The future of portfolio construction

With Charlie Haynes, CEO of Lonsec.

It's never been more important for financial advisers to have a clear and quality investment philosophy for their clients. Charlie Haynes, CEO of Lonsec, discusses how managed accounts and investment research is evolving and the portfolio construction benefits they are bringing advisers and investors.

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Matt Heine: Hi and welcome to this episode of between meetings. I'm delighted today to have one of the industry stall wells who've I've known for many, many years and has had a very varied and interesting career. He's been a dealer head, he's worked in technology and he's now heading up one of Australia's largest research firms. Welcome to the show Charlie.

Charlie Haynes: Thank you mate, nice to be here.

MH: So Charlie Haynes you're currently the CEO of Lonsec but how did you actually end up in this position, what have you done throughout your career and was it always an interest in finance that got you where you are today?

CH: The short answer is no, I actually started off in IT, so my degree in the 80s was in systems analysis, which was the only IT degree that didn't require a maths A level as the UK had then and then from there I started working with Lloyd's bank, so that was my first exposure to finance but very much working in the IT systems department.

MH: So, systems' department back in the 1980s are we talking punch cards or was it a bit more advanced than that?

CH: It was slightly more advanced than that, my first, when I did my education, my first O level assignment was to send a bunch of cards off to Brighton. Brighton University had a punch card reader and they actually then translated it and sent it back with all the errors and it was a very slow process.

MH: I can imagine but in many ways that gives you a deep understanding of how computers work.

CH: Absolutely, I was there when Microsoft Windows came in, I was there when mice first got used and in the days when I worked for Lloyd's bank, the computer room was literally the size of football pitch and you had golf carts to go from one end to the other. So very different today.

MH: Why IT, I mentioned it was a very early days and there wouldn't have been a lot of people looking to study IT, back then, and I should preface that you're not that old.

CH: The answer is probably because it wasn't that popular and it was new and it was exciting and nobody really understood what it was including me. And so I thought I'd just go in and have a go, I didn't fancy being an accountant or a lawyer or anything like that, this was something new and emerging and so I got stuck in.


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MH: And you end, did you say Lloyd's bank?

CH: I did, Lloyd's bank for a while but then after that I very quickly joined a management consulting firm dealing in case tools, which are computer aided system engineering tools, very rudimentary compared to what you'd envisage today, but it gave me a good understanding in data modelling and process thinking, which is actually what stood me in good stead for the whole of my career.

MH: Case management being workflow?

CH: Very much so, so workflow management and as I said, data modelling and data management now. All the terms have changed so now we have use cases and we have objects and we have whatever else but it's all the same principles.

MH: And how did you end up going from IT consulting into financial services?

CH: So most of my clients when I was in the management consulting firm were financial firms, started off in retail banks and then when I came to Australia, Bankers Trust as it was then was a big client, and it was always interesting to be involved with those financial products. Then I actually worked for BT for a while, and that gave me great exposure to unique registry systems, but it was the very early days of BT wrap and BT margin lending and things like that, and it was a really interesting field and I found I really enjoyed the subject matter. And I never wrote code, I was always on the analysis side, so I was understanding how the business is worked and that just got me hooked in I guess.

MH: Because the unit trust registry systems back then were very rudimentary and I think many of the early platforms, BT included were sort of built on top of these systems that were really meant to administer manage funds.

CH: Exactly right, so BT systems is a system called Trust, written in COBOL, COBOL 74 I think it was, and it was just this big monolithic beast that was very hard to manage so you started building satellite systems around the outside, and that's where wrap effectively emerged from.

MH: And did that then move into Asgard?

CH: Ah look, I then left BT, so they did acquire Asgard, so BT Wrap was one system the built in-house, and Asgard was another system they acquired from Securitor effectively and put the two together and today have still not emerged into one consolidated platform, they still running all of them.

MH: And is that where you met your long term partner Ian Knox?

CH: No it's not, so Ian and I, so I carried on doing IT, the consultancy firm I was with eventually closed down, got acquired by a US company and I ended up running a life insurance system business called FIS in Australia, and we implemented some big systems there, but they were sort of 14, 15 million dollar projects, and I very quickly worked out that there weren't going to be very many of those in the Australian market-

MH: And they're more like 200 million dollar projects-

CH: More by accident than design but yes and so I decided I was recruiting graduates who came out of university into IT jobs and I had no idea what they were talking about and I thought this is going to be interesting if I get caught out in my forties, I'm going to end up not knowing what I'm doing, so I deliberately left a well paid job back in the 90s in IT, it was a very well paid job, and said no, I want to do something different. And networking at the time I got introduced to Ian through a mutual contact, who said hey, what you're talking about and what he's talking about are actually the same, you should meet that guy and yes it turns out that Ian used to be heavily involved with Asgard.

