Vertical Integration Goes Horizontal

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Don’t you just love the way fancy terms are used these days to cover up the real intent…

Network Marketing? Pyramid Selling…

Vertically challenged? Short people…

Virtue signalling? The ‘sheep’ that follow the crowd…

Correctional facility? Jail…

These fancy terms are known by an equally fancy word…euphemism.

When it comes to the investment industry, there are plenty of euphemisms.

The industry marketers have a field day when it comes to creating sexy sounding names for their products.

Here’s a tip. The more exotic the name of the product, the more the provider makes and the more you lose. Simple rule…nothing fancy about it at all.

The ‘fancy term’ that’s been getting plenty of attention at the Banking Royal Commission is…vertical integration.

In layman’s (or should that be, layperson’s) terms, vertical integration is the good old fashioned ‘tied sales force’. The sales reps are flogging the boss’ products.

But that crude image doesn’t send the right signal to prospective investors.

Vertical integration is far less threatening…and far less understood.

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What is virtual integration?

The way vertical integration works is…

Client goes to a planner who is owned/aligned/tied to an institution.

The tied planner recommends the administration service owned by the institution AND/OR the institution’s managed funds…this is what’s known as the backend.

And it’s in the backend where the real money is made.

The name of the game in the industry is…funds management.

Clipping the ticket — taking a percentage of funds under management — is the honey pot.

Owning the ‘front end’ of the process — the planner — ensures the pipeline into the lucrative products keeps on flowing.

It’s been a great business model for the institutions, but, as we’ve seen from the Banking Royal Commission, not so great for the clients.

Financial advice — like medical advice — should be independent…untarnished by an allegiance to an institution or (in the case of the medical profession) to a pharmaceutical behemoth.

The Banking Royal Commission has shone a very bright light on this lopsided arrangement called Vertical Integration.

As reported by ABC News on 27 September 2018 (emphasis is mine):

Australia’s big banks, superannuation funds, wealth managers and insurers are now facing massive and enforced changes to their culture, management and conduct, largely thanks to their own testimony.

The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry has forensically picked apart the appalling behaviour that has become entrenched; examining sales-driven commissions and remuneration, poor risk management, tardy customer remediation, as well as the role of regulators and the law in the disintegrating trust the community has for the sector.

The ‘tied sales force’ business model is a breeding ground for conflicts of interest.

Does the planner work for the client or for the institution?

The client should be first and foremost when it comes to advice.

But this becomes an arbitrary objective when you have a tied sales force that’s under pressure to meet sales targets.

To illustrate just how valuable the backend is, SBS News reported on 31 October 2018 (emphasis is mine):

Commonwealth Bank has confirmed it has entered into an agreement to sell its investment management business for $4.13 billion.

Would the CBA have been able to build such a lucrative business without a tied sales force?


The CBA is not the only institution that’s decided to jump before being pushed by the Royal Commission.

NAB has flagged its plans to spin-off its asset management and wealth business, which would probably include MLC Financial Planning, Godfrey Pembroke, Apogee, Garvan and Meritum dealer group brands’.

Professional Planner October 2018

This from The Australian Financial Review on 5 September 2018 (emphasis is mine):

Westpac Banking Corp is weighing a sale of its financial planning arm, as it joins rivals in the scramble to prepare for any fallout from the Hayne royal commission.

Sources told The Australian Financial Review that Westpac – the lender most staunchly wedded to its wealth business – had quietly tested appetite in the market to offload its inhouse financial planners…

Among its key areas of focus, the commission has investigated potential conflicts in financial services companies which provide advice and push sales of their products to customers.

The dismantling of so-called vertical integration – where banks manufacture and sell financial products – is considered a potential recommendation of the commission.

And, finally from ABC News on 27 September 2018 (emphasis is mine):

Hugh Dive, chief investment officer at Atlas Funds Management, says one of the main likely outcomes of the royal commission is that the vertically-integrated models, such as those of AMP and listed wealth manager IOOF, will take the biggest hit.

Vertical integration is being read its last rites

None of this comes as a surprise.

The inherent flaws in the vertical integration model were there for all to see.

But they do say, ‘There are none so blind as those who do not want to see,’ and, as the Royal Commission has shown us, the regulators turned a blind eye to what was happening.

Is this wisdom gained with hindsight?


In my book, How Much Bull Can Investors Bear? (published early 2017), there were these two passages relating to the business model that’s heavily skewed towards the institutions.

From the ‘Introduction’:

The other major problem in the industry is figuring out ‘who owns who?’ and ‘who is working for whom?’ Is your adviser working for you, themselves, or their institutional owner?

Depending on your perspective, the industry’s business model either works like a charm…or is deeply flawed. If you’re the provider of products and advice, the system is perfectly OK. However, if you’re the recipient of the advice and products, you need to tread cautiously.

Knowing how to spot the industry’s bull and bias is going to be critical to your financial well-being in the challenging times we face.

And, in ‘Chapter 16’:

Real Life Experiences

It is difficult to get a man to understand something, when his salary depends on his not understanding it.

Upton Sinclair

Unfortunately, a lot of people in the investment industry do not understand what it is they are doing.

The fact that we’ve had government inquiries into the advice provided by the industry is proof of this. The incentives within the industry means there’s an inherent conflict of interest between the adviser and you.

Over 80% of financial planners are owned or associated with one of Australia’s six largest institutions — the Big Four banks, AMP and Macquarie. All six have been named and shamed for doling out poor advice.

Institutions own or have a business arrangement with financial planning groups in order to ensure funds flow into their products. That’s the name of the game.

An adviser aligned with CBA is not going to recommend ANZ any more than a Holden dealer would recommend you buy a Ford.

Financial planners do not have appropriate advice targets; they have sales targets. They need to sell you their institutional master’s product. The financial planners I know are caring people with the highest of integrity, but they operate in an environment where the game is rigged towards the “house”.

As long as institutions are permitted to employ or own financial planners, the conflict of interest issue remains.

The vertical integration model is being read its last rites…soon it will go horizontal…and not a moment too soon.


Vern Gowdie,
Editor, The Gowdie Letter

PS: Income specialist reveals five stocks he calls ‘…the best dividend paying stocks on the Aussie market today.’ Find out which stocks he picked here (free).

About Vern Gowdie

Vern is a contributing editor to Money Morning — Australia’s biggest circulation daily financial email. (To have Money Morning delivered straight to your inbox you can subscribe for free here).

Vern has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of…

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