14.08.24
By William Sargent
Championing Unbiased Financial Advice – Why Independent Advice Matters
In the financial services sector, the concept of “independence” isn’t always as clear-cut as it seems. It is often assumed that all financial advisers are working solely in the best interest of their clients. However, the reality is more complex, and it’s crucial to understand the structures that can influence the advice you receive.
At the heart of this issue lies a practice known as vertical integration. It’s not a term heard in everyday conversation, but its impact on your financial decisions could be significant. In this article, we’ll explore the ins and outs of vertical integration, its prevalence in the New Zealand financial sector, and why it matters to investors. We’ll also discuss how to identify truly independent advice and why it’s essential for your financial well-being.
The Vertically Integrated Model
Vertical integration in financial services occurs when a single company controls multiple stages of a product’s lifecycle – from creation to sale. For example, a large financial institution, such as a bank, creates, advises on, and sells its own branded products. Other examples include:
- An investment advisory firm which is owned in full or part by their product provider
- An investment advisory firm owned in full or part by a Fund Manager
- A share broking adviser who solely uses their in-house brokers and foreign exchange dealers
- A bank adviser who provides advice on their bank’s investment and KiwiSaver fund options.
While this model streamlines operations and increases profits, it can lead to inherent biases and conflicts of interest that may negatively impact consumers.
To further illustrate, imagine you’re in the market for a new car. You walk into a dealership that exclusively sells one brand e.g. a Mazda dealership. The salesperson shows you the latest Mazda models, highlighting every feature and benefit. While these cars might be perfectly fine, a car of a different brand, such as a Ford, may be best suited to your needs. However, the salesperson is unlikely to recommend a Ford as they work for and are remunerated by Mazda.
The above scenario illustrates the limitations of vertically integrated financial services. Just as that car dealership restricts your choices to a single brand, many financial institutions confine their advice to their suite of products. You might walk away with an acceptable solution, but you’ll never know if there was a better fit out there that could have saved you money, offered superior performance, or more closely aligned with your unique circumstances.
Understating Product Bias and Conflicts of Interest
In vertically integrated financial models, advisers may face pressures leading to product bias and conflicts of interest. These issues arise when an adviser is influenced to prioritise their organisation’s products over potentially more suitable alternatives available in the broader market. Several factors contribute to these issues:
- Familiarity: Advisers often have more in-depth knowledge of their company’s products. This familiarity can lead to an unconscious preference for these products, even when alternatives might be more suitable for a client.
- Incentive structures: Compensation models that reward advisers for selling in-house products. These can include higher commissions, bonuses, or other financial incentives.
- Pressure from management: Explicit or implicit pressure to meet sales targets can compromise impartial advice.
- Limited product range: In some cases, advisers in vertically integrated organisations may only have access to their company’s products, severely limiting their ability to consider alternatives.
For consumers, this can mean suboptimal solutions and missed opportunities for better products that could align more closely with their financial goals.
The Prevalence of Vertical Integration
A study by the Australian Securities and Investments Commission (ASIC) found that 68% of financial advice provided by vertically integrated institutions in Australia was “poor” due to conflicts of interest. In New Zealand, this issue is particularly evident in KiwiSaver where many of the largest KiwiSaver providers are banks that create and distribute their investment products.
An independent financial adviser, free from the constraints of vertical integration, offers a more comprehensive view of the KiwiSaver market. They can compare schemes across providers, considering factors such as fees, performance, risk profile, and ethical investment options. This broader perspective enables the adviser to recommend the most suitable KiwiSaver scheme, rather than being limited to a single provider’s offerings.
Overcoming Conflicts of Interest
In New Zealand, a Financial Adviser’s disclosure obligations are regulated under the Financial Markets Conduct (Regulated Financial Advice Disclosure) Amendment Regulations 2020. These regulations require advisers to disclose conflicts of interest and how they will be managed. Additionally, if an adviser provides advice about products from particular providers, this information must be disclosed. This transparency ensures that clients are aware of any potential biases in the advice they receive.
Understanding Disclosure Statements
When engaging with a financial adviser, it’s crucial to review their disclosure statement. This document is an “under the bonnet” look into the adviser’s business model and potential conflicts of interest. Pay particular attention to the fees section – are they charging a flat fee, an hourly rate, or a percentage of assets under management? Be mindful of advisers who rely heavily on commissions from product sales and look for transparency in how they’re compensated.
Additionally, querying how an adviser chooses financial product providers can reveal much about their independence. If they work with only a handful of providers, it might suggest limited independence. An independent adviser should have access to a broad range of providers, ensuring they can recommend the best options for your specific needs.
Asking the Right Questions
Ask the adviser about their research process and whether they can recommend products outside of their usual list if it’s in your best interest. A truly independent adviser should be able to consider products from across the market. Don’t hesitate to seek detailed explanations about their business practices and conflict management.
While many financial advisers work for dedicated advice firms rather than banks or product manufacturers, it’s still important to scrutinise their level of independence. Some advice firms, despite not being owned by product providers, may still have commercial arrangements that influence their recommendations. These can include volume-based bonuses or preferential pricing, which could subtly shape the advice given.
Rutherford Rede’s Approach
At Rutherford Rede, we pride ourselves on maintaining a high standard of independence, free from any alliances with specific product providers. Our fee-for-advice model also ensures our recommendations are never influenced by commissions or bonuses from third parties. This means our advice is solely based on what we believe is best for each client, drawing from the full spectrum of financial products and providers.
We follow a rigorous due diligence process for investment fund selection and our portfolio construction is based on comprehensive research and strategic analysis, not sales incentives. This approach guarantees that only the best funds and investment products make it into our recommendations. Furthermore, our level of independence allows us the flexibility to “fire” investment fund providers if they do not pass our due diligence process. This approach contrasts with investment advisory firms that are owned in full or in part by their Fund Manager and have an incentive for keeping everything “in-house”.
Our level of independence is rare in the industry, but we believe it is the only way to ensure you receive advice that serves your best interests – because you deserve access to the entire showroom of financial products, not just a single manufacturer’s lineup.