The way centralised investment propositions run today is far from perfect. So where do we go from here?
There should be a name for the rule of thumb that says, just as the retail financial services industry reaches some consensus that something should be done a certain way, it all starts falling apart.
In fact, let’s make one. This is my column, so I am going to call it The Lang Cat’s First Embuggerment Principle. You may wish to shorten that to TLC-FEP, but that’s up to you.
TLC-FEP applies in many circumstances, but the one concerning us today is the use of centralised investment propositions. We have just finished researching 235 adviser firms, and one of the things that struck me was that almost 90 per cent of them ticked the “we run a CIP” box (the other 10 per cent, we think, were confused Russian bots trying to swing an election somewhere).
So, how have we reached this extraordinary level of consensus that CIPs are the thing to do?
The turning point began when the then-FSA warned it would be vigilant, in an eye-of-Sauron fashion, for signs of clients being shoehorned into portfolios. Then the RDR emphasised the importance of consistent client outcomes, as did subsequent regulatory pronouncements.
Fast forward to 2019. Mifid II and its UK offspring, Prod, combined with portfolio management technology on platforms, now make mass commoditisation of portfolios possible and desirable – at least from a risk control point of view.
This is better than the pin-sticking of ages past, not to mention horrible restricted insured fund ranges and all that stuff we have cheerfully shot behind the woodshed. But that does not mean everything is working.
To create consistent outcomes, advisers today use technology and judgement to put clients in a risk-banded box, which drives volatility limits, which drives asset allocation, which drives portfolio construction. You know all this.
What you may not know is that various studies, including our own, suggest most advisers use just one type of CIP. Now, everyone might have been a genius and completely nailed it right out of the gate. Or it might be that regulatory pressure is leading to clean processes, but less than optimal outcomes. This is like kids growing up in overly sterile houses, so not getting any kind of immune system (that probably needs work as an analogy).
Talking of things that need work, the FCA’s 2018 Investment Platforms Market Study interim report found that portfolios with labels including “moderate” and “balanced” had allocations to bonds ranging from less than 5 per cent to over 60 per cent. Explain that to an end investor.
There is other stuff that does not feel great. We have seen a number of situations where adviser firms (as opposed to individual advisers) are exceeding their advisory permissions by rebalancing clients without proper consent. This is not done out of badness – usually the firm genuinely believes the client needs to rebalance, and an administrator is just trying to keep things tidy. A wee moment of “ach, they’ll send their form in, just include them” and suddenly the world is a different place.
There is also the “trail of dead” issue, where a few clients lie around in old versions of models until, one assumes, the Earth is consumed by the sun and we all die screaming.
It is really hard to run models efficiently with advisory permissions – at least at any kind of scale – and that is before Mifid II upped the admin load further.
The answer to that might be to use discretionary fund management models. But it is far too hard for advisers to compare different discretionary propositions due to the lack of transparency around the composition of DFM model portfolios. Researching it is horrible, even for us, and we lap this sort of stuff up.
So, the way CIPs run right now is far from perfect. Where do we go then from here?
I reckon we will see further specialisation in 2019 and beyond. The practice of portfolio management is very different to that of financial planning. We may see firms split formally; at the very least more and more will head towards gaining discretionary permissions, outsourcing or having to spend time and effort developing very good processes with watertight controls.
Prod asks you to segment clients into groups with similar requirements. But everyone’s different and 10 boxes that are shades of each other all feels a bit simplistic. Happily, next-generation technology will offer greater opportunities for individualisation, enabling firms to create bespoke portfolios at scale.
However, technology is not the whole answer. Improved transparency will require much better disclosure. Advisers and DFMs need to be clear on their requirements to improve processes and controls, and alleviate day-to-day administrative logjams.
Greater portfolio individualisation needs the different parts of the advice chain to work together with investment managers offering increased choice and diversity, and advisers using available functionality to the fullest extent.
In short, the industry needs to work together in the aligned interests of everyone involved – most importantly the client. And not to get upset when, just as it seems everything is sorted, TLC-FEP once again applies.
Mark Polson is principal at The Lang Cat