Fixed Income

Today I argue that Magellan will revolutionise the LIC/LIT market with its shift to a commission-free distribution model that we had long advocated and which is already sending shockwaves through the funds management and financial advice industries with one major bank reportedly stopping all distribution of LICs and LITs that pay brokers/advisers conflicted sales commissions and Magellan's peers looking to drop conflicted remuneration and raise capital purely on the merits of their products consistent with the Future of Financial Advice (FOFA) laws that otherwise govern all capital raising activities for retail funds (click on that link to read for free or AFR subs can click here). This is a seriously big deal and Hamish Douglass and his team are to be congratulated for taking this bold new step and establishing the gold standard for conflict-free investment practices across the entire industry. I go on to analyse the Federal Court's decision to reject ASIC's claims that Westpac breached the responsible lending laws, which we predicted ages ago. Excerpt enclosed:

Magellan’s commission-free precedent further begs a profoundly important question of its peers: if Magellan can raise money purely on its product’s merits without the need to pay conflicted remuneration, why can’t they do the same thing? This is, after all, the way the entire funds management industry works outside of LICs and LITs.

The Future of Financial Advice (FOFA) laws were enacted with bi-partisan support in 2012 primarily to ban all payments of conflicted sales commissions by fund managers to people who are advising retail customers.

For some bizarre reason in 2014 the Coalition decided to grant LICs and LITs an exemption from the FOFA laws, which has unsurprisingly resulted in fund managers shifting their capital raising efforts away from normal FOFA-regulated channels towards the FOFA-exempt ASX market.

At the time, the Coalition was hell-bent on diluting FOFA’s consumer protections to allow vertically-integrated institutions to pay their salaried advisers sales bonuses for pushing in-house products to customers receiving the most sacrosanct “personal advice”, which thankfully was rejected by the Senate in no small part because of this column’s constant criticisms.

Since the 2014 exemption for LICs and LITs, the value of money in these vehicles has more than doubled as fund managers race to raise as much of this highly lucrative “permanent capital” as they can by paying commissions of up to 3 per cent to push their wares. This is despite evidence that more than half of all LICs and LITs end up trading below the value of their net tangible assets.

Time after time fund managers that have not previously raised much, if any, capital via FOFA-regulated channels have secured hundreds of millions in days via an LIT on the ASX. And these are often the most complex products, including leveraged hedge funds, junk bond funds, and leveraged debt products, with extremely high fees that have not been subject to any real negotiation because those promoting them are conflicted via the payment of huge commissions. Globally, Australia's FOFA-free LIT market is the talk of the town---many big fundies are now rushing to exploit it.

In response to Magellan’s decision, one experienced financial adviser relayed: “I thought it might be useful to hear about my experience with LIC and LIT placements within a advice firm,” he said via email. “What I’ve seen happen, time and time again, is the partners of the firm bid for a large amount of an LIC or LIT placement to maximise commission.”

“Inevitably, it’s tough to find clients who require additional exposure in that space, so there is always a surplus. The result is advisers finding any possible client they can flog part of the placement to.”

“It’s a broken system when advisers are trying desperately to fit an investment product to a client rather than picking investment products that are suitable for clients and are selected on the basis that they are in their best interests.”

Read the full column here.




Comments

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Norman Taralrud-Bay

Good on you, Christopher! What on earth was the basis for the Federal Court's decision? Too many conflicts for too long in Australian finance.

Darryl Middleton

What has the brokerage exemption for LITs and LICs got to do with banks and vertically integrated financial institutions???? 99% of the LICs listed in the last few years would be provided by independent fund managers with no connection what so ever to the likes of AMP or the Banks.