Market Commentary 2016 YTD

Industry Overview

The prevalent theme over the year has been one of compliance. This is the continued over hang from the Commonwealth Bank Financial Planning scandal of 2014 who received an Enforceable Undertaking.  Over the last 3 years we have seen Macquarie Bank receive an Enforceable Undertaking, NAB compensate 750 customers $10 to $15m for bad advice and ANZ reimburse 8,500 financial planning clients $30m. More recently the ANZ rate fixing scandal moved to include Commonwealth, NAB and Westpac. IOOF faced a senate enquiry and paid $2.8m to 57 customers. Then early this calendar year the disgraceful action of CommInsure denying genuine claims was brought to the industry and public’s attention.

ASIC released details of its Wealth Management Project for the period Jan 1 to June 20 2016 with the following results. Three individuals permanently banned, fourteen banned for a period of time, two Enforceable undertakings, four conditions or fines and one person charged for criminal proceedings. Of the actions taken, six involved NAB, six with CBA, Macquarie were linked to five, three attached to AMP, two Westpac and two with ANZ. In the 6-month period ASIC secured $13.4m in compensation down from $149m the previous period.

Compliance or risk management is king at the moment and is dominating decision making within the large institutions. One Institution anecdotally has more than 400 compliance officers employed. This has created a shortage of experienced compliance services as significant 6 month contracts are being offered at compelling remuneration levels. It is also from an outsider perspective stifling any innovation or investment.

Whilst public confidence in the advice industry has been badly damaged we are seeing industry growth, especially in the non- aligned advice space.

An interesting study was recently completed by Einsights into the growth of our industry from an adviser numbers perspective pre and post GFC.

Einsight reported “a key contributor to the growth in active adviser is the number of new advisers joining the industry”. The report nominates there were about 25,282 active advisers as at December 2015. For many this revelation would come as a surprise as we have felt like our industry was in a period of contraction not expansion.

The number of new entrants may diminish with new entrants requiring degree qualifications in 2017.

Forte through our valuation work has not seen a lot of wage pressure in the advice industry post GFC as there was thought to be little talent retention or attraction demand. The new entrant’s numbers above may explain the reason for the low inflationary wage pressure being experienced. How-ever we will likely see wage pressure come to bear in the future as confidence/growth increases and experience and education rightly attracts a premium.

Einsight also identified that since 2009 there has been a significant increase in the number of advisers “switching” licences approximately 10% per annum have transitioned to new Dealers.

Money Management also conducted a survey of 140 planners with 55% nominating they were dissatisfied due to cost. Of those dissatisfied 58% said they would pursue a self- licencing model with 30% of those seeking to access Dealer service support. Nearly 60% expressed the desire to separate product from advice or were critical of bank-aligned dealer groups.

The focus on cost will become even more pervasive as we see groups move from the subsidized Institutional Oligopoly to non- aligned or self- licencing models. With rising Professional Indemnity and the search for profitability by mid -sized dealer groups cost/benefit is always going to create a commercial tension and be hurdle to transition.

Forte Dealer Solutions (sister company to Forte Asset Solutions that assists practice Dealer migration) and IFA will be releasing our findings on Dealer Satisfaction levels in September 2016. Last year we had more than 1,000 participants that clearly showed a high level of satisfaction with only 16.8% looking to move and of those only a very small percentage looked to move to Institutionally aligned Dealer Groups. The findings showed a dramatic increase in satisfaction from the previous 2014 findings but still higher than normally accepted 10% with the main reason for higher satisfaction being that the dust had settled over many groups that had experienced ownership and management changes. The greatest reason for movement in 2015 was the desire for assistance with compliance.

Dealer Commentary

Suncorps dissolution of Guardian Advice in Dec 2015 forcing the migration of 87 advisers of these 77 moved on to non-aligned Licensees such as Centrepoint Alliance, Fortnum, GPS Wealth, Synchron, MyPlanner and Infocus. Highlighting the industry trend of migration from Institutional ownership to non-aligned. The break- up of Genesys and subsequent adviser migration did not show the same “independent” preference but this was largely due to institutional loans still resident within many of the practices.

Many of the non-aligned dealer groups are experiencing growing pains with the significant growth of adviser numbers stretching resources and creating service standard issues with resources focused on “onboarding” new practices whilst still seeking to deliver relevance to existing practices. Much of the new Authorised Representatives came from the Accounting profession seeking a solution to limited advice authorisation.