MH: So I think he was running it back then.

CH: He was indeed when it was part of Westpac.

MH: So what was the first venture that the two of you embarked on? Was it the consulting business that we actually ended up acquiring at pathway or was it the licensee.

CH: Well it was actually the licensee so we set out, when we first got together, we set out to build a licensee, but we very quickly realised that nobody was going to join if we didn't have any dealer services. So we then thought okay, how do we quickly get into the dealer services business, and to cut a long story short, we decided to buy DBOS off of Zurich, which was a sister company at that time to Lonsdale and Lonsec, which is a bit ironic from where I've ended up now.

So yeah DBOS stood for dealer back office services, and it was, effectively had a BT badge, a BT Wrap badge at that time, but it consulting around compliance and technology implementation and research, hence the Lonsec connection. So we put that together, we then bought the Tribeca compliance business off what is now Kaplan, and so we suddenly found ourselves with 25 compliance consultants and an awful lot of revenue but not very sophisticated client base. So overnight we decided to double the price of everything because the business was losing money and we lost half the clients but that meant we had the same revenue but with half the amount of work to do so we could actually rationalise the workforce and have a profitable business.

And that was the start of Paragem dealer services.

MH: Right so the dealer services actually came before the licensee.

CH: Yeah well we had one practise in the licensee and as I said that we worked out quickly that no one else was going to join so we built the dealer services, we thought that would take us a year to get back on its feet and always happens it took us three years to get it back on its feet, so that became the core business for quite a number of years, and that had as you know sort of 23, 25 staff at certain points along its journey, which in itself takes a lot of time plus several thousand advisors that we had to deal with around the country so it was unexpected but exciting part of the journey and a great learning curve for what it takes to actually run a licence.

MH: And what years was that?

CH: Well we started in 2004 and I guess we finally exited that business in 2011 when it was bought by [inaudible 00:08:20]?

MH: And what was the landscape like back in 2004 from a licensee perspective, what was it that you saw as the opportunity and why did you think you could win in that space.

CH: Look that's a very fair question and that's why Ian and I set it up, we both went out to actually find independent financial advice and everything came with strings attached. And we discovered very quickly that we were not alone, in thinking that there must be a better way so we wanted to set up a licensee from the outset, that did not rely on effectively volume rebates and grandfather commissions. So we set the dealer group up but we accepted no sponsorship from any product manufacturer at all, it was all advice based and it was all focused a 100% on what the client needed to achieve. The APO was as wide as we could make it without being unreasonable, which meant we used the Lonsec recommended and highly recommended list but we no constraints.

And the only reason we could do that was because we insisted that we would only recruit really high calibre advisors. And we had a very simple test, we'd put them through the compliance test, we'd interview them and whatever else but at the end of the day, we'd turn around and say to each other, would you refer your mother to that advisor? Because if you wouldn't refer your mother to it, why would you refer someone else's mother to it. And that was the test and we probably turned away some good advisors, but at the end of the day we kept out of trouble.

MH: So back then so a model, which is really going to be the prevalent model if you like moving forward, would have required you to charge a much higher dealer fee, so if you're not being subsidised through rebates and product sponsorship, how is that received? I imagine that would have made very difficult to recruit in the early days?

CH: Look the answer is yes but it wasn't as high as you might think because that's where Paragem dealer services came in. Effectively Paragem was one of 200 odd licensees and several thousand advisors, so our infrastructure costs we shared across all those people and in fact Paragem, could pretty well get it for free on the back of the broad distribution of the other avenues. So we had a totally scalable model, we didn't have any fixed headcount cost at all in licence, and we simply paid a revenue split to the dealer services business every time we took on a new advisor. So we could never lose money, we never made much money, but we could also never lose money, which was a very nice position to be in.

MH: So 2004 was broadly when we started to come into the market and get some traction and it was very hard because I think the independent part of the market may have equated to 20 to 25% of the total number of advisors and so it was tough and the size of our opportunities it was relatively small. Did you find back then that there was a move towards the institutions? Was it people that you were coming across that wanted to leave institutions? What was sort of the dynamic at the time because it's gone through a number of cycles over the years.

CH: So back in those days it was very much the institutions were growing, everybody was joining, they were acquiring dealer groups left right and centre and every BDM you met who worked for an institution, had a target of adding another 50, 60, 70, 80 advisors in the year and obviously there weren't enough to go around and so it was very competitive, but where we were succeeded was very much on, one on one personal relationships. Where talking to people who came to us for whatever services might have been and saying well there is another way, would you like to be part of a band of like minded individuals who really want to focus on being professionals and not get bogged down in the politics of products flogging or part sales or whatever you want to call it, and that was it, so we grew very, very slowly and it was very deliberate, we probably only added about four advisors a year but we had no intention of being big, it was all about quality.

