The Retail Distribution Review:
The challenge and the opportunity
for wealth managers
Autumn 2010
Contents Foreword		
Who we surveyed 			
Executive summary	
How this report is structured
1. Labelling: independent vs rest...
The Retail Distribution Review (RDR) has been four years in development.
Launched in June 2006, the RDR was intended to de...
Wealth managers
Throughout this report we include the findings of an online survey conducted across 23 representative
firm...
03
The Financial Services Authority embarked on the Retail Distribution Review to
improve the provision of investment advi...
Adviser charging – wealth managers ready but need to be mindful of external threats
With three-quarters of wealth managers...
05
The Retail Distribution Review presents challenges and opportunities for all types
of advisory firms. In the following ...
Key considerations for
wealth managers
n Is it more commercially important
to be able to market our firm as
independent or...
Defining a retail investment product (RIP)
The FSA has widened its existing definition of ‘packaged product’ to ‘retail in...
08
Response by wealth managers
Of the 23 wealth management firms we surveyed, fewer than half (10, 43%) say they currently...
09
Many firms believe that the definition of independence under the RDR proposals needs to be
revised, with half of our re...
Key considerations for
wealth managers
n What proportion of our advisory
staff will be qualified to QCF Level 4
by end-201...
11
n Advisory staff will also be required to complete an annual minimum of 35 hours (pro rata for
part-time staff) of cont...
First-hand: Wealth managers looking to exceed benchmark
All of the firms we spoke to one-to-one were confident of bringing...
Key considerations for
wealth managers
n Will we have to amend our systems
and administration to accomodate
adviser chargi...
14
What is being proposed6
n Adviser firms can only be paid for their services through charges set out upfront and agreed ...
15
However, our respondents are not necessarily convinced of the business benefits that may arise from
this greater transp...
Key considerations for
wealth managers
n What percentage of our business is
reliant on distributing packaged
investment so...
17
The RDR response to DIFs
The FSA stated in 2009 that firms can use DIFs as long as they do not restrict their advice to...
18
Diagram 6: Take-up of distributor influenced funds by client AUM
Q: What percentage of your client AUM is currently hel...
Comment: Time for a new focus on merit
The ability to unitise portfolios can provide significant benefits, bringing togeth...
Key considerations for
wealth managers
n Do we want to capture more
outsourcing business from other
intermediaries, and do...
21
Diagram 8: Potential for wealth management outsourcing after the RDR
Q: What impact will the RDR have on the level of w...
22
Diagram 9: Perceived cost burden of the RDR
Q: How would you describe the likely cost burden of the RDR on your firm? (...
Comment: Wealth managers face RDR cost balancing act
Wealth managers are bullish about the outsourcing opportunities that ...
24
Outsourcers seek external expertise at the right price
In the final part of this report we assess the opportunity creat...
25
Diagram 12: Future outsourcing expectations among IFAs
Q: How would you like your outsourcing of portfolio management t...
26
Selecting a wealth manager
When choosing a wealth manager, competitive charges ranked by some margin as the most import...
27
Diagram 15: Adviser charging on outsourced portfolios
Q: Where a client’s portfolio has been outsourced, how would you ...
28
Diagram 16: Acceptable charging levels
Q: Where the ongoing adviser charge and portfolio management charges are combine...
29
Outsourcing concerns
Performance is a key issue for IFAs when outsourcing portfolio management. 43% of IFAs say they ar...
30
Comment: IFAs are sceptical but the need for outsourcing remains
The expectation that the RDR will increase demand for ...
31
The Retail Distribution Review has both direct and indirect implications for the
wealth management community.
Labelling...
32
Professionalism – a short and longer-term challenge for business investment
While contending with greater pricing press...
Implications for wealth managers
Like advisory firms, wealth managers face the challenge of bringing all their advisory st...
34
The Retail Distribution Review: background
Origins of the RDR
The Retail Distribution Review was first announced by the...
35
Timetable for implementation
Final rules on describing and disclosing advice and on adviser charging were published in ...
This document represents the view of J.P. Morgan Asset Management Limited in this subject at the date of this documents an...
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The challenge and the opportunity for wealth managers and ifas nov 2010

  1. 1. The Retail Distribution Review: The challenge and the opportunity for wealth managers Autumn 2010
  2. 2. Contents Foreword Who we surveyed Executive summary How this report is structured 1. Labelling: independent vs restricted Contentious requirements put the value of independence into question 2. Qualifications and professionalism Increased professional standards set to bring new cost pressures 3. Adviser charging Most wealth managers ready but need to assess impact on outsourcing partners 4. Distributor influenced funds Unitised client portfolio solutions may decline, but still have a role to play 5. The RDR opportunity and cost Wealth managers face cost balancing act to capture commercial opportunity 6. Wealth management – the IFA perspective Outsourcers seek external expertise at the right price Conclusion Appendix: The Retail Distribution Review: background
  3. 3. The Retail Distribution Review (RDR) has been four years in development. Launched in June 2006, the RDR was intended to deliver a regulatory framework for investment advice that would increase professionalism, restore consumer trust and enable all savers and investors to receive investment advice appropriate to their needs. The RDR’s intentions are highly laudable. Like any legislation that looks to impose a one-size-fits-all framework on a multi-faceted industry, however, the RDR accommodates some areas of investment advice better than others. To date, the bulk of attention has been focused on what the RDR means for financial advisers – both tied and independent – that advise on packaged investment products. At J.P. Morgan Asset Management, we have decided to turn our attention to what the review means for another vital segment of the investment advice community: wealth managers, by which we mean those firms that focus on the investment aspect of managing client assets, including private banks, private client investment managers and third-party wealth management services. Having spoken to a cross-section of the UK wealth management industry representing around 1 million private client accounts, we are able to provide a unique overview of what wealth managers are thinking and doing in response to the RDR proposals: how they describe themselves, their professionalism and remuneration, and how they view a post-RDR world, both in terms of potential opportunity and cost to their business. Many wealth managers rely heavily on marketing their services to other intermediaries. So we have also captured the views of over 270 IFAs nationwide to see how they view their investment outsourcing practices in the light of the RDR, and the attributes that will encourage them to partner with wealth managers in the years to come. It must be stressed that the RDR proposals are still evolving. All RDR references in this report are based on the latest FSA guidance as at August 2010. While the RDR is not yet finalised, we hope that this report offers a valuable and practical insight into peer practices and opinions for any wealth management firm looking to position their business for the challenges ahead. Jasper Berens Head of UK Retail J.P. Morgan Asset Management September 2010 Foreword ‑ one size does not fit all 01
  4. 4. Wealth managers Throughout this report we include the findings of an online survey conducted across 23 representative firms of the UK wealth management industry. Participants include most of the UK’s leading private banks and wealth management services (both those that manage money for their own clients and those that are providing outsourcing services) and also a number of regional discretionary portfolio managers. This cross-section represents around 1 million private client accounts1 . The online survey was conducted by Owen James Events Ltd. We also include verbatim quotes from one-to-one interviews conducted with six national wealth management firms and private banks. The survey and one-to-one interviews were all conducted in July 2010. To enable participants to be as candid as possible, all comments are unattributed. Independent financial advisers In the final section of this report we assess the opportunities for wealth managers to outsource their services to other advisory intermediaries. To support this, we conducted a survey of more than 300 IFAs through Incisive Media Research & Consulting, with a core of over 270 advisers completing the survey. We canvassed firms of all sizes, both standalone and network members, including firms that currently outsource wealth management and those that do not. This research was conducted in August 2010. Diagram 1 – Breakdown of IFAs surveyed (Base: 335) Source: J.P. Morgan Asset Management/Incisive Strategy 1 947,270 private client accounts declared – this figure not supplied by seven participating firms. Who we surveyed 02 56% 23% 18% 3% Indirectly regulated IFA (network member)Directly regulated IFA at a small, independent firm Directly regulated IFA or similar at a large firm Other
