‘Killing Macquarie Wrap, BT Wrap and CFS Firstchoice’ – 1 April 2015

The wrap provider incumbents are in the perfect position to serve a new segment of consumers - those that don't want/need advisers and those that want to partner with an adviser for only some of their wealth. If the incumbents do not choose to directly serve them, new entrants will...

Yes, a title to grab your attention, and a play on the book title ‘Killing Fairfax,’ but all will make sense if you can get through the latest tome!

The power of incumbency

The power of incumbency cannot be underestimated.  Because of previous investment in their businesses, sometimes over decades, incumbents make it difficult for new entrants to come into their territory.  Barriers to entry include both tangible and intangible assets including distribution relationships, people, brand, technology, legislative protection, cash at bank etc – but usually, it is a combination of these factors that act as a deterrent to young ‘up starts’ coming in and eating away at their margins/market share.

But even with these huge barriers, new entrants often do succeed because of their sheer brilliance, by redefining the industry operating model, by challenging the status quo and because they have insights that the existing players just can’t (or won’t) see in terms of changes to buyer preferences. This process is often referred to as “creative destruction,” (‘Capitalism, Socialism and Democracy, J Schumpeter, 1942).

 

In our lifetime, we have seen multiple examples of creative destruction, as existing business models have been cast aside be new ones (and quickly). Amazon, for example, has caused havoc to traditional ‘bricks and mortar’ book retailers, by redefining the model around the consumer experience, providing close to unlimited choice and at better price points – goodbye Borders – importantly, Amazon is still not EPS positive, even with $90bn in sales per annum! They offer a no constraint world though, where even one star rated books can be purchased i.e. Amazon is not there to decide what people can and can not buy, as a gatekeeper (although nuclear weapons are not on offer yet).  Not a model built around publishers and authors but built around consumer preferences and ease of transacting.

Closer to home, groups like Realestate.com.au and carsales.com.au have decimated traditional classified advertising earnings that was once the domain of the key newspaper empires, and more recently, two ASX listed companies are doing the same to other staid industries.  In the case of Xero (ASX Code: XRO), they offer SMEs a cloud based accounting proposition that is hurting the traditional players, whilst 1Page (ASX Code: 1PG), is redefining how companies recruit their staff through social connections, which has the potential to severely hurt traditional recruitment, including market darling Seek, who themselves, redefined the market for recruitment. You get the picture.

When you think about the above examples, both the traditional media and book companies were better placed than any to have redefined their own businesses and to have won big in the internet age, however, even when faced with evidence that an industry is undergoing structural change, it is difficult for many to make such changes to their existing models – it is those existing barriers that make it so hard for the incumbents to change.  Primarily, this is because of the “sunk cost fallacy” where managers justify increased investment in their current model, based on the cumulative prior investment, despite new evidence suggesting that the cost, starting today, of continuing the decision outweighs the expected benefit.”

What has this got to do with wrap accounts?

The existing wrap account market has been largely built around internal distribution channels in a business to business context.  In acting this way, the consumer has taken a back seat, whilst the wrap providers have reacted to the needs of their primary customers in both their internal and external dealer group relationships, with compliance protocols and governance standards largely setting the scene in terms of the investment menus offered.

Of course, if the wrap accounts do not provide exceptional service to end investors, this will reflect badly on the adviser, and then the dealer group, and so, that tension ensures that the wraps provide great consumer experiences but importantly, the permissions required are set by the dealers and wrap providers and not by the consumers.  Borders versus Amazon – who is still around today?.

But a major structural change is now occurring in our industry, which presents a huge opportunity for the existing players to increase their advantage, without hurting their existing franchises – if anything, their models will get stronger.

The consumer is now empowered and there’s no turning back

At no other time in history have consumers had more tools available to them in terms of being able to make smart investment decisions, without the need for an adviser (recognising that advisers serve a far wider purpose).  The consumer is now well connected in real time, to various media sources, tip sheets, social networks, financial experts and robo advice models but their need for asset administration is still paramount.  As we know, $680bn currently sits in the SMSF sector, (not including non-super assets that are in the trillions) and this sector is growing quickly.  Much of the assets in this segment are already administered by wrap accounts but much of it is not.  We also know that over 80% of consumers currently do not have an adviser through lack of affordability but still have assets to manage.

