Independent Financial Advice

The Total Cost of Independent Financial Advice

By The Enforcd TeamThe Enforcd Team

The FCA has traditionally tried to secure the greatest good for the greatest number of consumers. Enforcd was interested to note that one of its key themes for 2017/18 remained independent financial advice, now the preserve of those with £250k of investable assets.

The following paragraph seemed relevant:

“Financial advisers may give insufficient attention to the total cost of investment products and of advice, which results in poor value for money for consumers.

What they’re talking about is the fee stack.

The IFA charges a fee (let’s say a modest £1,500). They may well then to go on to recommend a platform (most useful to the IFA, who would otherwise have to access separate share ISA and SIPP accounts) which levies a fee. The FCA has already spoken about platforms and the indiscriminate way in which IFAs place their customers’ assets on them. The IFA might then recommend that the customer place sums with a discretionary investment manager (DIM), who might then go on to place these with investment funds which apply a management fee (creating a DIM fee and an investment fee). Depending on the specialisation level of the fund, the fee might be split into an entry, on-going, and exit fee.

This generates a blizzard of costs and almost guarantees that, even if a client targets a modest rate of return (say 5%), their investment managers will have to place their assets in higher risk assets in order to generate the extra return that covers their costs.

This is behind the serial mis-selling of such exotic offerings as geared traded endowments, traded life policies (death bonds), and serried ranks of unregulated collective investment schemes offering exposure to property development (leisure and commercial, home and abroad), and other exotic schemes (most recently bioethanol production). On the regulated investment side, it means illiquid assets such as high yield (formerly junk), bonds, and securitised bank loans (organised as ETFs, or mutuals). It also means geared index trackers (ones which return n times the rise or fall of the index they are tracking).

What links all of these products is risk, not all of which flows from market exposure. Integrated Financial was fined £3.5mn for CASS breaches in 2011, by the Financial Services Authority (as was). 94,000 retail customers had their holdings on their platform, and the firm’s internal funding arrangements meant that at one point, client accounts were short almost £7mn.

Now one could argue that any wrap provider (SIPP, ISA, or fund supermarket), who holds client assets, introduces a risk that would not exist if the customer held their investments in single name shares, via CREST. The difference is that a customer might deal with a number of these, whereas an IFA will place them on a single one. Chance dictates that one wrap provider is more vulnerable than two or three.

DIM costs are another matter. The regulator will only pick a fight if the DIM goes outside mandate, churns assets to generate extra transaction charges, and/ or places clients’ investments in their own funds (without evidencing their suitability based on need or cost). The fact of four layers of fees will not necessarily go against the IFA (unless they failed to set out why DIM was the right solution, rather than annual rebalancing aligned to a model portfolio). Enforcd reviewed the publicly available fee schedule of Rathbones, a UK provider of investment management services. This allowed for a 3% ­­introductory fee payment to the IFA, further quarterly fees to the IFA, and annual charges on a portfolio of £400k of £4,500+VAT.

Helpfully, the Financial Ombudsman Service has published two ombudsman decisions, covering the issue of Rathbones’ investment management non-performance.  In short, you can underperform the relevant index by picking the wrong stocks, and collect your management fee, so long as the portfolio looks appropriately diversified:

“… the portfolio at this time had holdings across all the main asset classes. There were direct equity holdings as well as collective investments, which in turn added to the diversification by including the expertise of other fund managers. It was also invested globally in a range of sectors, and the asset weightings were relatively low.

The test here remains one of negligent mismanagement. So long as that’s avoided, the Ombudsman Service has the capacity to reject complaints based on performance. It’s curious then that the FCA’s partner in financial regulation does not, of its own accord, consider the issue of fees, and whether the same post-fee performance might have been generated with a few passive index trackers. Still, the examples given were issued in 2015, so there’s been plenty of time for the ombudsman to amend their approach.

Those recommending discretionary investment managers (for a significant slice of their customers’ money), should watch this space very carefully.