Updated: LIC/LIT lobbyists get desperate and resort to personal attacks...

I guess it is not surprising, because I have been repeatedly threatened by vested interests in the LIC/LIT debate with personal attacks unless I withdraw from it...And so it arrived: today a paid representative of the LIC/LIT lobby group LICAT, Dom McCormick, launched a crazy ad hominem assault on me to divert attention away from the public policy question of whether fund managers should be allowed to pay financial advisers large selling fees of between 1% and 3% to push their products to advisers' retail clients. 

For the avoidance of doubt, this should not be a heated debate. It has only become emotive, with lobbyists resorting to these desperate efforts, because there are literally hundreds of millions of dollars of adviser fees at stake, and billions of dollars of fund managers' enterprise value at risk. 

The truth is the debate was resolved ages ago by the establishment of the Future of Financial Advice (FOFA) laws, which banned all payments from fund managers to financial advisers in 2012. It was addressed again by the recent Banking Royal Commission, which strongly endorsed FOFA's intent (despite efforts by the Coalition to unwind it in 2014, which I aggressively battled at the time) and further recommended that all exceptions, such as the LIC/LIT exemption, to FOFA's ban on conflicted remuneration be removed over time. Paul Heath from the independent adviser Koda Capital put it best when he recently wrote in the AFR: 

"How can an adviser possibly serve the interests of both the fund manager and their client? Any payments of sales commissions to promote a product that contaminates clear-eyed and independent advice should be seen as just that. This sort of ‘advice’ is completely compromised and utterly incompatible with the intent of FOFA. Royal Commission? What Royal Commission? Commissioner Hayne made his view on this subject clear, commenting that “there must be recognition that conflicts of interest and conflicts between duty and interest should be eliminated rather than managed”."" Paul Heath, Koda Capital

The lengths Dom goes to tarnish me are extreme and petty. Apparently my AFR columns are "sycophantic", but given my willingness to enter into this debate has come at enormous personal and financial cost, it is not clear who I am ingratiating myself to. I must be doing the bidding of all those mums and dads who have no organised lobbyists to represent them! 

Dom concludes with an attack on my political preferences with the implication I am seeking to support the Coalition, and yet all my LIC/LIT commentary has been a full-frontal demolition of Coalition policy, as it was when I engaged in exactly the same criticisms over and over again in numerous AFR columns in 2014. 

By way of contrast, the Labor Party has enthusiastically backed the policy view that LICs/LITs should be captured by FOFA's consumer protections (as they were between 2012 and 2014 before the Coalition granted the exemption). Back in 2014 the Labor Party, Industry Super and I were all likewise joined at the hip when I resisted the Coalition's efforts to both roll-back FOFA's best interests duty and allow financial planners to receive conflicted selling fees for recommending in-house products.  

While it is commercially convenient for a paid lobbyist to attack me personally to muddy the debate, the problem is that most advisers and fund managers agree with the very simple proposition that FOFA should apply to all investment products irrespective of whether they are listed or unlisted. 

Are leading advisers like Koda Capital's Paul Heath and Will Hamilton (who has been appointed by the government to the Financial Adviser Standards and Ethics Authority board), respected researchers like Jason Coggins and Jerome Lander, LIC/LIT operators like Paul Moore at PM Capital and Hamish Douglass at Magellan, all likewise conflicted? I don't think so. 

These are simply folks who are willing to stick their necks out because they worry that fund managers paying advisers selling fees will gradually destroy the profound reforms legislated by FOFA and endorsed by the Royal Commission. Setting aside the almost certain mis-selling crises, it will create huge competitive dysfunctions between advisers who take commissions and those who do not, and between fund managers that pay these kick-backs and those who would rather just compete on their merits. As Jason Coggins asks:

 "Are we still debating the merits of conflict-free advice ten years after Storm Financial and six years after Banking Bad...Let’s be clear, this is not an anti-LIC/LIT crusade. It is calling out all conflicts. Conflicts can’t be ‘managed’. That’s an oxymoron. Yes, most try and do the right thing. But create the option to do the wrong thing and a minority will prioritise their self-interest ahead of others. The industry does not need lobbyists to tell us what is right or wrong. It’s simple: work actively (and only) for the client."  Jason Coggins

It is no surprise that we have seen different high yield debt LITs frozen---from PIMCO,CVC a---in the last week because of Treasurer Josh Frydenberg's review into the sector. But if, as some fund managers surprisingly claim, the 1.5% to 2% selling fees have no impact whatsoever on adviser recommendations and behaviour, why not offer these LITs with no sales commissions like all other unlisted funds, ETFs and even some LITs (eg, Magellan's recent offer) have done. Why not just compete on your merits? We all know the answer as to why selling fees are paid: because they allow fund managers to raise much more money.

