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(March-2004) The real test: disclosure and integrity
Conflicts of interest are not new issues in business, not least in financial services where money or money equivalents are the stock in trade.
In the past we have seen conflicts such as where an ‘independent’ stock analyst’s recommendations appear to be affected by the greater demands of the more profitable corporate finance area. For example, where an investment bank or stockbroker requires a buy recommendation on a company from which it seeks to win a multi-million dollar corporate deal. A similar conflict could arise for a financial planner where a product recommendation to a client could be influenced by the remuneration from that product.
Over recent years there has been a trend for asset consultants to move into so-called implemented consulting. Since the late 1980s, asset consultants have become increasingly influential in advising superannuation funds on their investment strategy and selection and on the monitoring of fund managers. The more recent change has been to move clients into an implemented consulting product where the service provider (or implemented consultant) has discretion to make and implement investment decisions.
The trend towards developing and using in-house fund-of-fund products has partly been driven by business factors. Funds under management can be more scalable, therefore more profitable, than traditional fee-for-service or retainer fees for advice given. But it has also led to concerns relating to potential conflicts of interest.
There is nothing intrinsically wrong with the concept of implemented consulting. However, as with any important decision, clients should go in with their eyes wide open.
A conflict may arise where a superannuation fund adviser recommends that trustees move their fund from a traditional advisory arrangement to an implemented structure, and recommends his own product. This move may actually be in the client’s interest and the best product available, but a suspicion often arises.
One solution to this dilemma is seemingly very straightforward. Never recommend one’s own product. But this response is certainly not in the client’s best interest if that product is indeed the best alternative. In fact, such a policy may even inhibit the adviser from giving the client the best advice for its needs. A more practical solution may be to engage a totally independent adviser, with no competing products, to review the fund’s needs.
An allied conflict may
arise due to the size of the
consultant (traditional or
implemented) and possible capacity constraints of their preferred managers. In recent years, we have seen the exodus of senior investment managers from large investment houses to set up their own boutique firms. Some of these more successful managers have already closed several products to new investment. In this situation, who has the first opportunity to access the product’s limited capacity — the traditional or implemented client?
Another potential conflict relates to implementation leakage. Let’s say the adviser makes a recommendation to their traditional client. Chances are by the time that recommendation can be approved and implemented, the delay has resulted in reduced performance. Not so, in the case of their implemented clients, where less delay is likely. There is a valid argument here for suggesting that in real terms the service the implemented consultant is providing is more aligned with a funds management role than with traditional consulting.
Solutions to this conflict range from reducing decision times for trustees (not always practical) to completely separating the two arms of the business (again not always easy, as the same manager’s research team typically services both implemented and traditional businesses).
At the end of the day, any concerns about conflict of interest issues should be reduced by the co-existence of several factors. Ideally, these include independence (of ownership, management and absence of competing products), maximum disclosure and transparency (of operations and fees) and total integrity of organisations and individuals (often a very subjective assessment).
Some providers will find it less easy to demonstrate the necessary independence and transparency required to allay client concerns. Institutional ownership, strategic alliances with partners offering products and the oh-so-common Chinese wall structures all potentially conspire against the credibility of implemented consulting firms in our more suspicious times.
And we can only expect more trustees and members to start to question the level of independence of advice they are offered, particularly if investment performance comes into question.
Are we on the brink of a new super cycle, in which funds actively seek assurances on behalf of their members that the advice they are provided is absolutely in their best interests?
And will we see Australian superannuation celebrating ‘Independence Day’, a recognition that while there are several shades of grey in the context of what constitutes independence, the test of true independence remains ‘is this the best advice we can provide for this client?’
— John Parrish is director of independent investment consultants, Counterpoint Group
— Tony McDonald is managing director of listed financial services company, Snowball Group
AUTHOR
External
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