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How we differ from most financial advisers

In Australia, there are very few genuinely independent financial advisers. Almost all are part of a large dealer group and have significant restrictions on the type of advice they offer.

We all (Travis Morien, Matthew Ross and Daniel Brammall) all used to work with one of those large dealer groups and know from first hand experience how difficult it can be for these types of advisers to put together a proper portfolio when they don’t even have access to the majority of funds on offer. It was primarily out of frustration with the limitations of non independence that we decided to start an independent financial advising company.

There is conclusive evidence coming in from all over the world that there is a better way to invest than the standard managed funds used by most investors. Actively managed funds are expensive, both because they charge a lot to make profits for their shareholders (the fund manager’s shareholders – not the investors buying the managed funds) and also just because actively managing a fund is an expensive business, with costs related to research, order execution, marketing, account keeping and other fees.

While it isn’t our belief that the market is so efficient that it everyone should just throw in the towel and use a dart board to pick stocks (though for many investors this would dramatically improve returns), it is a fact that most managed funds more than swallow up their extra gains due to their high costs. This is not just the opinion of the author, it is a proven fact supported by a substantial body of academic and industry based research.

It is not only a fact supported by research, it would be impossible for any other situation to prevail. It is a self evident fact that the average investor will achieve the same returns before costs as the broad stock market (because investors are the market, hence their average return is the market return). Professional investors as a group can’t outperform the market because for the most part they trade against each other. The extent to which professional investors “prey” on small unsophisticated investors is relatively low since many professional managers trade off-market via “block trades”. After costs, the average investor, including the average fund manager, actually lags the market as a whole because the average return of investors will equal the market return minus average costs. A very good way to ensure above average returns is to invest with below average expenses.

A significant portion of our investment strategy is aimed at achieving these low costs by using inexpensive funds called “index funds”. These funds cut down on costs by simply buying an indicative sample of stocks and bonds in the same proportion as they are represented in the common benchmarks.

For the last three decades, the overwhelming majority of actively managed funds have failed to add enough returns from their investment processes to compensate for their costs. Only about a quarter of all managed funds make up for their high fees and reward investors with higher returns over periods around one decade, but here’s the kicker – there is no reliable method of figuring out which quarter of funds will beat their benchmarks, and which three quarters will fail in this objective, and the longer the time frame the fewer funds beat the index.

The best advice we can possibly give our clients is to tell them to forget about their illusions of beating the market by a huge margin, but instead to concentrate on asset allocation decisions to create an efficient portfolio that will offer good long term returns while minimising risk. It is best to buy an appropriate mix of low cost funds rather than participate in the impossible game of picking the one fund in twenty that will outperform the market over the very long term.

There are actually a huge number of index type products in Australia, some replicate common indexes like the All Ordinaries, but others deal with other indexes. There are indexed property trusts, bond funds, cash, small companies, large companies, “value” companies, domestic, global, American, European, Asian etc.

The way we add value for clients is to create a diversified portfolio using a great variety of these funds, by achieving the right mix of funds one can create a high performance portfolio with less risk than traditional portfolios and then work on other more meaningful aspects of financial planning, like structuring, tax advice, succession planning, finance costs etc.

No single index fund, or even a small basket of conventional managed funds, can achieve a portfolio with the right qualities of risk and return compared to a properly planned portfolio. This is why we consider my “product” to be advice on portfolio construction and financial planning, as opposed to selling the funds themselves.

The “trick” is not just to buy an index fund, proper investment is about constructing diversified portfolios, there are many different asset classes each with their own advantages and disadvantages. For the best results you need to work out a proper diversified asset allocation to use, create that portfolio and rebalance it on an ongoing basis in response to market movements. That is what you pay a professional financial planner to do.

Unfortunately, the financial planning industry does not always operate in such a way. Close to 100% of money put under management by professional financial planners goes into the more expensive active funds. This would be fine if those advisers could justify their picks with some evidence that getting their clients to pay these fees actually results in them attaining higher performance, but there really isn’t any evidence to support that assertion, quite the contrary in fact.

If index funds are so good, why do financial advisers not use them more? The answer is simple, and we will be blunt in answering. One major reason why financial advisers almost never recommend index funds because index funds don’t pay a commission. Some index funds do, but these tend to be very expensive and genuine index fund aficionados don’t use them because high costs defeat the central purpose of indexing.

Index funds usually pay no up front or ongoing commission to advisers at all, so despite these being such good investments they are ignored by the majority of people selling advice.

A second reason which also plays a part is that many advisers wish to be seen by clients to be working hard and choosing a simple passive strategy is easy enough that some clients may think their advisers aren’t doing enough to earn their fees. This is strange, because when questioned the majority of advisers admit that funds management is only a minor part of the work they do and the majority of the value that a planner adds is in the ongoing advice on tax, estate planning etc and forming strategies. There are no medals given for difficulty of execution in this game, only final success. Just because it is a lot easier to make money with index funds should not be a reason for advisers to shun them! (On the contrary, that seems to me to be an excellent reason to buy index funds).

Most financial planning groups do not have index funds on their recommended product lists at all. Not even one, index funds are shunned by the financial services industry. Even discount brokers rarely carry them – except sometimes the expensive ones that pay a trail commission. To receive totally impartial advice where the reality of the limitations on active funds is acknowledged, you will need to steer clear of commission based advisers and most major dealer groups.

It isĀ AIFA’s policy not to take commissions from fund managers, we work on a fee based service paid for by clients and not fund managers. Because of this, our recommendations tend to be very different from what most advisers give.

To distance ourselves as much as possible from all of this commission driven product sellingĀ AIFA has made a decision to rebate all commissions to clients whenever possible, and/or avoid commission paying funds altogether. This allows us to be completely impartial in terms of what particular investment products we use, commissions play no part in influencing our research process and recommendations.

The concept of the fee only adviser helping clients with asset allocation and using index funds is not new. Many of the top independent advisers in America already do this, they advise on asset allocation and risk management instead of fund picking (or more precisely, fund selling). The concept of an independent adviser is only novel in Australia, where markets are less mature and the industry is still mostly commission driven.

In Australia, however, the concept is quite novel. There are a few such advisers around, but not many. In this way I get to offer a service that is as close to the true meaning of “financial planning” as possible, a service where my only product is high quality professional financial advice, as opposed to managed funds and insurance.

There is anecdotal evidence that shows fee for service advisers are becoming more common, and most industry players expect that in ten years time fee for service will be the dominant way to do business as a financial planner, but today, in 2005, true independent fee based financial planners are still very rare. If you take out the advisers that charge on a fee for service basis for the up-front charge but still take a trail commission the number of true fee for service financial advisers in Australia is almost negligible.

Being independent, we have no restrictions on which products we can choose for our clients. We can recommend virtually any investment option available to Australian investors. Decisions are made on an objective basis determined by product quality alone, and are not in any way influenced by commissions, soft dollar arrangements of contractual sales obligations.

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