MH: And what did the licensee get to at it's peak? Advisor numbers?

CH: When we finally exited, or when I finally exited Paragem, because Paragem is obviously still going, we had 72 advisors but that was over a journey of 15 years. So it was a very slow build up.

MH: Certainly that's very interesting I guess it would have taken a lot of resolve or debates or arguments over the boardroom table around, I guess that conflict around growth and doing what everyone else was doing at the time and they were very well rewarded and there was a lot of money being made, how did you actually make sure that you stuck to your values and your principles at that time? Was it just your alignment between you and Ian, did you challenge each other regularly? How did that partnership actually work?

CH: Yeah it was the alignment and it was an uncanny alignment because we really didn't know each other at the start, and for the first three years we didn't have any shareholder agreements or anything we just carried on and we just learnt that we both thought completely differently in as much as Ian is very much a loves PR I guess and he is very extroverted, and he enjoys thinking on his feet, I'm very analytical, I like the logical process, it's probably my IT background, but we found that we always ended up at the same place, and so it didn't matter, which way you came from you ended up at the same point. And the easy part was it was always with a consumer in mind. If we were doing the right thing by the consumer, and therefore employing advisors who understood what that meant, then it seemed to work.

But we did have the luxury of having the sister business, Paragem Dealer Services business, to keep paying the bills so we had no urgency to grow.

We had no need to get scaled in a hurry, we could do it patiently.

MH: And we're now seeing a lot of dealer services launching presumably to subsidise a lot of the advice or the licensees, do you think it's realistic to have that many providers in the market and seems like every couple of days a new one's launching.

CH: Yeah the short answer is no. I think having said that there is a great opportunity for highly professional dealer services businesses to exist and ideally independently of product providers and I'm only aware of one really is completely independent in the market today.I think there're opportunity to put together a good package of services and charge appropriately without any conflicts around products and distribution is fantastic. But no, there's too many people popping up with ulterior motives some of them with no distribution or no real value proposition other than we can get it cheaper than you can, which is not a very sustainable value proposition at all so, I think there's a day of reckoning coming.

MH: And lots of opportunities in the market at any given time, back in 2004 when you did require Tribeca and DBOS, do you remember the process that you went through was it a strategic intent that you're looking for those assets or was it more opportunistic and you thought at the time this sort of fits, let's have a go?

CH: DBOS was, I guess a strategic intent, would be pushing it, but it was part of the conversation Ian and I had when we first met. When I said based on what you're talking about I think you need to target a business like DBOS, and unbeknown to be Ian had actually put in a request for the IM, so we had and we thought that there was an opportunity there to take it to the independent market rather than have it institutionally aligned. Tribeca was far more opportunistic, we knew the Tribeca team and we discovered that they were for sale and that the sale was all around the monetary return to the owner rather than thinking about the people so we focused on the people and low and behold they decided they'd rather wanted to join us than be sold to an unknown third party. So, that was more opportunistic.

CH: So as I say we suddenly found that we had all those staff and no premises and very nicely Kaplan actually agreed to let the people stay on site for three months while we found premises even though we'd effectively taken them from under their feet, so it was an interesting time.

MH: From that perspective, was that probably the biggest lesson you learnt, on acquisitions or what do you find makes for a successful acquisition, versus one that's not successful?

CH: Look I think we've seen a few now on both sides of the fence, and I think the key is-

MH: As a seller and also a buyer?

Charlie Haynes: Exactly right, and the key seems to be the level of integration. You've either got to decide to run them at arms length or decide to integrate, but you can't be half pregnant. If you're trying to dabble and have people do what you want but they're not really aligned then you won't get the benefits you're seeking.

MH: When you say that in that they might still have equity or in what way?

CH: More in terms of the strategic direction of the business and understanding why decisions have been made. And effectively all pushing in the same direction. It's very easy to have people thinking you're going off in one agenda but actually you're trying to achieve another agenda, and if you miss that alignment you're going to end up spending more time focusing internally than you are externally and someone else will just pass you by and it's not to say that you can't run them independently, when we sold Paragem to HUB24, it was run as an arms length independent business and still is today and that works find as long as it's a conscious decision, but if you're going to integrate, then do it properly and get integrated very quickly.

MH: Because acquisitions as we know can go very well and very, very wrong and there's great examples across the board I think at the moment.

So changing directions a little bit, I think probably as a firm back in your Paragem days you were one of the very early believers in managed accounts, what was it that you saw back then that excited you about managed accounts and why did you push so hard into that space when you did?

