26th June 2012

Counting the cost of Independence

If you pop into Gieves & Hawkes at 1 Saville Row and head for the made-to-measure department, you will have two choices, bespoke, made from outset specifically for you, or the so-called ‘personally tailored’ suit. Unlike bespoke, £3,000 plus, the personally tailored suit is produced to order from an adjusted block pattern and costs from about £1,000. There is also the ‘off-the-peg’ option at around £500.

The difference in cost shows that it is labour that defines cost not material. In a fee-based world, the cost of labour is going to count like never before.  Clients want to see their money invested, not squandered on costs.  Yet the FSA is becoming increasingly prescriptive, valuing bespoke over personally tailored.

This approach is both misguided and expensive. Some say “You can’t do too much for your client.’ Sorry, when you are charging them, you certainly can.

Others don’t share the FSA’s view. Carol Sargeant’s Treasury team working on simplified products has adopted a ‘better off with than without’ mantra.  Whilst the Financial Services Consumer Council have a totally different view on advice to the FSA. If they had their way, simplified advice would be a reality and so it should be.

Some 60% of advisers now believe that asset allocation and fund selection should be outsourced to experts; in the case of network and national bosses, that figure grows to 100% (King’s New Clothes, CWC Research, 2012).  This might be in the form of model portfolios, multi-manager or discretionary management.  Model portfolios were dealt with on GC 12-06, a helpful paper that made sense bar the section 4.9 which was, apparently misinterpreted and will be clarified.

The latest paper published this month, “Retail Distribution Review: Independent and restricted advice”, is intended to help with the advisers’ crucial decision on this issue. UCIS, at least, are now out of the game - some common sense there.

That apart, little has really changed in terms of regulatory risk or operational cost. They have defaulted to “rarely if ever’ on the use of a single platform. If I have read this right, a single platform plus ‘off-platform, is never likely to be enough. Oh dear. This takes no account of operational costs that will have to be passed on to the customer.

I should add before going further that financial planning should be utterly bespoke. It should be perfectly cut to fit the client. However, when it comes to investment, the only issues for the vast majority are attitude to risk/capacity for risk and term of investment.

The exceptions are rare. Please note that I am referring to retail investment products – not the contents. Thus a socially responsible investor will have different stock in the fund/product/wrapper. The regulator has always quoted the ethical investor as an example of where the range can be restricted. This is not the case. The independent adviser will still be required to research all products, including those from abroad, on a comprehensive and fair basis. There is then a secondary stage where the products have to be screened for content i.e. the actual securities held – quite a challenge. A restricted ethical adviser could focus on purely ethical funds. The issue is whether or not the comprehensive analysis at individual client level justifies the cost. My answer is ‘no’.

Typically default propositions are managed funds of one form or another, and rightly so. The designers of NEST understand the impact of cost. No provider of group retirement benefits, being compelled to offer good value, would consider a bespoke approach – yet for many, their pension is their biggest asset.

Model portfolios are personally tailored rather than off the peg. Sadly the regulator is looking for more. The latest paper says:

If a firm is constructing its own model portfolios, which include one or more retail investment products, for use in providing independent advice, it should ensure that it bases its selection of retail investment products on a comprehensive and fair analysis of relevant product markets.

There is little wrong with this piece, except that the expression ‘comprehensive and fair analysis of relevant product markets’ is beyond the scope of most adviser firms (this is based on our own research). It is setting the hurdle very high – and the cost. It gets tougher:

If any aspect of the model portfolio is not suitable or consistent with the client’s investment needs and objectives, then either: 1) the model portfolio should not be recommended; or 2) the model portfolio should be tailored so that it is suitable (which would make it a ‘bespoke portfolio’).

This piece is much trickier and shows the regulator’s penchant for ‘bespoke’. I just cannot understand the view that some aspects of models may be unsuitable. We are not that complex on the investment piece – it is only about risk and timeframes.

Once you introduce bespoke advice, it is not just the initial cost that is higher, but the ongoing cost. Reports, analysis, reviews and rebalancing are now individual pieces of work as opposed to automated processes that the platform does for nothing. This will add hours of expert work, equal to thousands of pounds. For what?

The next issue that I tussle with is discretionary investment management (DIM).  The use of DIM is a perfectly legitimate way of outsourcing investment advice. In most cases, it means that professionals are running the money rather than keen amateurs. Yet, the regulator has singled out DIM for special treatment. Can someone please explain to me why, other than legal structure, a fund of funds is any different to a DFM? Or indeed, a balanced fund, a manager of manager fund or indeed any fund where the manager can buy and sell whatever he or she likes as long as it is within the mandate. 

A ‘recommendation’ in this context is used to mean a situation where an adviser has considered a client’s personal circumstances and decided that a discretionary investment service is the right solution for them.

I do not understand what personal circumstances would dictate a fund of funds over a DFM, or managed etc, etc. I do accept that an adviser with a client proposition focusing on those with investable assets >£250,000 is right more likely to consider a DIM solution than one whose clients have smaller sums. Indeed, a firm may have two propositions for two client segments, a DIM solution for one and manager of manager for the other. They might run on different platforms!

The important issue is that they are not bespoke with associated costs. The concern is that the regulator is becoming too prescriptive in an area where prescription is dangerous.  

The Eurozone crisis demonstrates that people of the highest intelligence express totally divers views on the problem. If at such a basic level of economics there is no consensus, how is it possible to be prescriptive about investment outcomes?

There are those who favour long-term strategic asset allocation and passive funds. Others favour tactical asset allocation and active funds. Both can be wrong; both can be right. The buyer must be made aware, as much as is feasible, of methodology and cost. After that a degree of caveat emptor must apply.

Advisers considering whether to opt for restricted or IFA should study the facts but weigh expert opinions carefully. Some have businesses that depend on large numbers of IFAs surviving; others will make their fortunes from restricted propositions. I am in neither camp, but if I were an IFA today, I would opt for a whole market restricted proposition and my clients would benefit from a total lack of provider bias together with an operational set-up that drives costs to a minimum whilst delivering outstanding service.

Clive Waller, Managing Director, CWC Research

This article first appeared in FT Business 20 June 2012 

FSA/FCA, Panacea Comment