AMP faces an uncertain future

One of the worst financial results for the week was reported by giant insurance and fund manager AMP (ASX: AMP), after the company lost much of its board and management due to evidence at the financial services Royal Commission.

First half profit fell 74 per cent to $115 million due to impairments linked to its financial planning scandal, with the total bill set to hit up to $500 million.

Underlying profit was also down due to the financial planning troubles, falling to $495 million for the half from the $533 million recorded in the first six months of last year.

Compensation payments blunt profits

AMP has previously announced it will put aside $415 million to compensate customers found to have been affected by poor or non-existent advice going back 10 years – a provision that will cost AMP $290 million after accounting for tax.

It is a sorry set of figures but the real worry for AMP is that investor’s money has been flowing out of the company.

Money flowing out of AMP investments

AMP acting chief executive Mike Wilkins said customer withdrawals picked up following the royal commission hearings in April but had slowed down in recent weeks.

AMP’s wealth management business saw total net cash outflows of $873 million for the first half of 2018, compared to net inflows of $1.023 billion in the prior corresponding half.

Most of those outflows – $673 million – happened in the second quarter, which is traditionally AMP’s strongest quarter.

Board and management being restocked

It is a worrying picture as the fund manager begins to restock its board with the former head of Treasury John Fraser and continues to look for a permanent chief executive to carve out a future for what is still one of the most recognisable names in insurance and money management in Australia.

AMP investors will certainly be feeling the pain as well quite apart from the prolonged fall in the share price with dividends down to 4.5 cents to 10 cents per share.

The real long term problem for AMP is how it can modify its business model to not only regain the trust of investors in itself and its products but to compete and thrive in the new and very different environment that is certain to arrive following the Royal Commission.

Royal Commission shows importance of fees

If it achieves nothing else, the Royal Commission has shone a very bright spotlight on the fees charged by some super funds and all but the most uninvolved will now know that they need to take notice of this issue.

Interestingly, local exchange traded fund (ETF) company BetaShares this week produced some interesting research showing the extent to which fees can blunt investment returns, given the power of compounding returns over time.

Compounding returns make low fees vital

Using their example, an investor who puts $10,000 into Australian shares that grows by 5 per cent a year and leaves it for 40 years will grow that balance to $38,835 if the investor had paid the average Australian active investment management fee of 1.55 per cent a year.

That sounds great but consider what the result would have been if the same investor instead used a low cost ETF to invest in the Australian market.

Using the 0.07 per cent fee charged by their Australia 200 ETF (ASX: A200) – which is a very low fee – and assuming the same five per cent a year return, the investor would be left with an amazing nest egg after 40 years of $68,547, or a whopping 77 per cent more!

Can a passive approach be 77 per cent better?

At this stage the critics are likely to start howling that you can’t compare a “dumb’’ ASX 200 index fund to the combined strategic genius of active fund managers.

Well, they may have a point if you are somehow able to pick the best of the best active managers and also find one who stays at the top of this game for 40 years.

However, the figures simply don’t bear this out.

Most active fund managers underperform

Most active funds managers still tend to under-perform investment benchmarks over time.

The recent S&P Dow Jones SPIVA Survey, found around two-thirds of active Australian equity managers under-performed their benchmark index over the past five years to 30 June 2017.

Those results have not tended to change much over time, and it is a similar situation overseas, suggesting that active managers struggle, on average, to beat passive investment benchmarks.

That is not to say everyone should immediately only use passive investments and ETF’s – far from it – but it does show how the issue of fees is one that is vitally important to the financial interests of investors and should take centre stage following the Royal Commission.

Active approaches can be very rewarding and many active fund managers can significantly improve investor outcomes but all of them need to be happy to show how their fees have been earned over time by outperformance.