On December 24, one week after becoming aware the Financial Review had received the confidential ASIC documents and 4½ months after Treasury received ASIC’s warnings, Mr Frydenberg wrote to Mr Shipton requesting an update. “I am sure you share my concern that ASIC’s analysis revealed some correlation between higher stamping fees and underperforming LICs,” Mr Frydenberg wrote. “Can you please provide me with details as to how ASIC is monitoring LICs and other investments to which the stamping fees exemption applies to ensure that the interests of consumers are not being compromised.”
Dozens of listed investment funds that have raised tens of billions of dollars from retail investors are rife with “poor performance” and are paying “conflicted” commissions to financial advisers for “worse” returns, the securities regulator has warned Treasurer Josh Frydenberg.
The Australian Securities and Investments Commission (ASIC) told Treasury the government’s exemption was “hard to justify” for commissions paid by fund managers to advisers and stockbrokers selling listed investment companies (LICs) and listed investment trusts (LITs) to mum and dad investors.
The regulator also revealed the Coalition ignored ASIC opposing the government in 2014 weakening Labor’s conflicted commission laws for financial advisers, including warnings it would be to the “detriment” of consumers, according to ASIC documents released to The Australian Financial Review under Freedom of Information (FOI) laws.
ASIC more recently also cast doubt over whether advisers were satisfying their best interests duty under the law when recommending LICs and LITs that are paying conflicted sales commissions.
A LIC or LIT is an ASX-listed company or trust set up to invest in a portfolio of securities managed by a fund manager and its shares are traded on the Australian Securities Exchange.
A new confidential ASIC analysis for Treasury of 48 LICs and LITs that floated on the stock market since 2015 found a “significant proportion” had negative returns, with a cumulative return of negative 6.1 per cent since inception, including two funds that were delisted due to fraud.
Of the 48 listed funds, 42 traded at a price below their net asset value, with the discount averaging 10.7 per cent, according to the August 2019 documents. ASIC said they involved a “conflicted selling incentive” – where “stamping fees” (sales commissions) were paid by fund managers to advisers and brokers selling listed funds to clients.
“Higher stamping (selling) fees for LICs and LITs are correlated with worse investment returns and bigger discounts to NTA [net tangible assets],” ASIC senior markets specialist David Dworjanyn wrote to ASIC colleagues and Treasury on August 5.
“It is hard, on the historical data available, to justify maintaining the stamping fee exemption from conflicted remuneration for these products.”
“We do ask that we have the opportunity to review your report to the Treasurer before it is finalised …”.
The email messages and slide presentation, classified as “sensitive”, were sent by ASIC to five Treasury officials between August 2 and August 5 last year.
Since the Coalition in 2014 weakened conflicted remuneration rules for advisers and enabled sales commissions to resume for some listed funds, the combined LIC and LIT market rapidly doubled to almost $50 billion.
Retail investors are buying the LICs and LITs with exposure to equities, hedge funds, private equity, direct loans and leveraged junk bonds.
Low interest rates have exacerbated the riskier “reach for yield” among investors.
Best interests duty scrutiny
Advisers and brokers at National Australia Bank, Morgans Financial, Crestone Wealth Management, Evans Dixon, Ord Minnett, Wilsons and Bell Potter Securities have been among the biggest seller of the listed funds.
Mr Frydenberg and ASIC chairman James Shipton initially spoke on the matter in July, following a series of articles by the Financial Review which exposed fund underperformance and advisers pushing the products in return for commissions.
The FOI documents show ASIC’s subsequent investigation by the following month in August had uncovered major problems in the listed fund market and it had expressed concerns to Treasury.
On December 24, one week after becoming aware the Financial Review had received the confidential ASIC documents and 4½ months after Treasury received ASIC’s warnings, Mr Frydenberg wrote to Mr Shipton requesting an update.
“I am sure you share my concern that ASIC’s analysis revealed some correlation between higher stamping fees and underperforming LICs,” Mr Frydenberg wrote.
“Can you please provide me with details as to how ASIC is monitoring LICs and other investments to which the stamping fees exemption applies to ensure that the interests of consumers are not being compromised.”
Labor demands action
The government’s roll back of Labor’s Future of Financial Advice law in 2014 allowed fund managers to resume paying advisers and stockbrokers hefty commissions, often between 1 per cent and 3 per cent, for selling LICs and LITs to retail clients.
Stephen Jones, Labor’s shadow minister for financial services, has called for the conflicted remuneration “loophole” to be closed for “highly risky investments”.
So far Mr Frydenberg has declined to intervene and the listed fund sector believes the Treasurer is unlikely to overturn the exemption for commissions paid for selling LICs and LITs.
There is already a blanket commission ban on unlisted managed funds and exchange traded funds.
ASIC’s Mr Dworjanyn wrote to ASIC colleagues on August 8, calling into question if advisers were abiding by the best interests duty law when selling LICs and LITs and receiving sales commissions.
“The poor performance of the majority of these funds don’t justify the fee structure generally and it makes me question any advice to go into these products, particularly at issuance stage,” Mr Dworjanyn wrote to ASIC colleagues on August 8.
Koda Capital chief executive Paul Heath, who advises clients on over $6 billion in assets and does not accept fees from fund managers, said the FoFA “loophole” must be closed to stop fund managers paying incentives to advisers who sell LICs and LITs.
“The key question to consider is how can an adviser who is receiving a significant fee for selling a product be in a position to offer good advice to their client? The truth is, they can’t,” he said.
Concerns raised in 2013
ASIC’s confidential research into LICs and LITs reveals that many of the concerns they foreshadowed to the Coalition government in 2013 about the watering down of FOFA have come true.
The 42 funds that paid a conflicted stamping fee returned negative 7.3 per cent since their inception from 2015 onwards.
In contrast, the six funds paying no conflicted stamping fee recorded a positive average cumulative return of 3 per cent.
Of the 42 investment funds paying commissions, 22 paid stamping fees of 1.5 per cent and about 10 funds paid fees of between 2 and 5 per cent.
ASIC also noted they charged higher management fees than exchange trade funds, “while significantly underperforming on average”.
A July 24 internal ASIC email, titled “brokerage and stamping exceptions – legislative history”, noted lobbyists in 2013 pushed the Abbott government for a “carve out” from FOFA because companies would not be able to raise capital.
ASIC said an initial carve out was restricted to companies that “made things and provided services”. Listed investment companies were excluded from the concessions unless they were investing in infrastructure.
But a subsequent “streamlining” FOFA package by the Coalition extended the stamping fee carve out by including concessions for LICs.
“In December 2013 ASIC wrote to Treasury again opposing the expansion of the carve-out for the following reasons: ,” ASIC’s financial advisers senior specialist Anna Dawson wrote to ASIC colleagues last July 24.
She copied ASIC’s confidential advice to Treasury from December 2013, which said, “Broadening the exemption will expand the scope for conflicted advice and corresponding consumer detriment. It will also cause an undesirable market distortion by preventing conflicted advice in the secondary market but permitting conflicted advice for the whole primary market. From a consumer protection perspective, we do not see any policy rationale for this distinction.”
“We are also concerned that any broadening of the exemption will lead to arguments by other industry sectors that they have been put at a competitive disadvantage by the uneven playing field that the exemption creates Subsequent relaxing of the FoFA reforms will inevitably lead to consumer detriment.”
Leading fund manager Magellan Financial Group has broken ranks by launching a LIT that pays no commissions to stockbrokers and financial advisers recommending the product to investors. Magellan chairman Hamish Douglass has said the Morrison government should consider capping the commissions to stop misselling risks.
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