Investment Platforms Market Study
The FCA published its Interim Report MS17/1.2 in July 2018. This article represents ValidPath's summary commentary on this key piece of research.
Please note that whilst we do not reference every section in MS17/1.2, we retain the chapter numbers & topics to assist you to reference the original document.
MS17/1.2 usefully contrasts what is going on in the D2C ('Direct to Consumer') market with the experience of customers within the advised market. Generally speaking, the conclusions of this interim report tend to reflect the issues we highlighted in our previous commentary on MS16/1.3, in relation to the pensions decumulation market. There is much helpful content here, but it is the proverbial curate's egg - the text is strewn with questionable assumptions, as well as classic moments of missing the point entirely.
Chapter (1) is an executive summary. Chapter (2) is an introduction which largely requires no comment, other than to say that, in its summary of market features explored, it entirely omits any reference to the effective management of risk. We would consider this to be one of the most critical considerations.
Chapter (3) - How consumers choose
This section appears to be mostly about the 'non-advised journey', although (perhaps unhelpfully) it drifts into brief contrasts with the experience of advised customers. Apparently, the three main reasons for non-advised customers to choose platforms are: control, access and convenience. Those priorities, whilst no doubt shared by advisers, represent perhaps less critical bases for (our) choice. The FCA has found that fewer than 50% of all non-advised consumers research multiple platforms, although 'multi-homing' (look it up!) is actually very common - the main objective being to diversify risk. This is suggestive of how profoundly ignorant non-advised consumers are of risk, as 'multi-homing' across platforms as a strategy is a complete irrelevance, unless quite different investment strategies are pursued.
There are plenty of hints within this section of the kinds of danger inherent in the D2C market: some 48% of all consumers based their fund selection on "my own research" and would, effectively, run their own portfolio, based upon their own asset selection. Such consumers are sceptical about the default solutions on platforms and would prefer to "go to someone who is producing independent information". These days, one wonders exactly what would qualify under the heading of 'independent information'? It is no surprise, then, that the FCA's research indicates that the majority of non-advised consumers are very or quite satisfied with the result. James Montier's excellent 2007 text, 'Behavioural Investing' provides a detailed analysis of the kinds of bias which result in the version of self-delusion noted by the FCA.
Apparently, for non-advised consumers, the two factors most important in choosing a platform are (a) breadth of investment choices, and (b) charges. Later on, the FCA states that "price is the most important factor" although later we learn that, of the same group of consumers, some 60% incorrectly estimate their platform charges by at least 50%. This kind of pathology appears baked-in to the DIY model. Later, we learn that "a key driver for switching platforms is access to lower charges" and yet "most consumers (73%) have not carried out any direct switching activity in the last 3 years". That correlates with the kind of complacency associated the the preservation of biases that Montier details in his wonderfully acerbic way.
Chapter (4) - Competition between adviser platforms
Here we begin to see the way in which the FCA perceives the advised market and it seems, frankly, a bit of a pig's ear. In relation to how advisers perceive whether or not their clients receive 'value for money' (VFM) when it comes to platform selection, the FCA says that "many (advisers) said platform charges are the key consideration", but then a mere two paragraphs later we learn that, actually, this isn't the case, and that "advised consumers do not apply pressure on their advisers to choose the cheapest platform". So, which is it? To cheap or not to cheap? And does a healthy adviser-customer relationship involve "applying pressure" on the adviser to always opt for the lowest-cost solution, especially when the FCA tells us (in Chapter 7) that 60% of all platforms are simply unprofitable? IFA's following the kind of approach which MS17/1.2 inculcates are likely to be given short shrift by an almost unbearably smug FOS Adjudicator at some later date.
The same conflicting approach is apparent when the report deals with platform fee discounts. Apparently, some advisory firms are able to negotiate discounted fees for their clients, which is a good thing. But then, in the next breath, we're told that those discounts may provide a disincentive to switching platforms. So, that's a bad thing then, is it? Although, tantalisingly, the FCA includes the caveat that such switches "may be better for consumers" - but we've just been told that the number one criterion for selection is cost, which would imply that the mere negotiation of lower charges ticks the only important box in the consideration. Advisers know from experience that cost is only one part of the equation - so making it the be-all-and-end-all grossly reduces the due-diligence process to the point of irrelevance. It makes you wonder why DeFaqto list hundreds of criteria in their research tools, when you could boil everything down to the issue of cost.
In section 4.36, the FCA categorises (A, B, C) the kinds of adviser tools available on platforms according to the extent to which they align adviser and client interests. It is on this point, one senses a losing of the plot, for model portfolio management and rebalancing are placed in the second category (B) about which the FCA would have more concern. This appears to be because it believes that rebalancing the client to the correct risk-grade as efficiently and cost-effectively as possible is somehow not in the client's best interests. Verily, this represents an insoluble mystery - the FCA concludes by stating "there still appears to be scope to align consumer and adviser interests better". It is difficult to imagine a functional component of platform provision which more perfectly exemplifies precisely that kind of correlation of interests.
There is more here which is both puzzling and perplexing, but I want to skip on to focus on the matter of orphan clients. Firstly, the FCA states that "Orphan clients are unlikely to benefit by staying on adviser platforms, because their ability to access and alter their investments is often restricted." Whilst accepting that this may be possible with certain, highly-complex adviser platforms, this is certainly not the case with our CIP hosted by Parmenion. Next, the report goes on to state that "Clients can be effectively orphaned if they are paying for an ongoing advice service that their adviser is not providing." Again, perhaps there is an element of truth in the statement, but it misses the bigger and more significant challenge of what happens to consumers, driven by an overarching obsession with costs, who opt-out of their adviser's annual review service - something that this kind of regulatory stance almost recommends. MiFID II, for example, has created a whole new group of disenfranchised customers who cannot afford the new requirements forced on them by bureaucratic largesse.