CH: Look ultimately it was that we saw the all advisors dabbling in portfolio construction but with no particular core expertise in that area, and that coupled with the inefficiency of running multiple portfolios across a business, and then if you finally dig in and you realise actually the implementation is sporadic at best, you actually from a licensee perspective, you say there's actually quite a lot of risk embedded in here. But from an advisor's perspective there's a lot of lost opportunity and inefficiency that could be achieved elsewhere. The hard part of course was to getting the advisors to understand what was their real strength and what was not their strength but it's fair to say that GFC kind of focused peoples attention on that. And suddenly it was not desirable necessarily to claim that all your skills were wrapped up in investment selection and that maybe other people could do it just as well and that probably coupled at the same time like Netwealth in particular, and UP24 and others that moved into the managed account space, very vocally and you were able to do things that three or four years before you simply couldn't do.

And then the final catalyst was the demise of the limited MBA, which many advisors had been operating KWAZI managed accounts on, on some of the traditional platforms under that environment and suddenly that was no longer an option so you had to choose to either go back to the old ways of IT SOA's and ROA's for every investment change or looking for an alternative structure.

MH: What was some of the big lessons you learnt because change management is part that often gets neglected when implementing managed accounts whether its at the licensee level or at the practise level, how did you actually go about bringing people along for the ride or for that journey?

CH: Look that was the biggest single lesson that we learned out of the whole thing. You know just because we understood the benefits at the headline level did not mean that people were going to actually do it, and not least of it because A, what's in it for them?, but B, it's actually an incredible amount of work in understanding. But the biggest single lesson was an advisor would not put them into a position where they could potentially embarrass themselves in front of a client so what that meant was giving them enough information so that they understood that it was not enough. You had to give them enough information so that they understood how to answer any potential question that a client might come up with.

MH: At the stock level? Or just around how to manage account operations?

CH: Just well it's three levels effectively, it's first of all at the structure level, then at why did you pick that particular manager and then is what is that manager actually doing now and if you can't address all those three areas then you've got a problem. And as I say the advisor will just shy away from it, simply out of self preservation until their confident, which is why whenever you see an advisor latching onto managed accounts, you tend to see very slow feed in the early days, and then suddenly momentum builds because they get it, the confident and off they go.

MH: Was it difficult to change the mind set for advisors from going ... from management stock selection to redefining their value proposition for the client?

CH: Absolutely, there's definitely a multitude of reasons why advisors will and won't do it, and I'd say even in paragem with its connections to HUB24 and Netwealth, they probably 50% got it and 50% didn't and by got it, I don't mean they didn't understand, it's just that they felt that there was nothing necessarily wrong with what they were doing or that their clients had selected them for a particular reason already and they were comfortable with the current model whereas others who were particularly looking to grow, and looking to the long term were saying okay, how do I grow a scalable business in the current climate and keep myself out of trouble from a risk perspective and they saw managed accounts as the opportunity.

MH: So we've talked a lot about the benefits to the advisor and the licensee, how do you best articulate or describe the benefits to the client?

CH: Look this is where I'm actually most passionate, and I'm an avid user of managed accounts for this very reason, the best example I can give you is that with Lonsec, we've produced model portfolios for years, and model portfolios are basically paper based models that people can download, off the research system, that say okay for each sector these are the funds we recommend, and if you put it together, here's a good portfolio. And what we'd find is that advisors would take anywhere from three to six months to implement those recommendations. Well the rationale for the recommendation in March has long gone by the time you get to September plus there's significant pricing movements and all sorts of things, so the benefits I see are the timely consistent implementation for all clients, where you can have one justification for doing it, you make the choice and you make the move and you do it straight away and that to me is the biggest single reason why managed accounts makes sense for the client and the for the advisor as well because the advisor doesn't have to do the paperwork to back it up.

But first and foremost, Lonsec did actually do some work to try and cost the delay and it's very significant that after one month and after six months you might as well not bother.

MH: One of the early reasons for managed accounts was the tax benefits, now in our experience that relates to stock selection, you know selling stock at the right time, those sort of things, but the experience would suggest that 75% of the assets if not more are in managed funds and that argument largely doesn't exist, are you seeing a similar trend within Lonsec in your current role where in many ways it's the traditional managed fund models simply being put into an automated environment?

CH: Yes, I mean the answers yes, that's definitely where it's been, where it's going at the minute is to things like ETF's and portfolios, so not so much the traditional managed funds but still managed investments as opposed to individual stock selection.

MH: Which is about 25% of our total managed account now?

CH: So the growth we're getting at the minute actually is in the listed portfolios because they have a listed portfolios because they have a lower ICR and those are for people who are particularly happy with passive type selection. On the retirement portfolios is the other section where we're seeing people looking for a mix of income, and capital growth and that has some SMA's in there as well as traditional managed funds. The actual pure traditional managed fund portfolio are still growing but they're not growing as fast as the other two.

