There have been some epic investment product and strategy failures in the past two years and certain dealer groups have been burnt more than others.
Licensees that have had wide approved product lists (APL) with an ability to tap into most of the market or those that have had substandard processes and selection criteria in place have encountered some rude shocks and paid the price for their shortcomings.
"The dealer groups that have had looser guidelines and a broad list actually allows them to attract advisers to their dealer group, but then they suffer the pain because their processes have been a little too loose," Axa investment research manager Rob Thomas observes.
"Where a lot of advisers failed is they used products poorly without guidelines."
In Association of Financial Advisers (AFA) chief executive Richard Klipin's view, the global financial crisis (GFC) is at the core of bringing risk management into focus for dealer groups.
"What that's meant for licensee management and executives is that they need to revisit their APLs and re-look at their training and re-look at the risk that they have within their APLs, because when the worst does happen ultimately the licensee ends up with the complete responsibility, complaints and so on," Klipin says.
"So to mitigate that risk what licensees are doing are obviously paring back their recommended lists and getting really clear on what their core value is and what their core advice is, and so you've seen recommended lists effectively reduced as a result of that."
It's no surprise dealer groups have generally cut agribusiness products from their APLs, largely because the market has been decimated as a consequence of the GFC.
Meanwhile, other products and strategies that sit in the exotic basket, such as structured products, hybrid financial instruments, property syndicates and gearing have also come under closer scrutiny by licensees.
However, regardless of whether dealer groups were prudent enough or not to have vigorous processes in place that weathered the storm, there's now a general movement by licensees towards applying a more stringent approach to their recommended lists.
Wealthsure is now monitoring the products on its APL more frequently and has implemented a more thorough ongoing revision.
"We're always constantly reviewing our APL, but have we gone and slashed and trashed it? Not really," Wealthsure chief executive Darren Pawski says.
"All that we've done is considered what are the causes of all of these issues - was it due to our approved list being too extensive? We came to the conclusion that no it wasn't."
However, Pawski says Wealthsure has since raised the buffer requirements for margin lending and increased its selection criteria on structured products.
"We applied harder criteria, basically they had to tick more boxes, so we looked at where some of the failings were and what we found is sometimes research doesn't always affect the exact current positions of those structured products," he says. Collapsed funds such as MFS and the well-publicised fall of Basis Capital are good examples of this, he adds.
When Basis Capital was originally set up it was a fairly low-risk hedge fund, but over time they significantly increased their internal gearing and it went from being a low-risk product to a high-risk product, he says.
Similarly, MFS changed from being a fairly vanilla mortgage fund to an extremely diversified fund with loans out to related parties.
"So what we've done is said, 'okay certain products need to be more regularly monitored than what they are by the research houses', because most researchers only do a thorough review every 12 months," Pawski says.
"Now if you take a Basis Capital, that's too late because their gearing levels increased significantly in those periods. So what we've done is taken more of a thorough ongoing review."
Likewise, AMP Financial Planning (AMPFP) reviews products on an ongoing basis.
"Where we believe the product has merit and is within our licence, we will consider it for inclusion on our APSL (approved product and service list). In order to be approved the product must pass a number of tests to ensure the viability and benefit of such an addition," AMPFP research manager Brendan Irwin explains.
"If by exotic products you include alternative funds and structured products, we review these more complex products, which have the potential to be misunderstood, on a case-by-case basis.
"If AMPFP believes that such an exotic product has a place on the APSL we require a planner to obtain accreditation on the use of such a product before they are able to recommend it to clients."
Meanwhile, the Axa and Charter dealer groups haven't had to cut products from their APLs to any great extent.
"In the main, no we haven't. We've had a robust process for picking products in the first place. Our products have stood the test of time, they're picked to go through robust cycles, we are transparent in our processes and in reality we've got an experienced team," Thomas says.
"These issues -whether it's a tech wreck, a property bubble, mortgage funds failing - have happened before.
"So if your team experience and you can communicate clearly with your customers as to why things are or aren't added, despite commercial pressures to add products or flavours of the month, then you can explain that to your customers and explain the rationale and look beyond the marketing hype."
Furthermore, Klipin argues there's also an obligation and responsibility for product providers to be true to label.
"What we saw through the GFC was products that everyone thought were conservative in nature turned out to be highly speculative and highly risky," he says. Boutique Financial Planning Principals' Group president Claude Santucci agrees.
"I sat and listened with incredulity to a fund manager, who I won't name, explaining why the product was a huge success even though it had fallen in value and people had lost money," Santucci recalls.
"He said under normal circumstances this would be a terrific product and I made the comment that circumstances are normal right now and your product has fallen over because it was too complex and people didn't understand it including yourself."
While a dealer group's decision to cut products from its recommended list can impact on all parts of the value chain to varying degrees, Thomas argues having robust processes and guidelines in place for APLs is the heart of the issue.
"It doesn't so much matter what products are on the list, which everyone likes to talk about, it's actually how the guidelines and how the products are used which is far more important, and that goes back to the research houses as well because they give a product a rating," he notes.
