In 2012, the Retail Distribution Review (RDR) permanently overhauled financial advice in the UK. Our panel discussed the impact it has had on distributors, and what more can be done to improve the industry.
Bella Caridade-Ferreira (chief executive, Fundscape)
Martyn Gilbey (head of business development – UK, Aberdeen Asset Management)
Shiv Taneja (principal, Market Metrics)
Bill Vasilieff (chief executive, Novia Financial)
Funds Europe: Has the ending of fund rebates affected the way distributors select funds?
Bill Vasilieff, Novia Financial: Active management has dominated the marketplace because it paid commissions, or rebates, to advisers, which gave active management a stranglehold. Since the ending of commissions in 2013 with the RDR, passive management is taking a bigger market share.
Ultimately, passive management is going to, on average, outperform active management – it’s bound to. The sum alpha in the market is zero, and passives are cheaper, so they’re going to get more business.
The attack on inducements by the FCA helped us at Novia. We were getting squeezed out of the market by networks paying massive inducements.
The banning of commissions and the banning of inducements are good things, and I think we’ll see much more passive management in the future.
Bella Caridade-Ferreira, Fundscape: You are right about passive. In our data we see that, although there are big flows into one or two funds, the likes of Vanguard and Dimensional, which have large passive businesses, are at the top of the rankings and attracting a lot of business into many funds.
Yet don’t understate the status of active, because next in line is Neil Woodford, with one fund. So the power of brand, reputation and god-like status can work wonders.
Martyn Gilbey, Aberdeen Asset Management: RDR is certainly one reason why passives are enjoying success – but there are other drivers of change.
Pensions freedoms is one, as is the related growth of workplace defined contribution (DC) default pension funds, where there is a need to provide a blended investment proposition within a price cap. Passives play a key part in delivering a product to the end client within the price cap.
Shiv Taneja, Market Metrics: The UK mutual fund marketplace has probably been one of the most successful in the world, but there are some very dramatic changes that have taken place within the industry.
The first is that the share of flows that are going to the top five or ten fund managers has dramatically reduced in the last five years. We’ve essentially seen market shares decline from 61% in 2011 to under 40% in 2015.
This is happening for several reasons. RDR is a component – but so is the shape and structure of product demand. If you go back 15 years, in the UK we had a classic Anglo-Saxon equity/fixed income/cash model. Now we have a multi-asset, multi-strategy income-generating model.
Another fact is the UK’s unique distribution model is predicated on financial advisers and wealth managers, not on banks.
This has allowed some firms to rise through the top ten rankings in terms of perception and satisfaction from financial advisers. Woodford Investment Management, a firm that didn’t exist three years ago, has got two products but one fund is right up at the top also. You may not have seen that in a highly stratified, bank-led distribution model.
Caridade-Ferreira: However, the market is now seeing more vertical integration with, for example, the likes of Old Mutual and Standard Life buying adviser firms and wealth managers with their own platforms and getting more control of flows. It’s not necessarily good for the client.
Vasilieff: But will this last? In the UK, vertical integrations have always ended in tears.
Taneja: In Australia, vertical integration – the ownership by a bank or insurance company all the way down to a financial adviser – has worked well.
But I’m convinced the real growth driver for the industry is going to be the DC market. The question there, though, is who’s going to own the client, who’s going to own not the product but the wrapper within which that client sits?
Gilbey: The pool of assets in the wealth and DC markets are highly attractive to an asset manager and what was interesting in the recent UK Budget was the blurring of product lines between wealth and DC in long-term savings provision.
Vasilieff: I don’t think that has changed. People are always saving for the future. That’s all people do, even if DC were dead. The chancellor, in the budget, made moves to basically replace DC with the lifetime ISA. It doesn’t change anything, people are still just saving for the future.
People are looking at all their holdings as one unit. The worry with pensions freedoms was that people would take their money out and buy property. If they were to do that, they would still be investing for the future, they’d just be using a vehicle different to their pension.
People that save for the future don’t suddenly wake up and throw their money away.
Gilbey: There were some fairly significant Budget changes. Pensions are now, effectively, inheritable assets, and compulsory purchase of annuities has ended. That’s significant.
People aren’t necessarily thinking now about how many more years they have to save and how long their assets will need to last to fund retirement. They’re thinking beyond that.
