This article outlines the history of product-based financial advice in Australia and how the industry evolved from advisers being employed directly by product issuers.
Vertical integration has long been blamed for many of the industry’s indiscretions, with most advisers now preferring to offer more independent recommendations to clients. The prevailing view is that this model leads to more objective, higher-quality advice than what was offered in the past.
And yet, some firms continue to employ the same vertical integration tactics once used by the big banks, all in the pursuit of more revenue.
Bank-Based Advisers
Up until the late 2000s, a large portion of financial advisers were employed by the big banks. Their primary role was to sell the bank’s products – namely managed funds, super funds, and insurance policies. This is the classic form of vertical integration, where both the product and the salesperson sit within the same business.
These bank-employed advisers were remunerated through commissions and bonuses tied to how much product they sold. The conflict of interest here was obvious: if you’re paid more to recommend a certain product, there’s a clear incentive to push that product regardless of whether it’s right for the client.
This came to a head during the GFC, when many retail clients suffered significant losses from exposure to high-risk, complex products like structured investments.
These failures – along with others, like the collapse of Storm Financial – led to the introduction of the FOFA reforms in 2012, and eventually the Banking Royal Commission in 2017.
Banning of Commissions (The End of Vertical Integration?)
Under the Future of Financial Advice (FOFA) reforms in 2012, commissions on new investment products were banned (insurance received a carve-out that still exists today). FOFA also introduced a statutory best interest duty for advisers.
Commissions on existing investments continued until 2019, when the Royal Commission recommended their removal. Much of the Commission’s focus centred on the sales culture that vertical integration fostered and the poor client outcomes it created.
These reforms signalled the end of large-scale vertical integration in financial advice. Westpac exited the advice industry in 2019, meaning no major banks retained a financial advice arm. Most advisers moved to small or mid-sized advice firms unaffiliated with product manufacturers.
While many advisers remained licensed through groups like AMP or IOOF – both product-based businesses – the key incentive to push their products (commissions) was gone.
That said, licensees continued to influence adviser recommendations through approved product lists (APLs) which in some cases include products that have paid to be there. While this remains a factor in the lack of adviser independence, it’s not considered as harmful as full-blown vertical integration.
The New Vertical Integration (SMAs & MDAs)
The modern version of vertical integration is now largely in the form of Separately Managed Accounts (SMA)s and Managed Discretionary Accounts (MDAs).
SMA
An SMA is essentially a portfolio of assets managed by an external party – often a professional investment firm like Macquarie or Lonsec. On its own, it’s not inherently vertically integrated, as many SMAs are used by advisers unaffiliated with the investment manager.
The vertical integration arises when an advice firm sets up its own funds management entity specifically to create SMA portfolios. These SMAs are then almost exclusively recommended by that firm’s advisers. In many cases, they are the only investment options advisers are allowed to use – a one-size-fits-all suite of products.
Worse still, these small advice firm-led SMA providers are often too small to get listed on major platforms, limiting them to a handful of niche platforms. Some firms even mandate the use of a specific platform purely to access their in-house SMA offering.
MDA
An MDA is both an investment product and an advice service – it allows investment decisions to be made on a client’s behalf without their approval for each individual transaction. While some MDAs are operated by external providers, others are established by advice firms directly – either under their own AFSL or through white-labelled arrangements.
As with SMAs, vertical integration occurs when these in-house MDAs become the default investment solution recommended by the firm’s advisers. The same platform limitations apply – and in some cases, even fewer options exist, with firms using only one platform capable of hosting the MDA.
The Conflicts of Interest
Fortunately, many advisers recognise these arrangements as detrimental to clients. These product-linked models have driven some of the industry’s most damaging scandals and continue to erode public trust.
Firms that embrace this new form of vertical integration are repeating the mistakes of the past, prioritising revenue over client outcomes. By controlling both the investment solution and the platform, they effectively strip their advisers of professional judgment, turning them into the same product-pushers that gave the industry a bad name.
Clients should rightly question whether their adviser is acting in their best interests when the firm profits from both the advice fee and the investment fees paid from their portfolio.
The usual justification is that these SMA or MDA arrangements are “better” than what’s available on the open market. This is generally a ridiculous proposition. How could a firm with only a handful of advisers possibly build a more sophisticated, better-governed portfolio than the broad range of institutional managers already available?
Outsourced Management
In most cases, these advice firms don’t have the internal resources to run investment portfolios directly. Instead, they white-label portfolios from third-party providers or engage external consultants to build portfolios based on the firm’s preferences.
These pre-built solutions obviously already have their own management fees. The advice firm makes additional money by charging a margin on top – either via a separate investment entity (for SMAs) or through their AFSL (for MDAs). In other words, money for essentially nothing.
Some proponents argue that this is simply reclaiming “lost margin.” The logic goes that if the adviser has reduced the client’s overall fees, by replacing expensive managed funds or platforms, then an additional investment management cost is justified. It’s also pitched as a way to diversify an advice firm’s revenue into something that doesn’t require annual opt-in, unlike ongoing advice fees.
But for a profession meant to act in the client’s best interest, the idea of clawing back lost margin just for the sake of it is repugnant. This isn’t margin, it’s the client’s hard-earned money, taken with little justification by exploiting the trust they’ve placed in their adviser.
Final Thoughts
Many of the scandals that plagued financial advice in Australia were fuelled by the misaligned incentives created by vertical integration.
Thankfully, most advice firms recognise the damage this model can cause and choose not to engage with it. But in a profession, ethical standards are upheld through internal critique – not by looking the other way.
To support ongoing professionalism, vertically integrated advice practices should continue to be called out by the wider industry. Clients of these firms deserve to understand where the real priorities lie – and no, a blurb about the directors’ conflicts of interest in an FSG is still not enough.