"So it does impact on advisers, it impacts on licensees operations, it also impacts on clients, and there are winners and losers. But I think good quality advice when it's margin lending or structured product, as long as they're used appropriately for the right client they're fine."
While the Australian Prudential Regulation Authority is placing additional requirements on financial planners to ensure they know their product, Irwin notes the GFC has also exposed products such as those linked to collateralised debt obligations.
"At the time that many products were designed no-one anticipated the full extent of a worst-case scenario and subsequently these products became cash locked. This could be seen as a driver towards a more conservative approach to lists," he says.
The GFC also uncovered the intricacy of some of the more exotic products and instruments available in the market, according to FPA chief executive Mark Rantall.
"One of the key drivers at the macro level has been the GFC where many of these products in times have been found wanting and have really exposed their complexity," Rantall observes.
"If a product can't be understood and can't be explained effectively, then you have to question the appropriateness of use for a retail client. Advisers need to be very conscious of the complexity of products when they're offered to retail clients in terms of whether they can actually understand them.
"There will be an increasing focus on AFSL (Australian financial services licence) holders and advisers to critically look at their APLs to ensure that they have the right mix of products that importantly are appropriate for their clients and the client can understand the product that they're investing in."
Santucci agrees. "If an adviser can't explain the product in about three sentences, then it's a complex product and ought to be restricted because people will not understand it," he says.
However, if a dealer group chooses to ban or restrict products from its APL, could this be viewed as a lack of confidence from the licensee in the competency level of its authorised representatives?
Rantall dismisses this. "I don't think that's the real issue. The real issue is the appropriateness of the product sometimes," he says. Irwin also disagrees. "Not necessarily. We have a responsibility to our customers to ensure we have high-quality products and services on our APSL," he says.
Meanwhile, Santucci argues the lack of confidence could be twofold. While it could be perceived as a lack of confidence in advisers, it can also be brought back onto the licensee's operations.
"It could be a lack of confidence in the dealer group's own ability to research product and research strategy and to work out how best they fit. It could also be a lack of confidence in the dealer group's ability to police their own rules and regulations," he explains.
Alternatively, it could just be a case of a knee-jerk reaction by a licensee, Pawski adds.
"If products sit on your approved list irrespective of whether you've got poor economic conditions or not, you should have a process in place that's there for the good and the bad cycles," he says.
On the other hand, Klipin says it's just a case of risk management 101 by a dealer group, rather than a lack of confidence in its advice network.
"Understanding the risks within your APL and understanding the risk within your network is of absolutely core confidence for licensees," he says.
"Those that didn't pay enough attention to it are paying the price by having to clean up their APLs, address complaints, address systems and processes and that detracts from all the other things that they need to do and want to do as licensees."
Thomas agrees, noting particular licensees have been more lax in their accreditation and guidelines than others.
"The way they're managing that to some extent is maybe tightening the guidelines and having accreditations," he says.
"They're also doing that by altering their APLs, but it's a multi-pronged approach but it's effectively responding to financial services reform, which is a good thing for the consumer in the main."
As the large institutional dealer groups become even bigger, the sheer size of these super dealerships will demand severe risk management strategies, according to Futuro Financial Services managing director Dennis Bashford.
"It means they're going to dumb down advice and you're going to see restrictions in terms of product type and investment strategies. The most obvious in that right now is a number of the larger dealerships no longer allow margin lending," he says.
"Now margin lending is a very legitimate part of financial advice. If you're a dealership where you can't adequately control the advice that your authorised representatives are giving, the easiest way to control it is to ban it, and we're seeing the same thing too with products."
Bashford adds planners will be affected because their licensee will restrict them to providing clients with vanilla advice rather than advice which is in the client's best interests. "They will be forced to offer canned advice and with the paring of APLs recommend the institution's products," he says.
"The consumer then suffers because the licensees are more interested in covering their own backside than in doing what is in the best interests of the client."
Santucci agrees, noting advice is already "dumbed down".
"If you're an institutionally-owned financial planning group, then I say this with respect for a lot of people out there who are very good planners and who do a good job, but your advice is already dumbed down," he says.
"I mean you put on the institutions' glasses and then go out there and give financial planning advice. We're giving dumbed down advice in a sense that it's limited or restricted, not necessarily that the advice is any dumber."
Should an APL become too limited, Irwin says the commercial reality is that it's possible the planner or client will become so dissatisfied they consider moving their business elsewhere.
"At AMP we have an open dialogue with our advisers to understand their customers' needs. A balance of interests needs to be considered when compiling an APL, but ultimately a product should be chosen on merit," he says.
If a dealer group takes away speculative-natured investments from its APL, Pawski points out the argument that can arise is they're possibly denying clients the right to higher returns.
"On the one hand we've seen the speculative-natured investments have major problems in the last few years and in some cases caused 100 per cent loss, so the argument there is, should they have been there in the first place and by taking them off the APL are we disadvantaging clients?" he says.
"That's a very difficult position for a dealer group to be in because remember we're not required to have any particular product on our approved list - we set our own approved list, and as long as the client is aware of what our limitations are, that's the important part.
"So it's probably more about disclosure than anything else and as long as the client is aware of that, that's an informed decision they can make."