Management is being challenged not only in quality control but also in cultural maintenance. These challenges being experienced are within a hyper compliance environment and why some will be looking for a capital injection or an equity event.

Forte has not changed its position in regards to the expectation of more merger and acquisitions to come in the mid-sized Dealer space in the next 12 months.

A significant and industry meaningful win was achieved by Synchron on the issue of payroll tax. The State Revenue Office (SRO) agreed with the agreement that authorised representatives are not employees or relevant contractors for payroll tax purposes. Had the SRO been successful this would have created a 5% impost on dealers who would have had to push this back to advisory practices or impacted already marginal profit performance.

Funds Management

The Funds Management industry continues to face significant challenges -a Morningstar report showed management fees have fallen by up to 50% in the last 5 years making Australia one of the lowest asset management fee environments in the world. This has been due to the movement from retail to wholesale too institutional pricing (mandated pricing), with the market take up and use of new technology platforms. Retail funds have fallen from 2005 levels of $370B to $326B in 2015. Betashares reported the rise of the use of Exchange Traded Funds to $23.2 Billion FUM in May 2016 with a growth of 30% in a month to $411m. Australian ETF’s cost structure is as low as .15 % management expense ratio. The other growing trend is for Dealer groups to have their own in-house asset management as seen recently with Synchron’s announcement of the creation of Valant Capital Investments. This trend to “in-house” asset management will continue as Dealer Groups seek greater participation across the value chain and further creates a barrier of less open markets for Fund Managers.

Offshore Interest

The Canadian financial services company, Pavilion Financial Corporation, via its Californian alternative asset advice firm LP Capital Advisors announced it will acquire Altius Associates. Altius operates in UK, US, Singapore and Australia. It is expected to complete the transaction in the 3rd quarter of this year.

International wealth management group Focus Financial Partners announced MX Lomax had joined its network.

South African insurance company Professional Provident Society SA to enter the Australian retail life market with the creation of PPS Mutual.

The Italian Asset Manager Azimut via it’s Next Generation Advise business continues its acquisition strategy with more than 10 completed and more in the pipeline.

Forte has had multiple discussions with International “study groups” from the US, South Africa and Asia who are all looking at acquisition opportunities within the Australia market and across all sectors of the wealth management industry.

Forte has never before seen the abundance of capital, both international and domestic looking for investment opportunities.

Technology and Administration

The merging of Hub 24 and Fortnum was completely logical and a development that Forte had signalled last year as a natural industry progression. It was reported in June 2016 by Hub24 that $190m of FUM would be migrated. The new technology platform providers are predominately listed (with a couple of exceptions) providing access to cash, capital or debt and they need distribution so we will see similar transactions in the immediate future.

Powerwrap to list 4th quarter 2016.

OneVue Holdings have been very active in acquisitions in recent years and this was evidenced again with the recent acquisition of Diversa Ltd with the Scheme of Arrangement to be implemented in September 2016 ($49m cash and script offer).

Managed Accounts last year came to market stating that they were looking to take equity positions in advice businesses and in July 2016 took a minority interest in Holman McGregor.

AMP followed up its acquisition of Just Super in July 2015 with the acquisition by AMP owned SuperConcepts of Reckon desktop platform for $2.5m ($1.25m upfront and $1.25m in 2 years). This gives AMP a SMSF market penetration in the administration and software services of 9.7%.

In June Netwealth announced it had exceeded $9B with a $1.6B increase in FUM or 22% growth in the 12 month period. Illustrating the growth being experienced by the total Managed Account industry.

Mining stock Star Striker re-engineered themselves with the acquisition of Intiger Asset Management. Intiger is known for its work on automating the production of Statement Of Advice.

A new Managed Accounts provider came to the market in July 2016 MA Operator. MA Operator nominated they have workflow systems and processes that allows Dealer groups to better manage and execute bulk trades.

Adviser Intelligence finalised a multi-million dollar deal with Avocado Consulting to fast track Adviser Intelligence’s integrated advice and CRM technology.

ANZ has outsourced it’s Oasis platform to Macquarie Investment Management. Oasis had $6.9B FUM with 50,000 customers.

Robo-Advice

Robo-advice continues to grow in use in the US and UK with US$50 billion FUM as at June 2016.

