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The Market Background
Despite the unfavourable conditions of the last 12 months, the trend is for the number of High Net Worth (HNW) individuals to increase. In addition, individuals are required to play an increasingly active role in the control and management of their investments. Numerous surveys have shown there are significant numbers of people who would benefit from Wealth Management services but who do not currently use them. One reason for this is the general lack of trust in financial advice. One of the aims of the RDR is to remedy this.
Two recent research papers, published by Compeer and JP Morgan, have shown a marked increase in the wish to receive financial guidance. These surveys also highlight the trend for investors moving towards making more decisions themselves, and moving away from the wish to delegate. Vitally, this is even more marked among the wealthy.
Summary of the Retail Distribution Review Proposals
The RDR aims to improve the industry’s structure, building trust and ensuring that competitive forces work in favour of the consumer. The proposals focus on the IFA sector as the dominant distribution channel, however some proposals will also have a direct impact on Wealth Managers and it is anticipated that others will directly change the market landscape.
The main changes proposed (as they relate to Wealth Managers) are:
- A modest increase in the capital requirements for distribution firms
- A new standard for ‘independence’ – and a requirement to clearly disclose as ‘restricted’ any service that does not meet these standards
- New professional standards
In this paper we do not propose to repeat the contents of the FSA consultation paper, but proceed directly to the likely impacts.
Likely Market Impacts
Smaller IFAs will be impacted dramatically by these proposals. A small 5 person firm will now be compelled to review a much wider range of products for each client.
To manage the transition, advisers (circa 50% of which are 55 or over) will be required to achieve re-accreditation to a higher level. It is anticipated that a significant minority will exit the market.
The overall aim of the reforms is to improve the public perception of investment management services across the whole market. This is expected to increase the accessible market for all Wealth Managers. Research continues to show that a large proportion of the HNW market do not seek guidance. Frequently this is due to anecdotal information relating to commission driven behaviour and it is hoped that these reforms will successfully reduce this, rebuilding trust in the market.
The challenges and opportunities for Wealth Managers
In this section we set out our thinking on the key challenges for Wealth Managers in the period leading up to implementation of the RDR at the end of 2012.
Meeting the ‘independent’ standard
Many Wealth Managers do not currently find the need to describe themselves as ‘independent’. However, the FSA makes clear that under the new rules, if a firm does not meet the standard of ‘independence’, then it must disclose itself as giving ‘restricted advice’.
It is clear from the background research that has been undertaken on the part of the FSA that the label ‘Independent advice’ was highly valued by consumers. The new term mandated by the proposed rule changes, ‘restricted advice’ was much less valued. HNW individuals in particular felt they would not use a service that described itself as giving ‘restricted advice’.
Whilst many Wealth Managers may believe that they will meet the new independence statements, it is clear that the FSA will be looking for clear evidence that firms describing themselves as giving independent advice have made recommendations based on a comprehensive and fair analysis of the relevant market, and have provided unbiased and unrestricted advice.
We see two specific challenges for some wealth managers in achieving this standard. Firstly, it is clear that the number of product classes expected to be reviewed, and the depth of analysis to be undertaken, precludes the review being undertaken by a single individual, except for the very largest of portfolios. This necessitates separating out the selection of individual products (i.e. research on particular stocks, ETFs or Funds) from the construction of strategies. In turn, each individual client must be continually reviewed to ensure that the strategy is still relevant to them. Whilst many Wealth Managers strive for this today, we believe investment in systems will be required to deliver the level of rigour and evidencing that will be required by the FSA. However, those firms that do invest in this way will benefit from an enhanced service to their clients, delivered at a much lower cost, and capable of a significant increase in the number of clients serviced.
The second challenge arises directly from this. Some firms have already begun to organise in this way. They may have established certain fund structures to optimise the management of the strategies. Firms must demonstrate that this form of product is an efficient way of delivering the desired outcome for the client.
