The FSA validates fees for advice
The key proposals of the FSA Retail Distribution Review were well trailed – here as elsewhere. The main one is a gamble: forcing IFAs into a professional business model will also push it even further into the high end of consumer income and assets, leaving an even bigger mass-market gap below it to be filled by better products and service formats. It is a gamble because this mass market space has so far been dominated (and abysmally served) by underqualified transaction-orientated IFAs and banks. Both have the worst records managing the conflicts betwen sales incentives and treating customers as fellow humans.
I will return to the gamble in respect of these groups in a later post. My first comments are on the implication that consumers will be able to trust a freshly-branded ‘profession’ of independent financial planners just because of collective actions, such as fees agreed with the customer (instead of commissions agreed with providers), membership of trade associations and threshold exam qualifications. There are already many firms who rightly claim all of these in their marketing literature. As insiders, what we know is that these firms nonetheless offer wildly different value propositions. The differences that count are not so much in their traditional financial planning expertise but in their grasp of the core investment skills, and consequently in their thinking and processes, as well as a wide range of differences in clients’ all-in costs. Customers need to discriminate rather than rely on labels, even a fresh set of labels.
Going with the markets – all four markets At the QEII Conference Centre on Wednesday a group of regulators, industry trade groups and consumer groups revealed the product of an unusually collaborative review of how we might sell financial products better and provide advice better, in a marketplace the FSA has described as dysfunctional.
The whole review process, involving five working parties with participation of all these different interest groups, as well as the Discussion Paper published on Wednesday and the ensuing six months consultation period, testifies to a key new insight at the FSA. The regulator is not as powerful is it (and others) once thought. It cannot legislate to make dysfunctional markets function better. It has to work with markets and go with the grain of markets. It also knows that its legal powers are restricted by conflicting authorities, including Europe’s attempts to prevent barriers to trade in financial products. Prescriptive practices (like the ‘menu’ – and possibly some of the proposals in this paper) are liable to be viewed in other countries as restrictive practices.
Most comments on the paper focus on the FSA’s segmentation of the market into four categories. In terms of economic groups, this translates more familiarly into three levels.
At the bottom end, public money is required to help people who are not commercially interesting to financial services firm. They need help accessing advice and information about basic things like benefits, means testing, debt management and whether to opt out of the new ‘personal accounts’. Most of this is generic in nature, but still relevant to (and customised to) individual situations. One output of generic advice is what sort of services are needed next.
The top segment will be better defined as a result of these proposals, as it is characterised by a professional advice model. This is likely to be even more our of reach for households with modest savings and accumulated investments. Face to face advice is already a luxury. There is no reason to suppose that these proposals will alone make it any cheaper. In fact, most of the changes suggest adviser costs will rise rather than fall.
The middle segment is the Tesco of financial advice and product distribution, with core custom that is marked by modest income whilst also attracting custom above and below that. I anticipate that there will be many Harrods shoppers who will prefer to do some or all of their shopping at Tesco if the FSA’s hopes are realised that new products and services emerge in this segement that get the job done simply, possibly (with technology) more robustly and certainly with much lower costs.
I am very interested in solutions that meet these objectives and have ideas for their design and delivery mechanisms. However, I am also realistic about the challenges when customers appear not to care about value. If people will not take the trouble to discriminate between a high street bank with a damaged reputation and a new brand with a completely different attitude and service offering, why risk the millions it takes to establish that brand?
A professional financial planning model Until new services fill the void, readers of this blog are likely to want to fancy their chances with the new breed of professional financial planner.
The FSA proposals rely on a combination of rules, incentives and capital hurdles to herd IFAs either into a professional grouping on the moral high ground or into the middle ground along with banks and everyone else with tacky ways of getting paid (these ‘general’ advisers can still live off commissions) and with limited skills and limited offerings. A lot of IFAs are not going to like that but the argument on commissions has at last been been won and they will struggle to reverse the reforming zeal of this aspect of the proposals.
Chat at the conference had this bottom-end IFA herd marked out for an early trip to the abattoir. The FSA appears to be playing into the hands of the banks by adopting suggestions these people pose big risks and need much more capital. Higher capital will be a good way to finish them off – or send them off to work for banks, where at least compensation to damaged consumers will get paid.
I expect a lot of clients of high-end IFAs will have had calls since Wednesday subtly reminding them their adviser is already a Chartered Financial Planner, and that the firm already offers Customer Agreed Remuneration: fee-based charges. So is it really a new breed and what difference do these proposals really make up on the high ground?
Not much difference. That would not matter if all was rosy in the IFA segment of the retail investment business but it isn’t.