Chapter (5) - Complexity & transparency of fees and charges
The report states that "Advisers, in contrast (to D2C) generally said that they find platforms' charges clear and simple to understand and consistently scored platforms highly on this feature". I surmise that this is a product of (a) access to data at a more granular level, via our research tools, and (b) the natural impact of the kind of expertise which you simply wouldn't expect consumers to have. Later on, the FCA states that "Overall, we found that platform pricing is complex and the differences across platforms may make comparison difficult for consumers" (which is suggestive of the value added by IFAs) and concludes that D2C platforms tend to be more complex than the adviser equivalent, when it comes to charges.
The issue of complexity is an interesting one. At 5.28, the report states that "Financial products are often inherently complicated", but then a little later opines that "We do not consider these pricing structures to be simple or easily comparable across platforms". There are a whole raft of responses that could be made to this, depending upon one's perspective as product-provider or adviser, but in the next few sections, the authors of the report evolve a line of argument that terminates with the line (5.35) that "...we expect effective competition between firms to drive simplicity, not complexity." Now, that's not a line you'll find consistently deployed across the FCA's oeuvre: last week, I blogged on MS16/1.3, and it's clear there that the FCA favours the development of 'innovative solutions', seeing them preferable to 'simple drawdown products'. For 'innovative', therefore, read 'complex', and that trajectory of development necessarily involves greater opacity and a nesting, or hierarchy of cost. That's the complete inverse of what MS17/1.2 is proposing.
Chapter (6) - do platforms aid good choices?
My own, perhaps flippant, response to such a questions is that whilst platforms may not aid good choices, advisers must achieve that objective. Of course one must have a reasonably clear picture of what good choices looks like in practice. However, the adviser justifies his or her existence by delivering only good outcomes, and that, necessarily, must involve good choices. For this chapter, in order to cut to the chase, I have bulleted the FCA's concerns about the functionalities on platforms, by correlating them with what we have created, jointly, with Parmenion, in the form of the VIP:
most providers offer 3 to 7 risk-rated, in-house portfolios - whereas we have eleven, consistent with 10% increments in equity exposure
most providers utilise subjective (and frankly misleading) labels ('Cautious' etc) - whereas we do not
inconsistent practice when risk-rating investment models - not an issue with the VIP
limited and imprecise information on asset-allocation models, making it difficult for consumers to compare potential risk exposure - all clearly documented within the VIP
actual data regarding underlying assets often difficult to access - all explicit within our client reports
poor and inconsistent information on past performance and benchmarking - all clearly documented for the VIP
total cost of investing is obscure or ambiguous - clearly disclosed in the Parmenion report
variable efficiency in mapping client preferences and objectives to the end solution - seamless on the VIP, whether you are using Finametrica, DeFaqto or Parmenion's own solution
average charges for model portfolios across the spectrum are 0.84% (ranging from 0.05% to 2.5%) - whereas ValidPath's average is 0.14%
negotiations between platform providers and fund managers (aiming to improve terms) are very limited - whereas Parmenion have a formal annual process
Chapter (7) - whether competition is working
There's not a great deal to conclude here, other than to reiterate what the FCA stated earlier in the report , namely that "there is a wide range of charges for a given scenario" especially in the D2C market. Nevertheless, the authors of the report felt it valid to create what they call a 'price proxy' for platforms, based upon total retail revenue, divided by average AUA for each year. Given the very wide dispersion when it comes to charges, it is quite difficult to determine how meaningful that kind of average might actually be in practice. The fact that price dispersion is far greater amongst D2C providers is simply a function of the nature of that market.
Within the D2C market, the generally poor correlation between consumer priorities, and actual platform selection leads the FCA to conclude that there must be "obstacles to consumers making choices on the basis of price". We conclude that it is vastly more probable that non-advised consumers lack the capacity to reliably conduct that kind of analysis. It is enough of a challenge for the seasoned IFA!
As we have already indicated, the FCA's conclusions about platform profitability are (depending upon how much due-diligence you have been in the habit of performing) quite shocking. Out of 20 providers surveyed, only 8 had what the FCA calls "substantial operating profit over 2013-2016" (the three in the ValidPath shortlist sit within that group). Given that the remaining 12 providers either had total costs significantly in excess of revenues, or were posting operating profits close to, or only slightly above zero, we conclude that 60% of operators are non-viable. The FCA also noted that "vertically integrated firms tend to be less profitable than the standalone platforms" which is encouraging, given that ValidPath's main competitors tend to be of a vertically-integrated orientation!
There is more in this report, but I think I have covered enough. In chapter (8), the report asks 'Is regulation creating barriers to entry or expansion?' but then seems to skip around the question. I would conclude that if the Regulator is making cost the overarching criterion for assessing value (and it appears to be doing so), then that, necessarily, presents a barrier to entry. Transact, as a key example, has spent years carefully managing (and reducing) costs to the consumer, but if it had launched back in 2000 with a 2018 charging structure, I suspect that it would not have survived.
My overall conclusion is that platforms can be very effective tools in the right hands, but that, in 99.9% of cases, those right hands need to be competent, and careful Independent Financial Advisers.