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Planners' Money Drain

August 2, 2006
Planners' Money Drain
By Scott Francis

PORTFOLIO POINT: Most offerings to retail investors promise to beat the market, but few do. Investors should compare carefully and be sure to check funds' after-tax returns.

Financial planners are getting into all sorts of trouble this year over what might be called "professional standards", but for most investors the burning question is how they have performed as investment managers.

Sharemarket funds run by the "back end" of the big finance houses, which in turn operate the big financial planning networks, remain the main path to market for many private investors.

If the funds recommended by the planning networks perform strongly, many investors will forgive any failings at the front end of the system.

Virtually every sharemarket fund offered by the big planning networks will promise to "beat the market". Investors take these promises at face value, but how often do they come true?

AMP is not alone in having a large base of financial planners; most of the big financial service companies examined here having financial advisers recommending their own products.

It's worth noting that AMP is by far the biggest financial planning network in the local market with a network 1552 financial planners. AMP's nearest rival is National Australia Bank with 1346, then Commonwealth Bank with 1022: The rest of the market has significantly smaller networks: AXA 951, ANZ 821 and Westpac 504.

AMP is in the front line as controversy surrounds how the finance house does business. A new survey from ASIC revealed that up to half of the investment recommendations offered by AMP planners in a random sample could not be justified under the terms of current regulations.

Of the 11 financial services companies in the ASX Top 100, AMP, although it is not the biggest company, has by far the biggest planning network. The companies are:
  • AMP
  • ANZ
  • AXA
  • Challenger
  • Commonwealth Bank (Colonial First State)
  • Macquarie Bank
  • National Bank (MLC)
  • Perpetual
  • St George (Advance)
  • Suncorp Metway
  • Westpac (BT funds Management)

So how have the biggest operators in financial planning actually performed? There is little value in looking at short-term returns so I have looked at five-year managed fund returns. The past five years have been quite a mixed period for the Australian sharemarket. The first two were difficult, with overall negative returns, and then the following three were very strong years, with the total return from the index over the last three-year period returning just over 90%.

In order to fairly compare sharemarket funds with sharemarket returns, the most useful benchmark is the Accumulation Index, which measures the growth in value of all the companies in the index, plus the dividends paid, to work out the total average return for shareholders

Over the five years to the June 30, 2006, the ASX 300 Accumulation Index has provided an average return of 12.31% a year. (Companies in the index are weighted according to size, so that bigger companies have a bigger impact on the index.)

Another feasible comparison to sharemarket fund returns is sharemarket index funds. These are managed funds that invest in all of the companies in the index and in the same proportion that they exist in the index, to provide investors with the same return as the index, less the cost of the fund. One of the best known of these is the Vanguard Index Australian Shares Fund. It mirrors the ASX300 index and its return over the five years to June 30 has been 11.63% a year.

Index funds should be low cost but it is not always the case. The Vanguard Index Australian Shares Fund has a management expense ratio (MER) of 0.75% but if an investor buys into it through the MLC financial planning network it is going to cost a lot more: 1.28%.

So how have the big funds matched these benchmarks of 12.31% a year for the market and 11.63% for the best known index fund?

The results are comprehensively disappointing. I have looked at the core Australian managed funds for each company: their Australian share fund, imputation fund or industrial companies fund. I have not considered specialist funds such as ethical funds. I have also excluded small-company funds, as they should be compared against a different index. The appropriate index for small-company funds is generally the ASX Small Ordinaries Index

The Challenger funds group had a major restructure four years ago, so does not yet have five-year results data. The returns from AMP and MLC funds are only updated to May 31, 2006. It is not expected that these returns will be significantly different from the five-year returns to June 30, 2006.

As you can see from the table below over the last five years you would almost always be better off putting your money directly into the market than putting it into share market funds from the big planning groups. On average you will lose $8,000 on every $100,000 in lost earnings.

