Out of commission
Do you know how your financial adviser is paid? Probably not, because most advisers make money selling investment products. They earn a commission from the vendor - and this can be substantial - with money changing hands behind the scenes, with limited disclosure to you.
The upshot is that financial advisers are strongly motivated to sell products with a high commission, not necessarily those that are right for the client. It is a poor arrangement that could see advisers recommending bad investments, which is why British and Australian regulators are banning the practice.
The good news is that there is one firm in Hong Kong, ipac, that mostly rejects this kind of commission model, charging instead for advice as a percentage of assets managed. The bad news is that ipac's Hong Kong office is going out of business, and it's virtually the only one of its kind in the city.
Its demise shows how difficult it is to get people to pay for financial advice in Hong Kong.
'People want free advice. Of course, they got free advice on minibonds. But if you offer them [clients] free advice, they would take it again,' says a Hong Kong-based adviser for ipac, who wishes to be unnamed.
To understand why this is the case, a little background is in order.
Ipac, a financial advisory firm with roots in Australia, announced on January 9 that it is shutting down in Hong Kong and Singapore.
The process will take as long as six months, and the firm has assured clients that their money and investments are safe, and the unwinding will happen in an orderly fashion.
Ipac's closure will affect about 2,000 clients in Hong Kong and Singapore, says Gary Harvey, chief executive of ipac wealth management Asia. He adds that about 30 ipac advisers and about 80 other employees will lose their jobs. Ipac is closing partly because its service model is unpopular with Hongkongers - the business is not believed to be profitable - and partly because ipac Asia has been lost in a shuffle of mergers and acquisitions.
Ipac began as an independent advisory in 1983 in Sydney. Paul Clitheroe, an Australian television personality and markets commentator, was a founder.
French insurance giant AXA bought ipac in 2002 and launched the Asian ipac franchise that year, with offices in Hong Kong, Singapore and Taipei.
In March, AMP, an Australian asset manager, bought all of AXA's Australian and New Zealand businesses, including the Australian ipac franchise.
Following that transaction AXA probably looked at the ipac business it held in Hong Kong and Singapore, and deemed it too small and too peripheral to its main businesses. 'There was a lack of alignment between ipac and AXA. Ours was a small business in an emerging market,' says Harvey.
The closure marks the end of Hong Kong's only substantial fee-for-service independent financial advisory. A few independent advisers offer this model, and Calibre Asset Management - owned by National Australia Bank - is developing a similar service in Hong Kong, but this is at an early stage.
Hong Kong's financial advisers otherwise make money on commissions. This makes them more like brokers than advisers, potentially leading to conflicts of interest.
For example, an adviser may push a client to trade more than is sensible, simply because the adviser earns a commission on each trade. They may also pressure the client to buy bad investments that come with steep commissions.
For example, insurance companies commonly sell pension products that lock in investors for long periods, as much as 25 years.
Because the insurance firms hold on to your money for decades and invest it to earn compounded returns, profits can be huge.
Insurance firms pay investment advisers the full commission from 25 years of premium income, upfront. By way of reference, an insurance product with a 25-year commitment and monthly contributions of US$2,000 can easily translate into an upfront selling commission of US$12,000 for the adviser.
Think about that. Your financial adviser may be earning US$12,000 for the simple act of getting you to sign a contract committing to a pension plan. Given the size of that pay cheque, can you be sure that adviser is recommending that pension plan on its merits?
And it's not just financial advisers who use this model. Investment managers at retail banks and relationship managers at private banks get incentives to sell high-volume, high-commission products.
It is because of such potential conflicts of interest that ipac used a simpler, fairer model of charging clients a main fee unrelated to the sale of products.
Typically, ipac charged clients a fee of 1 per cent of assets managed, from which it paid its advisers a monthly salary. That meant the advisers could focus on the task of giving financial advice. Because they are earning a reasonable fee income regardless of whether clients are trading, the ipac advisers can focus on giving their clients straightforward advice (and not constantly scrambling to sell products so they meet monthly revenue targets, as seen at other firms).
Although it's a good model, ipac was not popular locally. AXA has been trying to sell ipac's Hong Kong and Singapore businesses but found no takers, suggesting it was not profitable and lacked potential.
Insiders say the business over-spent on marketing in recent times. Harvey would not confirm or deny that ipac's Hong Kong and Singapore offices were making a loss, but he did say 'start-up businesses in the early years tend to incur high development costs'.
The ipac financial adviser says management has squeezed hard on costs recently, suggesting budgetary pressures.
Tellingly, ipac's Hong Kong employees are finding it tough to find new jobs because so few other firms do what ipac does.
'Now that I'm looking for a job, I know how unique we are,' says the adviser.
In its 10 years in Hong Kong, ipac never found much interest among local Hongkongers. The adviser says about 60 per cent of ipac's Hong Kong clients are Australian expatriates who need advice on issues such as the tax implications on offshore investments.
The Hong Kong office failed to penetrate the local market partly because it didn't hire enough decent local advisers, says Harvey. Most of the recruitment was in Australia. Insiders say most local advisers did not want to work at ipac because they could earn more at firms that derive income from commissions.
Tony Archer, managing director at American Century Investments, was one of the original clients of ipac Hong Kong. He is Australian.
'Their products were meat and vegetables. They were good for you, but they weren't going to give you 30 per cent returns,' says Archer on why ipac did not take off locally.
Archer says there other cultural issues. For example, ipac advisers like to create a complete financial plan for a client, during which they ask for a full disclosure of a person's investments, money and assets.
But many Hongkongers are uncomfortable with such disclosure, says Archer, adding that ipac encourages spouses to do joint consultations, which he believes also fell flat with local clients.
'In the local culture people are reserved. Most people will not tell [advisers] the full picture, and even husband and wife may not have full transparency with one another,' Rainbow Pan, chief executive of ipac Hong Kong, says.
Furthmore, ipac's main selling point - fee transparency - did not gel with local investors. There is little hard evidence why Hongkongers prefer to pay financial advisers through commissions on products, but there are many theories.
There is a view that, because people may not realise that investment commissions are being paid to advisers, they (wrongly) assume the advice is free.
Many Hongkongers have strong views about investing, and see financial advisers more as brokers than advisers. They are willing to pay brokerage commission and other transaction fees, but not for investment advice as such.
'If you don't know what you don't know you are confident about your abilities. They [Hongkongers] go to financial planners to place orders. Those intermediaries say, 'I have this and I have that - what do you want?' It's a product approach,' says Pan, emphasising that ipac was selling a complete financial plan.
Little good has come out of ipac's winding down in Hong Kong. Clients such as Archer have complained about abrupt termination of funds managed by the firm, on their behalf.
Some Hong Kong clients have also had to oversee the transfer of investments held by a Dublin account managed by ipac to a Hong Kong account, which was inconvenient and led to complaints.
About 800 ipac clients in Hong Kong are looking for new financial planners, and dozens of advisers are looking for new jobs.
Meanwhile, Hong Kong's financial advisory industry embraces its habit of seeking money from product providers for selling products instead of getting paid by clients for unbiased advice.