MH: Okay that's interesting, what are some of the observations or other observations you make about managed accounts at the moment given where they are today and the growth that the industry is seeing?

CH: Well the obvious ones and the ones that we know that [Asix] looking at is the quality of the investment manager is everything. Packaging up any old portfolio and calling it a managed account is fine from an efficiency perspective, but is that really acting in the clients best interest. And that's something that's now starting to become I guess front and centre after the raw commission.

And the obvious correlty to that is really is whether or not you should be charging a fee for the investment portfolio construction and the investment management tree, and it's fair to say that with most platforms and that's wealth included, charging a fee at the investment management level if you're also the advisor is probably unpalatable, it's not illegal and that's one of these things where community expectations have probably got ahead of the law, but certainly trying to explain ISI give advice, I charge a fee for that, then I put you in my product and charge a fee for that, those days are kind of over.

That doesn't mean the product is necessarily bad, it just means the assumption is that this is a bad conflict and you have to defend yourself rather than using the third party product.

MH: It comes down fundamentally to what is the service that you're delivering to the fee that you're collecting. And you need you be able to articulate that very clearly and certainly we're having fairly robust discussions with a number of groups around that particular point, where we're saying we don't have a particular problem with you charging a fee, but as long as you can demonstrate what it is that you are doing for the fee.

CH: Correct and that's exactly Asics view. And the other side of that is they're also having a good look at the quality of the investment committee, so who's actually making the decisions and then whose accountable for those decisions. Because there are some models in the market where effectively the accountability is pushed right back to the individual making the decision but they're not carrying the licence, they're not the one been issued the authority to do it, so the shooting back the authority to where, sorry, shooting back the responsibility back to where it belongs is a big thing and also the professional standards of the individuals who are making the decisions. And that's where a company like Lonsec is a beneficiary because that kind of brings into the play the research houses and we're obviously one of them.

MH: That's your DNA.

CH: Exactly.


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Do you want to make comment on SMA versus MDA?

CH: Look I have a personal preference, I think my view always been SMA is preferable, I think the MDA is probably a structure that had its day and the reason it came into being was very simple to allow people to flexibly manage individual portfolios of stocks and things like that but what has happened now is advisors have especially under the what I call the [Venta] licence models, where you can actually set up an MDA investment committee as an extension of the licence without having to have the MDA operator licence yourself, that is making you quite removed from the point of Asic appointed the licence to the point where the decisions are being made. You know there's strengths in that model, you have to produce the SOA every 13 months so you have to prove that the investment programme is relevant and that's a good thing, but again it comes back to the calibre of the people making those decisions and historically in particular it was perceived as easier to become an MDA managed account operator than it was to become a SMA or a managed portfolio one, because of the vetting if you like that goes on at the platform level.

And some of those models now have RE's involved as well, certainly they have trustees involved if they're being used for super and all those layers give a better quality outcome than if you're just a group of people manning together and doing it ad hoc.

MH: Absolutely. Research like every part of the industry has been going through a reasonable amount of change, over the last two to five years, where do you see future of research and what's the real value that you as Lonsec can deliver to clients?

CH: Look the answer is I think the research is stronger than ever, the need for research, and the demand for research and really I look at it from the shoes of the advisor, but also then the shoes of the investor. Because there are two mega trends that we are effectively responding to, embattled advisors and empowered investors.

MH: I love those two terms, I might spend a bit of time on both if that's all right?

CH: Of course, no worries. But what I'm getting at there is I guess the empowered investor who are simply a lot of people who are self directed not necessarily through choice, some of them are as Netwealth calls them, previously advised clients where they used to have an advisor but that advisor is no longer licenced for what ever reason or can no longer afford to service the clients typically with smaller portfolios and things. Unfortunately one of the objectives of FOFO was more affordable advice for more Australians. One of the outcomes in recent times is less affordable advice for more Australians. So we're finding a greater need for direct access to information that traditionally has been made available to intermediaries like financial advisors but now needs to be made direct.

MH: Do you think those direct empowered, you mentioned the empowered investor, do they want to be direct or is that they didn't understand what they were paying fees for, the value the advice was adding outside of stock selection? Because a lot of people don't have an interest.

CH: The answer is a bit of each. So there's definitely some people who want to be individual investors if you like but even there I'm recognising today that the days of the hero trade back in and retiring into the sunset is over, and the need the for diversification and the need for sophisticated portfolio construction, and to understand yes how the funds behave individually but how they behave collectively, is just as important. Those things are becoming better understood but then you need the information to back that up and then product selection is also equally as hard.

