The economics of Australia’s financial advice sector is about to undergo fundamental change under the combined force of a post-Hayne regulatory shakeup, the slow dismantling of vertical integration in wealth management and ongoing technological innovation.
Demographic transition as older advisers leave the industry and the growing penetration of robo-advice solutions are other harbingers of change.
What’s interesting is that many of these same trends are being felt in the US advice sector and there are lessons we can learn here as our industry turns into a fully-fledged profession.
Until now, the dominant framework for financial advice in Australia has been one in which the real cost of the advice was subsidised by a major financial institution through the revenue raised via products and platforms.
As Commissioner Hayne observed in his final report recently, the industry’s transformation – from one dedicated to sale of financial products to a profession concerned with the provision of financial advice – is far from complete.
Banks are reviewing their wealth business as this transformation takes shape, exposing the real costs of maintaining a network of professionals providing client-centred financial advice as opposed to being mere distribution channels for product.
The perfect storm
So, on the surface, this looks like a perfect storm. First, there is ongoing fee compression amid a growing mismatch between what Australians are prepared to pay for advice and the estimated cost of providing it. Second, there are the rising costs associated with the pressure of regulatory compliance. Third, there is the need to invest in new skills and technology. Fourth, there is the loss, for many advisers, of a significant subsidy as former conflicts are removed.
In the US market, where many of the same challenges exist, one trend is under-the-table discounting. While advice firms’ published fee schedules have not changed, there is evidence of firms offering discounts averaging 30 basis points.
After years of false starts, the penetration of robo advice appears to be finally having an impact there. The latest Investment News Pricing and Profitability Study shows that, after holding steady since 2012, the pricing power of US advisory firms slumped in the two years from 2015-2017, with average revenue yields falling from 77 to 69 basis points.
Amid this disruption, where some robo firms offer assets under management (AUM) fees of just 0.25 per cent for asset allocation services, industry commentators and many financial themselves began to raise the question of whether the traditional 1 per cent AUM fee would inevitably have to be cut to compete.
Margins holding steady
Yet, while fees are in decline, profit margins are so far holding steady, a fact that commentators attribute to the same technological forces driving the robo sector. It seems the overall productivity of traditional advice firms has improved as new technology lowers the costs of doing business. This has given firms scope to cut fees in what looks more like fee deflation than compression.
The productivity improvement is evident in the fact that in just a few years, the average number of clients per staff member and revenue per staff member have risen 8 per cent, more than making up for the decrease in average revenue yield.
Offsetting that, though, is that the productivity of financial advisers themselves has fallen by more than 20 per cent in recent years, as advisers are compelled to deepen client relationships and do more work with fewer clients to justify their fees in the first place.
So if fees are declining, advisers are having to do more for each client and fewer advisers are entering the industry, at some point the laws of supply and demand will kick in. In the meantime, firms who invest in technology and skills, boost their productivity and focus on end clients, rather than on product, are more likely to survive the perfect storm.
After all, we know that profit margins are a function of two things – the cost of doing business and the value the client sees in the services you offer. We know that new technology is delivering low-value, commoditised services cheaply, so for firms to survive the focus must shift to high-value, individualised advice that clients will pay for.
As the US adviser Michael Kitces has observed, the natural evolution in this changing economy is not for traditional advisers to compete on price in a war they cannot win anyway. Instead, they need to compete on value and differentiation to survive and prosper.
In the meantime, the investments you and your firm can make in your own skills and business infrastructure will provide a long-term pay-off in an industry making a fundamental transition.