There is some logic behind exempting equity, debt and hybrid securities listed on the ASX from the FOFA rules to enable companies to continue to raise working capital for their operating businesses from both retail and institutional investors in the same manner they have done for many years. The implied safeguard for private investors in an approved capital raising is the role of institutional investors in both demand for and pricing of the issue. Institutional investor participation in these equity and debt issues helps ensure there is a sound investment thesis, the issue is priced appropriately for the risk and there is a vibrant, liquid secondary market in the securities.
This is, however, completely different to a fund manager seeking to raise capital for a leveraged equity or high yield investment strategy via a Listed Investment Company (LIC). LIC’s operate like a managed fund, except they are a listed company rather than a unit trust. Unlike a unit trust, the capital an LIC raises is permanent; investors enter and exit the strategy by buying and selling shares in the company, rather than applying for, or redeeming units in a trust. Poor performance in a unit structure is a disaster because investors simply redeem their units. Managers of permanent capital do not face the same problem.
There is a noticeable lack of institutional investors in LICs because of their tendency to trade away from the portfolio’s net asset value (NAV). The substantial risk of a retail investor being left with exposure to a LIC that is trading materially below NAV—as has occurred in recent deals—is exacerbated when those LICs hold highly illiquid assets such as direct loans, junk bonds or private equity investments. These are assets that are difficult to re-value regularly and almost impossible for a retail investor to price properly.
But the big concern with these LICs is that those responsible for protecting their clients’ interests are advisers who are – because it is an approved capital raising – being paid by the product issuer and are therefore conflicted.
Hardly what the architects of the FOFA reforms had in mind.
In this context, it is crucial to understand that there are fundamental conflicts between the interests of the fund manager, which wants to secure access to permanent capital and maximise the fees generated by the assets it manages, and those of a retail investor, who wants to allocate savings to investments that are appropriate for their needs, managed by the best possible solutions provider at the best possible price.
This begs the question: how can an adviser possibly serve the interests of both parties? 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”.
It is no longer acceptable for financial service professionals to pretend the world hasn’t changed. It is beyond time for advisers to act in good faith to uphold the intent of the regulatory framework that provides their social licence to operate rather than seeking to exploit loopholes in it.
For an adviser to give their clients truly impartial advice they must be independent, full stop. They cannot accept payments or enter into favourable arrangements for the distribution of investment products. Pre-FOFA practices where conflicts of interest could be “managed”, incentives hidden and product sales could masquerade as advice need to be laid to rest.
And this evolution is in everyone’s best interests, because any industry that profits from conflicts at the cost of the client it is meant to be serving faces a very bleak future.
Paul Heath is chief executive and partner at Koda Capital