The argument that funds should be able to pay advisers commissions of circa 1.5% to compensate advisers for the time they spend researching products is utterly specious. It contradicts the purpose of FOFA and the Royal Commission's conclusion that advisers should not be able to capture conflicted kick-backs (ie, they should only ever be paid by their clients, like accountants and lawyers). 

And this notion that advisers are "only" earning $200 is bogus. A typical adviser with ~200 clients might convert at least ~25% into an LIT if their firm is pushing it hard. If they get a ~1.5% selling fee, they will earn a huge $22,500 commission (given $30k/client). Leading LIC operator Paul Moore from PM Capital put it bluntly when he stated:

“When you have an anomaly in capital markets, it gets exploited and it only takes a few rogues to destroy the credibility of an industry where the vast majority of players are very conscious of their duties as custodians of other people’s money...There should be no payments allowed from fund managers to the distribution system...I fear—in fact I know—the risk-reward trade-off on many of these new LITs is not at all understood by retail investors (and many so-called “sophisticated” investors). Under the wrong market circumstances there could be real problems down the track—these new LITs could potentially be toxic time bombs" Paul Moore, PM Capital 

UPDATED: After I filed this piece, a reader highlighted that Dom actually appears to agree with my core criticism that conflicted selling fees paid by fund managers to advisers are driving retail flows into LICs/LITs. In October 2018, Dom wrote in Professional Planner:

"But perhaps the biggest factor in the popularity of these listed investment structures has been the ability of brokers, dealer groups and planners to earn ‘selling fees’ of 1-2 per cent as part of the IPO process. Financial planners have become a larger component of LIC initial public offerings in recent years, compared with the listings’ historical reliance on stockbrokers and direct investors. While the fees are not particularly large and some rebate them to clients, the ability to earn what are effectively commissions on listed fund IPOs is one of the more obvious Future of Financial Advice (FoFA) anomalies...It remains to be seen whether the selling fee anomaly will continue to exist, given the current focus on eliminating grandfathered and other previously excluded forms of conflicted remuneration. Greater scrutiny around, and possible elimination of, the ability of some to earn these selling fees following the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry is one potential headwind for growth in the LIC/LIT sector. " Dom McCormick, October 2018

Writing in 2017 for the Portfolio Construction Forum, McCormick argued that one of the reasons Magellan’s new LIT would be “very successful” is because of the “the number of major brokers involved keen to earn a selling fee of 1.5 per cent (joint lead brokers receive an additional 1 per cent)” and the apparent problem that there was a “dearth of commission opportunities”.

The only thing that Dom of circa October 2018 and I appear to now disagree on is whether a selling fee of 1% to 2%---the same as what a real estate agent earns (although the agent typically only keeps half this fee) or more than what a mortgage broker captures---is a large fee or not. I believe any selling fees above say 0.25% are large enough to conflict financial advisers, especially when this selling fee is added to the other transaction fees, including arranger fees and manager fees, which can easily push it above 1%. The bottom line is that financial advisers should not be capturing any conflicted fees---they should only be paid by their clients.

I have written in detail about my long history with this public policy debate, starting in 2014, in this recent Linkedin post. Dom claims I am motivated to stop fund managers paying advisers selling fees because of my commercial conflicts. Some argued the same point in 2014 when we tried to stop the Coalition from rolling-back FOFA to virtually nothing (see one of my many 2014 columns on the subject here).  But what are these conflicts? 

