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Are AMP Shares (ASX: AMP) a Buy?

This article was originally published at MF & Co. Asset Management.

AMP (ASX AMP) is a leading wealth management company. It is Australia’s largest retail and corporate superannuation provider, as well as the largest life insurance business. Founded in 1849, AMP has built up a highly loyal customer base with over 3.8 million in Australia and New Zealand.

Nevertheless, its reputation and customer loyalty are under siege due to the banking royal commission scandal, following testimony from clients and upper management. All this casts doubt on AMP’s management capabilities and future profitability.

About AMP (ASX AMP)

AMP provides financial planning, banking, life insurance, managed funds, superannuation, property, listed assets and infrastructure investments and advice. Cooperating with large international firms such as China Life and MUFG: Trust Banks in Japan, the company has customers around the world, including Asia, the Middle East, Europe, the United Kingdom and North America. It operates in 11 countries globally. The market capitalisation of AMP is $11.24 billion, one of the large-caps of ASX.

AMP is Well Diversified Diversified

AMP is the biggest player in superannuation funds management service and life insurance in Australia. AMP has more than 3.8 million customers in Australia and New Zealand and has helped 142,000 retired to live better. Extending its business into mortgage broking, financial asset investing, property operating enables AMP to diversify its portfolio and stay competitive.

In 2017, AMP further strengthened its strategic partnerships with global players such as China Life in China, and Trust Bank in Japan. This increases both cash flows and market share in China and enhances collaboration in the Japanese institutional marketplace. AMP is also partnered with US advice business United Capital who shares similar investment philosophies with AMP, allowing them to tap into the US market.

With an aging population, Australia is the world’s 4th largest pension market with US$1.6 billion in assets. Baby boomers entering retirement ensures growth in AMP’s main client base. Providing services in the Australian wealth management sector has grown to be its distinctive competitive advantage.

Additionally, AMP bank products offer an opportunity for the group to engage with customers earlier in their financial lifecycle and allow AMP to provide services to clients through multiple channels.

ASIC Taking Action On Vertically Integrated Institutions

Vertically integrated institutions such as AMP, Commonwealth Bank (ASX CBA), Westpac (ASX WBC) and Australia and New Zealand Banking Group (ASX ANZ) have been in the spotlight recently at the Royal Commission. A conflict between an advice licensee’s interest in selling its in-house products and the customer’s interest in receiving optimal advice has proven to be a big problem. The government policy regulates advisers to act in the clients best interest, but, wealth advisers are motivated to sell products to get a sales-based bonus, as the chart below shows.

With that being said, ASIC said there is no need to separate products and advice arms. Customers obtain advice and buy financial products from a vertically integrated institution, often due to convenience. They also benefit from economies of scale.

Financial Planner Exodus A Key Risk

 The vast distribution network that AMP used to be so proud of is in the spotlight. Many of AMP’s financial planners are not employees, but rather individual Advisers paying a licence fee to operate under the AMP brand. According to recent poll by Adviser Ratings, more advisers are shifting business from institutionally affiliated to privately owned.

Furthermore, the Financial Adviser Standards and Ethics Authority which was recently set up in April 2017 is going to issue a new code of ethics for advisers to abide by in less than 2 years’ time. This could professionalise the sector, setting a standard at a level that accountants and lawyers are at. Financial planners are also required to follow higher education and training standards which could put pressure on existing Advisers that may not meet these requirements.

Another issue for AMP is that they are a buyer of last resort (BOLR) for Advisers who decide to leave. AMP will be forced to buy back the planners’ businesses at elevated prices as any planner who chooses to leave the contract must give the customers back and is not allowed to compete with the company for 3 years. Morgan Stanley indicates that even though not every planner signs a BOLR, the contingent liability is $1.4 billion in the worst case, which can be substantial.

Large Portion of Revenue Generated From Grandfathered Commissions

To avoid financial planners recommending products that were in their interest rather than the customers’, Future of Financial Advice (FOFA) reform was carried out in 2013 by Gillard government. However, the reforms have had minimal effect on AMP.

At AMP, the majority of revenue being paid to financial planners are generated from grandfathered commissions. ASIC says this encourages advisers to keep clients in legacy products instead of moving them onto better products. Both AMP and ANZ are resisting, saying that the government could end up paying the loss of advisers and “encounter institutional difficulties”. Pre-FOFA contracts may ask for property acquisition to end the contractual rights.

The regulator also said the fee for ongoing service should be invoiced to a customer. Payment should be authorised by the customer when planners provide services, while the current practice is that a client’s investment funds are automatically deducted. This delivers meaningful value to the customer and builds confidence as transaction transparency is enhanced.

Moderate Financial Performance

AMP shares grew EPS from -0.12 in 2016 to 0.29 in 2017 mainly due to increased investment gains and decreased profit attributable to non-controlling interests. However, their revenue will be under threat with the recent negative news from the royal commission.

Any forecasts for AMP shares revenue at this point in time will be unreliable, as there has been a very large material change in the company due to recent events. This includes multiple issues such as a client and Adviser exodus, multiple class action lawsuits, potential enforceable undertaking, criminal charges and other factors that will affect their bottom line.

AMP Shares Have Massive Headwinds

AMP is underfire faced with board and executive changes, two class action lawsuits and the threat of more profit downgrades. ASIC has a range of investigations underway in relation to the issue, which could mean a future Enforceable Undertaking may be issued. The royal commission’s interim report isn’t due until September 30, with the final report due early next year which is almost certain to spell penalties and restrictions for AMP. Legal uncertainty and criminal charges still hover.

The wealth management industry is undergoing a new period of heavy regulation, with Financial Adviser Standards and Ethics Authority in place and the need to completely close down grandfathered commissions. However, with these changes, consumer confidence will pick up again. Having said that, this could potentially take years.

With such a large amount of uncertainty in this industry and with AMP itself, it could take years before the market can feel confident again about AMP and whether they can put clients best interest first.

Henry Fung is a Partner Managing Director and co-founder of MF & Co. Asset Management. He is a highly experienced equities, derivatives and financial markets professional with over 12 years of experience. Henry specialises in building trading algorithms & systems, quantitative & qualitative analytics across macroeconomic, fundamental and technical disciplines and currently runs the MFAM VPAC AU/US models portfolios. The management Partners and Adviser team have decades of experience between them, with experience from major Investment Banks and Brokers. Their Advisers are highly experienced, having dealt with some of the wealthiest clients in Australia.



Categories: Australian Stocks, Featured, New Zealand Stocks

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