Taneja: This leads to the issue of the RDR advice gap. Pre-2013, I don’t think there was anyone in our industry or the regulators who did not appreciate that there was going to be an advice gap – but it wasn’t fully appreciated how big an advice gap there could be. In the next ten years, this will be almost a socio-political issue for the state and the government.
Caridade-Ferreira: But pension freedoms have actually brought a lot of people back into scope, because if you retire with a big pension pot that you wouldn’t have had access to before, you are of interest to a lot of advisers.
The advice gap has always existed – 85% of the population never sought advice. The 15% that did has shrunk to about 10%.
I entirely agree that pensions are going to be a key driver of industry growth, but I also think it’s more nuanced than that. Decumulation is what is going to drive development. There’s going to be a shift from accumulation to how to manage money in retirement and still leave enough for your kids.
Gilbey: This will lead to a challenge for the industry. Could a firm enter the market at the point of de-accumulation, or would it have to be in at the accumulation phase in order to participate in de-accumulation?
Funds Europe: Have platforms, those aimed at professional distributors, risen in importance as a result of the RDR, and what do these platforms offer, and what are the drivers for their usage?
Gilbey: Platforms have risen in importance, but I’m not convinced RDR is either the sole or the most important reason for that. There is a wider dynamic at play around digitalisation.
Post-RDR, there is a much greater focus for everyone on transparency and business efficiency, so for advisers, for example, being able to aggregate a client’s portfolio in one place, trade in one place, these are operational efficiencies that I think make a compelling case for platforms. But these platforms existed and were growing before the RDR.
Caridade-Ferreira: Yes, platforms already dominated pre-RDR, with perhaps some 85% of flows. What happened post-RDR is that everything switched into them, because the one thing that advisers and fund management companies wanted facilitating was adviser charging. Platforms do this. Some providers decided not to make their products RDR-compliant and that accelerated the shift to platforms.
Gilbey: For asset managers, platforms perform a critical role because they aggregate the wholesale market for us. That’s a big section of the UK retail market and this is really important in terms of how we can efficiently access that market.
Vasilieff: As a platform provider, I agree that platforms are really about business efficiency, giving a single portal into an entire market. Platforms bring massive efficiencies to advisers through a single point of contact to the whole market, and it’s all online. RDR just consolidated that position, because some managers couldn’t be bothered to build their own infrastructure.
Sometimes people criticise platform costs, but remember that we do a lot of the work others don’t want to do.
Caridade-Ferreira: In the early 2000s, fund managers were falling over themselves to sell their backbooks of business to be serviced by platforms. Now they’re considering doing it themselves, even though they don’t have the infrastructure or the resources.
Taneja: What firms that want to re-engage with their end clients really need to be thinking about is not circumventing the platforms, but re-establishing a channel of communication with the end client.
Vasilieff: Asset managers have lost that link with the end client and I think it’s going to be very difficult for fund managers to get that loyalty back.
Taneja: You may be right, but when we evaluate the quality of websites, we see that in the last three or four years – and in the UK particularly – that intermediaries are increasingly only going to asset manager websites for best investment ideas, thought leadership and market commentary they are not able to get elsewhere. This is largely because they get everything else from platform and other third-party websites.
Gilbey: Digitalisation has impacted all of us in our industry. Aberdeen is investing in this space – we recognise that in order to be successful through intermediated channels and through platforms, we have to be accessible to end investors.
Taneja: Bill, as a platform, do you believe that the future battle will be less about the nuts, bolts and piping, and much more about the quality of what you provide in terms of tools, online advice and guidance to service either the intermediary or end client?
Vasilieff: We were the first platform [under a previous company] to offer tools. What’s frustrating is that people don’t want to pay for all this added value we give.
If we’re providing added value to the customer through the IFA, then the theory should be the IFA charges less to the client, because there’s less work. That’s the logic, but it doesn’t always go that way.
Caridade-Ferreira: Well, look at it from the end user’s point of view. They are paying for the service, but all they really need is custody of products. Do they need all those fabulous little tools that they’re paying for the adviser to use?
Taneja: The answer would be yes if the experience for the adviser was significantly better, and the resulting quality of service improves.
Caridade-Ferreira: But this is where platforms could run into issues with the regulator. The regulator could ask whether this is the right platform for the array of clients a firm has, whether they really need all those tools.
