AFA Brent Sheather wrote an opinion piece last week, in which he said many bond portfolios were lower quality than they should be. He said many financial advisers were recommending high yield/high risk bonds that were effectively junk, instead of sticking with lower-risk council, SOE and bank bonds.

Those junk bonds would act like shares at the first sign of trouble, he said, instead of going up when the stock market fell, which was a driver for many people including bonds in their portfolios.

“As is often the case the reasons for bad behaviour can be traced back to fees - if you are charging a 1% monitoring fee and another 0.5%  in platform fees your client isn't going to generate a satisfactory return from low risk bonds yielding 4% to 5%,” he said. “This was the reason behind the popularity of finance company debentures and the same theme continues today with higher risk bonds.”

He told Good Returns that most people were compromised in one way or another. “Typically it’s that they have high fees so they have to buy higher-risk bonds.”

He said there was a lack of practical advice for advisers on how to put together and manage a fixed-interest portfolio. “This isn't altogether surprising because a sensible bond portfolio couldn't sustain a high annual fee structure and few people involved seem to know or care what best practice looks like.”

Michael Naylor, of Massey University, said Sheather was generalising too much. He said advisers who were CFP qualified would resent the way he attacked all AFAs but cited just a few bad cases.

“At the lower end of AFAs, however, my impression is that advice is becoming far worse than even Brent alleges. Aiming for a CFP has stopped becoming de facto – and the unfortunate impact of regulation has meant that many new advisers, especially those bank-based, are settling for level five certification. These advisers are so far out of their depth discussing bonds that it’s scary.”

Naylor said authorisation had given advisers the idea that they could advise on bonds, “when they don’t even know the depths of what they don’t know. These AFAs should certainly stick to saying – ‘put x % in our provider’s KiwiSaver and x% in our provider’s fixed deposit.’  Their main focus should be on client behaviour and creating a savings/ investment plan, via low-cost funds.”

He said Sheather’s point about fees making it hard to recommend low-return bonds was a good reason for advisers to move to set fees.

“As noted in other industry discussions, it would help if the FMA required all NZ funds and platforms to release all fees, including embedded fees.”

You can read Naylor’s full response in the blog section.