Hugh Dive, Head of Listed Securities

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Tales from the Trenches - Wealth Management in Australia

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Funds management and in particular the vertical integration of advice, administration and management has generated much debate this week, with the government's plans to wind back some of the investor protections in Labor's Future of Financial Advice (FOFA) being strangled in the senate. In this week's piece we are not going to debate the merits of requiring financial advisers to act in their clients' best interests nor conflicted payments and fee disclosures. This week we are going to have a closer look at the funds management landscape in Australia, and in particular the dominance by the largest players of this A$1.9 trillion industry.

Influence of the major institutions

The wealth management businesses of the major banks (plus AMP) include funds management, life insurance and general insurance, investment administration platforms and financial advice. The wealth management business is attractive for the banks, not only due to the government mandated growth that comes from rising compulsory superannuation contributions, but also because wealth management earnings carry a low capital charge.

Alternatively when a bank makes a home loan with a 70% loan to value ratio (LVR), the Australian Prudential Regulation Authority (APRA) requires that the bank holds approximately $2 in capital for every $100 lent. This rises to $10 for every $100 in the case of a loan to a business that incurs a higher risk weighting. When a company is required to quarantine more capital to conduct their activities, their return on equity (ROE) declines. This may not seem very significant, but in an environment where the Australian banks are facing higher capital requirements from regulators globally, earnings from wealth management are very attractive as they can boost the bank's return on equity.

Weath-Management-in-Aust1.JPG

Profitability

In the 2014 financial year, the four major trading banks in aggregate earned $28.6 billion representing an increase of 5.1% on last year. A significant proportion of this came from the banks' wealth management operations, $2.7 billion in total. In 2014 approximately 10% of bank profits were attributable to their wealth management divisions, with CBA (Colonial First State) and Westpac (BT) gaining a higher percentage of profits from wealth than the Melbourne-based banks. In the Core Equity Portfolio we have our exposure to wealth management indirectly via positions in the banks, rather than in listed wealth managers such as Perpetual or AMP. This results in buying $1 of wealth management earnings on a price to earnings (PE) of 13 times rather than 16 times!

Vertical Integration – clipping the ticket at three stages

Essentially the wealth management industry comprises a value chain of advice (financial advisers), portfolio administration (platforms) and manufacturing (funds management). The major financial institutions have captured a dominant market share in these three links in the wealth management chain via acquisitions and IT expenditure. From the below chart on the right, the four major banks plus AMP have financial relationships with 65% of the financial planners in Australia. Their market share has been increasing with acquisitions (Count acquired by CBA for example) and heightened compliance requirements tend to favour the large institutions over smaller practices.

Investment platforms are the "middle man" in the process, connecting the fund manager to the adviser providing administration services and tax reporting for a client's portfolio of managed funds, shares and cash. Platforms generally charge around 0.3-0.6% of funds under management annually. Whilst this may not sound very glamorous, this has been a lucrative area for the major financial institutions, which by virtue of their IT expenditure have been able to capture over 85% of this market.

Finally the major financial institutions have also been very successful in capturing a large share in the business of actually managing the money. The below chart on the left shows the dominance that the large institutions enjoy in "manufacturing" the investment products or funds for sale to retail investors. Currently the major banks plus AMP manage almost 80% of the retail funds under management.

Weath-Management-in-Aust2.JPG

Negatives

Whilst this sounds like a solid way for banks to supplement banking profits in an environment of relatively anaemic credit growth, the ownership of wealth management businesses by the banks do pose some risks.

Aside from the volatility in investment returns, wealth management businesses have the potential to deliver adverse headlines that could impact on an institution's core banking business. Recently both CBA and Macquarie Bank have received "enforceable undertakings" from ASIC and faced Senate Inquiries relating to allegedly fraudulent behavior and bad financial advice from the banks financial planners. In 2014 CBA spent $477 million in advertising building their banking brands. One would have to imagine that a portion of the goodwill that spend generates is dissipated by headlines detailing ASIC probes into the bank's financial planning division. The banks are clearly concerned that negative activities occurring in the wealth management businesses do not spill over to damage their core banking brands that generate the bulk of their profits.

Philo Capital are an independently owned portfolio construction and management service for long term investors - focused on capital protection, sustainable real growth, and disciplined risk management. Philo is remunerated purely on the basis of assets managed / advised, not on products sold, turnover, brokerage, rebates, trail commission and receive no benefits from any product providers or suppliers.

Disclaimer
This article has been prepared by Philo Capital Advisers Pty Ltd ABN 70 119 185 974 AFSL 301808 (Philo) and contains general investment advice only. The information in this article does not take account of your objectives, financial situation or needs or those of your client. Before acting on this information readers should consider whether it is appropriate to their situation. We recommend obtaining financial, legal and taxation advice before making any financial investment decision. To the extent permitted by law, neither Philo nor any of its related entities accepts any responsibility for errors or misstatements of any nature, irrespective of how these may arise, nor will it be liable for any loss or damage suffered as a result of any reliance on the information included in this article. The information in this article is based on information obtained from sources believed to be reliable and accurate at the time of publication but we do not make any representation or warranty that it is accurate, complete or up to date. We accept no obligation to correct or update the information or opinions in it. Opinions expressed are subject to change without notice. Past performance is not a reliable indicator of future performance. Any forecasts included in this article are predictive in character and may be affected by incorrect assumptions or by known or unknown risks and uncertainties. Nothing in this article shall be construed as a solicitation to make a financial investment.

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Hugh Dive, Head of Listed Securities


Prior to joining Philo, Hugh was Head of Basic Materials Group Investment Research; covering the chemicals, building materials and steel sectors. In the 2011 Reuters StarMine Equity Analyst Awards, he was rated 5th overall in Australia for stock picking and first in the Diversified Industrials and Chemicals sectors. Hugh has extensive portfolio management experience gained at Investors Mutual, with a successful track record managing both small and large cap value funds. In 2009, one of the funds he helped manage, the IML Future Leaders Fund, won the AFR Smart Investor Award for the best Australian small cap fund.


Hugh started in funds management with CC&L Investment Management in Vancouver; Canada’s largest independent fund manager with C$37B under management. At CC&L he focused on asset allocation and then Canadian equity analysis. Hugh holds bachelor’s degrees in both Economics and Law from Sydney University and the University of British Columbia, Canadian Securities Course (Honours) and is a CFA charter holder.

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