It has been estimated that RDR will reduce fees payable to advisors by several billion pounds per year but lower fees are likely to be just a side effect of RDR. The main benefit hoped for is better investment decisions for people seeking investment advice. This is likely to happen because RDR in effect requires independent advisors to put their client's interests first.
But unlike the case in NZ the FCA's prescriptive approach to "putting client's interests first" is not "pie in the sky" which everyone is free to interpret as they wish, i.e. ignore. In the UK the FCA have made some effort to define in terms of product what "putting clients' interests first" actually looks like.
Unsurprisingly what it looks like is a lot like what portfolios administered by professional trustees like pension funds look like. The FCA's emphasis seems to be on forcing advisors to choose from the full range of products which in effect makes advisors include low cost products like exchange traded funds and investment trusts. The significance of this is not just the fees because low cost products are often the sort of products bought by institutions and as a general rule they make more sense for retail investor portfolios than more expensive, esoteric, specialised offerings.
I'm thinking here of more exchange traded funds that buy the whole market for 15 basis points and less of hedge funds, venture capital and structured products which promise the world but in reality cost the earth. Recall also the telling statement by an executive of the Pensions Institute at the Cass Business School a while ago who said "there is little academic evidence to support the argument from advisors that asset management and the potential for outperformance is more important than cost". The FCA's move is designed to make advisors focus on the big issues and those are costs, diversification and getting the asset allocation right.
So let's take a closer inspection of what the FCA is on about to see if it gives us any idea as to what might make sense for retail investors in NZ. The FCA recently published the results of a question and answer session for advisors setting out what they need to do to be RDR compliant and avoid getting into trouble.
One important question from advisors was "what must I do to prove that I have been offering independent advice?" The answer to this question is the sort of input one would hope to see in local continued professional development courses, indeed it should have been a core component in the unit standards some AFA's had to do to become qualified as an AFA.
Sadly this isn't the case - much of the CPD in NZ is sponsored by the providers of high cost specialist products with the result that many retail portfolios are unnecessarily complex, undiversified and expensive in terms of the annual fees - thus the RDR's relevance for New Zealand.
What the FCA said in answer to this question was that firms need to show evidence that they are able to advise on all retail products capable of meeting the investment needs and objectives of their clients. The firm needs to show evidence that its product research is undertaken consistent with the independence requirement and the "client's best interest rule". The RDR specifically stipulates that financial advisors must consider investment trusts and exchange traded funds. No surprise that these just happen to be the lowest cost products on offer in the UK and NZ and in the case of exchange traded funds this sort of thing that institutional investors love.
Another question was "Can I use a single platform and remain independent?" The FCA said "we expect it to be very rare if possible at all, that a financial planning firm could use a single platform for all of its investment business and meet the standard for independent advice. In NZ there are some platforms which include the full range of products but there are others which have a very limited product range and in some cases the main product used are the funds managed by the platform provider. This latter type of advice would get a financial planning firm into big trouble in the UK if they wanted to be known as independent.
So it there any downside to the RDR? For investors with large sums to invest it is hard to see any but for smaller investors the fear is that, as may be happening in NZ, the reality of a less opaque fee structure and a more aggressive regulatory regime will mean that smaller investors find advice difficult to get.
Furthermore the advent of the RDR has seen a number of banks withdraw from the financial planning area and a large number of independent advisers exit the industry with regulatory risk hanging over advisers' heads many now look at the risk reward profile of taking on a small client and decide it is not worth it. Even in NZ when a new client comes in the door advisers now give some thought as to whether, even with the best intentions, if things go bad, the new client could cause problems down the track.
Perhaps the main lesson that the RDR has for the NZ financial planning industry is that costs are too high, they must come down and the best way to do this is to recommend widely diversified funds with low management expense ratios. So get your house in order before regulation forces you to do it. The upside is that if you can pass on higher returns to your clients with lower volatility your business will likely grow strongly.
Brent Sheather is an Authorised Financial Adviser. A disclosure statement is available upon request.
