For many years financial planners have been consolidating clients’ assets into so-called ‘wrap platforms.’
Historically, platforms were a great way to consolidate a view of a client’s portfolio, particularly for tax reporting and access to a range of product types. However, this convenience has always come at a high cost in Australia where, unlike the rest of the world (which operates on a custodial model), we have a direct ownership model – the Holder Identification Number (HIN).
What’s so important about HINs?
To answer this we need to take a little history lesson.
Back in the ‘dark ages’ before electronic registries, everything was paper based – when you bought shares, you received a paper share certificate as proof of ownership, and this certificate needed to be presented when you sold your shares.
Then along came the ’87 crash. Those of us around at the time well remember asset values halving overnight, but a by-product was the system literally getting clogged up with paper, with delays of weeks, in some cases months, in settling transactions.
In response, much of the world moved to electronic registries and sub-custodial capabilities where generally a bank held the assets and end investors became what are called ‘beneficial owners.’
Here in Australia (and NZ) we did things differently, and basically replaced the share certificate with an electronic version called a HIN, where the custodian or central counterpart is the ASX through its CHESS facility.
So now, when you buy shares through a stockbroker, you are allocated a HIN where essentially the safe keeping or custody component is included in the brokerage fee you pay. Think of the HIN as an electronic filing cabinet where all of your listed equity positions are held together, in one place, in your name.
Now to a little known secret – the cost of this safekeeping is about one dollar, whether you buy one thousand dollars’ worth of shares or one million dollars’ worth. This is very unlike bank custodial fees, which are charged as a basis points (bps) fee on value. So, for example a $100,000 equity position held by a custodian charging 5 bps costs you $50 per annum, and that’s before adding on transaction fees and settlement fees of around $20 each per transaction.
Banking on super
Going back to the dark ages for a moment – when the move to digital holdings happened in the early 90’s there was also another seismic change in Australia courtesy of Messrs’ Hawke (RIP) and Keating, compulsory superannuation.
Now we had the banks in Australia, who up until then had existed as solely deposit taking and mortgage/property institutions, thinking it would be a great idea to match their offerings with mature age investment or wealth businesses. Not only did they get to sell young couples a mortgage, but as they mature, pay off their mortgage and look to invest, they then get to advise (and charge) them on their investments. What could possibly go wrong?
The Royal Commission showed us in excruciating detail exactly what did, and we see the banks no divesting themselves of these businesses. But back then things were different. Investors had just been scorched by the crash, and the new kids on the block were managed funds, where a professional took care of all those pesky considerations like which stocks to invest in.
First fees – hidden off HIN
At the time, managed funds were all unlisted vehicles, meaning they had to be held by a custodian. Banks, being banks, devised the concept of the ‘wrap’ platform, where all assets could be consolidated under a custodial arrangement and included in consolidated tax reporting. Of course, this was not free, and the cost was a fee based on the value of the investor’s assets.
When clients mostly held unlisted managed funds, this made a lot of sense – pay a small penalty for listed assets to include them in the custodial wrap, and enjoy the consolidated reporting benefits.
Fast forward to today though, and the listed, lower cost fund structures like ETFs, LICs and LIT’s, allow advisers to devise asset allocation models that can potentially use 100% listed or HIN capable investments.
Additionally, advances in technology and SaaS solutions mean assets even if they are both listed and unlisted can be consolidated for tax reporting purposes – even if they’re both listed and unlisted –and importantly for clients, displayed via user-friendly front ends.
So enough with the history lesson, what does this all mean today?
in 2019, bank platforms and (mostly) independent platforms, which have effectively just replicated the bank platform models, hold more than $1 trillion dollars in assets.
If we assume that 30% of these assets are listed, we have $300bn of assets being held and reported on within a custodial model that potentially could be held via HIN for a fraction of the cost.
Hidden fee #2 – milking the cash cows
Moving onto the next and maybe even more controversial fee – the cash skim. Platforms rightly don’t want to take any credit risk against investors, and so insist that clients need to hold a percentage of cash, relative to their asset values, for the purposes of rebalances and buying investments when their adviser or manager dictates changes.
Perfectly reasonable… except that for platforms to reduce their credit exposure they charge the end investor by paying them a discounted rate for their money on deposit. For example, let’s assume a platform can earn 1.5%pa by placing all its clients’ funds on an overnight cash rate. You might assume that, as this is for its own benefit to ensure it has no credit exposure, it would at least pass this through to the end client, but no. The platform takes a margin – between 50-100bps – meaning that in the current low interest rate environment, investors are receiving close to zero for cash balances. This cash skimming adds up to many hundreds of millions of dollars siphoned away from investors’ accounts every year.
Broking the bank – hidden fee #3
Next, we look at brokerage fees.
Most platforms generally negotiate a bulkrate of brokerage for consolidating all their individual trades and sending them to a big investment bank for execution. However they then charge a retail rate back to the investor for each individual trade or allocation – as if each trade had been sent individually to the market.
This could be seen as, if not fair, then at least reasonable – most businesses add a margin for services. Except that in many cases there has been no actual trade, due to the ‘netting’ of transactions. Netting takes place because, on any given day among the hundreds of thousands of investors in a platform, there will inevitably be some who need to sell X stock and some who need to buy that same stock. Those transactions are ‘netted’ and all that takes place is a book entry. Shares are never sent to market and no transaction fees are paid by the platform. But does the end investor still pay expensive retail fees? Yes, in almost all cases, they do.
So here we have the three layers of fees that we believe are not widely understood in the platform market.
All the fees – a massive fee lunch
To be fair on the platforms, they do perform a good service and they do deserve to be paid for that. But remember these are largely now technology businesses, who are already being paid a SaaS fee or subscription fee, disguised as an account keeping fee, on top of these fees and other rebates they may be earning for distributing product. Overall there are potentially five layers of fees a platform will charge:
- Account keeping fee (which will include a minimum dollar amount)
- Cash fee – discounted rate on deposit (cash skim)
- FUM fee – basis points on account balance
- Transactional/brokerage fees
- Model manager or fund manager fees
Here at FinClear we believe a far more transparent and fair approach is to charge a single low fee upfront, so advisers and end investors can see precisely what they are paying for.
This could be a single low basis point service fee (capped) for managing accounts with zero transactional and zero cash fees, held directly on HIN to avoid custodial fees. Or it could be as simple as providing fixed low-cost execution fees fed as HIN data to the adviser’s choice of back end reporting system – enabling an adviser to manage their own platform.
We believe the power now is with the adviser and ultimately the investor to question what they are paying, and in return receiving, for a service.