On the other side of the fence, absolutely there's people who have no interest at all, who've ended up with a portfolio of assets that may well have been relevant when they were first put in them but as time progresses they may still be relevant today but roll forward five years, will those assets still be the right assets for that person? Probably not, and what worries me most is the idea that, and it's happening in the superannuation space now, publishing league tables of last years winners. Which is simply going to encourage people to jump around and chasing last year's winner.

MH: Which is why everyone's been trying to steal into investors as far as I can remember, which is past performance is ... I forget the saying right now, no indication of future test.

CH: No indication of future test effectively.

MH: Correct.

CH: Look and I think it's a nightmare, I think it's encouraging exactly the wrong behaviour, we know it's a recipe for disaster, you know potentially some of the heat maps or the league tables that we're getting even the regulators talking about, are going to promote that behaviour. So the need for education and to actually say no build a good portfolio and then monitor it yes, adjust it yes, but don't just throw the baby out with the bath water. I think is really important.

MH: Do you think with the league tables they're going to also look at our cell location, because that is one of the very contentious issues at the moment, around actually trying to standardise what a balanced portfolio looks like and what assets are deemed income versus growth. Are you hearing any movement on that particular topic?

CH: Absolutely, so we know that, in fact we know there's about three different camps of people who are all trying to address the same topic, so that presumably means we'll get at least three different answers, which is one of the challenges but at least it is being understood and it's one of the areas we've had a lot of success with so about a year ago we started to make our superannuation research available to advisors, along side the managed fund and listed research and more recently we've exposed what you might call the Lonsec standard asset allocation models and line them up against the super.

Not to try and say whose right or whose wrong but to simply demonstrate the difference so that of you're in a balanced fund for example and you pick a superannuation's balance fund it may well look like a growth fund and if so you need to be aware of that because as an advisor, you are now not acting in the clients best interest because you've put them in product that does not line to what you identified to be their preferred asset allocation. And it also has implications for BI insurance so you do need to understand the products you're putting people into.

In the past advisors didn't have access to that information and we didn't make it available whereas now we're finding that's probably our biggest single demand if you like is to expose that information.

MH: So it's currently available through Super Earnings or it's something that Lonsec and Super Earnings are working on?

CH: So we've made the Super Earnings research available through Irate, which is our research delivery platform, and yes in Irate now you can pick a balanced and then line up three of four different funds next to it to see which ones are really balanced and, which ones are actually doing something else.

And it's not necessarily right or wrong, it's just the label on the tin, it's not necessarily what you get inside and you need to be aware of that.

MH: I'd love to have a look at that because I think you're right, if you put a balanced fund against it might actually be a conservative fund or an industry fund, to look at the discrepancy of performance, is really where I think as an industry we need to start focusing on because it is so broad the definitions now that it's certainly not doing consumers any favours.

CH: Absolutely and as soon as we explain that to an advisor, I mean Irate just walks off the shelves.

MH: So going back to the empowered investor, do you see this as a trend that's sort of coming from the UK and America? Is it replicating what's happening over there or are we gaining to that spot in a different way?

CH: Look I don't really know the answer to that because I know that those two markets are more advanced in the self directed space, I think from us it's very much a fall out now of advisors that A, diminishing in numbers and B, more circumspect about who their clients are, at the same time as investors are more savvy about the fees they're paying and what they getting for in return. So I think those drivers are what's getting us there, are we going to end up in the same place as those markets, I'm not sure. But I take a longer term view because it's very hard to pick when you're going to cross a certain threshold, so I look out and I say okay, if you go back, I was going to say 10 years, but it's probably more like 20 years now, people thought Comsec would never work and the stockbrokers thought, ah that's not a threat to our business, well now we have a whole generation who can't imagine life without Comsec and I can't help feeling that's going to be the same when it comes to managed accounts or managed funds or whatever there'll be more of a different options if you like to access those things available to retail investors.

And so Lonsec in particular feels we have a role to play to actually help educate people to make good investment decisions when those options are available. We're starting to see it now, Netwealth obviously got a large direct percentage of clients, which are now ending up as direct whether they want to or not, and we think we can help those sort of people.

MH: So I don't like the term but are you talking Rob or more self directed in that they'll take responsibility for their own S allocation and risk profiling.

CH: So we see that as a journey, we're talking all of the above but I don't see Rob as a robot making decisions on your behalf, I very much see that as Rob assisted advice. But in the first instance yes, it's giving people the tools to understand how to understand their risk profile, and how to blend that with their goals. You know a lot of an advisors job today is actually sitting down and having conversations with people and going okay you can't take zero risk and make 20% returns, it's just not possible, so it's a trade off, so people have to understand how to get to a trade off where they're comfortable. Then out of that we'll produce an asset allocation and then out of that they need to move into asset selection. Well yes we can effectively once you have an asset allocation, if you decide you want certain objectives to be met, you want to reach a certain level of income or you've got a certain time frame we can actually recommend a particular portfolio that we've constructed but then you're moving into Robo advice because you're actually taking the person's situation into account to produce a particular product recommendation.