The list of those who are coming to the local market is increasing with Financial Index, Spring Financial, Yellow Brick Road (YBR) with Guru, Ignition Wealth, Mercer, Infocus, Six Park, OmniwealthDirect, NAB Prosper,Macquarie via OwnersAdvisory, BetaSmartz in or coming to market in the immediate future.

QuietGrowth announcing their entrance and search for High Net Worth Robo users.

Decimal announced release of two robo advice packages ( Eqillize/Tentalon) designed for use by Institutions.

YBR acquired Brightday positioning a direct and online strategy to be released in 2017.

AWI re branded to InvestSMART Group and has 700,000 registered users, 62,161 investors using its portfolio manager and Robo advice services.

Robo- Adviser Stockspot announced the use of Artifical Intelligence (AI) to assist investors optimise their portfolio’s and assist in decision making

The Link Group announced a partnership with Ignition Wealth which will see Industry Superfund members get access to online advice tools.

The Australian Independently Owned Financial Professionals (AIOFP) announced their beta testing release of online tool – Financial Forum.

The proliferation of Robo advice has also been witnessed by Forte currently representing two Robo Platforms that are for sale.

Fintech

There were 34 IPO’s in the six months to June 2016 compared with 27 in the first six months of last year. The IT sector accounted for 35% of the floats in the six-month period, followed by financial services with 15%. The average returned of those listed in the six months to June was 23.3% compared with the negative 1.2% of the ASX 200 Index.

Advice Market Convergence

Stockdale and Leggo announced a referral relationship has been created with S&L Financial Logic. Stockdale and leggo’s representative stated “financial advice is a natural extension of real estate offerings”

CPA Australia got their long awaited AFSL and Australian Credit Licence for CPA Australia Advice in April 2016 and will adopt Section 923A of the Corporations 2001 which allows them to use the words” ïndependent and impartial” with no commissions and no asset based fees. Authorised representative licence costs will be $1,760 per month for “comprehensive advisers”.

Synchron announced referral partnership with NAB mortgage funder Advantedge.

Notable Acquisitions

QT Mutual and RACQ announce merger creating a distribution channel for banking, insurance offers to 60,000 members.

Auswide Bank and Your Credit Union proposed merger.

ANZ’s Esanda Dealer Finance sold their predominately retail car financing book of $7.8B loan portfolio to Macquarie for $8.23B

NAB sell 80% of MLC Life for $2.4B on a P/E ratio of 19x with a 20-year distribution agreement to Nippon Life Company of Japan.

Zurich Australia to acquire Macquarie Life the expected price is $300m with net policy revenue of $140m with profit of $26m and net assets total of $202m.

In response to media speculation to ANZ and Commbank selling their Insurance division the response was “an internal review is being conducted”.

Insurance is a capital intensive business and with increasing bank regulatory requirement for capital buffers with home loan and bad debt concerns combined with brand risk evidenced by CommInsure there is little doubt “internal reviews” are being conducted.

Financial Planning

The unprecedented buyer demand articulated in the last Forte Market Commentary #8 released late last year has, if anything been further exacerbated as we enter a period of low interest rates, All Ordinaries growth, greater legislative certainty and confidence (briefly diminished with Liberal slipping electoral support) and ever increasing costs of production requiring size and scale to maintain or grow profitability.

We have witnessed the supply side slowly increase as confidence of revenue certainty is experienced. Especially after the successful compliance delivery of Annual Fee Disclosure Statements, with little apparent disruption to revenue being experienced. The forced adoption of legislative initiatives and the accompanying fee for service business model has ensured delivery of service. This has been affirming for enterprise values as we see more practices enjoying a closure relationship with engaged clients on a structured, well managed basis.

The quality of practices has substantially increased over the last 5 years as compliance has dominated activities especially in Dealer surveillance and the investment of meaningful CRM information. Most principals are able to quickly produce data on client numbers segmented by service offer, age, location, Funds Under Management (FUM) – platform, individual product etc. This transparency has also meant more meaningful management reports and a tighter focus on service delivery and corresponding revenue and profitability measurements.

Compliance implementation has led to better businesses who can now turn their attention to growth rather than the internal orientation the industry has had to adopt over the last 8 years – Global Financial Crisis client retention, Future Of Financial Advice (FOFA) legislation and political uncertainty, FOFA compliance delivery and back office enhancement.

We have not seen any sellers come to market nominating the proposed education draft legislation requiring current practioners having degree qualifications by 2019. How-ever if the requirements do pass this will impact on supply in the medium term. The increasing of additional barriers to entry will be positive to future pricing but after a brief period of increased supply. We expect the increased supply to meet the current demand levels and we will come back to more traditional price metrics.

