The UK, like NZ, has had its share of problems in the retail financial advice space and, like NZ, the UK regulator, known as the Financial Conduct Authority (FCA), has spent a number of years and many millions of pounds in an effort to improve things.

Late last year the FCA gave the industry a test to see how well things were being done. It published the results of this examination in a report entitled "Wealth management firms and private banks - Suitability of Investment Portfolios".

In the UK wealth management looks after some £600 billion of retail money for around 1.8 million clients so its performance is vitally important for the UK economy.

In a startling revelation the report found that despite all the efforts thus far around 60 per cent of customers of wealth managers and private banks are getting bad advice.


Lessons here for New Zealand perhaps. Locally this column has argued that whilst the cowboys of the industry have left town in a hurry the regulators have yet to rehabilitate many of the major players and those players aren't as well-behaved as their glossy brochures might suggest.

A major platform of the FMA is to facilitate a fair and transparent market however most people in the industry know that markets are frequently tipped towards major players, insiders and other interested parties.

That's not to say that things haven't improved - they have. When I started out in this industry in 1984 insider trading was rampant.

Indeed there was a prevailing view that taking advantage of inside knowledge was perfectly legitimate and indeed part of the job description. But there is a long way to go.

We have discussed the "fair" illusion previously and the equally ludicrous notion that clients' interests are put first.

The standard private banking proposition for retail investors with up to $500,000 to invest typically involves all up annual expenses, including all transaction costs, of around 3.0 per cent pa and thus delivers, on a share portfolio, the risk of equities with the return of bonds. Not obviously fair.

One popular joke amongst industry participants is that private bankers only cater for the super-rich because no one else could afford their fees.

Transparency is also a problem.

The way the fx market works is the larger the transaction or the bigger the client the better the foreign exchange rate they receive.


One good example occurs when Mum and Dad roll up to a bank to buy some foreign exchange ahead of that trip to the Gold Coast. They are told that the fee is 1 per cent or whatever or there are no fees. But the reality is quite different. The way the fx market works is that the larger the transaction or the bigger the client the better the foreign exchange rate they receive.

On the 19th July at 1.24 pm the mid-rate in the NZD/AUD market was 0.9325, according to IRESS so to buy A$10,000 would cost NZ$10,723.86. That's the wholesale rate. To get the retail rate I phoned one of four big Australian banks at that time and got a quote to buy A$10,000. I was told the rate was 0.9088, i.e. a cost of $11,003.52 and that the fee to buy the A$10,000 was 1 per cent of the NZ$ amount (NZ$110.03).

Thus the real cost of buying the $10,000 was around $390 not $110, but it gets worse. If you bought the A$10,000, left the bank and then decided that the Gold Coast was a bit hot this time of year and asked them to sell the A$10,000 the rate would be even worse. I was quoted 0.9560 or NZ$10,460.25. Fair, transparent, yeah right.

Back to the UK situation.

The Suitability of Investment Portfolios report and in particular the instances of unsuitable advice provide some background for retail investors of what to look out for when enlisting the services of a financial advisor. So let's have a look at the report.

The FCA reviewed 150 client files from 15 firms. "We initially asked each firm to provide us with a list of customers and some basic information for each customer, including the value of the account balances, as well as other information relating to the firm's approach to delivering its wealth management services.

From the customer lists we randomly selected 10 files for each firm. We then asked the firms to provide copies of the files to us so we could carry out a suitability assessment".

The FCA concluded that:

• A third fell substantially short of our expected standards.
• A third need to make some improvements to meet our standards and
• A third raised no substantial concerns"

So despite all the regulations, all the effort and the fact that many of the worst firms and individuals have left the industry just one third of the UK private banking industry was up to scratch.

The key issue identified was "inadequate risk profiling" and unsuitable portfolios "due to inconsistencies between portfolios and the customer's attitude to risk, investment objectives and/or investment horizon".

The FCA found that problems related to:

• investment allocations being made that did not accord with the customer's expectations and / or match the customer's attitude to risk. "One firm had elderly customers including one over 90 years old who were documented as having a medium risk appetite and a 20 year investment horizon. Their portfolios consistent mainly of direct holdings in shares".

• no clear rationale recorded for investment allocations and

• no evidence on discretionary and managed advisory customer files to explain the lack of diversification within the portfolios.

None of this should come as a surprise to the FCA or indeed the FMA as these transgressions simply reflect the implementation of the private banking sectors' standard business model.

At the risk of boring readers this business model is to mis-specify clients' risk profile, move client portfolios out along the risk curve and appropriate most of the risk premium for themselves whilst, at all times, being careful to put clients' interests first (LOL).

Specifically, it's no surprise that "investment allocations were made that did not match the customer's attitude to risk" and that there was "no clear rationale recorded for asset allocation" because high fees demand high prospective returns and that means an equity- centric asset allocation irrespective of risk profile or investment horizon or anything else.

This column has argued for a long time that the biggest threat to good advice is high fees, not just because the fees reduce returns, but because high fees dominate risk profiling.

The other elephant in the room here is the FCA's determination that portfolios weren't sufficiently diversified. Annexe 2 of the report provides more colour.

Specifically the FCA found that many financial advisers in the UK, like some private bankers locally, put their clients into individual stocks ignoring best practice and the benefits of diversification. Again we can see the rationale for this totally illogical behaviour if we follow the money.