cash until this correction happens.

However, investing in cash only provides you with limited returns. What would be great is benefiting from a correction when it happens. Or what if you think the market as a whole will keep going up, but think that Telstra shares are overpriced and are due to fall and want to benefit from this fall?

Well the answer is you can. You do this by "going short". There are numerous ways to go short, or sell a stock (or index) that you think will fall. You can purchase Call Options or Warrants, or sell Contracts for Difference (CFD's) or even short sell on the ASX. However, these strategies are risky, and not for the novice investor.

There are other ways to benefit from this strategy though. This involves investing in fund managers who can "go short". These are usually referred to as "Long / Short Funds". In a previous post I have written about how the after tax returns of actively managed funds often do not justify the extra risk and fees involved. However, a fund with the option to take on strategies like this can definitely provide value IF they get it right!

These types of funds are relatively new to the market. I have tried to find some returns on some tried and tested long/short funds, however they all seem to have existed for less than 12 months. Time will tell if these fund managers can predict when to go long and when to go short.

Some funds offering a long/short option are:

Acadian Australian Equity Long / Short
PM Capital Australian Share Fund
JANA Australian Share Long Short Trust
Macquarie Alpha Opportunities Fund
Perpetual Share Plus Fund

Time will tell what the success of these funds is.

Index or Active Managers - It's all in after tax returns

Numerous bloggers out there blog about this. The argument over which is better. Active fund management or Passive fund management (otherwise known as index following). Interestingly enough, the mainstream media seems to stay out of this one, probably for fear of backlash from Financial Planners and large Dealer Groups who are sponsoring their publications. For the uninitiated here is a brief rundown.

Active fund management involves a fund manager actively monitoring a portfolio with the aim to outperform an index.

Passive fund management involves a fund manager simply monitoring their portfolio to ensure it replicates an index with the aim to generate a return as close to the index as possible.

Now the active fund managers charge relatively high fees due to the time and expertise involved in their work but promise to provide higher long term returns. The passive fund managers charge lower fees as all they are trying to do is replicate the index, not outperform it.

This issue that many people have (bloggers included) is that for the relatively high cost of active management, does it actually provide a better long term return, or are you better off just investing in the index for a better net of fee long term return.

My opinion is divided. I see value in both strategies. If you pick the right Active Manager, you can definitely receive better long term average returns than the index, however, if you pick the wrong Active Manager you can end up performing worse than the index, and pay high fees for the pleasure of it! Start diversifying across fund managers to 'lower your risk' and you end up with some outperforming and some underperforming, leaving you with a net return of the index less management fees.

However, the issue isn't this complicated. You see, when comparing these returns, apples must be compared with apples. It's one thing to quote a certain return, however, if the investor is going to be liable to pay more tax on generating this return, then the 'net benefit' is not what is being quoted. It's like earning $100,000US in the United States, or earning $100,000US in Dubai. You're earning the same income, but you're going to be better off in Dubai where there is no income tax (and you get to ski on indoor snow and have servants at your beck and call).

This might be easiest to explain with an example.

Lets say your index fund has a return of 'X'. Of this return, 20% is returned to you in distributions, such as dividends and realised capital gains. You're actively managed funds generates a return of 'Y'. Of this return 50% is returned to you in distributions. Given that an active fund is constantly being analysed, stocks are being bought and sold based on feelings of whether it will go up or down, you would expect that more capital gains will be realised by the active fund.

I've gone to the liberty of researching average 5 year returns for a large Actively Managed Australian Share Fund and a large Index Australian Share Fund. To be fair, I've taken 6 active funds and taken an average return of the lot from VanEyk. The funds chosen are the flagship Australian Share Funds from AMP, Barclays, BT, Challenger and Colonial First State. The index fund I have chosen is run by Vanguard. I have not bothered averaging out returns for index funds as it would be expected that they would have similar returns.

Here's what I came out with.

Fund	Income (%)	Growth (%)	Total (%)
Barclays	12.85	3.49	16.34
BT	3.53	12.15	15.68
CFS	10.2	5.97	16.17
Challenger	9.37	8.01	17.38
AMP	9.77	5.05	14.82
Average	9.144	6.934	16.078

Index Fund

Growth: 10.73%
Income: 4.49%
Total: 15.22%

Well, between these 5 funds, we have outperformance of the index fund of 0.86% pa. Barclays, BT, CFS and Challenger have all outperformed the index, but AMP has underperformed. Good for you Mr Fund Managers!! However, 57% of the return has been distributed as income, compared to 30% on the index fund. I'm going to assume that the 4.49% income on the index fund is all dividends (in reality there will be some capital gain) and the 9.14% income on the active fund is made up of 4.49% dividends and 4.65% capital gains. For simplicity I will say that ALL of the capital gains are on assets held for more than 12 months, therefore are entitled to the 50% discount (in reality, not all will be held for that long).

Therefore, after tax return, assuming a marginal tax rate of 31.5% (which applies to most people with taxable income between $25,000 and $75,000) gives a return as follows:

Active Funds - 13.93%
Index Fund - 13.81%

The 0.86% per annum out performance has all of a sudden eroded to 0.12% per annum. This doesn't leave a lot of room for underperformance!

As Tim Shaw once said, "but wait, there's still more!".

The fund managers, after much criticism of late regarding these after tax returns have hit back. They have said, hang on a minute, you're only looking at returns whilst you are invested in the fund. By providing you with part of your capital back every year, we are helping you by spreading the capital gain out over the life of the investment, so you don't get hit with it all when you exit the investment at the end.

This argument is fine, apart from a few issues.

1. How much of the gain is being distributed with 12 months, where there is no 50% discount for capital gains? If the fund manager is buying and selling within a 12 month window, the investor is missing out on this 12 month exemption.

2. Many long term investors plan the sale of their taxable assets in years when their income is lower. They don't need you, Mr Fund manager to help them decide when is the best time for them to pay tax.

3. Gains are being duplicated. Whilst a stock may be held for the 12 months mentioned in point 1, there still must be some duplication of gains where they are realised over and over again. Eg, sell stock on a high, share price drops, rebuy, sell on high, etc. Multiple gains are being realised here.

The index vs active management debate is something I will address more often. I believe that there is a place for both. I actually have money invested in active funds and am happy with the returns I have received, although come tax time this year I'm sure I will do my usual round of complaining.

Something interesting I found whilst researching for this entry, from the funds I have compared here, the one year returns for the active funds and index fund are:

	Active	Index
Income (%)	18.92	6.65
Growth (%)	3.28	15.45
Total (%)	22.2	22.1

Using the assumptions used above, this is an after tax return of the active options of 18.17% and the index options of 20.01%.

Time to start finding some tax deductions I think!!!