Now all of that's doable but at the minute, we'd rather make the information available as general advice and let the investor make the decision.

MH: For the previously advised clients that do sit on the Netwealth platform, asset allocation it's difficult to the point where they get stuck and then when it comes to picking those assets within the asset allocation with the asset classes, they either lose interest or don't have the skills and capability or the information.

CH: Or they look for last years winners, which we don't want to do.

MH: So that was one mega theme, the second one that you mentioned earlier, the embattled advisor, what does that mean?

CH: Look it's really the advisors focus at the moment is on self preservation, and in that's not in any way negative it's just they've been through FOFO, they've now got Fasea and apparently there's going to be up to 30% of the advisors are going to leave the industry and not qualify whether they leave or become statesman in a practise and then look to recruit junior more qualified advisors, only time will tell. I think that's a very viable model but the cost to running an advice business up, which means it's going to put the cost of advice up, and so advisors have to reinvent their value propositions and say what can I afford to do and what can't I afford to do. And how can I have a scalable business that allows me to service the appropriate types of clients at the appropriate time for a reasonable fee. And all of those things mean and actually and that's if you like besides the fact that they've got a day job, which is giving advice to a 100 or 200 hundred clients odd, so we see those advisors as very much weathering the storm and the advisors that are ahead of the curve if you like, have already passed their Fasea ethics exam, they've already worked out their qualifications and they're one a journey.

But there's still quite a lot of advisors not quite so much with their head in the sand but if you like looks down at the headlights not quite knowing what to do and those people are going to have to come to a cross roads pretty quickly and in that context, one of the things they can outsource if they want to is portfolio construction and asset collection because people like ourselves and plethora of Asic consultants who are now around can actually do that for them.

MH: Which is when you rank what's important to a client, investment management, stock selection is one of the last items that ever get mentioned, it's the upfront relationship and structuring and advice where they need to be focusing their efforts.

CH: Absolutely very much around the, am I going to meet my goals?, or are my goals need adjusting and shifting in which case and that I think is where the advisor adds the most value, then the structuring and strategic advice and then finally once you understand the risks and the goals, the investment becomes relatively straight forward.

MH: So if you had your crystal ball and looked forward we'll say three years because I think five years anyone's guessing, what does the industry look like, what does it look like from a licencing perspective, what does it look like at a practise level, and what is going to be the predominant advice model in your mind?

CH: Look that's, an interesting question to say the least. I think you know it's a no brainer there's going to be less institutional licensees. Whether that results in the rise of the professional boutique licensee or whether it means individual licencing at the practise level, I'm not sure. I think on the one hand I can see very many benefits around having individual licencing, for the professional but not so much for Asic who has to manage and monitor all these people.

MH: You might still have a licensee who is responsible for compliance and commission brokerage processing, those sort of things but the actual licence sits with the advisor.

CH: Correct, which means that he becomes more of a dealer services or licensee services business and the value proposition is probably around helping those practises grow and scale and how to become professionals.

MH: Back to the future.

CH: Back to the future. I think the other one that has not been addressed yet probably is succession planning because I think the days of a young advisor walking in and offering three times gross revenue when they've got a two million dollar mortgage because they're trying to live in the heart of Sydney or something are over and so the people selling may believe they have a very viable practise to sell but the problem is who is the buyer. And in that context I think a whole new model of succession planning will emerge and could well be very similar to the professional services firms, the partnerships models, where gradually senior partners phase out and gradually junior partners buy in but there's no big lump sum transaction and overnight change of control again that will rely on the value proposition at the heart of the organisation, which is probably around dealer services and professional standards and things like that.

MH: Do you think there's an optimal size for practises in the future? Whether it's staff numbers, revenue?

CH: Look I think the answer is there's an optimum efficiency model whether it's an optimal size or not I don't know, but I definitely think you need to have around about 100 clients for an advisor if they're all paying for holistic advice but if they're not if you're doing more limited or scoped advice then you're going to need a higher number but that means is that you're going to be heavily reliant on technology and that's where I say where there Robo assisted might come in, I don't believe in the Robo taking over, because of those hard conversations that you have to have up front, but once you've had the hard conversations and you plug in the outputs then I think you can move into a more Robo model-

MH: Which is really around the engagement as opposed to the complete experience.

CH: Correct and then the production of paperwork and things like that can very much become automated and then all you need is the document trail to support the advice that's been given.

