Financial institutions have three major advantages compared with the IFA business:

1. For banks, they are able to have interest income. Interest income is obtained by lending at a higher interest compared with the interest given to depositors.
2. Banks are able to create and manufacture investment products. Sometime they manufacture together with other counterparties and sometime themselves. Built into the product is a profit margin earned by shareholders.
3. For products not manufactured by itself, banks are also able to take a cut in the commissions and trailers given by these third party products.
4. Insurance companies can create and manufacture new insurance products. Sometime they do this by outsourcing some risk to others called re-insurers and sometimes they absorb all risk. Again, they can earn a profit margin built into products. For par products, they earn 10% of the profits. For non-par, they can still earn something by charging a higher premium for the insurance component or earn through management fees for the underlying investments.

Due to these many sources of income, financial institutions can reward their advisers far greater than IFAs. IFAs’ only source of income is the commissions given by product manufacturers, full stop. For trailers from unit trusts, a large portion has already been taken away by the platform provider.

So you can see that IFAs are the worst lot for they have to purely rely on product sales to earn a living. Because IFAs are not the product manufacturer, they always run the risk of manufacturers reducing commissions. Thus, IFAs are held “hostage” by bureaucrats.

1. Financial institutions have “brand” while IFAs have nothing. Currently there are a few dominate IFAs players in Singapore but none of them have the same brand as big name financial institutions. In a brand conscience society, this is a disadvantage to the IFAs.
2. Financial institutions have marketing power. In year 2008, much of these marketing effort was reversed due to the massive misselling which resulted in a lost of confidence and reputation. But Singaporeans are a forgetful lot and they will forget about it after a while. Moreover, the constant marketing and advertising effort will eventually neutralize the lost reputation.
3. Financial institutions have unlimited capital. Not enough money? It can go to the capital market to raise capital either through debt, equity, preference shares or combination of these. With a higher capital means more money for marketing and advertising (and of course greater incentives for its sales force).

One adviser asked me how to get out of the trap. From what I see, there are only two ways: (1) not to be overly rely on product sales and (2) get yourself freed from bureaucrats. Bureaucrats are like an overly unreasonable management, underwriters and regulations.  But how could an adviser earn anything other than from product sales? Simple: you have to start charging fees for value being created for clients. Value creation? Never heard before? Here are some common experiences by IFAs:

1. Helping and “fighting” for clients to get more favorable underwriting outcome from the same insurer and across different insurers. Sometime this involves diplomatic means but other times involve escalation to insurers’ top management. Currently, many IFAs do it for free. You know what? The IFAs efforts all gone to waste when the client refuse to take up the product. No doubt value was created when the IFA fights for more favorable underwriting but if at the end of the day the product is not purchased (for whatever reasons), the IFA’s value creation was done for vain.  
2. Doing endless product comparisons and providing an objective report on which product is the best in terms of premium and benefits. Value is definitely created in this case. Prior to the exercise, nobody knows which product is the best. After the product comparison, knowledge is gained on which product is best. Again, if the client doesn’t buy the product or buys from someone else, the IFA’s value creation comes to nothing. In fact, it is a common practice that a client takes the value created by one IFA and buys the product from another. Maybe the latter has a nicer face or is a friend or maybe because rebates were promised.
3. Sometime I am asked whether Fund X is good or not. But often, after I have listed down the non-obvious risk of the fund and I propose a proper asset allocation, the person did not heed the advice and proceeded to buy from someone else. Value was created as the client acquired knowledge but did not use it. Again the value created was in vain.
4. Very often, good products have little or no commission at all. For example, certain Exchange Traded Funds, term insurance, group insurance, shield plans, etc. Value is definitely created for the client if the IFA recommend these good products. But if the client really takes up the recommendation, the IFA’s value creation is not remunerated.
5. Many ordinary folks who borrow hundreds of thousands to million dollars of money from banks to finance their property purchase don’t even know how to calculate how much their mortgage installment will be given different interest rates. But not everyone knows how to or remember about the usage of time value for money. Advising these property owners on managing their debt and mortgage servicing ratio do create value. It creates value because the property owner does not possess the knowledge and concept of time value for money. Once the knowledge is acquired, the property owner can make prudent decision without the risk of over leveraging.
6. Many insurance advisers know how to explain the importance of risk management but forgot that insurance is no use unless a proper estate plan is executed. No point having insurance when the proceeds will be given to the least needy survivor. The good news is that many lawyers do not know how to do estate planning. The best people in the position to do so are financial advisers because they know all financial information about their clients. Estate planning is not merely based on “hard facts” but the bulk of the work is related to personal’s desires. Many financial advisers have a comfortable relationship with their clients and therefore are the best people who can implement an estate plan according to both “hard facts” and personal desires. Value is definitely created if an estate plan is done for their clients. Prior to making an estate plan, nobody really knows what will happen if the client dies. After the plan is made, everyone is clear what will happen.
7. Clients who are “expert” in investment knowledge either through experience or acquired from academic learning are often over confident. Either they take too much risk (thinking they can do better than the average Joe) or too little risk (because they are able to spot countless risks which the average Joe can’t). Moreover, these “experts” do not know how their existing portfolio fit into their existing financial situation. The IFA can be an independent third party to provide an opinion on whether the portfolio risk is excessive or too conservative. The individual client only has the experience of self. However, the IFA can tap the real life experiences of many more clients and advise his individual client. Value creation is definitely made.

I’ve listed on seven common value creations. There are many more of course. The IFA who wish to escape from the Commoditization Trap must start charging fees for value creation. In this way, there is no more reliance on product sales to earn a living. The question is this: Will the firm allow it? Will MAS allow it? In other words, will the bureaucrats permit it?  

Will MAS allow it? Nothing in the regulation prohibits the IFA charging for service actually rendered. What is prohibited is that IFA must not handle insurance premium and investment money. The IFA should list down the service he or she will be providing, the deliverables and the consideration (the fees) in a contract that adviser and client must sign. This contract will than come under usual contract law.

Will the firm allow it? I believe majority of the firms will not permit it. This can be a good thing because it means you have (1) less competition and (2) easier time to select a fewer group of firms to join. Another reason why most firms will not permit it is because they themselves are trapped under the Commoditization Trap. An individual or firm that is still trapped cannot help others to escape from this Trap.

Personally I am ¾ out of this Trap. In a few years, I should be able to escape out of this trap completely.