The supply/demand imbalance has seen an increase in multiples being achieved as well as beneficial terms and conditions. It has certainly led to a sellers’ market with an average of 50 buyers for every seller. The dominant principle being expressed by sellers is it is not about the best dollar price for the practice but the best adviser for the client.

The current sellers’ market is being expressed on two fronts not only by the multiples achieved for Financial Planning practices of between 3 to 3.5 times but also by the terms being entered into. Not only are sellers enjoying larger upfront considerations, greater level of vendor clauses protection but what vendors are really appreciating is the wide selection of potential buyers and being absolutely comfortable they are finding the best possible advisers to look after the welfare of their clients, staff and family interests.

There is a close correlation to high profit businesses attracting higher multiples. This year we have recorded sales at 4 times Recurring Revenue and Earnings Before Interest and Tax (EBIT) valuations of 7.5 but these were for exceptional businesses demonstrating high profit performance of 40% plus. The average sale has been the traditionally expected 3 times Recurring Revenue and for internal sales 5 to 6 times EBIT. Nil or slight discount being seen for regional businesses. The average age of client base is an important determinate to value and if there is a high percentage of over 70 yrs of age a discount may be applied.

Irrespective of the Life Insurance Framework we have not seen any changes to supply (very rare) and prices have been maintained at 3.5 Times Recurring Revenue depending on age segmentation and lapse rates.

Mortgage book valuations have increased if they enjoy direct contractual relationship with a big 4 bank from 2 to 2.5 times on average. If franchised or use aggregator the average is 2 times.

Accounting practices have maintained their normal range of .6 to $1 maintainable earnings but the use of EBIT is increasing with productivity and profitability gains being achieved with new technology e.g Xero being adopted. EBIT average was 4 times.

Market Summary

This Financial Year 2015 to 2016 has been a period of significant activity especially in the roll out and take up of technology.

Australia is clearly on the map for international and domestic disruptors with little apparent push back by the Institutions. The noticeable exception is BT with the ongoing investment and rollout of Panorama.

Distribution channels are changing and adviser migration too non- aligned is evident and at consistent levels.

2015/16 will go down as a time of compliance, significant capital, adviser movement, buyer hyper demand, seller opportunities, new technology/platform penetration, innovative products such as crowd funder Domacom and more peer to peer lenders and robo- advice acceptance.

The attraction of our industry to most market participants is the dynamic nature of change we experience. The last 2 years has been a period of change but now we have a clearer and predictable trajectory.

As an industry we been very cognisant of the fact we are only as good as the smallest piece in the chain e.g Storm. However it now appears we are also only as good as the big pieces in the chain as well. There are appears to be a fracturing of our industry re aligned and non- aligned with non-aligned taking a philosophical higher ground, in my experience excellence of advice and service is resident within both business models. Our Associations also seem to be fractured and this diminishes our collective voice, representation and perception of professionalism. Whether aligned or non- aligned we still have a lot of work to do to regain and increase the confidence and trust of Australians but positive steps are being taken with the greatest development being evident at the coal face of the actual practices delivering advice.

The refreshing outcome to come from all the change in the last 5 years is the adaption and adoption of change to create better businesses providing better consistent client experiences. The dark clouds are still there but they are starting to part on hopefully a new dawn of quality advice.

Disclaimer:

We have accepted third party information at face value, and have assumed it to be both adequate and accurate for the purposes of this commentary. Forte Asset Solutions denies any responsibility arising in any way whatsoever to any person or organisation, in respect of the information set out in this commentary, including any errors or omissions therein arising through negligence or otherwise, however caused. This commentary does not purport to be all inclusive or contain all information. Forte and its agents, directors, officers and employees do not warrant or represent the origin validity, accuracy, completeness, currency or reliability of, or accept any responsibility for, errors or omissions in the information or any accompanying or other information (whether written or oral); disclaim and exclude all liability (to the extent permitted by law) for all losses, claims, damages, demands, costs and expenses of whatever nature arising in any way out of or in connection with the Information (or accompanying or other information), its accuracy, completeness, or by reason of reliance by any person of any of it; do not have any obligation to advise any person if any of then becomes aware of any inaccuracy in or omission from the information (or any accompanying or other information); and do not, by this commentary, provide any recommendation, service or advice.