  5. 5. 03 The Financial Services Authority embarked on the Retail Distribution Review to improve the provision of investment advice to retail consumers. The review has three core aims: to place stringent requirements on those advisers calling themselves independent; raise levels of professionalism among all advisers; and impose remuneration practices that minimise product bias. The RDR is targeted primarily at intermediaries who advise on packaged products. Wealth managers that focus on portfolio management have therefore found themselves caught by proposals that are not necessarily intended to address their activities specifically. This report has been written to assess how wealth managers including private banks, the wealth management arms of global banks, and standalone discretionary managers are preparing to meet the main proposals of the RDR and how outsourcing demand for their services is likely to trend over the coming years as the RDR rules come into effect. Independence – one-third of wealth managers expect to be ‘restricted’ The most direct impact on wealth managers from the RDR has come from the definition of independent advice. Because many wealth managers advise only on investments rather than packaged pension or life assurance-based products, more than half currently do not meet RDR requirements on independence. While some firms are intending to acquire the necessary product expertise, one-third of wealth managers currently expect to be defined as restricted post-2012. Some wealth managers are resigned to this, believing the restricted label will free them to focus on their core area of competence or feeling the issue of labels is irrelevant to clients. Other advisers, though, view the restricted label as a major competitive drawback. We anticipate increased pressure in the next few years to allow intermediaries to call themselves specialist and independent, provided the advice in their area of specialism (e.g. portfolio management) is unfettered and covers the whole market. Professionalism – the RDR’s biggest immediate and long-term cost burden for wealth managers The RDR requirement for all investment advisers to hold qualifications at QCF Level 4 is widely welcomed by wealth managers, and many are encouraging their advisers to train well above this benchmark level. Nonetheless, with one-quarter of firms in our wealth manager survey (all of which are large national firms) still need to bring 75% of their advisory staff up to the minimum standards, the industry has a major training task ahead. Bringing staff up to the required professional standards appears to be the biggest cost burden of implementing the RDR for wealth managers (particularly as discretionary managers are also now set to be subject to new qualification standards for portfolio management under the FSA’s recently- released Consultation Paper 10/12 – Competence and Ethics). There could be a longer-term cost implication of higher levels of professionalism for firms: higher- qualified advisers will expect to earn more. While some wealth managers already have a business model based on employing advisers at QCF Level 6, others will need to assess the future cost implications for their business and their clients of training and retaining advisory staff at the new RDR standards. Executive summary
  6. 6. Adviser charging – wealth managers ready but need to be mindful of external threats With three-quarters of wealth managers surveyed already operating on a mostly or fully fee-based remuneration model, the RDR proposals on adviser charging represent less of an upheaval for wealth managers than other intermediaries. The biggest threat from the adviser charging regime may be the impact on wealth managers’ outsourcing partners: n Some IFA partners may struggle to shift to a fully fee-based model; n The greater cost transparency created by adviser charging means that IFAs (and end-clients) will become more price-sensitive; n The ban on commission may also require wealth managers to reassess how they market their expertise to third-party advisers. Distributor influenced funds (DIFs) – more focus on performance and suitability A ban on incentivised income combined with concerns over RDR independence rules could see a sharp decline in demand among IFAs for distributor influenced funds (unitised portfolio solutions managed by wealth managers for specific advisory firms). Given the tax and efficiency benefits that these structures can offer, three-quarters of wealth managers believe DIFs should be able to continue to operate in some form. We anticipate that DIFs will continue to be a feature of wealth managers’ services, although there may be a shift among IFAs to discretionary portfolio services to side-step the RDR rules. However, with remuneration no longer able to influence choice of DIF provider, we welcome a renewed focus on performance and suitability for the client. The outsourcing opportunity – wealth managers and IFAs diverge in expectations More than half of wealth management firms believe outsourcing of wealth management by advisory firms will increase after 2012, with 30% of firms believing it will increase significantly. Currently half of IFAs outsource some of their client portfolio management. But only 19% of IFAs say they would like to increase outsourcing significantly over the next few years. A small number – mostly large IFA firms – are intending to significantly decrease the amount they outsource. Our research suggests these more conservative outsourcing expectations may reflect concerns among IFAs to rationalise their own ongoing charges after the RDR and also worries whether the performance of an outsourced portfolio will justify the cost to clients. Even so, IFAs widely acknowledge the commercial and client benefits of outsourcing. Around one in four large IFAs who expressed an opinion say business cost-effectiveness is a very big factor in their decision to outsource. More than half of all IFAs look to outsource in order to access expert fund research, a need that may become more critical given the wider knowledge of retail investment products required under RDR independence standards. Capturing the RDR opportunity While not the intended focus of the RDR, wealth managers as a group are reasonably well positioned for the changes ahead in terms of their existing levels of qualification, their charging models and their focus on ongoing service. Even so, many firms must be prepared for financial challenges as external pricing pressures and increased internal costs meet head-on. In particular, with the advent of adviser charging, firms must be prepared for cost becoming the critical factor in most wealth management relationships, both with clients and outsourcing partners. The wealth managers that will survive in this environment are those that can combine an attractive charging structure with demonstrable investment expertise and client support that truly justifies the cost of their service. Such wealth management firms embody the aims of the RDR, and these are the firms that will flourish long-term. 04
  7. 7. 05 The Retail Distribution Review presents challenges and opportunities for all types of advisory firms. In the following sections, we focus on the RDR proposals and their implications for wealth managers in three areas: labelling of advisory services; professionalism; and remuneration. We also take a separate look at the impact of the RDR on distributor influenced funds. In the final part of the report, we assess the opportunity for wealth managers to outsource their services to other advisory firms, primarily independent financial advisers (IFAs). A background summary to the RDR is provided in the Appendix to this report. How this report is structured
  8. 8. Key considerations for wealth managers n Is it more commercially important to be able to market our firm as independent or be restricted and focus on our core competence? n What impact would the restricted label have on our ability to outsource our expertise to other professions such as solicitors? n How are our key competitors (in the UK and overseas) likely to market themselves? n How can we market ‘restricted advice’ as a positive? What is being proposed2 n From January 2013, all firms providing investment advice to retail clients must clearly describe their services as either ‘independent advice’ or ‘restricted advice’. n Firms that wish to describe their advice as independent will have to demonstrate: - recommendations based on ‘comprehensive and fair’ analysis of the relevant market (see below); - ability to provide unbiased and unrestricted advice; - sufficient knowledge of all types of retail investment product (RIP, page 07) that could give a suitable outcome for a client. n Both independent and restricted firms will need to meet the same requirements on professionalism and adviser charging – see Sections 2 and 3 – and restricted advisers must continue to meet suitability requirements for the products they offer. n If a firm is restricted, its advisers will need to disclose this orally to clients and prospects and explain the nature of that restriction. Defining a ‘relevant market’ The FSA has said a relevant market should comprise all retail investment products that are capable of meeting the investment needs and objectives of a retail client. While the regulator acknowledges some firms may specialise in restricted relevant markets – e.g. ethical investing or advising trusts and charities on investment – it has stressed that these incidences should be quite rare. In the vast majority of cases, advisory firms will need to assess the whole product spectrum in order to be called independent. Where a firm provides independent advice in respect of a relevant market that does not include all RIPs, the firm would be required to set out an explanation of its relevant market. If there is a retail investment product outside of a firm’s relevant market that would be able to meet a client’s investment needs, the FSA says it would expect the firm to direct the client to an adviser firm that is able to consider all products. 2 Based on PS10/6: Distribution of retail investments (March 2010). This is a policy statement and therefore represents final rules. 06 1. Labelling: independent vs restricted Highlights n Around 4 out of 10 wealth management firms currently meet the definition of independent advice laid down by the Retail Distribution Review. n One-third of wealth managers currently expect to be classified as restricted. n There is strong demand for RDR labels to be revised, but some firms favour the restricted label as an opportunity to focus on their core area of expertise. Contentious requirements put the value of independence into question
