The Singapore financial services industry has undergone a seismic shift since October 2001 when the Singapore Parliament passed a new legislation called the Financial Advisers Act (FAA). The legislation became operational in the third quarter of 2002. The Act consolidated the regulatory regime governing the provision of financial advisory services in respect to life insurance products and investment products such as unit trusts, stocks and futures contracts. This new act gave birth to a new financial intermediary, the IFA.
But the odds looked to be firmly stacked against the nascent IFA industry which was formed of small outfits without big war chests, public awareness and IT infrastructure support. They also faced the uphill task of changing a sales-oriented culture to an advice-based culture and constant challenge to recruit, train and retain competent advisers.
Now almost 5 years after the enactment of the Financial Aadvisers Aact (FAA), is Singapore’s fledgling IFA community fighting a losing battle against the hegemony of the banks and insurance companies, or is it gradually gaining ground and credibility?
For the consumer or man-in-the-street, ‘holistic financial planning’ after the FAA has taken a new meaning. Before the FAA, financial planning was almost synonymous with insurance planning. Iinsurance companies’ sales representatives, also known as tied agents, sold a myriad of insurance products that were marketed as tools for retirement planning, education planning, risk management, income protection, wealth accumulation, and other financial goals. Stocks and property were the other wealth accumulation vehicles used by some investors. For the higher net-worth individuals, private banking offered additional investment options, but this was the domain of the wealthy minority. To the masses, investing was a rich man’s activity that required huge capital outlay.
Insurance products such as whole life and endowment plans were marketed as a hybrid between insurance and savings plans, and were very popular instruments for retirement and education planning. Both types of insurance plans guarantee the principal with some capital appreciation in the form of non-guaranteed bonus. Many were attracted by the high bonus projection, but some of these were found to be unrealistic and resulted in revisions and cuts, much to the ire of the policy holders.
According to a story from ‘The Business Times’ dated September 2006, all except one insurance company had cut bonuses. The report also noted that the insurance industry began to impose a cap on long-term projections for policies in the mid-1990s. The cap started at 7% between 1994 and 1997; it was later reduced to 6% and since 2002, to 5.25%. This was largely due to the insurance companies’ inability to meet the original projections as there was a dearth of long-dated bonds, and their underlying assets underperformed.
Investment-linked policies bundled term insurance and investment, and were introduced in the early 1990s by insurance companies to allow policyholders to partake in investment and generate better returns for the policies. The controversy over this type of insurance plan was the high mortality charges that made it uneconomical for either insurance or investing purpose when compared to other alternatives,especially for certain age groups like retirees. Mortality charges are the costs of insurance and in such a policy, it can escalate very fast as the age of the policyholder increases. The charges are paid via the deduction in the units of the fund, and this deduction incurs transaction costs like administration fees and bid-offer spread and market risk, adding to the charges. Some policyholders complained that they were unaware of the escalating mortality charges that could affect their investments adversely, leaving them with poor or no returns.
UNIT TRUSTS IN SINGAPORE
Unit trusts became available to Singapore investors in the late 1980s. Otherwise known as Collective Iinvestment Schemes or Mutual Funds, they are hugely popular in more developed financial markets in the US, UK and Aaustralia as a wealth accumulator for pensions or superannuation, retirement nest egg, etc. The low capital outlay, relatively lower volatility, diversification and ability to invest globally with experienced fund managers are the key attractions.
Unit trusts were distributed or sold by banks, fund house direct sales representatives and investment brokers in the early days in Singapore. Banks set up their own asset management division, e.g. DBS Aasset Management and UOB Asset Management to compete with international fund houses such as Aaberdeen Asset Management Aasia, Fidelity Investments, and Schroder Investment Management in the lucrative fund management industry. International fund houses use banks as one of their distribution channels and to this day, it is still the strongest distribution channel for the fund houses in terms of sales.
Unit trusts made negative headlines during the Aasian financial crisis in 1997 and the dot-com bubble burst in 2000 for incurring hefty negative returns. The CPFIS-approved funds most notably tainted investor sentiment as 82% of 113 CPF-approved unit trusts and 71% of the 76 investment-linked insurance products suffered negative returns in 2000 amidst the global markets’ downturn. Some investors who suffered heavy losses during that period may still be reeling from those losses. But with global markets picking up from 2003, coupled with stricter regulations on the CPFIS-approved funds which put a cap on fees and weeded out poor performing funds, unit trusts have restored some of the lustre.
Bancassurance was born when banks tied up with insurance companies to offer insurance products as part of their suite of financial products. Typically, banks will offer insurance products of only one insurance company and unit trusts from numerous international fund houses, excluding direct competitors like other banks’ funds.
Banks have built strong brands in providing financial services through deft marketing strategies. They are able to cross-sell different financial products to different customer groups as they are privy to their own customer information. For example, a fixed deposit customer can easily become a unit trusts customer as the bank’s financial consultants know when the customer’s fixed deposits are maturing. Before the FAA, even bank tellers could ‘sell’ funds.
