‘Complete lack of diversification’: AFCA says advisers not being blamed for product failures

Diversification is one of the “fundamentals of financial planning”, the Australian Financial Complaints Authority (AFCA) said, and putting the blame on advisers that fail to uphold this is reasonable.

A key part of the push to include managed investment schemes (MIS) in the Compensation Scheme of Last Resort (CSLR) has been related to financial advisers paying the bill for what are essentially product failures.

While far from the first time the Financial Advice Association Australia (FAAA) had made the argument, submission to the Treasury review of the CSLR the association singled out the inclusion of MISs as particularly important.

“At the core of what has gone wrong, are issues directly related to the development and promotion of in-house investment products that were poorly managed, with unacceptable levels of conflicts of interest,” the FAAA submission said.

“This is compounded by insolvency laws that favour corporations over consumers, resulting in the CSLR creating a moral hazard for the profession, in that the consequences of poor behaviour are not borne by those who have perpetrated it, but by those who are innocent of wrongdoing.”

During AFCA’s member forum on Thursday, senior ombudsman – investments and advice Alexandra Sidoti said despite the issues with the products, what the complaints authority is “fundamentally observing are advice failures”.

“A product failure is never a good thing. It's not good for the financial firm. It's not good for the consumer,” Sidoti said.

“When there's a product failure, though, and that's maybe 5 per cent of a person's portfolio, that's not going to have a catastrophic impact on someone's superannuation funds. The issue that we're really seeing here is a complete lack of diversification, and that's an advice issue.”

At the heart of the problem, she added, is that the advisers are not taking into account the client circumstances when they walk in the door.

“At the time of providing advice, they're not thinking, what's this person's attitude towards risk? What are their objectives? Are the recommendations that we're making likely to meet the client's objectives? Sidoti explained.

“Fundamentally, we're seeing at times 100 per cent, as I said, of someone's investment funds going into a single product. If that product then fails, that's 100 per cent gone. Sometimes it's not as high as 100 per cent but still, 50 per cent, 60 per cent, 70 per cent – really high volumes.”

She likened the issue to another trend that saw self-managed super funds linked with direct property through “one-stop shops” that had an advice arm, a real estate arm, and accountants.

“The financial advice was consistently for people to establish an SMSF and go into a direct property. A lot of the time, these people had maybe 200 grand combined in their superannuation. You then use that for one direct property investment, and you've got all of your risk in a single asset,” Sidoti said.

“It's that fundamental lack of diversification, which is just one of the fundamentals of financial planning.”

Shail Singh, AFCA lead ombudsman for investments and advice, added that while there have been a total of 201 funds frozen this century, “not all of those are actionable against the adviser”.

“It's a really important point. So, for example, if people put someone into a mortgage fund for 5 per cent, it was suitable to their portfolio, and there was no information to show that that fund was not going to perform – the adviser’s not responsible for that sort of conduct,” Singh said.

‘Don’t expect advisers to have a crystal ball’

According to the complaints authority, it is not singling out advisers for product failures if their advice process is sound but something unpredictable happens.

“One of the things we consistently say is we don't expect advisers to have a crystal ball,” Sidoti said.

“I think one of the best examples of when we saw a lot of this was with the agribusiness post-GFC. There were a lot of people invested in agribusinesses, there were certain tax benefits associated with that. When the GFC hit, a lot of these agribusinesses failed.

“We saw a lot of complaint volume at that time, but quite often that didn't result in a finding against the adviser, it would really depend on the proportion of someone's portfolio that was exposed to that particular product and whether that level of exposure was problematic, rather than the fact that the product ultimately didn't perform, because there's always risk.”

This, Singh added, highlights the role that financial advisers play as a “gatekeeper” there to protect their clients.

“Most do a fantastic job at this,” he said.

“But as we've highlighted, there are business models that are problematic. Generally, they're vertically integrated. Generally, it's conflicted remuneration, and these continue to exist.”

Speaking at the FAAA Roadshow in Sydney on Thursday, chief executive Sarah Abood reiterated the association’s stance that these product failures are “at the heart of every case that has gone to the CSLR so far”.

“Product failure is being redefined as advice failure, because if it's an advice failure, the client will get compensation. If it's a product failure and the product provider has fallen over, the client gets nothing,” Abood said.

“So, we're seeing a lot of work happening behind the scenes, many groups organising to redefine what they do as advice failure. We're really concerned about that. We think it's really important that MISs should come into the scheme.”

Also speaking at the roadshow on Thursday, FAAA general manager policy, advocacy and standards Phil Anderson stressed that the “real pain is being experienced” because of in-house or related party products that fail.

“Why are advisers paying for product failures? The reality is that the law allows for where there's advice failings for the adviser to take the full pay,” Anderson said.

“The CSLR doesn't even include managed investment schemes. So, there's more than one reason why we end up paying for everything. We want the scheme to be genuinely last resort, not first resort.”