How the funds performed
5-yr annual return to 30.6.06
5-yr under or over performance
Value created/ destroyed on $100k investment

Index Return
AMP Limited
AMP Equity Fund*
AMP Blue Chip Fund*
ING Australian Share Trust
AXA Asia Pacific Holdings Limited
AXA Equity Imputation Fund
AXA Australian Equity Growth Fund
AXA Industrial Fund
Commonwealth Bank Of Australia
Colonial Australian Share Fund
Colonial Imputation Fund
Macquarie Bank Limited
Macquarie Leaders Imputation Trust
Macquarie Active Aust. Equity Trust
National Australia Bank Limited
MLC Vanguard Aust. Shares Index*
MLC Australian Share Fund*
Perpetual Limited
Perpetual Industrial Share Fund
St George Bank Limited
Advance Imputation Fund
Suncorp-Metway Limited
Suncorp Australian Shares Fund
Westpac Banking Corporation
BT Australian Share Fund
BT Imputation Fund
* 5 year returns to 31 May 2006

The average return was 10.64%, against the index return of 12.31%. Yet the funds listed belong to some of the biggest and, you would expect, best-resourced financial services companies in Australia. The value added by Suncorp Metway and the BT Imputation fund go against the general trend. BT's imputation fund provided a very strong return but its Australian share fund failed to beat the index.

What about tax?

These return figures are all pre-tax. The after-tax returns will generally be a lot worse.

One of the realities of these managed funds is that there would be considerable trading within their portfolio over the five-year period. This trading means there will be tax to be paid on capital gains, and therefore the after-tax returns to investors will be less than the returns published.

Very few Australian fund managers publish after-tax returns. This is a shame, because pre-tax returns offer an incomplete picture for the investor. At the end of the day tax is a reality for all investors, and returns after tax are all that really matter.

Vanguard does publish after-tax returns. For an investor with a 31.5% tax rate, the five-year after-tax return from the Vanguard Index Australian Shares Fund is 11.33%, meaning that only 0.3% of the fund's return is lost in tax. This is based on the investor not selling the actual investment, just paying any capital gains tax and income tax each year. Index funds are very tax-effective because they are not actively trading and trying to beat the overall market; there is very much a buy and hold strategy.

It is disappointing that other fund managers have been reluctant to make this information available, information that would help investors make informed investment decisions. The calculation of this should not be difficult. Indeed, if I had money invested with a fund manager who did not have the skills or resources to calculate after-tax returns for each of five tax rates rates ? the super fund rate, a 16.5% rate, 31.5%, 41.5% and 46.5%, then I would be extremely worried about their competence to manage my money.

Most people take an "active" approach to managing their money. This does not necessarily mean that they are regular traders and always looking to buy and sell; rather it means that they hold investment positions that are different from the index in the expectation that they will get long-term returns that are higher than the index. There is certainly nothing wrong with this approach, but it is worth measuring your returns to be sure that the active approach you have chosen is actually adding value to the index. After all, if the biggest and best-resourced financial service companies in Australia can't beat the index it would seem to be a difficult task for anyone.

Are wrap accounts an alternative?

The short answer is no. Here's why: Many financial planners like to promote their ability to access investments at wholesale rates. In most cases this means placing investments into wholesale funds using "wrap"-style accounts.

Wrap style accounts collectively invest money into cheaper wholesale accounts. The catch is that the wrap accounts have their own fees. The fees on wrap accounts are up to 1%. Add that to a fee of 1% for the wholesale managed funds and you are paying the same amount as when you started out as a retail investor stuck with retail fees. You generally have to access the wrap account through a financial planner, so if they add another 1% fee on top of the wrap fees and wholesale managed fund fees the total fee being paid is 3%.

Some financial planners will argue that the wrap account adds significant value to the client. The wrap account will collect the paperwork for the year, prepare a tax statement and allow clients to log on to a screen and see all their investments in the one place. However, a 1% fee is a lot to pay, particularly if a client is happy to collect the paperwork for themselves and track the value of their investments themselves. What is also certain is that wrap accounts make things very easy for financial planners. They have all their client accounts at the one place, they can charge their fees through the wrap account and can use the wrap service to print of portfolio reports and performance reports for clients. If a financial planner recommends a wrap account, you should ensure that you are getting real value from the recommendation; that it is not merely in your planner's best interest. After all, there is no point in saving 0.5% in fees by accessing a wholesale managed fund if you are paying an extra 1% in fees for the wrap account.


The results of the past five years show that large managed funds, even when they are managed by the biggest financial services firms, do not produce great results for investors. With this in mind, all investors should keep one eye of the performance of their investments, to ensure that they are getting the investment returns that they deserve.

You can try and access lower fees through wrap accounts, but unfortunately you are likely to end up paying even higher fees at the end of the day.

The poor performance of the biggest players in financial planning, many of whom will be supported by a strong sales force of "financial advisers", is a reminder that all investors relying on the advice of an adviser should know exactly how they are paid and who owns their firm.