Gilbey: As an industry, we need to continually remind ourselves that when we talk about distribution and advice, we’re talking about a relatively small portion of the population at a very specific point in their life journey. People need to start saving and, at some point investing, much earlier than when we as an industry tend to engage with them.
Funds Europe: How successful is the industry at creating a savings investment culture among the public?
Caridade-Ferreira: Ask most people who they banked with at university and they generally bank with the same bank now. So if you engage and treat them well at 18, you have them at 50.
As young people they may not all be interested in personal finance and they may not have much money, but give them support in other ways, such as providing budgeting tools at the university level, and you could maintain them as customers for the long run. But nobody wants to do that.
Taneja: The head of a large asset manager outside the UK said to me that he doesn’t expect to work in the industry for more than ten years, yet maintaining relationships with the young until they have significant money will take 35 years! He just was not sufficiently invested in that idea and that’s where the conversation about this topic ends.
Caridade-Ferreira: You’re right, but Feri, my previous company, started out in Germany attracting customers on campus. They recruited legal students, medical students and so on, and got them saving and investing. As a result of that long-term approach, Feri became one of the largest wealth companies in Germany.
Gilbey: To take a 30 or 40-year view as people become relatively wealthier throughout their lives – particularly as did the generation that benefited from DB pensions and house prices – then we need to remember that those investable assets will rework themselves into the world, through inheritance.
Vasilieff: But people are really baffled by our industry. The lack of knowledge is huge.
Caridade-Ferreira: Equally, you have to look at it from a young person’s point of view: are they ever going to be able to afford to buy a home in the town they were brought up in?
Vasilieff: Yes – but from their parents.
Caridade-Ferreira: Only a very small percent will inherit, and that just reinforces the whole dichotomy between the haves and have-nots. If you don’t have rich parents, you won’t inherit a home, and so you will never, ever be able to afford one.
Vasilieff: The housing market is bound to correct that. If in 20 years time there’s no one buying houses, house prices are going to drop. It’s only a matter of time. But it could be a long time.
Taneja: Yes, I think government is trying to set into motion a series of events – but we also need to recognise that changing the mindset of people is important. We are no longer a welfare state. Certainly our children will no longer be able to rely on any sort of welfare in any meaningful fashion.
Vasilieff: People get the wrong idea about risk. The highest risk asset you can invest in is cash because you’ll get destroyed by inflation. The best thing you can do is invest in equities, they’re the least risky.
In the long term, you’ve got to be in real assets, like equities and property, or you’re going to lose your money. In the 1970s, very high interest rates still meant that in real terms you lost half your money. If you hold on to cash long enough, it’ll be worthless, that is the bottom line.
Caridade-Ferreira: There is a great deal of passive investment today, but in the long run you do need to be invested in active funds to provide better outcomes.
Investing in a good active fund manager for 25 years compared to a passive fund, the difference could be substantial.
Vasilieff: The trick, of course, is to pick the long-term winner.
Caridade-Ferreira: Prior to RDR, an adviser would buy funds that paid the most commission, regardless of how well the fund did. Now the adviser is doing one of two things – either buying really cheap passives, or the alpha generators at the other end of the spectrum, and not the expensive funds that sit in the middle, with mediocre performance at high cost.
Gilbey: The focus on closet indexers is coming to the UK, having started in Norway.
Vasilieff: A lot of active funds get ‘put down’. It is a way for fund managers to get rid of their track record, by just merging it away. One firm was famous for it, killing underperformers to shoot the track record. So track records are actually not real.
Caridade-Ferreira: This brings into light the impact of gatekeepers in the UK, which we have studied at Fundscape.
To build recommended shortlists, and with so much information around – too much, in fact – it is easier, and especially following RDR, to outsource the investment selection to somebody else. A large national or a network adviser will have a unit that does that. The question is how independent those gatekeepers are, including ratings agencies.
Taneja: The rating agency rates a fund, but doesn’t actually select the fund, the gatekeeper would use the agency.
Caridade-Ferreira: But how do they decide which funds to rate?
Vasilieff: They get paid for it.
Taneja: That’s a scandal all of its own.
Caridade-Ferreira: It is if they’re only rating funds from large fund managers, because large houses can afford the fees to pay for the badges to put on their documentation. It creates a bias towards larger funds.
Gatekeepers control 50%-70% of all flows in the market, so this is a big thing, especially since RDR, a lot of advisers are outsourcing to discretionary fund managers.