Is your adviser really an investment professional? Much as I admire the work of good holistic financial planners in this country, it is not worth nearly as much to clients as it would be if it was informed by real investment expertise.
There is a certain amount of financial advice that needs no investment understanding, such as identifying personal goals, insuring the risk to household income posed by death and disability or writing a will. But as soon as you start talking about how to resource any personal goals that involve funding, about household borrowings, about the trade-offs between consumption and saving, or about the relationships between entrepreneurial income risk and financial asset risk, you need to be able to combine knowledge of the dynamics of people, their cash flows and their balance sheet structure with knowledge of financial markets, how they behave and and what they may reasonably permit.
As soon as you move from the generic to specific product structures and funds or securities, you need an accurate understanding of the interaction between markets and product returns. And without a realistic understanding of what both markets and individual managers can jointly and severally provide, you have no basis for making judgements involving relative after-cost advantage between different approaches and products within an approach.
The unnatural gap between planning skills and investment skills is an accident of history but not one the development of the industry has cared so far to repair. In fact, the difference in business model between professional fees for advice, usually time-based, and asset-gathering, in which revenues are maximised by gathering assets and attaching a value-based fee, is creating an even greater division.
In the planning model, profitability is maximised by delegating investment to third parties with their own commercial agenda, completing the severance of the link to the dynamism of the owner’s life plans and freeing both the planner and the owner of all responsibility for outcomes. In the asset-gathering model, profits are maximised by standardising investments, preferably on a discretionary basis, and limiting the cost of time spent advising or planning on a customised basis. It is a striking omission that the Discussion Paper does not even address this divergence.
This omission is most relevant where training and qualifications are concerned. Even for planning-led firms it is a bit of a joke to expect the Personal Finance Society, an arm of the Chartered Insurance Institute, to be able to equip people to work as investment professionals. Even the Association of Financial Planners, which from its origins has focused on holistic planning as an alternative to the broker-based origins of its rival, is weak in investment practice. Both organisations are limited to preparing people for investment papers that are equivalent to the entry level exam in the institutional investment industry, the Investment Management Certificate, taken by recruits in their first or second year.
Costs of the asset-gathering model In retail asset-gathering firms, the business model is increasingly becoming blurred between firms that originated as IFAs (like Towry Law), as accountants (Smith & Williamson), or stockbrokers (Rensburg Sheppards). There is much to criticise in the investment approaches of all these business formats, compared with best practice in the institutional market. Nothing in the Discussion Paper will necessarily deal with these weaknesses, which include all the commonest targets of this website:
Mass standardisation where goal-based customisation is called for
Poor techniques for asset allocation and risk management
An obsession with active management at the expense of trackers
A bias (from asset-based charging) to using low-risk packaged products as a substitute for cash
A bias against planning options that reduce assets under management, such as annuitisation, debt repayment or investment in asset classes or approaches best provided by third parties
Poor disciplines for valuing the after-cost advantage of tax-favoured investments
A value-destroying weakness for following market fashions
These weaknesses expose retail clients to additional costs, for no reasonably-expected additional return.
The Retail Distribution Review does not itself address these wasted costs. Indeed, by validating fee-based charges that emulate asset-based ‘trail’ commission they will tend to validate continuity of existing preferences.
The review does impose an additional cost on advisers, if they want to avoid raising invoices and getting clients to write cheques. This is the time-related cost of the process of calculating how fee recovery should be optimally spread between different product providers, as there is no obligation to link client-mandated payments of fees to particular products.
Like us, some of these firms already effectively operate customer agreed remuneration. At the conference I chatted to Andrew Fisher, head of Towry Law, a good example of the transformation from transaction-orientated IFA to asset-gatherer. The firm had taken a full-page ad in the FT Money section promoting fees and an outright ban on commissions. He explained to me that charge a discretionary management or advice fee of 1% of assets (more, I believe, if in a tax wrapper) and invest in the institutional units of packaged products, at an average annual management charge of .65%.
Fine, Andrew. But how do you justify 1.65% or more for barely-customised portfolios that are full of active-management risk (compared with institutional tracker rates of about 0.3%)?
Maybe Towry Law can succeed where all else have failed to make the active management game pay off. Maybe not, in which case firms that focus on asset allocation and use trackers should provide much better value. Or even firms (like No Monkey Business) that charge fixed fees, not asset-based fees, to eliminate those other biases in an asset-gathering model.
This is the point: clients need to discriminate within the fee-based adviser market. They cannot rely on categories. They need to understand and think about the value proposition.