How should financial advisers deal with underperforming choice products?

In February, the Australian Securities and Investments Commission (ASIC) released Report 779 – Superannuation choice products: What focus is there on performance?, which looked at the conduct of superannuation trustees, financial advisers, and Australian Financial Services (AFS) licensees.

“In our review, we focused on the practices and decision making of trustees, advisers, and advice licensees across a range of superannuation investment options and products, and across both the accumulation and retirement phases, in response to persistent failures of investment options to perform as anticipated,” ASIC said in the report.

Looking specifically at advisers, ASIC highlighted the “key role” they play in meeting the superannuation and retirement planning needs of Australians.

“Good quality financial advice can help members grow their superannuation balance before they retire and make the most out of their superannuation savings during their retirement,” the report said.

“Poor quality financial advice can significantly affect members’ financial positions and retirement outcomes.”

Consequently, the report explained that advisers should treat performance as a “primary consideration” and look to a range of sources to develop and support their recommendations.

“Advisers should be careful not to over-rely on advice licensee product approvals or external research ratings. The fact that an option is approved by an advice licensee or has a minimum external research rating does not mean that an adviser can ignore the performance of the option when providing personal advice,” ASIC said.

“Advisers must also ensure that their advice explains the basis on which the advice was given. Regardless of whether the adviser’s recommendation is to acquire, retain or redeem an underperforming option, they should explain why that recommendation is appropriate despite the underperformance and based on the client’s relevant circumstances.”

Writing on Advisely, Financial Advice Association Australia (FAAA) general manager of policy advocacy and standards, Phil Anderson, said the report made it clear that advisers need to explain why an underperforming fund is still the best option for a client if they advise them to stay invested in it.

“This might seem like a prickly situation to some advisers, given that they position their service and value proposition on the basis of advice strategies rather than stock picking,” Anderson said.

“Others will argue that some of this is contrary to the old adage that past performance is no predictor of future performance.

“Nonetheless, we all need to be aware that performance is critical to long-term outcomes for members/clients – and both licensees and advisers should maintain a close focus on it.”

He explained that through ASIC’s review, in which it found that advice was inappropriate in 11 of the 88 advice files it inspected, the regulator is concerned advisers were failing to demonstrate that a reasonable investigation and assessment of the underperforming option had been conducted.

ASIC also noted concern around failures to identify the underperformance, as well as explaining why it was appropriate for the client to retain the option despite the underperformance.

“In aggregate, then, ASIC Report 779 delivers a message to trustees, licensees, and advisers: they need to increase their focus on underperformance and build processes to ensure that underperformance is understood and that clients are being informed and advised (including the reasons) whether to retain or move to another fund or investment option,” Anderson said.

“Many advisers will already be doing all of this – but if not, it will be necessary to reassess business processes and data sources.”