Recently, a person named David Blake implied that almost all financial advice given today should be outlawed.
You often hear outlandish claims from people less than fully informed on financial advice, but David Blake does not belong in this category. His views should be respected and his claims taken seriously by advisers, directors and executives of advice firms, and investors in considering how they are advised.
Who is David Blake?
David Blake’s career straddles both academia and industry, and he’s been highly successful in both. Completing his PhD in 1986, Blake is Professor of Pension Economics at Cass Business School, City University London, Director of the Pensions Institute (which he founded in 1996), and Chairman of Square Mile Consultants, a training and research consultancy. He is also: the co-founder with JPMorgan and Towers Watson of the LifeMetrics Indices; Senior Research Associate, Financial Markets Group, London School of Economics; Senior Consultant, UBS Pensions Research Centre, London School of Economics; and Research Associate, Centre for Risk & Insurance Studies, University of Nottingham Business School.
To say that he is well qualified to voice a strong opinion on this topic is an understatement.
What did he say?
Blake led the production of a report by the Independent Review of Retirement Income (IRRI) in the UK, released in March 2016. The report was far reaching, but his recommendations regarding financial advice were especially relevant:
“The use of deterministic projections of the returns on products should be banned.”
(‘Deterministic’ effectively assumes the average outcome will be achieved and it is only this outcome that is communicated).
“They should be replaced with stochastic projections that take into account important real-world issues, such as sequence-of-returns risk, inflation, and transactions costs in dynamic investment strategies.”
In short (on reading the full document), there are two important elements of this recommendation. The first is that advice needs to consider all of the key risks, most of which fall into two main groups: investment and mortality risk. The second is that the analysis of outcomes needs to be stochastic rather than deterministic. This simply means that the range and associated likelihood of outcomes are presented, something that can be quite hard to model in practice.
By suggesting that any advice that doesn’t meet these standards should be outlawed, Blake means that offering a deterministic prognosis represents dangerously misleading information.
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How does this apply to the Australian advice industry?
This recommendation is produced in a UK environment and policy setting. However, Blake has shared his views at conferences in Australia and they appear to be universal.
Does the financial advice provided in Australia meet the standards recommended by Blake? The broad answer, unfortunately, is no. Most of it has similar failings to the advice provided in the UK: namely it doesn’t account for the major risks to financial outcomes, particularly mortality risk, and it tends to assume an average outcome such as 7% per annum over a defined period.
This is largely a failing of the advice industry rather than the advisers themselves (though they should push hard for the tools they need to deliver quality advice), and most of the major financial planning software fails to address the issues raised by Blake.
Additionally, the majority of roboadvice offerings appear to fail to meet the standards set by Blake. While many provide stochastic reporting it is largely based on one or two investment risk factors (which are relatively easy to model) while ignoring mortality risk. In this respect, roboadvice appears to be at a crossroads – will it represent high-quality online advice that takes full advantage of systems designed in a clean-sheet-of-paper environment, or will it simply consist of smart graphics wrapped around basic advice tools?
Regulators are not likely to rush to implement Blake’s recommendations in the near term. However, the advice industry has been called out by a universal claim from a highly respected thought leader. It remains to be seen if there’s sufficient motivation out there to significantly raise the bar regarding the standard of financial advice. It’s also unclear if leaders with appropriate skillsets can move the industry in the right direction going forward.
There is no denying that developing tools, and using, interpreting and communicating the output are challenging areas. In my view the primary management challenge is twofold: overseeing the technical issues while successfully communicating complex issues to clients.
Facing the challenge
I’ve been to industry conferences where I sometimes lose confidence that this challenge can be met. One such conference left me aghast, the spirit of the day evolving as follows: ‘Modelling needs to consider all risks and be stochastic’ and ‘It is challenging to communicate more complex modelling to people who are not financially trained’ to ‘This is too complex and we should stop talking about all this stochastic stuff’.
Many other industries develop complex products which are explained effectively to consumers; consider for example the technology in cars and medical treatments. Too hard to explain cannot be an excuse for not innovating.
If you consider the following alternative lines for inclusion in a statement of advice, the motivation for change becomes clearer:
1. In developing your financial plan we assume that you will die with 100% certainty at the age of X and that markets will perform exactly Y% each year.
2. In developing your financial plan we have considered the possibility and likelihood of you dying at different ages and have considered a large range of possible scenarios for investment markets, which we all know are difficult to forecast.
It is obvious to me which approach represents superior advice. Dismiss this article if you like, because regulatory-led changes are unlikely, but you do so at your own risk. The poor quality of advice provided to individuals all around the world, including Australia, is a fundamental challenge to an important service industry. At some point it will become a strategic issue. Some people will see the opportunity to improve an important service currently being delivered at sub-standard quality. Others will see the opportunity to profit by innovating. Whatever the motivation, I look forward to seeing our advice industry meet David Blake’s standards.
David Bell is Chief Investment Officer at Mine Wealth + Wellbeing. He is working towards a PhD at University of New South Wales.