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Bridging the gap

Gill Hutchison, head of investment research at the Adviser Centre

The financial adviser’s role of interpreting the complexities of the investment world and bridging the gap between investors and fund managers has never been more important, says Gill Hutchison, head of investment research at The Adviser Centre

The shifting sands of the financial services industry are leading to significant changes in the extended supply chain that serves the end-investor. Prompted by regulatory changes and the drive for cost transparency, all industry participants are being forced to adapt in order to position themselves for the next phase of the industry’s development.

In the early stages of planning The Adviser Centre, City Financial spoke to many advisers who explained both the challenges and the opportunities of this emerging world. We could see the tangible excitement for those intermediary businesses that had not only survived the changes, but are now thriving and expanding.

"Explaining investments to clients who have differing levels of knowledge about financial markets is one of the great challenges for an adviser."

There is some irony in the fact that, although the importance of an adviser’s position in the chain has been reinforced, fund managers’ direct relationships with advisers have been weakened – in part because of the role of platforms and in part because of cost pressures and the inevitable focus on the largest distributors of products.  

Indeed, for most fund managers, the challenges of this phase are more overt than the opportunities. The spotlight on fees has seen the industry hang out its dirty laundry and the braver players in the game, who were prepared to state their position early with regard to their clean share class pricing strategy, helped everyone to alight upon the natural lower stopping point for annual management charges.

Profitability is therefore under pressure – even more so for well-established fund managers who have a large back-book of retail business that is being re-priced. Consolidation will continue as it becomes ever more challenging for smaller or less profitable organisations to survive. Fund management companies will continue to review their structures and product offerings and question where they can add value for themselves and their clients on a sustainable basis.

For fund managers themselves, business pressures are coupled with intensifying performance pressures, as the rise and rise of passively-managed vehicles results in a greater number of converts to the tracking world on the basis of price and all too often, unfortunately, returns.

The ‘whole of market’ challenge

We have spoken to many advisers in the past who wish to remain independent but have been troubled by the concept of ‘whole of market’ coverage. From the regulatory point of view, the FCA’s expectations are better understood as time has passed and further guidance has been issued. The requirements for the appropriate delivery of independent investment advice are far-reaching but those who have put into place the necessary processes are well-placed to satisfy and exceed the regulator’s expectations.

The thematic review that was issued in March 2014 – ‘Supervising Retail Investment Advice: Delivering Independent Advice’ – reinforced the point that offering independent advice requires a comprehensive analysis of the whole of the market before making a recommendation. This is different from the idea that every product in the market must be comprehensively reviewed, which is clearly not feasible in any shape or form. 

The review also sanctioned the use of third-party services and tools to help in the process of covering the whole of the market, on the important proviso that advisers are in a position to assess the advice and provide the final solution to the client. 

Demonstrating a comprehensive and fair process for filtering the enormous universe of funds and products is therefore critical but there are no rules on exactly how this should be done and each firm’s approach will vary according to factors such as the profile of the client base and the structure of the business.

Explaining investments to clients who have differing levels of knowledge about financial markets is one of the great challenges for an adviser. While acknowledging all the difficulties of explaining financial products in a language the majority of investors are in a position to understand, the fund management industry overall has fallen very short on this subject. 

Prompted by the regulator, basic fund information is improving but one of the adviser’s jobs remains that of jargon interpretation. Independent fund research houses help to shed more light on funds and products but, when it comes down to brass tacks, a description of the qualitative attributes of a fund is of limited help if advisers are still not clear what to expect in terms of its patterns of behaviour.

If a fund is languishing in the fourth quartile of a peer group’s performance table, is this surprising, or not? When Invesco Perpetual Income experienced periods of underperformance compared to the market and peers, did investors think Neil Woodford had suddenly turned into a poor fund manager? The answer is clearly ‘no’, because most investors knew what to expect of his approach and trusted his ability to deliver attractive returns, typically with less downside risk, over the longer term.

Acknowledging the need for this degree of clarity and understanding on a broad range of funds across the market, we have framed our research output around a point-by-point description of what we believe can be expected from a fund in different market circumstances and how a fund might be used in its own right or else blended with other funds to achieve diversification. 

Assessing and explaining risks

Our efforts to ensure we describe a fund’s characteristics in an appropriate manner inevitably caused us to think carefully about risk metrics and the presentation of risk. We do not berate the industry for being unable to identify an all-encompassing way of explaining risks and, over the years, we have also tried different approaches – from more simplistic and qualitative to more complex and quantitative. Nothing was perfect, nor did it satisfy everybody. 

Through the Synthetic Risk and Return Indicator (SRRI) system, which is incorporated into each fund’s KIID, the European Commission has gone some way to helping investors to be more informed about risk. However, with the score of 6 (representing historical volatility in a range of 15% to 25%) covering most equity funds, from UK equity income funds to emerging market equity funds, its usefulness is limited in practice. In our work, we have included our own interpretation of the SRRI score but we recognise this paints only part of the overall picture. 

If we extend this challenge to the world of multi-asset products, the picture is even more complex because the risk outcome is determined by a range of different assets that have their own characteristics, with these assets also interacting with each other to generate the final risk and return experience.

Of course a numbering system at least goes some way to helping investors understand the degree of risk they are taking, based on a scale they can visualise. However, talking to most investors about an expected volatility outcome, expressed around a number or a range, is probably futile. It almost certainly would not pass the, ‘would my Mum understand this?’ test.

Most investors do not see risk in cold, academic terms but ‘feel’ risk when they see the fluctuations in the value of their portfolio – and advisers know this better than anyone else. On this basis, we are of the view that a simple illustration of the maximum drawdown over time is the most illuminating risk metric you can show to most investors.   

We see a really bright future for financial advisers who are well-positioned in this post-RDR world and, through The Adviser Centre, we seek to help them in the process of identifying suitable investments for their clients. We all know individuals need to save more and with greater efficiency but we do not foresee swathes of investors with the sudden inclination to find their own way through the investment labyrinth.

Advisers retain a critical role in interpreting the complexities of the investment world and bridging the gap between investors and fund managers – and this role has never been more important.

The Adviser Centre is an online fund research and consultancy service designed by City Financial specifically for financial advisers and which seeks to cater for their investment needs in the post-RDR environment

 

 

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