  9. 9. Defining a retail investment product (RIP) The FSA has widened its existing definition of ‘packaged product’ to ‘retail investment product’ to better reflect the range of investment products now being recommended to retail clients. Retail investment products are defined as any designated investment that “offers exposure to underlying financial assets in a packaged form that modifies exposure compared with a direct holding in the financial asset”. In addition to products currently classified as packaged products3 , this will include: n Unregulated collective investment schemes, including exchange-traded ones; n All investments in investment trusts (not just investment trust savings schemes); n Structured investment products. All retail investment products will be subject to Adviser Charging rules (see Section 3, page 13). Where a firm wishes to advise selectively across retail investment products, the FSA has said: n A firm must be able to demonstrate clearly why it feels a particular market or product (or class of products) is not suitable for its clients; n Firms can exclude certain retail investment products from a panel, provided they have valid reason for doing so; n If a firm concludes that certain products (e.g. structured products or unregulated collective investment schemes) are not suitable for its clients, it will not then need to review the market for that product for each client. However, the regulator generally expects firms that define themselves as independent to advise on most types of mainstream packaged product. Implications for wealth managers The primary labelling issue for wealth managers is the requirement to be familiar with all types of retail investment product in order to be classified as independent. Many wealth management firms are only involved in advising on direct securities and pooled investment products and do not advise at all on packaged products such as insurance-based investment contracts or pensions. Such firms will have to decide whether to acquire the necessary product knowledge to be classified as independent or, instead, to be classified as restricted. This has created an uneven playing field where intermediaries that only advise on packaged products can call themselves independent whilst those advising on direct securities cannot. Another anomaly may arise concerning wealth managers regulated in other countries who may still market themselves as independent. Adopting the restricted label may also have an impact on wealth managers’ ability to provide investment management services to law firms, which are required under the Solicitors Regulation Authority’s Code of Conduct to deal only with independent advisers. 3 Packaged products means regulated collective investment schemes, investment trust savings schemes, life assurance policies with an investment component and certain types of pension product. RIPs vs PRIPs The European Commission is at the early stages of developing its own plans for an EU-wide approach to regulating packaged retail investment products (PRIPs), taking into account existing MiFID and UCITS legislation. Mindful of this, the UK regulator says it has based its definition of retail investment product on the likely PRIP definition, but is prepared to make further amendments when the European PRIP legislation is finalised, although this is not expected for a number of years. 07
  10. 10. 08 Response by wealth managers Of the 23 wealth management firms we surveyed, fewer than half (10, 43%) say they currently meet the RDR’s definition on independence and can advise across the full range of retail investment products. Diagram 2: Proportion of wealth managers that qualify as independent Q: Does your firm currently meet the RDR’s definition of independence? (Base: 23) Source: J.P. Morgan Asset Management/Owen James Of the 13 that do not, only two firms intend to acquire the necessary product expertise to be classed as independent. Seven firms – one-third of all the wealth management firms surveyed – are prepared to be defined as restricted, while four still do not know what they plan to do. None of the 13 non-qualifying firms is considering sourcing the necessary retail investment product expertise through another firm, such as an IFA. Diagram 3: Likely action by ‘non-independent’ wealth managers Q: If your firm does not currently meet RDR definitions of independence, what action is it likely to take? (Base: 13) Source: J.P. Morgan Asset Management/Owen James NoYes 43% 57% Do nothing and be defined as restricted under RDR proposals Acquire the necessary RIP expertise in-house to be classified as independent Join forces with external IFA firms to provide the necessary RIP expertise Don’t know/ no response No.ofrespondents 8 7 6 5 4 3 2 1 0 7 (54%) 2 (15%) 4 (31%) 0 (0%)
  11. 11. 09 Many firms believe that the definition of independence under the RDR proposals needs to be revised, with half of our respondents believing the current definition could lead to inappropriate sales of packaged products over unpackaged securities. Thirteen of the 23 wealth managers (56%) believe that different definitions of independence should be applied to IFAs and wealth managers/private banks. The same proportion believes that – for wealth managers and private banks – the definition of independence should include knowledge of direct securities. First-hand: Be restricted and focus on what we do best The wealth management firms we interviewed generally feel further clarification is urgently required around the definition of independent advice under the RDR proposals. In particular, many firms want clarity as to whether discretionary management is a retail investment product itself and therefore needs to be assessed alongside other competing services. A leading private bank says: “We want to offer a channel of investment advice that can be marketed as independent but we are struggling to see how that might be possible. There is a lack of clarity as to whether discretionary management is a product or a service. If it is viewed as a product does that mean we need to appraise and offer other firms’ discretionary managed service alongside our own in order to be called independent?” Another major private bank believes there is a clear contradiction in having to call itself restricted simply because its wealth managers do not advise on packaged products: “We wouldn’t be happy if our private banking business had to be described as restricted. We are whole-of-market. We aren’t tied to any product provider or to in-house funds. We give clients the scope to invest in anything from securities to funds to commodities. Independence is absolutely fundamental to our offering and taking that away from wealth management firms like ours would severely contradict our client offering.” Some firms expecting to be classified as restricted are more relaxed about the prospect. One says: “To be honest, this issue is of very little interest to discretionary clients. It’s doubtful that clients would understand what either the independent or restricted labels really mean.” Another major discretionary manager ultimately hopes to be able to market itself as offering “Independent investment advice”. Nonetheless, it feels accepting the restricted label will enable the firm to retain its core focus: “Describing ourselves as restricted means we can focus on the products and disciplines that matter most to our clients. We have never “shouted” that we are independent – we have always described ourselves as specialist investment managers – and this should have little impact on how our clients perceive us.” Another wealth management firm says it is deterred from being independent if it means being a jack-of-all-trades rather than a real specialist: “In that respect, being restricted is very appealing as it takes the pressure off and you can focus on your real area of competence.” A number of firms would prefer the industry to use the term ‘generalist’ and ‘specialist’ to distinguish financial planners and wealth managers. One firm comments: “Wealth managers should be able to look at their own capabilities and decide what they can and cannot advise on. There should be more scope in the RDR proposals to be both specialist and independent.”
  12. 12. Key considerations for wealth managers n What proportion of our advisory staff will be qualified to QCF Level 4 by end-2012, and what contingencies will be put in place for those who are not? n Are there sufficient examination sittings between now and end-2012 for all our staff? n Are we properly aware of the respective qualification/continuing professional development (CPD) requirements for investment advice under RDR and for discretionary management under CP 10/12 (Competence and Ethics)? n What organisation should we select as our accredited body? Are we willing to hire staff verified under other accredited bodies? Comment: Specialist expertise should be valued not penalised The definition of independent advice in the RDR is, in our view, penalising some sectors of the investment advisory community unfairly and is likely to put them at a disadvantage to those firms focused solely on packaged products. That said, we should acknowledge that some wealth managers are very unconcerned about labelling and feel this is a non-issue for clients. Even so, we believe scope should remain for specialists such as discretionary portfolio managers to call themselves independent, provided that their service is genuinely unfettered and the limits of their expertise (portfolio management, trusts etc) are made completely clear. Like many wealth managers, we favour the GP/specialist model. Consumers are used to – and understand – this advisory structure in the medical world. There is little reason why it cannot work extremely successfully in the financial advisory sector too. 2. Qualifications and professionalism 10 Increased professional standards set to bring new cost pressures What is being proposed4 n To improve levels of professionalism, all investment advisers must hold qualifications that meet Qualifications and Credit Framework (QCF) Level 4 or better by the end of 2012. The regulator continues to rule out the option of ‘grandfathering’, requiring all advisory staff – regardless of experience – to hold the necessary qualifications. n The FSA has published a list of existing qualifications that meet its criteria, with a requirement for ‘qualification gap filling’ (previously referred to as CPD top-up) where necessary5 . The FSA has said that qualifications commenced after September 2010 are likely to meet the updated RDR exam standards so no gap filling will then be required. 4 Based on CP10/14: Delivering the RDR: Prefessionalism (June 2010). This is a consultation paper and therefore proposals are still open to revision 5 Qualification gap analysis is likely to be tasked to awarding organisations/accredited bodies. Highlights n Over 40% of firms have three-quarters of staff qualified to RDR standards. At one in four firms, fewer than 25% of advisory staff are currently qualified to advise clients after 2012. n Wealth managers with the lowest proportion of qualified staff have the highest RDR cost burden expectations. n An up-and-coming generation of more highly qualified advisers may put upward pressure on recruitment costs.