It’s all about too much information and digitalisation, which mean advisers outsource selection. But have they done the research into how good the fund selector’s process is?
Gilbey: Where advice really comes into its own is not in selecting the next best fund and churning through your portfolio, it’s making sure that in five years’ time the portfolio you’re invested in is still delivering what you need. That’s got to be the power of advice, and that creates an opportunity for asset managers and probably insurance companies and banks. I would rather pay an adviser to keep me on the right life path, and pay a very smart multi-asset manager to blend a portfolio together to deliver what the adviser and I are agreeing is important to me.
Funds Europe: Should banks get back into the advice business?
Vasilieff: Yes, but they handled advice very badly in the past, they never trained their staff.
Caridade-Ferreira: If they come back in they’ll come back in with automated processes. They can’t risk unleashing an army of untrained, uneducated advisers on the public.
Gilbey: The boundary between advice and guidance is an area all of us have to pay attention to in the next 12-24 months. It’s very clear that some banks think the Financial Advice Market Review is a green light for them to re-enter the advice market by providing guidance, whether face-to-face or online.
Caridade-Ferreira: The lines are still really blurred. Last year the regulator brought out the paper on the differences between the types of advice – but it still didn’t really pave the way for organisations to close the advice gap. Firms still aren’t providing simplified advice.
There are no simplified advice solutions out there. Why? Because the amount of work you’ve got to do is just as much as for ordinary advice. The FCA needs to reduce the burden.
Gilbey: Banks are also mindful of avoiding the next mis-selling scandal. They paid out more in PPI mis-selling claims relative to their profits made on the products. They are paranoid about going back into product lines that create a future liability for them or shareholders. They have a trust issue and, I think, an economic credibility issue around going back into the advice market.
However, I think they probably do need to go back into that market.
Caridade-Ferreira: But what they’re doing is launch or buy a platform, as are doing the life companies who lost with-profits and annuity business. But advisers who use platforms are always suspicious about life companies’ ultimate aims.
Funds Europe: What are you looking for in the next couple of years to improve the distribution market in the UK?
Gilbey: Some of the key topics for us are pension freedoms and the resulting development of DC and ISA savings. These are of genuine interest alongside digitalisation and the growth of passives. This all creates opportunity for asset managers. The biggest threat to being an asset manager now is to narrowly define yourself as an investment manufacturer and to not understand distribution.
We cannot hope to ever compete with established, mature, scalable distribution channels like the adviser market in the UK. It’s very important that we work in partnership with that, but all of these changes that we’ve talked about around digitalisation and regulation and pensions liberalisation, we think just creates new opportunities for asset managers. The growth in DC is going to take 15-20 years to reach scale, whether that’s in the workplace channel or direct to consumer, but we can see a way forward now that gives us multiple opportunities to grow our business, and not just be defined as an investment manufacturer.
Caridade-Ferreira: RDR was not about buy-side reform. People still need advice – more so now than ever. We’re living a lot longer, we have complicated needs, we need to manage our money in a different way.
Pensions reform has actually created and extended the market exponentially, so there are plenty of reasons to be cheerful if you’re a fund manager, a distributor or a platform. Fund managers need to partner closely with insurance providers, distributors, etc, to make sure they’re delivering the kind of solutions people want and need in the future, and it isn’t just about funds, but how funds fit into that solution.
Taneja: Has the UK marketplace done fantastically well for clients? In the main I’d say yes, but clearly there’s a long road to travel.
We need to be able to leave good things in this industry alone. This industry has this intense desire to constantly meddle with itself.
Take passive investment as an example. In its most basic and simple form it is a transparent, easy-to-understand concept. If you go back 20 years – as with guaranteed, structured products which also served a need when first set up – it has become overcomplicated. We sometimes just need to control ourselves and not over-engineer the business.
We have a pretty good distribution structure which, in the main, works well.
Vasilieff: The need to self-provide is going to grow, and longevity is going to drive that. Therefore people need to be invested in real assets. There will be a big growth in passives over time, and I believe that advice will continue to dominate in my lifetime. I don’t think people will go self-advised.
But vertical integration worries me. I see some good-quality advice firms being bought up, and that’s a sort of worry for us.
It will lead to a worse deal for the customer because the intention is to distribute their own product.
©2016 funds europe