MH: And for your typical bit of holistic advice and I know that this is, how long is a piece of string but, where do you say the cost of that plan sitting in the future.

CH: Look I have no idea, I mean I know many and many advisors who charge 10 to 15000 dollars for that advice and it's very, very well valued. It's well understood, because it's all around, delivering real benefit, and it's not about just investment outcomes, it's about structures, it's about estate planning, and it's about retirement planning.

I know many other advisors who say they can do it for 3500 dollars, but it tends to be focused on transactional investment advice, so somewhere in between probably lies the truth, and I think it's all around the advisor being able to articulate the value and demonstrate the value that they bring, and as long as they can do that, I mean Jim had been singing that tune for many, many years and he's proven it time and time again, if you've got the right mind set you can actually charge whatever you want, if you're adding value.

MH: And for those that are set up well and have done I guess a lot of the heavy lifting already, and removed rebates and trailing commissions, and those sort of things, where do you see the big opportunities are for those practises?

CH: Well I think the opportunity is there are more and more people needing advice and so the opportunity is to come up with an efficient way of delivering that and I think technology as I think you say is the answer. If you can find a way of using technology to do what you might call the ongoing monitoring and supervision type of advice but then alerting the advisor when things need to be brought back into kilter, and or the client comes along and says hey I've had this life event but rather than have a fixed retainer every year and you charge the same regardless of what you do, having a model of where you can actually charge on demand for when you need to be heavily engaged and then have a lower retainer for the less engaged more transactional type advice.

And I think that sort of model we have not yet got, here for effectively in Australia, it is emerging more overseas, where they've progressed more with Robo, but backed away from it a bit and come back to a advisor with technology as opposed to advisor rather than technology.

MH: So you've seen that trend that we're seeing across probably many industries now around a less dynamic personalised pricing?

CH: Absolutely, look that's obviously the holy grail, and it's all based around the complexity and the value that you're adding through individual clients, there's no reason why it should be one size fits all.

MH: Unfortunately we are almost coming to the end of this chat, we could chat all day. Before we go though if you're able to talk about some of the interesting things you're working on at Lonsec that we might see severely next year and to next year and maybe some of the things that you are having in mind?

CH: Sure, I mean the first one is that we are now we've launched an SMFS investor site called the SMF Investor and the idea around that is to provide investment education for retail investors and ultimately allow them to subscribe to a Lonsec's research. In the past it's only been available it's only been available on a wholesale basis, and we're not trying to undermine the value of the advisor at all, we simply trying to make our information and expertise available to as wider audience as possible. The objective being to help people make better informed investment decisions and that's it.

So that's happening and then we hope to have the link through for there to say well actually if you're overwhelmed by all of this, you can actually go and invest in these portfolios via the Netwealth platform and select from the investment menu but obviously the managed portfolio effectively have the asset allocation and the asset selection done for you is where we see that heading.

Interestingly enough we're actually a number of SMFS trustees looking at, thinking about their succession planning and it's typically one member, he's heavily engaged whose making all the decisions but they're realising that they are not invincible and what happens if they're not there anymore and rather than having to give up the SMFS, the see that as an alternate way of managing it.

Other than that we're doing a lot of work expanding the breadth and depth of our research continuously and also looking at how we can use data analytics and AR to actually improve the assessment and the timeliness of that research. At the minute we're doing annual assessments but there's no reason in theory why we shouldn't be able to respond immediately a fund manager changes something, reassess that product in line with its peers and reassess the rating and do that on a dynamic ongoing basis rather than having to wait for a six or twelve month cycle.

MH: Just on that point, how big is your IT team now because I think it's probably a lot bigger than many would expect?

CH: Yeah we have 130 people in Lonsec, of which 25 are in IT, but that's the internal IT resources we then have three offshore partners in various different countries ranging from the Philippines to Germany specialising in different technologies so yeah IT is a fundamental part of our business and data is everything, I mean that's what we are.

MH: So like most businesses you're mostly a technology company that happens to operate in research.

CH: I think it feels like that sometimes yes.

MH: Anything else before we go?

CH: No, look I just really appreciate the opportunity, you know we definitely see managed accounts as being the future but we believe the differentiator for Lonsec is that their research backed managed accounts with a company of substance as we've just talked about both on the research analyst side and the technology side, that allows us to continuously improve what we do and I think that we are not unique by any stretch of the imagination, but I think that will be the very market moving forward.

MH: Charlie I've enjoyed working with you for many years now and I thank you as always for your time and for your generosity of comment. Look forward to a long term relationship.

CH: Like wise mate, thanks very much, very enjoyable.

MH: Well done.

CH: Good fun.

MH: Thank you.

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Views expressed are of the interviewee and may not be the opinion of Netwealth or its related companies.

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