  13. 13. 11 n Advisory staff will also be required to complete an annual minimum of 35 hours (pro rata for part-time staff) of continuing professional development (CPD) relating to investment advice, of which 21 hours must be structured learning. n Individual advisers will also be required to hold a ‘Statement of Professional Standing’ which must be independently verified each year by an accredited body. n The RDR will not introduce a separate code of ethics for investment advisers. Instead, accredited bodies must ensure their ethical code is aligned with the FSA’s Statements of Principle and Code of Practice for Approved Persons (APER). The regulator has also set out proposals on ethics in another consultation document (CP10/12 – Competence and Ethics), which applies to all approved persons, not just those within the scope of the RDR. Implications for wealth managers Like all advisory firms, wealth managers face the challenge of bringing all their advisory staff up to QCF Level 4 by end of 2012. Concurrent with the RDR paper on professionalism, the FSA has also released its consultation paper on Competence and Ethics (CP 10/12), which includes new qualification standards specifically for discretionary managers and in particular revokes grandfathering arrangements. Certain qualifications will cover both RDR advice requirements and the CP 10/12 requirements for investment management. Originally CP 10/12 omitted certain qualifications that were acceptable for RDR – notably the Chartered Institute of Securities and Investments (CISI) Certificate in Private Client Investment Advice and Management (PCIAM). However this has been amended so that discretionary managers who have taken PCIAM to comply with RDR qualification no longer have to take additional qualifications to continue managing portfolios. Discretionary managers with dual advisory/portfolio management roles may still need to commit to more CPD. The FSA has said that if an adviser carries out both investment advice and investment management, CPD for the latter will not count towards the 35-hour CPD requirement for investment advice under RDR. Response from wealth managers Of the 23 wealth managers we surveyed, 10 (43%) said three-quarters or more of their staff were qualified to QCF Level 4 or better. However, six (26%) claim that fewer than 25% of investment advisers currently meet RDR qualification requirements. All six are major national wealth managers, indicating a sizeable training task ahead of them. The firms that expect the cost impact of RDR to be high or very high are also those that have the lowest proportion of advisers with the required qualification standards. All firms with staff that do not yet meet QCF Level 4 requirements say their first priority will be to get staff to complete the relevant exams and CPD. Six firms say their secondary solution will be to move staff to execution-only or other support functions. Two firms say that under-qualified staff are likely to retire. Only one respondent firm says underqualified staff may be encouraged to leave.
  14. 14. First-hand: Wealth managers looking to exceed benchmark All of the firms we spoke to one-to-one were confident of bringing staff to the required qualification standards by the end of 2012 and firmly welcome the RDR’s focus on higher professionalism. A number of firms are looking to bring key investment advisory staff well above QCF Level 4 and see this as a key selling point for their organisation. A noticeable reported trend is younger advisory staff automatically taking qualifications at much higher levels, such as the Chartered Financial Analyst (CFA) accreditation or the CISI’s Masters in Wealth Management, creating an up-and-coming generation of investment advisers that is extremely highly qualified. The most favoured qualifications for wealth managers are those from the Chartered Institute of Securities and Investments (CISI). One private bank says it is making a clear delineation between its wealth planners, who will generally be required to hold Chartered Insurance Institute (CII) qualifications, and investment advisers, who will achieve CISI qualifications. As to ongoing continuing professional development (CPD), firms are resistant to prescribed CPD requirements. One firm says: “We are best placed to say what ongoing training and development each role requires and to impose any one-size-fits-all CPD requirement would be ridiculous.” Another firm says it has established a new CPD programme, which is in the process of being accredited by the CISI. In terms of affiliating to recognised professional bodies – or accredited bodies as the RDR refers to them – the Chartered Institute for Securities Investment again appears to be the preferred choice among wealth managers. There is a concern that some bodies listed under the RDR proposals might be poorly understood. “Investors need to know what an RPB (Recognised Professional Body) stands for,” says one firm. Some firms believe that higher professionalism is going to have a knock-on effect on recruitment in the future. One private bank says: “One of the main cost factors of the RDR is that higher-qualified advisers will expect to be paid more.” 12 Diagram 4: Percentage of advisory staff meeting RDR qualification requirements Q: What percentage of your client-facing advisory staff are currently qualified to QCF Level 4 or higher? (Base: 23) Source: J.P. Morgan Asset Management/Owen James 25%-49%Less than 25% of advisory staff 50%-74% 75%-99% 100% of advisory staff 2 (9%) 6 (26%) 2 (9%) 8 (34%) 5 (22%)
  15. 15. Key considerations for wealth managers n Will we have to amend our systems and administration to accomodate adviser charging? n What proportion of our firm’s revenue is commission-based – can we model the likely level of legacy trail commission after 2012? n To what extent do we currently rely on commission to distribute our wealth management services/ products through third-party firms? How will our distribution strategy have to change? n Regarding outsourced services, will IFA firms want to levy their own adviser charges through the portfolio management fee? What impact will this have on total expenses? Comment: Higher expertise will raise the price of advice Our research shows that current levels of qualification across the wealth management sector vary hugely, from firms that are already highly qualified and looking to go well beyond the RDR requirements, to those firms – often large national ones – that still have to bring a huge proportion of their advisory staff up to QCF Level 4 before the 2012 deadline. We believe firms that fail to genuinely embed professionalism into their culture and business model will struggle. The investment – both in time and money – that firms are now be expected to make in the training and professionalism of their staff is significant. Wealth managers may need to meet qualification demands both under RDR and also the new Competence and Ethics proposals, plus there are increased CPD requirements and the need for greater involvement with accredited bodies. Every hour advisory staff spend on these activities is one less hour than can be billed to clients. Also, as one wealth manager has pointed out, more highly qualified advisers may expect to be paid more. It will be interesting to see whether holding the minimum RDR requirement of QCF Level 4 qualifications – let alone, say, QCF Level 6 – will put upward pressure on staff compensation. Our research has shown that firms with the biggest qualification task ahead of them expect the greatest RDR cost burden. We believe the very long-term cost of high professionalism may be greater than many firms assume. The question is whether higher professionalism will increase the cost of advice, and whether consumers will think it a cost worth paying. 3. Adviser charging 13 Most wealth managers ready but need to assess impact on outsourcing partners Highlights n Three-quarters of wealth managers are mostly or fully fee-based and therefore largely compliant with adviser charging proposals. n Only 26% believe greater cost transparency will encourage more consumers to go direct to discretionary portfolio managers. n Widespread concerns regarding partner IFAs’ response to the new regime.
  16. 16. 14 What is being proposed6 n Adviser firms can only be paid for their services through charges set out upfront and agreed with the client, rather than commissions set by product providers (including ‘soft’ commissions in non- monetary form, e.g. technology provision). n Commission from product providers is outlawed even where advisers intend to rebate these payments to the client. n Consumers will be able to elect for adviser charges to be deducted from their investments if they wish but these charges must be ‘product neutral’ and cannot be influenced by any product providers recommended. n Where adviser charges are to be taken out of a product, product providers must obtain and validate instructions from the client regarding the money to be taken. Adviser charges may be deducted from products by a range of means including cancelling units or using cash accounts provided by investment platforms. n Ongoing charges can only be levied where a client is receiving an ongoing service. Advisory firms must provide full details of this ongoing service, its associated charges and how it can be cancelled. n After 2013, firms will still be able to receive trail commission from legacy business completed before the end of 2012, as long as products are not cancelled or transferred to another adviser, or a new product contract is negotiated. n The adviser charging rules will apply to all retail investment products. Implications for wealth managers These rules generally present far less upheaval for wealth managers than for financial planners/IFA’s, as many wealth management firms are already operating on a time-based or ad valorem fee agreed with the client for some if not all their business (see Diagram 5), and will therefore have the systems in place to administer adviser charging. Also, by offering investment management, wealth managers can already clearly demonstrate an ‘ongoing service’ to clients. However, there is potential conflict in a number of areas: n Wealth managers will no longer be able to pay adviser firms for recommending their services to their clients. This may have implications for how a wealth manager markets and distributes its services to financial planners/IFA’s. n Any payment that comes out of the discretionary portfolio to an advisory firm must be agreed with the client (not determined by the discretionary manager) and shown to be paid in return for a particular service by the adviser. n Discretionary client portfolios are often managed within a pooled fund structure to minimise capital gains liabilities. Whether such structures are set up for a wealth manager’s own clients or for those of other advisory firms, managers must not receive a financial incentive for putting clients in such a structure rather than any other collective investment scheme. See Section 4 for more on this issue. Response by wealth managers Three-quarters of the wealth managers we surveyed are mostly or fully fee-based. However, 26% of wealth managers still rely heavily on commission and will therefore need to make radical changes to their business model by the end of 2012. Over 80% percent of wealth managers (19 out of 23) – including all those who are currently mostly or fully-commission based – believe that outlawing commission will create greater transparency between the cost of an IFA and the cost of a discretionary portfolio manager. 6 Based on PS10/6: Distribution of retail investments (March 2010). This is a policy statement and therefore represents final rules.
