A sense of disquiet has been growing among independent financial advisers around the pricing of certain investment products sold by tied agents. When a product’s cost structure makes it virtually impossible to beat a cash rate or when other equally good solutions exist at a lower cost, is it best advice to put a client into that product?

One of our large financial institutions is offering an education plan starting at R150 per month. The fees on the plan are so significant that it results in a reduction in yield of 5.9%. That essentially means that the underlying investment would have to perform at around 11% just to match a cash return after costs.

Considering the product is aimed at the mass market there is no tax benefit on the endowment structure, nor is the estate planning aspect of any benefit. In fact there is absolutely no product benefit in an endowment structure for a lower income earner other than the fact that it creates a forced savings plan.

How then can an adviser knowingly sell the product and meet the best advice criteria?

The counter argument is that there are no other investment products that allow for such low monthly investments and the fixed costs of offering the solution are very high.

This is a spurious argument. Firstly the client would be better off simply by putting their money with Capitec where they would receive 6% per annum, in fact they could opt for a 24 month fixed deposit allowing for monthly contributions which would pay them 6.25%. Secondly there are several unit trusts that offer minimum contributions from R100 per month which would give them the benefit of growth from the equity markets at a lower cost.

The problem really is that no adviser is going to sell those unit trusts. The requirements under FAIS do not make it financially viable for an adviser to build a business on the R4.50 per month he or she would receive from a selling a unit trust for R150 per month. Endowment policies allow the adviser to receive a significant portion of the commission upfront which pays for the time spent with the client. This is the real reason endowments are still sold to the mass market, not because it is a good product.

Some would argue, and possibly correctly, that the individual may not be saving at all if it was not for the financial adviser, therefore the value of the advice is incalculable. Finding ways for mass market clients to pay for highly regulated advice remains a challenge for the industry, but investment products that are virtually guaranteed to underperform cash are not the answer and the industry is going to have to start thinking out of the box on how to deliver products at prices affordable to the client, not only to the provider.

There are now calls for the Financial Services Board to start looking at the costs associated with investment products. Finance minister Pravin Gordhan raised the issue in his 2012 Budget address when he stated “Fees for many products in the financial sector remain too high. High costs in savings products undermine the national objective of getting our people to save more. The financial industry must take more urgent steps to reduce costs and introduce more appropriate and transparent savings and investment products, including annuities”.

What really is needed now is a complete re-think around how financial advice is offered, who pays for it and ultimately what really constitutes the best financial advice. What we do know is that product structures based on remuneration of the distribution force rather than client needs is not a solution.

This article by Maya Fisher-French was first published in InvestSA.