We've repeatedly been offered the opportunity to do LICs/LITs (as recently in December 2019 I was approached by a top broker about this), but have chosen not to. My largest shareholder, Pinnacle, is a strong supporter of the LIC/LIT industry with three of its fund managers, Metrics, Antipodes and Spheria, having big LIC/LIT offerings. 

Neither my shareholder nor its fund managers are presumably delighted that I am calling for FOFA to be returned to its original 2012 state, and that could create nontrivial commercial problems for me personally. And then the 20% to 30% of brokers/advisers (mostly brokers) who take selling fees from fund managers are frustrated that I have taken this stand, and they have punished us by withdrawing their clients from our funds. Now layer on top of all of that personal attacks!

It would be much, much easier to sit on the sidelines, but I have never really done that on any issue since I began writing for newspapers almost 20 years ago. Only this morning I wrote to a leading LIC/LIT operator that is supportive of my position in the debate that, "I find it incredibly sad and dispiriting that so many very smart and talented people are happy to suppress what they know to be in their clients' best interests because they are commercially conflicted. I see this over and over again."

A final straw-man I am sometimes asked about is the hybrid market, to which our portfolios have a minority exposure. I've said this before and I will restate it again. First, I don't think financial advisers dealing with retail clients should take any conflicted sales commissions, whether they are paid for pushing an LIC/LIT, an equity IPO, or a bond/hybrid issue. It is all the same problem.

Second, I have explained that regulators overseas and here in Australia do distinguish between a productive company raising equity and debt/hybrid capital so that it can operate its business, where the standard regulatory practice is to allow sales commissions, and a fund manager paying a financial adviser a selling fee for a speculative investment product, which is often prohibited in the case of retail customers. 

Finally, hybrids are complex instruments, certainly more complex than cash or vanilla bonds, and beyond the comprehension of most mums and dads (though theoretically simpler than equities until they become one). I've made that point many times over the last decade.*** 

Returning to Dom's disappointing piece, which frankly makes me very sad, I will leave you with the completely unconflicted take of the respected asset consultant Jerome Lander, who was previously director of investment consulting at Russell and CIO of WorkCover:

"One of the worst articles I've ever read Dominic - in my dismay, I have tried calling you but not got through. I am shocked you would write an article like this attacking the person rather than sticking to the issues. The financial services industry would be much better if funds and advisers competed on a level playing field on their merits alone, and if financial industry participants could present what they believed was in the interests of clients instead of clamouring over the fast easy money (with no long term alignment) from raising LIC funds or from lobby groups. If those participants then choose to themselves work in alignment with these beliefs (which are also in alignment with client interests), then that should not be a surprise to anyone. Chris Joye has raised numerous excellent points about this issue and would quite obviously have been able to raise higher margin and more highly profitable LIC money should he have wanted to without any wrath from other industry participants . Furthermore, he is directly challenging Coalition policy and can hence hardly be considered a stooge for them. I don't believe Chris Joye is employed by any LIC lobby group nor does he benefit directly or indirectly from the large amounts of funds LICs have raised, as do the vast majority of people arguing in favour of keeping the commissions. Whether you like Chris Joye or not, I believe the way you have attacked him here - seemingly only because you are now employed by the lobby group and because he is the leading advocate of the other side of the debate (and not paid for by any lobby group) - is inappropriate and unprofessional in my view. It reflects poorly on you, the lobby group which has employed you and the fund managers that are funding that lobby group. I would be interested in knowing which fund managers are funding the lobby group?"

*** ASIC is introducing new Design and Distribution Obligation laws next year that will mean that issuers of hybrids will in all probability only be able to offer them to institutional and wholesale investors. We saw banks preparing for this with NAB's recent OTC hybrid issue that was only available to institutions. In truth, however, equities are ultimately the most complex securities a retail punter can ever be exposed to, but for some reason shares and margin lending against shares have been exempted from these new DDO rules, which seems extremely odd. Whereas there are an unlimited range of factors that can impact an individual company's earnings, a hybrid has a much more finite range of risks, albeit that they are still beyond most retail investors to come to terms with. So in the same way that high yield corporate loans have a role in retail portfolios (with their complex covenants and myriad idiosyncratic risks), so too do hybrids. But most retail punters should seek professional support when trying to manage these assets.