  17. 17. 15 However, our respondents are not necessarily convinced of the business benefits that may arise from this greater transparency. Only six of our 23 respondents (26%) believe greater cost transparency will encourage more consumers to go direct to discretionary portfolio managers and wealth managers for investment advice. Diagram 5: Current remuneration structure among wealth management firms Q: How are you currently remunerated for advising clients? (Base: 23) Source: J.P. Morgan Asset Management/Owen James First-hand: Already fee-focused, but big concerns remain Although most firms operate a fee structure, the transition to a fully fee-based business is still seen as a commercial challenge by some. One national private banking service that has recently overhauled its model says: “Being fully fee-based means that our new business model is fully RDR-ready but we must admit that if it were a standalone business, a fee-only business might struggle. We are fine because we are part of much larger organisation but I think [working on fees alone] will be an issue for smaller firms.” The majority of firms still have some commission-based business and are considering how this can be transitioned to the fully fee-based model. One firm says a major challenge will be repricing standalone products such as hedge funds and structured products where commission is embedded. A firm that provides outsourced wealth management says the introduction of adviser charging will also create a critical shift in how fees are set: “Currently, our clients sign a fee schedule that explicitly shows how much of our annual portfolio management charge is being returned to the IFA. So for example, the schedule may state that we charge 1.5% a year and, of that, 0.5% is returned to the IFA. Under the RDR, the client and IFA will be able to agree what the IFA will receive. So in the future, we might say to the client “We will charge 1% a year for our services; now what additional percentage do you want us to add on to pay your adviser?” The firm is concerned that, because discretionary portfolios are liquid and accessible, some advisers may view them as the simplest means of levying remuneration: “The truth is that for most IFAs, it is easier to get clients to sign up to an ad valorem charge deducted from their portfolio than to get them to write out a separate cheque to pay for advisory services. Consumers simply aren’t used to seeing exactly what financial advice costs.” Mostly commission/ some feesFully commission based Mostly fees/ some commission Fully fee-based 10 (44%) 5 (22%) 1 (4%) 7 (30%)
  18. 18. Key considerations for wealth managers n What percentage of our business is reliant on distributing packaged investment solutions to third-party firms? How will the charging structure on this business need to be altered to comply with the RDR rulings? n Do total expense ratios on our DIFs compare fairly to other collectives with a similar remit? n Do we know the intentions of our distribution partners after 2012? n If we wish to be independent after 2012, how will we justify the use of in-house funds for our clients to the regulator? 16 Comment: Adviser charging will demand greater dialogue The fact that three-quarters of wealth managers are already mostly or fully fee-based – and therefore have the appropriate systems to administer adviser charging – should put them at a powerful competitive advantage to commission-focused advisory firms over the next three to five years. In fact, for many wealth managers, the biggest business threat from the adviser charging regime is not likely to be internal but how external advisory partners cope with it. For example, wealth managers need to assess which of the IFAs they work with are certain to survive the transition from commission. Also, as we highlight in the next section, firms that run distributor influenced funds may have to reconsider their distribution strategy, given that IFA partners can no longer be paid any form of incentivised income after 2012. Finally, as one wealth manager has pointed out above, IFAs may look to add their adviser charges onto the portfolio management fee – and the wealth manager will have no control over this. In short, the introduction of adviser charging could have important implications even for those firms that are already fully fee-based. A close dialogue with partner IFA firms will be essential to ensure these implications are known and properly managed. 4. Distributor influenced funds (DIFs) Unitised client portfolio solutions may decline, but still have a role to play The ability to structure client portfolios as unitised funds in their own right has been employed by wealth managers for many years, whether for their own clients or to outsource their investment management skills to other advisory firms. These are variously known as portfolio-style funds, adviser funds or distributor influenced funds (DIFs). For the client, a fund structure means a portfolio can be actively managed without giving rise to capital gains tax liabilities and can give them a more personalised portfolio than an off-the-peg fund. Underlying managers can also be changed by redeeming fund holdings. For the wealth manager, unitising provides a scalable approach to managing portfolios on behalf of multiple clients with the same objectives and attitude to risk. As UCITS III rules now allow funds to mix pooled and direct securities and alternative assets, a fund structure can be used to replicate almost any discretionary portfolio. Highlights n Two-thirds (14) of wealth management firms use distributor influenced funds. No firm holds more than 50% of client assets in DIFs. n 30% of wealth managers believe distributors should no longer receive incentivised income from DIFs. n RDR rules could force shift from unitised solutions to discretionary management.
  19. 19. 17 The RDR response to DIFs The FSA stated in 2009 that firms can use DIFs as long as they do not restrict their advice to these funds alone7 . But concerns about inappropriate selling of DIFs in the run-up to the 2012 RDR deadline has led the FSA to address them directly in its policy paper on adviser charging8 . Here the regulator has stipulated: n Adviser firms will not be able to adopt higher adviser charges for recommending DIFs than for recommending other products such as collective investment schemes; n Firms will not be able to continue to receive additional income from other sources in relation to DIFs (including remuneration for sitting on a fund’s governance committee, for example). Implications for wealth managers The DIF ruling clearly has the biggest implication for those wealth management firms that are focused on outsourcing their investment management expertise to other advisory firms – although it can impact any firm managing in-house unitised solutions for its clients too. Distributing firms will need to ensure that fees deducted are comparable with any other collective investment scheme. Any fee paid to a third-party fund distributor (e.g. an IFA) will need to be shown to be paid for a specific advisory service. While the regulator appears to have accepted DIFs as an option within an adviser’s range of client solutions, firms wishing to be classified as independent may need to consider if putting clients in a single fund or range of funds undermines this designation. Many firms are keen to show the regulator that DIFs are a discretionary portfolio service in unitised form rather than a retail investment product. This may be easier to do where unitised offerings are clearly tailored to individual clients (which is only feasible for ultra-high net worth clients). However, if firms are putting a large proportion of their client base into the same DIF, then independence may be harder to demonstrate. Where DIFs are likely to suffer is where there only modest assets under management, resulting in relatively high total expense ratios. Now that DIFs are firmly on the regulator’s radar, firms will have to work harder than ever to demonstrate their benefits in terms of performance, cost and client suitability. Response from wealth managers 61% (14) of the wealth management firms we surveyed employ distributor influenced funds, either for their own or third-party clients. But firms appear to be careful how much client money is directed into them. The majority of firms hold 25% or less of client AUM in them. No respondent firm has more than 50% of total client AUM in distributor influenced funds (see Diagram 6). 7 CP09/18: Distribution of retail investments (June 2009). 8 PS10/6: Distribution of retail investments (March 2010).
