November 2012

RETAIL: Now, roll up your sleeves

rolling up sleevesFiona Rintoul looks at retail trends in the UK and finds that the denial period is over and it is time for acceptance and implementation of the Retail Distribution Review. Like any major regulatory overhaul, the UK’s Retail Distribution Review (RDR) – which, broadly, aims to improve adviser professionalism, increase fee transparency and eliminate commission bias – has drawn its fair share of flak, and there has been no shortage of doomsday scenarios. But with RDR due to come into effect at the end of the year, the denial period is over, suggests Nick Smith, managing director at Allianz Global Investors, and there is acceptance and implementation. “Financial advisers are rolling up their sleeves and thinking about what they want to do and specialise in as a firm, and whether to outsource,” he says. The best way
They do this in a market that could scarcely be more challenging for savers, advisers and fund managers alike. Perma-crisis in the eurozone, a weak outlook for the global economy and financial repression at home mean old solutions simply do not work any more. New solutions need to fit in with RDR and solve the not inconsiderable problem of getting results for savers in a growth-lite environment with an ever-decreasing circle of safe havens. Oh, yes. And savers need those results more than ever because, increasingly, they must take responsibility for their own pension provision and other welfare needs. It will come as no surprise, then, to learn that a survey of UK financial advisers conducted by Natixis Global Asset Management (NGAM), finds that 52% no longer believe traditional 60% equities, 40% fixed income portfolios are the best way to pursue returns and manage investment risk, with only 8% cleaving still to heritage methods. This raises the question: what is the best way? And, particularly, what is the best way in an environment where, as John Yule, UK sales director at F&C Investments, points out, “RDR is overarching everything that’s happening”? There are two (linked) principal trends: multi-asset strategies and approaches that in one way or another pay greater attention than was previously normal to risk. Certainly, NGAM, which will launch a range of UK-domiciled open-ended investment companies next year, believes that prioritising risk and diversifying across asset classes are the best way to construct what it calls durable portfolios. “In the 1990s, return against a benchmark was the main consideration. Now, risk should be the primary input when constructing portfolios,” says Ed Farrington, managing director, global key accounts at NGAM. “Therefore, we need to make better use of traditional investments and to think about new asset classes.” Fixed income is one traditional investment sector that is particularly ripe for development and where considerable innovation has, and is, taking place. “There is a broadening universe of bond products,” says Smith. “There is room to look at how to invest in high yield in a more defensive way. For example, by excluding certain categories of high-yield bonds. And we recently reopened our renminbi bond fund, as we still believe in its long-term appreciation.” Alternatives are a tougher bird to roast. One of the goals of NGAM’s Durable Portfolio Construction Research Centre is to promote a better understanding of alternative investments. The company’s survey of UK advisers reveals an interesting mismatch: investors are concerned about volatility – sometimes to the point of paralysis. But on the whole they do not know much about the alternative investments that could potentially help to control volatility in their portfolios. As the very word ‘alternatives’ can have some investors run screaming from the room, the solution, says Farrington, sometimes lies in semantics rather than investment fundamentals. “The first study we did, years ago, showed that investors across the spectrum did understand that diversification was a good thing. We need to continue to frame it in that way by saying ‘further diversify’ rather than ‘alternatives’.” The trend towards multi-asset funds and risk-labelled funds was, of course, in place before RDR, but the new legislation looks set to accelerate it. Some believe this will be a catalyst for another trend that is far from new: bifurcation of the market. “There has been a trend in the UK for the best part of a decade for the institutionalisation of the retail market,” says Tony Stenning, head of UK retail sales at BlackRock. “It’s connected with the rise of DC [defined contribution] pension schemes, which means many enterprises employ advisers to help employees. As a result of that advice, retail investors have become more comfortable with index solutions.” This has come at a time when investors are more focused on cost than performance because of the difficult economic climate. Passive funds
“When people see lack of growth, they focus on cost,” says Yule. “There’s a movement against performance fees. In mainland Europe, buyers are still quite happy to pay performance fees, but there is a lot less appetite for it in the UK. Over the past 12 months, a lot of advisers have been looking at passive funds.” Whether this is an entirely positive development is a matter for reflection. As Yule says, sometimes transparency does not mean that people understand. “A passive fund just buys you the market, which may not make sense if the economic backdrop is negative. If you look at good-quality active fund managers, their recent performance has still been relatively good. But a lot of people don’t see that. “They just see something that’s cheap.” To capitalise on the trend towards passive funds while acknowledging the advantages of good active management, BlackRock is launching a range of five asset allocation funds on January 1, 2013 that invest in its range of index funds. Named consensus funds and a decade in the making, the new portfolios are designed to be used alongside active funds. “Advisers can combine a passive core with active funds to tilt the portfolio for individual client needs,” says Stenning. Handy, off-the-shelf solutions such as this are going to become ever more important to advisers in the post-RDR world, particularly when they are dealing with less wealthy clients. “Large clients used to subsidise smaller clients,” says Stenning. “Now that can’t happen. In the new world, advisers need to be able to risk rate clients more effectively and efficiently.” Solutions such as the consensus funds cannot simplify the fact-find for less wealthy clients – that is not allowed – but they can simplify the implementation of a bespoke(ish) solution. It is a way of outsourcing part of the asset allocation. And that, increasingly, is what advisers want. “In the past, picking funds was an important part of what financial advisers did, but a growing number of them are realising they will have to rethink their business model, and outsourcing is part of that,” says Smith. Risk aware
Portfolios with risk ratings, labels or targets are also part of it, and most commonly go hand in hand with a multi-asset solution. The take of Smith’s own firm was to launch four target risk, multi-asset funds called Riskmaster funds. “Clients are becoming more risk aware,” he says. “Funds with clearer outcomes in terms of risk are more attractive to advisers. The risk managed area is where a lot of flows will go in the new few years.” But risk labels can bring their own problems. “A lot of funds are getting badged with a ‘4’,” says Yule. “But a fund can change.” Smith shares his concerns. “I’ve noticed traditional return oriented, multi-asset funds getting risk ratings,” he says. “A traditional multi-asset fund might be a ‘6’ today and something else tomorrow. There is no clear labelling.” A key challenge, then, is to educate advisers about the difference between risk rated fund and target risk funds. “A risk rating is a snapshot,” says Smith. “It doesn’t tell you anything about the future.” This all happily assumes that clients have an adviser. But one of the possible unintended consequences of RDR is that it will create what Smith terms “orphaned clients”. Will such clients convert into self-directed investors? And, if they do, will they make the right choices? “It’s a question that we as an industry should be thinking about,” says Smith. Many of the new multi-asset solutions with (more or less effective) risk profiles attached are designed to address such lower-income clients. Nonetheless, they do require advice. The US experience suggests that these investors will be accommodated, says Farrington. “When the US migrated to more fee-based advice, new models emerged that serviced the entire spectrum.” The UK is not the US, of course. It remains to be seen whether Smith is right when he says, “RDR could help build trust. It looks frightening from the outside, but we could end up with an industry where standards of advice are better than ever, and there is greater transparency about fees.” As far as fund management companies are concerned, it is now a question of them positioning themselves to thrive in the new environment. There are issues with legacy clients. And then there is the threat to the soft underbelly that any more robust regime inevitably brings. “The mediocre middle will get hollowed out,” says Stenning. ©2012 funds europe

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