One of the main objectives of the Retail Distribution Review (RDR) when it was introduced into the UK financial services industry on 1st January 2013 was to make fees and charges more transparent for the consumer so that he/she knew what they were paying and could assess whether that was value for money.
The previous system that had existed since the Financial Services Act of 1986 was opaque and expensive but was obscured by the bull markets of the following era, which provided strong returns despite the relatively high charges.
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Since then, the success of modern macro-economic policies in controlling inflation via interest rates has reduced average investment returns from equity and bond markets in absolute terms. The former part of the return is related to equities being a ‘real’ asset and the latter because interest rates are at historical lows due to the credit crisis.
The financial services industry has therefore faced a perfect storm when it comes to the scrutiny and justification of fees and charges. Theoretical projected investment returns are at their lowest absolute levels for a generation with inflation also at the lowest levels for a generation (and still falling), whilst the transparency and focus on charges is the highest for a generation. Small wonder we are seeing significant consolidation in the industry amongst financial advisers and discretionary fund managers (DFMs).
This is good news for the consumer up to a point. They are now in a strong position to assess what they are paying for the service they are receiving and should be getting a better return for the advice they receive, after costs, relative to market indices.
However, financial advice and investment management is a numbers game with wealthier consumers delivering the highest return for the effort involved. Those consumers below an investment threshold of £100,000 are increasingly finding it difficult to gain holistic financial advice with a well-qualified adviser as it no longer makes commercial sense for the adviser. New technology-led discounted services are emerging to plug this advice gap but the days of the provision of a regular face-to-face service to these types of consumer are numbered.
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By GlobalDataAnother consequence of the RDR is the focus on charges by the financial adviser which has been turned on its head. The old business model was transaction led with initial charges of 3%+ and trail commission of 0.5% ad infinitum with no commitment to provide a service to the consumer. The new business model removes trail commission and replaces it with the adviser charge, which ranges from 0.5% + VAT to 1.0% + VAT and more, dependent on the service provided. Initial charges are still made but are usually below 3% and related to the initial work undertaken for the client, charged as a fee and agreed with the consumer at outset.
Previously, they were buried in the product along with the trail commission and the consumer didn’t experience the impact of paying for anything.
The above will be stating the obvious for some, but it is driving total expense ratios down from above 3% to 2% and lower and all the service providers in the chain are having to work harder for less whether it be the IFA, platform, fund manager or DFM. Size increasingly matters to gain economies of scale to be able to compete. The small will have to prioritise service and individuality to survive, as the race to the bottom on charges intensifies. As Charles Darwin coined, only the fittest will survive.
Another consequence of the RDR is the relative attractiveness of passive investment and SmartBeta. This is gaining popularity with advisers and consumers alike due to the cost. The underlying fund manager charge on a passive fund can be as low as 7bps compared to an active fund charge of 50bps or significantly more for an overseas equity fund. Specialist investment strategies cost more to deliver and all advisers, IFAs and DFMs alike, should take note that consumers will question their worth if they do not deliver added value.
It is the easiest thing in the world to suddenly convert to a passive investment philosophy as an adviser, give half the underlying cost-saving to the consumer and pocket the balance. However, returns in the future will be lower and especially when in a bull market as in 2013. When greed returns to the investment markets, the passive consumer will be disappointed with his outcome.
As Warren Buffet famously said, when the tide goes out, we see who has been swimming naked. The fees and charges tide has most definitely gone out, is not coming back in, and lots of advisers and DFMs are running out to sea adorned in new swimwear!
Guy Stephens, is managing director at Rowan Dartington Signature