  20. 20. 18 Diagram 6: Take-up of distributor influenced funds by client AUM Q: What percentage of your client AUM is currently held in distributor influenced funds? (Base: 23) Source: J.P. Morgan Asset Management/Owen James Most wealth managers believe that DIFs should be able to continue to exist after 2012. To make DIFs compliant with the RDR requirements for product neutrality, seven firms (30%) believe firms should no longer be able to receive any incentivised income from them. Six firms (26%) believe they should simply be recognised as discretionary portfolios and not treated as retail investment products, which would therefore put them outside of the RDR rules. Four firms believe there should be no change to the structure of DIFs – simply that the onus should be on the advisory firm to demonstrate that they are the most suitable solution to a client’s needs. Diagram 7: Preferred treatment of distributor influenced funds Q: What should happen to DIFs to make them compliant with RDR requirements? (Base: 23) Source: J.P. Morgan Asset Management/Owen James Up to 50% of total client AUMUp to 25% of total client AUM None at all 4 (17%) 10 (44%) 9 (39%) Allow DIFs to exist but rule that the distributor receives no incentive income from them Recognise DIFs as dicretionary portfolios rather than packaged products Allow DIFs to be costed and distributed as they currently are, provided they can be shown to be the best choice for the client Outlaw DIFs completely Don’t know/ no response No.ofrespondents 8 7 6 5 4 3 2 1 0 7 (30%) 6 (26%) 4 (17%) 4 (17%) 2 (9%)
  21. 21. Comment: Time for a new focus on merit The ability to unitise portfolios can provide significant benefits, bringing together the advantages of discretionary portfolio management and a pooled structure. However, funds that pay incentivised benefits to distributors are clearly in conflict with adviser charging principles. Also, in some cases it is hard to justify what DIFs are offering that a retail multi-asset OEIC cannot. The RDR ban on incentivised income will certainly lead to a demise in expensive or poor-performing DIFs. As one outsourcer observes, we may also see demand shift from DIFs to discretionary portfolio management as a means of sidestepping the RDR rules. However, we would hope this all means that the DIF providers remaining are those that have got there on the merits of their performance, competitive costs and genuine ability to meet different client needs. First-hand: When is a service a product? All the wealth managers that we spoke to recognise that the cost structures of unitised investment solutions will need to be reviewed and revised before 2012. However, a number of firms say they need greater clarity regarding when a unitised portfolio is regarded as a retail investment product. One cites the example of pooled products run for private families, which are not publicly marketed at all. It also has hedge fund assets that are required to be held in specific pooled investment vehicles by its global custodian in Switzerland. “We need to clarify what the impact of the RDR will be on these structures,” the firm says. Meanwhile, a leading private bank says the treatment of its own-branded multi-manager funds may determine its advisory status under the Retail Distribution Review: “We view [our multi-manager funds] as a totally impartial way of managing money and the fund structure means we can chop and change managers without crystallising CGT (Capital Gains Tax) liabilities. But is that multi-manager product a fund or a service? Do we have to offer other multi-manager funds alongside it in order to call ourselves independent? Certainly the FSA’s decision on multi-manager products like these will be a key driver as to whether we decide to be independent or restricted.” 19 First-hand: From DIF to discretionary One national firm that specialises in providing investment solutions to other advisory firms says it has seen a significant decline in demand for new DIFs following the RDR proposals. But as its IFA clients still want to benefit from their investment expertise, the answer has been to move to discretionary portfolio management. “A non-unitised discretionary portfolio doesn’t have the administration and capital gains efficiencies of a single fund structure, but because it’s a discretionary service not a retail investment product it is outside of the RDR rules and that’s proving very appealing to IFAs right now.” By using nominees, the firm is able to offer discretionary portfolios that are managed to match a full spectrum of client risk profiles. “Ideally there’s a place for both unitised solutions and discretionary portfolios – so long as advisers can demonstrate a clear client-focused reason for using them. We welcome the clear differentiation that the RDR is creating between adviser, investment manager and administrator. But the FSA should also recognise that the demand for outsourced investment management comes from IFAs’ desire to provide more robust investment solutions for their clients – and that’s what regulation like the RDR is all about.”
  22. 22. Key considerations for wealth managers n Do we want to capture more outsourcing business from other intermediaries, and do we have a strategy to achieve this? n What are our criteria for the intermediaries we partner with (e.g. size of client, type of portfolio)? n Does the prospect of IFAs exiting the industry present any opportunities for us (e.g. capturing client books, hiring staff)? n Have we factored in the likely cost of implementing RDR requirements, both before the 2012 deadline and ongoing thereafter? n How do we intend to meet costs of RDR implementation (e.g. margins, budget reallocation, fee changes, staff remuneration)? 20 5. The RDR opportunity and cost Wealth managers face cost balancing act to capture commercial opportunity Key opportunities identified by wealth managers Lots of commentary has focused on the flaws and challenges presented by the Retail Distribution Review. However, our research suggests that the wealth management industry recognises plenty of positives from the proposals: n The RDR focus on fee-based remuneration is seen to put many wealth managers at a competitive advantage well before the 2012 deadline. n Many wealth managers believe demand for their services will increase, partly as other advisory firms – particularly those with a commission-based model – exit the industry or are forced to merge to achieve scale. n A number of wealth managers hope that the investment advice sector will adopt a GP/specialist structure with generalist planners outsourcing to specialist investment managers. n Over half of wealth managers believe that wealth management outsourcing by advisory firms will increase, with 30% of firms believing it will increase significantly – see Diagram 8. Highlights n 30% expect outsourcing of wealth management by IFAs to increase significantly. n 43% of wealth management firms expect the cost of implementing the RDR to be high or very high. n Cost of RDR to be met through reduced profit margins, lower staff remuneration and higher client charges
  23. 23. 21 Diagram 8: Potential for wealth management outsourcing after the RDR Q: What impact will the RDR have on the level of wealth management outsourced by IFAs/financial planners? (Base: 23) Source: J.P. Morgan Asset Management/Owen James The cost of RDR The cost of implementing the RDR proposals is widely expected to be substantial. Ten out of 23 firms (43%) say the cost burden of implementing RDR will be high or very high. Only four firms (17%) believe it will be negligible. Staff training appears to account for the bulk of this expense. Firms expecting costs to be high are generally those that still have to bring a significant proportion of their advisory staff up to QCF Level 4 qualifications. Conversely, of the 12 firms that say costs will be moderate or negligible, nine say that 75% or more of their staff already meet RDR qualification requirements. A number of firms also believe that higher qualification standards will increase the cost of recruiting and retaining staff. Increase significantly Increase a little Decrease a little Stay the same Decrease significantly Don’t know No.ofrespondents 8 7 6 5 4 3 2 1 0 7 (30%) 5 (22%) 5 (22%) 4 (17%) 1 (4%) 1 (4%)
  24. 24. 22 Diagram 9: Perceived cost burden of the RDR Q: How would you describe the likely cost burden of the RDR on your firm? (Base: 23) Source: J.P. Morgan Asset Management/Owen James To meet the cost of RDR, eight firms intend to absorb the impact in their profit margins while four intend to divert expenditure from other business areas. Six out of the 23 firms say the cost of RDR is likely to translate into higher charges for clients while the same number expect to meet the cost through controlling staff remuneration. Diagram 10: Meeting the cost of the RDR Q: How is your firm mostly likely to meet the cost of implementing the RDR proposals? (Base 23 - Total exceeds 100% due to multiple responses) Source: J.P. Morgan Asset Management/Owen James Very high High NegligibleModerate Don’t know No.ofrespondents 8 7 6 5 4 3 2 1 0 3 (13%) 7 (30%) 1 (4%) 8 (35%) 4 (17%) Reduce profit margins Divert expenditure from other business areas Impose higher charges Limit staff remuneration Don’t know No.ofrespondents 8 7 6 5 4 3 2 1 0 8 (35%) 2 (9%) 4 (17%) 6 (26%) 6 (26%)
