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Investors remain exposed despite LIC fee ban

Glenn Freeman  |  26 May 2020Text size  Decrease  Increase  |  
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Investors in listed investment products remain vulnerable to unscrupulous sales tactics despite the federal government's decision to ban stamping fees.

The government risks inadvertently discriminating between products, which will ultimately harm customers, says Jonathan Rochford, portfolio manager at boutique asset manager Narrow Road Capital.

"The government is trying to build this halfway house where some products are okay, and others aren't,” says Rochford.

“But it doesn't address the standing issue that some advisers are effectively using these fees as a way to earn extra income, while still claiming that they're independent."

From speaking to financial planners who deal in hybrid debt securities and are regularly approached by institutions, Rochford says many will get a phone call to introduce a new product which might have a stamping fee of 1 per cent.

"A good adviser will ask how it stacks up, and if it's a good product they'll buy it, and rebate the fee to the client," Rochford says.

"What a small proportion of advisers do is just buy each one that comes through, they're not checking whether it's the right product for their client."

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He says the main issue is transparency, if advisers fail to make clear they receive these types of remuneration.

"A small minority of advisers has long implemented a portfolio churning strategy with hybrids, always buying the new securities to replace existing holdings."

This earns the adviser a regular stream of additional income, but the new hybrid is sometimes not the best investment available. Older hybrids may offer a better margin and/or shorter term, which an unconflicted adviser would choose.

"If you hang your shingle up as an independent financial adviser and do this, that's a problem."

Bringing some perspective to the scale of the deals, Rochford points to embattled airline Virgin Australia's late-2019 issuance of $325 million of ASX-listed notes and US$425 million ($646 million) of high yield bonds.

"There's a good chance that the brokers but also some of the advisers who put these products in front of their clients got these payments," he says.

Rochford also refers to the latest Commonwealth Bank of Australia preference share — or hybrid — that has raised $1.65 billion. Having listed in November 2019 with the aim of raising $750 million, he says this would have seen a 0.75 per cent fee paid to the brokers and advisers who placed it with their clients.

Treasurer Josh Frydenberg last week announced the closure of a loophole to prevent mis-selling of listed investment companies and listed investment trusts to retail investors, by banning sales commissions paid by fund managers to financial advisers and stockbrokers.

Issuers of LICS and LITs charge stamping fees when they launch an initial public offering for a product. The brokers of these IPOs – those who drum up support among financial advisers, who in turn encourage clients to invest – receive these fees.

Why fees matter

These fees are important not only in the way they encourage parties to sell products, but in the overall performance of the products themselves. This is a point regularly emphasised by Morningstar, including within its Global Fund Investor Experience survey of managed funds.

Morningstar Australia director of manager research Grant Kennaway says fees are among the most important things an investor can control.

"You can't control market movements, and we find that the lower the fee, the better for the end investor,” Kennaway says.

The government's decision last Thursday to axe a commission loophole for listed funds, but leave them in place for hybrids, listed infrastructure and REITs, reflects the lobbying strength of stockbrokers and investment bankers.

"I think Frydenberg has decided that the whole LIC thing is impossible to defend, but he'd find it very difficult to go beyond that point into other capital markets transactions," says Graham Hand, editorial director of Morningstar company Firstlinks.

There are similarities in the way hybrids and other listed products are sold. And some advisers take fees to switch their clients into newer hybrids that may be inferior products.

"But there are also many honest advisers who charge a flat fee for their services to look after the client, and a lot of them reimburse the fee to the client. There is no one business model," Hand says.

An ‘illogical’ decision: Wilson

Others, however, lament the government’s intervention.

Geoff Wilson, chairman of high-profile local fund manager and LIC issuer Wilson Asset Management, has aired his disappointment, describing the decision to ban stamping fees as "illogical”.

Wilson argues the change will result in fewer new listed products coming to market in Australia, which will ultimately mean less choice for investors and less competition.

"Whether there's a selling fee or not. Whether BHP was doing a placement; or the latest capital raisings of Flight Centre or National Australia Bank, there are placement fees being paid to raise capital in the listed market," Wilson says.

"It's now a strange anomaly that LICs won't have them, so it's putting them at a disadvantage to the rest of the listed market, which I don't see as all that logical."

Wilson says the shift will present both a cost and psychological barrier to fund managers — both locally based fund issuers and those from offshore — that might have considered launching new listed vehicles.

"As an investor you want as much choice as possible. The more diverse and the better the managers are, you'd like to have more choice rather than less."

LIC lifecycle

The latest changes come into effect from 1 July, but under the current system the process works as follows:

A fund manager approaches a lead broker, sometimes known as an arranger or lead manager, indicating they want to launch a listed investment company onto the market.

If the lead manager agrees to broker the deal, they charge a fee that's usually around 2 per cent. On a $1 billion transaction, the fee would be $20 million.

The lead manager then pays some of this money into other parts of the value chain, such as other brokers, sometimes called joint lead managers or co managers.

These sub-brokers then contact other intermediaries, such as financial advisers, who in turn may receive around 1 per cent, or a total of $10 million, to place the product with their clients.

The advisers then call their clients — end investors in most cases — to offer them the new product. The adviser may keep the fee or reimburse it to the client.

While the new regime begins in July, the fees can still be charged for the sale of real estate investment trusts, listed infrastructure assets and “hybrid” debt securities.

Commissions and the bad behaviour they encourage—as unearthed in spectacular fashion by the banking royal commission and flagged on numerous occasions by the watchdog ASIC—live on.

Frydenberg defended his decision to continue allowing manufacturers of REITs, listed infrastructure investment and hybrids to continue paying stamping fees as "supporting the economic activity of companies in the real economy."

This again emphasises the politicised nature of this part of the financial services industry.

"I think what Frydenberg would say is that you're talking about raising capital for banks, and that's a mainstay of our economic system," Hand says.

"If you call something 'the real economy,' then you can still pay a commission in that particular area."


is senior editor for Morningstar Australia

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