Although the banks dominate unit trust distribution, for many of them, the challenge is the high attrition rate among their frontline sales staff (financial consultants) that has resulted in poor after-sales service and a lack of continuity. Generally, the remuneration structure is based on a fixed basic salary, supplemented by additional commissions if certain sales quotas are met in different product classes like mortgage loans, unit trusts and fixed deposits. The clientele built by a financial consultant is owned by the bank so when a financial consultant leaves the bank, a new financial consultant will take over the clientele. Most of the time, the new financial consultant will focus on new business and the service provided to the clientele he took over will usually be more sales-oriented and transactional as revenue is derived from transactions in the form of sales charges.
In light of the financial advisory landscape before the FAA, holistic financial planning for consumers meant that they had to shop around for different financial products on their own. For example, he would get insurance from an insurance broker who had access to a few insurance companies’ products, an investment-linked policy from a tied agent, mortgage loan and unit trusts investing through a bank financial consultant or investment broker. However in practice, the lack of consolidation made portfolio tracking difficult, comparing products for best value arduous and getting a thorough financial health analysis cumbersome. This ultimately led to consumers receiving conflicting financial advice from different financial intermediaries where the sum of each part may not constitute a healthy whole.
With the FAA and the subsequent birth of the IFA, the promise of true “holistic financial planning” or “true advice” as some put it, looked more plausible.
THE IFA'S UNIQUE PROPOSITION
ideally, what the FAA aims to bring to the end consumer is better value and financial advice. Through one point of contact, consolidation allows the consumer to have access to a whole range of financial services, spanning insurance and investments to estate and tax planning backed by a wide range of products from many product providers. Typically, an IFA offers insurance and investment products from more than 4 product providers in each product class.
IFAs endeavour to represent client’s interests first, instead of the product provider’s. This is possible because IFA firms are not owned by product providers and are not compelled to meet any sales quota set by product providers. Instead, they may have more bargaining power with product providers since they are not tied to them and can move to another product provider should the products be less competitive. The relationship between a product provider and IFA where the product provider is just one of the many suppliers that the IFA has access to, benefits the client in terms of value and cost.
With the IFA in place to research and compare products, product providers can no longer operate under a cloak of consumers’ ignorance and have to constantly innovate to create better products to compete effectively. IFAs can pick the best of breed in each product class to create the best value for their clients, given each client’s financial situation. For example, an IFA is able to select different types of insurance products from different insurance companies, each having its own strengths in different areas. Product recommendations must be substantiated with the basis of recommendation, along with the client’s risk profile and investment objectives. All these form part of the MAS compliance and disclosure regulatory framework set in place through the FAA.
WORD-OF-MOUTH EFFECT
As IFA are independently-owned, the entrepreneurial drive to grow the business makes providing quality advice and service integral for long-term survival and growth. Faced with the the immense marketing clout of financial institutions and their own lack of marketing budget, the word-of-mouth effect is especially crucial for the IFAs to grow their business. The word-of-mouth effect, although slow, is nevertheless the most effective marketing tool to build a sustainable business as it stems from positive client experience. As a service-oriented profession, positive client experience is the lifeblood of a financial advisory practice.
Part of the positive client experience is attributable to client education. Being a relative unknown dispensing investment advice, IFAs have to educate clients to gain their confidence. This education involves explaining the investment mechanism to manage their client’s expectations and cultivating the right investor habits so that the client does not run for the door each time the markets turn volatile.
And the approach seems to be bearing fruits. According to a report by research group Cerulli Aassociates, fund managers have feedbacked that the “stickiness” of assets brought in by the IFAs is far greater than that from the banks, and IFAs are gaining clients disgruntled from the rather “high street” approach that many private banks have taken with clients who have found a far more personalized service from financial advisers.
Follow-up services like periodic portfolio reviews, with rebalancing of investment portfolio to align portfolio asset allocation to the client’s risk profile and investment objectives, also goes a long way in building the client’s confidence.
ALIGNING THE INTERESTS OF THE IFA & THE CLIENT
IFA’s remuneration structure comes in various models. There is the traditional transaction-based pure commission model where the IFA earns a cut from the upfront fee or sales charge from the products sold, or the fee-only model where all commissions from product providers are rebated to the client and the IFA only collects a fixed fee. There is also a mixture of fees and commissions, or the “wrap account” model.
The “wrap account” model is seen to align the interests of both the IFA and the clients by tying the IFA’s remuneration to the client investment portfolio’s performance. This wrap account model encompasses an annual recurring fee for managing the clients’ portfolio. This recurring fee is also known as the “annual wrap fee”. The annual wrap fees are calculated as a percentage of the total value of the investment portfolio. Therefore, if the client’s investment portfolio value increases, so will the IFA’s remuneration. This model also provides “free-switching” where client can switch funds without incurring any transaction cost. This helps to promote active rebalancing.
Thus, such a structure ensures that the client’s long-term interests are well taken care of by the IFA as the IFA will be rewarded for growing the client’s investment portfolio value. There is an increasing trend among the IFAs to move away from a transaction-based remuneration model towards this wrap account model. The recurrent wrap fee also ensures that the IFA provides quality on-going service to keep clients’ assets under his advice.
The ability to offer various remuneration models is also a benefit as the IFA is then able to cater to different market segments. For instance, a pure commission model may work for clients with a small investment capital as the commission paid may be lower than the minimum fee in a pure fee-based model. For high net-worth clients, a mixture of fee and commissionor fee-only model may be more ideal, considering that the investment capital is large.
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