  25. 25. Comment: Wealth managers face RDR cost balancing act Wealth managers are bullish about the outsourcing opportunities that will be created by the RDR. However – as we will see in the final section of the report – their optimism may be somewhat at odds with the outsourcing expectations of IFAs themselves. In terms of bearing the cost of the RDR, we see two conflicts. First, one-quarter of wealth managers say they may have to increase client costs precisely at a time when end-clients and outsourcing partners are likely to be highly price-sensitive in light of the new adviser charging regime. A further quarter of wealth managers aim to meet the cost by limiting staff remuneration. As we reported in Part 2, however, the consequence of imposing high professional standards is that staff may expect to be paid more. Wealth managers therefore will have to perform a skilful balancing act to reconcile internal and external cost pressures if the RDR is not to have the unintended consequence of making investment advice more expensive and therefore less available. First-hand: Wealth managers prepare for increased demand Over half of wealth management firms we surveyed believe that outsourcing of client portfolio management will increase as a direct result of the Retail Distribution Review. Some firms say they are specifically investing in their businesses now to capture that opportunity. One says: “We have built up our fund research centre. We have put more business development teams in place to liaise with IFAs and we are introducing new functionality for clients such as online portfolio valuations.” One firm dedicated to outsourcing believes firmly that financial planning companies will have to outsource client portfolio management in order to survive the regulatory demands of RDR: “Given the ever-growing number of investment funds, we can’t see how IFAs can build robust investment solutions and have enough time to advise clients, unless they outsource fund selection and portfolio management. In our experience, more and more IFAs are looking for investment support in order to handle the demands of the RDR.” Another wealth manager believes that outsourcing the investment process also improves the dynamic between the client and adviser: “Both the IFA and the client are in a position where they are quizzing the skills of the discretionary manager. Outsourcing the investment management enables the IFA to move from a defensive to an interrogating position and as such they become much more aligned with the client.” One point stressed by two wealth managers involved in outsourcing is that ownership of the client relationship must be clear. As one puts it: “Where we are working with IFAs, it’s important to stress that our focus is on managing money, not taking their clients.” 23
  26. 26. 24 Outsourcers seek external expertise at the right price In the final part of this report we assess the opportunity created by the RDR from the perspective of the IFA firms that might use the services of wealth managers for their own clients. To do this, we have canvassed the views of over 300 IFAs, including both those that currently outsource and those that do not. As well as assessing to what extent outsourcing expectations of IFAs tally with those of wealth managers, this research considers the chief motivations and considerations when assigning client portfolios to a third-party firm. We hope this section can provide some practical pointers for wealth managers looking to increase their outsourcing activities. Outsourcing among IFAs Half of IFA firms surveyed say they outsource client portfolio management, but few firms outsource completely. Three out of five firms that outsource only do so for up to one-quarter of their client portfolio management – see Diagram 11. Around half of firms with scope to increase outsourcing agree that outsourcing activity is likely to increase in the next few years. However, only 19% of IFAs – compared to 30% of wealth managers (see page 20) – expect outsourcing to increase significantly. The trend to outsource is marginally stronger among smaller IFAs than larger ones – see Diagram 12. Indeed, a small proportion of larger IFA firms (6%) are hoping to see their level of outsourcing decrease significantly in the next few years. Diagram 11: Current wealth management outsourcing by IFAs Q: How much of your client investment portfolio management does your firm currently outsource to a third-party wealth manager? (Base: 330) Source: J.P. Morgan Asset Management/Incisive Strategy 6. Wealth management – the IFA perspective None Up to 25% 25-50% 51-75% 76-99% 100% 50% 31% 8% 6% 3% 2% 10% 20% 30% 40% 50% 60%0% Highlights n Half of IFA firms currently outsource – only 19% expect outsourcing to increase significantly in the next few years. n Cost is the prime consideration when selecting an outsourcing partner, followed by performance track record. n Three-quarters of IFAs are concerned that wealth managers’ performance will not justify their cost.
  27. 27. 25 Diagram 12: Future outsourcing expectations among IFAs Q: How would you like your outsourcing of portfolio management to trend in the next few years? (Base: 313) Source: J.P. Morgan Asset Management/Owen James Diagram 13: Reasons among IFAs for outsourcing Q: What have been/would be the biggest factors in your decision to outsource portfolio management? (Base: 279-287 – excludes ‘Don’t knows’) Source: J.P. Morgan Asset Management/Incisive Strategy Small IFA firmsLarge IFA firms Increase significantly Increase a little Stay the same Decrease a little Decrease significantly 15% 21% 34% 29% 45% 48% 0% 1% 6% 2% 10% 20% 30% 40% 50% 60%0% Fund universe requires expert research Delivers better investment results for clients More cost-effective for my business Want more time to advise clients Increased complexity of investment choice Concerns about client portfolio losses/ market volatility Increased client demand for portfolio management Need more time to focus on understanding retail invesment products Concerns about reduced stock market returns Big factorVery big factor Medium factor Small factor 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%0% 19% 34% 28% 19% 16% 32% 27% 25% 14% 35% 28% 23% 14% 36% 31% 19% 11% 34% 28% 27% 7% 39% 25% 29% 6% 20% 28% 46% 4% 21% 32% 43% 3% 25% 31% 41%
  28. 28. 26 Selecting a wealth manager When choosing a wealth manager, competitive charges ranked by some margin as the most important factor in the selection process, followed by performance. IFAs are also looking for partners that can tailor offerings to different client segments and deliver detailed and high quality reporting – see Diagram 14 below. Being able to offer fully bespoke portfolios is considered more important than model portfolios or multi-manager/funds of funds capabilities. A few of the wealth managers we interviewed for this report cited the growing importance of investment platforms. However, IFAs generally do not expect wealth managers to operate on the same investment platforms as they do. That said, online access for clients to portfolio valuations is now considered reasonably important. Diagram 14: Wealth manager selection criteria Q: How would you rate the following factors when choosing a wealth manager? (Base: 271-277 – excludes ‘Don’t knows’) Source: J.P. Morgan Asset Management/Incisive Strategy Implementing adviser charges After 2012, over 80% of IFAs are expecting to levy ongoing charges for advice from client portfolios, with 61% adding their full adviser charges to the portfolio management charge. Only 15% of IFAs confirm they expect to levy their adviser charges completely separately from a client’s portfolio. Competitive charges Not important Very important Performance track record Can tailor offering to different sizes of client Quality and depth of portfolio reporting Gives clients online access to portfolio valuations Runs a range of model portfolios Multi-manager/fund of funds expertise Enables client to meet the portfolio managers Localpresenceintheregionsweoperate Uses the same investment platform(s) as us Offersfullbespokeportfolios(i.e.including direct securities as well as funds) 6.72 5.77 4.67 4.67 3.15 2.45 2.12 1.11 0.51 -0.11 -1.01 0-1-2 1 2 3 4 5 6 7 8
  29. 29. 27 Diagram 15: Adviser charging on outsourced portfolios Q: Where a client’s portfolio has been outsourced, how would you mostly expect to levy ongoing adviser charges once the RDR rules apply? (Base: 276) (Total responses exceed 100% due to multiple responses) Source: J.P. Morgan Asset Management/Incisive Strategy In terms of acceptable levels of charges, over half of IFAs would expect to receive an ongoing adviser charge of 0.5% from an outsourced portfolio, equivalent to current standard levels of trail commission. However 40% of IFAs would like to see this increase to 0.75% p.a. or more. In terms of the portfolio manager’s fee, just over half of IFAs believe the portfolio manager should receive 0.75% or more. However that leaves just under half who believe the portfolio manager should receive 0.5% or less. Calculated as a mean, the acceptable aggregate charge for portfolio management and financial advice among our surveyed IFAs therefore works out at 1.35% p.a.9 . 9 Based on assuming ‘More than 1%’ as 1.5% It will be added to the annual portfolio management charge It will partially be deducted from theportfoliomanagementfeeand from other client sources It will be levied separately from the portfolio management fee (e.g. as cheque) Other 61% 20% 15% 6% 0% 10% 20% 30% 40% 50% 60% 70% 80%
  30. 30. 28 Diagram 16: Acceptable charging levels Q: Where the ongoing adviser charge and portfolio management charges are combined, what do you think is an acceptable level for each, for an average-sized client portfolio? (Base: 277) (Total responses exceed 100% due to rounding) Source: J.P. Morgan Asset Management/Incisive Strategy Client access IFAs are keen to be able to offer outsourced portfolio management to clients of all sizes. Just under half (47%) would like to be able to offer fund-based model portfolios to clients with £50,000 or less to invest. As to fully bespoke management, just over one in five IFA firms would like to be able to offer this service to clients with £100,000-£250,000. A similar proportion prefers to retain this service for clients with £500,000 or more to invest. Diagram 17: Client access to portfolio management Q: Ideally, what is the minimum size of client to which you would like to be able to offer the following outsourced portfolio management services? (Base: 266) (Total responses exceed 100% due to rounding) Source: J.P. Morgan Asset Management/Incisive Strategy 0% 10% 20% 30% 40% 50% 60% 0.25% 0.50% 0.75% 1.00% More than 1% 6% 13% 54% 36% 19% 26% 18% 24% 3% 3% Mean acceptable charge: Adviser: 0.65% Portfolio Manager: 0.68% Acceptable annual charge for the adviser (IFA) Acceptable annual charge for the portfolio manager Preferredminimumportfolio Preferredmaximumportfolio 0% 10% 20% 30% 40% Less than £20,000 £20,000-£50,000 £50,000-£100,000 £100,000-£250,000 £250,000-£500,000 £500,000-£1 million £1-5 million More than £5 million 14% 33% 27% 17% 4% 4% 0% 2% Model portfolio using funds only Fully bespoke discretionary management Less than £20,000 £20,000-£50,000 £50,000-£100,000 £100,000-£250,000 £250,000-£500,000 £500,000-£1 million £1-5 million More than £5 million 2% 3% 9% 27% 33% 18% 5% 3% 0% 10% 20% 30% 40%