As a result of being better enabled and better connected, there are now three distinct consumer cohorts.  Those that want to manage their affairs without help.  Those that want to partner with an adviser for some part of their wealth management strategy.  And those that want to outsource to a planner completely.

It is the first two cohorts that represent a massive opportunity for the existing wrap providers.  But to participate, the wraps need to do the following eight activities:

  1. Agree that this opportunity exists and that they can serve these segments profitably with existing technology or with minimal capex, when compared to a new entrant,
  2. Make consumers the primary customer, which will ultimately make the model better for advisers and dealers,
  3. Allow the administration of total family assets, including unlisted and private assets,
  4. Allow access to offshore markets (in the first instance listed securities and debt),
  5. Have the ability to include the adviser in the decision making process (not the other way around where the adviser gets to choose),
  6. Review every single business rule to see how it is getting in the way of opening up the opportunity to directly interact with consumers,
  7. Think about their businesses as technology companies, with an open source mentality and Ap like eco-system, and
  8. Open up the investment menu to any asset, removing the internal governance aspects for product approvals.

 

In essence, I am suggesting an adjacent channel strategy versus a fundamental change to the business model – this represents a far easier change, than say setting up a new model to compete with the ASX to deal away the mFund threat, if in fact, that is a threat.

Point 7 is contentious 

The current process of gaining approval to be included on a wrap account menu, very much favours large, well resourced fund managers over smaller boutiques – it is also a process that is all about an internal ‘governance’ orientation versus a consumer orientated ‘choice’ one, which I am suggesting needs a major rethink.  In some cases, this governance approach actually excludes some of the world’s best fund managers who will never get a fund rating or who cannot be bothered getting written support from advisers – they don’t need to!  Nor do empowered consumers need to be told how much of an asset can be held within superannuation, for example.

Currently, consumers who may wish to use a wrap account to manage their affairs are left with a ‘Border’ like book store experience (and that is where they can actually invest directly). A physical space where only so many books (investment products) can be stored versus an Amazon experience, where they can buy anything they like, even if it has a one star rating (or no rating at all).  Having not managed a wrap account, I am not sure if there are internal constraints to have an unlimited menu (I know it is not cost free), but if a manager is prepared to pay a fee to be listed, then let it list.  If the consumer is prepared to pay for no constraints, then what is the downside?

And this is why wraps need to slightly turn their ships toward the consumer because if they don’t, new entrants will take large market share that should have been the domain of the existing players.

In Chris Joye’s AFR Article (March 15, 2014) ‘the case for financial supermarkets’, he argued that “the development of these financial aggregators has been stymied by incumbent institutions that have no interest in boosting competition and facilitating switching.  The incumbents don’t want to cede control over product distribution, which they have been attempting to acquire or align via “vertical integration”.

Regulation is not an impediment to this approach

There are obligations on Regulated Superannuation Entities (RSE) to have robust corporate governance structures around how products are approved due to prudential standards around corporate governance.  At the moment they are too onerous and believe that the wraps can meet their requirements with a streamlined (and online) process.

My suggestion to meet these prudential standards is as follows:

  1. To provide a compliance and financial account audit each year that meet the GS 007 Standards,
  2. FSC document made available,
  3. Develop a scoring system around service providers used with higher weighting to top tier firms,
  4. Agree to pay the fees and to meet other service standards, and
  5. For consumers to sign a ‘death waiver form’ – yes, I have gone to far again – but ultimately to accept that, ‘I accept full responsibility for my actions etc.’

This would mean no need more need for ratings (but allow consumers to rate the investments they are in), and no need for bottom up support from advisers – let the consumer decide and let them live with the consequences.

The future is bright!

It is my proposition that the wrap providers best years are ahead of them but they will need to change their current operating model. I believe that they are in the best position to ‘open’ their technology by adopting a no constraint mindset, a consumer first orientation, (that will strengthen their existing business model), that embraces consumer empowerment, and allows some of the best and brightest fund managers to compete next to the well resourced firms, as long as they meet basic governance standards.

If the incumbents don’t change, the next book we will be reading in ten years will be called ‘Killing BT/Macquarie/FirstChoice etc’…

Andrew Fairweather, Founding Partner

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