The new rules state that ‘a retail investment product that invests in a number of underlying investments would not of itself meet the requirements’. As such, a full range of appropriate strategies needs to be available, with the ability to shape these in line with individual client needs. Our belief is that this requires the matching of sophisticated research functions; competent portfolio designers - and managers - to design and manage the strategies; skilled customer investor service managers (ISMs) to select the appropriate strategy, and vary and review as required according to individual client’s needs. Good systems will be required to ensure the productivity of the ISM, ensure clients’ needs are reviewed in their entirety, within an appropriate timescale, and that decisions can be evidenced to be in the interests of the client.
There is a need to carefully design the entire process to ensure that the outcome is the recommendation of the best solution from the whole of the market. Wealth Managers intending to use this strategy are strongly advised to review the proposals in detail, making comments direct to the FSA. Whilst the current proposals do not rule out this approach, we believe Wealth Managers wishing to use this approach should ensure they comment on the relevant rule (6.2.A.13).
Move from Delegated to Guided
Until the end of 2008, industry orthodoxy was that, if an individual could afford to delegate management of their investments, then they would do so. Compeer research published in early 2009 shows this to be no longer true, demonstrating unequivocally that there was a clear preference for guidance. Moreover, this preference was stronger amongst HNW individuals.
Subsequent re-interpretation of previous research has shown that there is a strong correlation between age and the divide between ‘Delegated’ and ‘Guided’, with younger people having a marked preference for ‘Guided’. As these individuals garner assets, the number of wealthier individuals who prefer Guided services increases.
This translates into a need for products and services to be clearly explained to these individuals versus relying on the Wealth Management firm to administer assets and reporting back. Individuals are seeking more engagement in the process. This interaction could include; regular reporting via email, the ability to check current positions online or the ability to vary portfolios themselves.
For many Wealth Managers this will be a challenge. Their current and typically fragmented systems will make it difficult to make this information available online, and will also increase the associated costs for more frequent reporting.
The exit of some IFAs from the market
The combination of a modest increase in Capital Requirements and the need to be assessed at a new level is expected to lead to an exit from the industry of a significant minority of IFAs. Many IFAs serve the same market as Wealth Managers, providing an opportunity to recruit clients that might otherwise seek to use an IFA.
More pro-actively, exiting IFAs will be seeking to sell their client books. Depending on the clients being served, it may be a better fit to transfer these clients to a Wealth Management proposition rather than a sale of the business to a national broker. This will be particularly true if they are long standing clients that have built up a significant pool of assets.
New Professional Standards
We do not believe the new qualification standards, and the expected code of ethics, will present a challenge to the majority of Wealth Managers. However, staff and processes will need to be reviewed to identify and rectify any minor shortfalls.
Conclusions and Action Plan
We believe the impact of the Retail Distribution Review will be positive for Wealth Managers. Further, this comes against a market background that is also positive. The implementation date is set for the end of 2012 and preparations need to start immediately. All actions must be aligned to wider changes in customer behaviour to ensure business success.
The following key actions are required:-
- Firms wishing to implement OEIC or other structures to efficiently manage their clients’ portfolios should review the proposed new text for rule 6.2.A.13 and consider commenting on these proposals. Obtaining appropriate wording in the rulebook at this time will save considerable time in terms of hours and days of negotiation with the FSA in the future.
- Firms should review the training needs of there staff to ensure they can meet the new standards required by 2012
- Firms should set out a strategy for acquiring clients from existing IFAs
- Firms should ensure there marketing strategy allows them to access clients that may previously have been referred to exiting IFAs. These are often personal relationships, so this may be a once-in-a-decade opportunity to form these relationships
- Firms should consider their entire product and service delivery. The twin challenges of the movement from ‘Delegated’ to ‘Guided’ services, and the requirement to demonstrably meet the new standards being set for independence require insightful product and service design, backed by significant investment in systems.
The successful Wealth Manager will be the firm that embraces the new realities, and successfully delivers valued customer experiences both in the new world, and in the transition to the new order.
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