  31. 31. 29 Outsourcing concerns Performance is a key issue for IFAs when outsourcing portfolio management. 43% of IFAs say they are significantly concerned that performance will not justify the cost to clients. In the same vein, 28% have major concerns that clients may not be willing to pay the cost of both advice and portfolio management. One quarter of IFAs are significantly concerned that the wealth manager may poach the client relationship. Only 15% of IFAs have a major concern about the time required to monitor a wealth manager. Diagram 18: Outsourcing concerns Q: How would you rate the following concerns when outsourcing portfolio management? (Base: 276) Source: J.P. Morgan Asset Management/Incisive Strategy First hand: IFAs look to justify their role IFAs and wealth managers diverge in their expectations for outsourcing wealth management. While 30% of wealth managers believe the RDR will lead to a significant increase in demand for their services, only 19% of relevant IFAs say they intend to increase the level of portfolio management they outsource. A few IFAs are even looking to bring wealth management back in-house in order to justify their ongoing adviser charges. One IFA says the RDR requirements will create a conflict between IFA and wealth manager, given the overlap in perceived responsibilities. A few IFAs cited concerns about losing clients. One IFA that does not outsource takes the view that clients can too easily view the wealth manager as their primary relationship: “Over time, the client might come to regard the firm that makes them money (the portfolio manager) as more important than the firm that costs them money (us) and they may feel that they can dispose of our services.” Performance won’t justify the cost to clients May take unacceptablle investment risks Clients won’t be willing to pay both an adviser charge and a portfolio management charge Wealth manager may poach clients relationship Additional work involved in monitoring manager Medium concernBig concern Small concern Not a concern 20% 40% 60% 80% 100%0% 43% 35% 15% 7% 28% 30% 29% 13% 28% 30% 26% 16% 24% 26% 28% 22% 15% 38% 31% 16%
  32. 32. 30 Comment: IFAs are sceptical but the need for outsourcing remains The expectation that the RDR will increase demand for outsourcing of wealth management cannot be assumed. We are surprised how few IFAs say they expect to increase their level of outsourcing significantly in the next few years, contradicting much anecdotal evidence from both IFAs and wealth managers. Nevertheless, with half of IFAs using third-party wealth managers in some capacity, the outsourcing market is still enormous. IFAs have cited the need for expert fund research as the prime reason for outsourcing. Given the RDR requirement for independent advisers to assess an increasingly complex array of retail investment products, we believe the need to seek out dedicated expertise on these products can only increase. What is clear is that some IFAs have major concerns about justifying their own role and/or the cost of outsourcing portfolio management to their clients; this may hold back some firms from outsourcing as much as they may wish, if only in the short term. It is nevertheless surprising that competitive charges are cited by IFAs as the most important criterion when selecting a wealth manager. We believe other factors (performance, range of solutions, local service and access to portfolio managers) will have more influence than these findings suggest. Nonetheless, wealth managers should brace themselves for increased pricing pressure from current and prospective outsourcing partners. Our research shows that – collectively – IFAs believe an ongoing fee of around 0.68% p.a. should be acceptable to a wealth manager. Wealth managers now need to consider whether that level of fee is acceptable to their business model. Indeed, although adviser charging is very much about disaggregating costs and charges, we believe that IFAs and wealth managers will have to work together more closely than ever before to determine a level of overall charging that is acceptable to their respective businesses and to the end-client.
  33. 33. 31 The Retail Distribution Review has both direct and indirect implications for the wealth management community. Labelling – the debate over independence is not over yet The most direct impact is labelling. One-third of wealth managers are set to describe their services as restricted rather than independent, even where their investment recommendations are completely unfettered. Some wealth managers have accepted this with resignation. Others see it as an unacceptable blow to their competitive standing. While the FSA’s policy statement for labelling has already been published, we believe the strength of feeling is such that further revisions are inevitable. In our view, a definition that enables an investment advisory firm to be both specialist and independent is the most useful solution both for clients and firms: it is the depth, and not just the breadth, of advice that should count. Adviser charging – wealth managers have a head-start but pricing pressures will grow If wealth managers are penalised by the RDR’s labelling requirements, they regain some ground when it comes to the proposals for adviser charging. Three-quarters of wealth managers we surveyed already operate primarily on the fee-based, service-focused charging structure that the Review sees as the gold standard for investment advice. This should place them at a distinct commercial advantage over the next few years, while other intermediary firms scramble to move their business model and their IT and admin systems from commission-based charging. It is less certain how greater price transparency across the investment advisory sector will benefit wealth managers in the long run. Few wealth management firms are convinced that more consumers will be encouraged to use wealth management services directly once they can compare the fees of different advisory intermediaries more easily. Wealth managers that rely on distributing their expertise also need to be mindful of IFAs’ responses to the adviser charging regime. The RDR has widely been expected to boost the level of outsourcing to wealth managers among IFAs. However, our research shows that most IFAs expect outsourcing to increase only marginally, and some larger IFAs are planning to decrease the volume of portfolio management they outsource. In some cases, this is a direct response to the RDR and the requirement for intermediaries to demonstrate an ongoing service if they charge an ongoing fee. Our research also reveals there is a high preoccupation with charges among the IFA sector. Competitive charges are the dominant criterion when selecting a wealth manager to outsource to, proving more important than performance track record. Three-quarters of IFAs are concerned that the performance of wealth managers will not justify the cost to clients. More than half of IFAs are also concerned that once adviser charging comes in, clients may be resistant to paying a fee both to their IFA and a wealth manager. Nonetheless over 80% of IFAs intend to levy some or all of their adviser charge through the portfolio management fee, and 40% of advisers believe it is acceptable to levy 0.75% a year or more for their services. All of this adds up to the potential for major pricing pressure. Wealth managers reliant on a high level of outsourcing for their business will need to maintain a close dialogue with their IFA partners to ascertain their pricing and outsourcing plans post-2012. Wealth managers also need to determine which IFA partners are likely to transition to a non-commission environment successfully. Some smaller partners may struggle, or choose to exit the market, and wealth managers need to determine any adverse impact on their business if the advice sector contracts. Conclusion
  34. 34. 32 Professionalism – a short and longer-term challenge for business investment While contending with greater pricing pressure from their outsourcing partners, wealth managers also need to address the cost of implementing RDR requirements. Along with IT and systems, training and CPD is likely to be the biggest cost, particularly as fewer than half of firms currently have three- quarters of their advisory staff qualified to minimum RDR levels. The professionalism cost burden of the RDR is likely to manifest itself in two ways. First, the actual cost of bring staff up to the qualification and CPD standards (and in this respect some wealth managers may need to pay twice: to meet investment advice standards under the RDR and to meet investment management requirements under new Competence Ethics requirements). The second longer-term impact may be increased recruitment costs: after 2012 investment advisers may be more highly qualified and more scarce, a combination that always puts upward pressure on staff reward. This presents a conundrum for many wealth managers, given that one-quarter of firms are looking to limit staff remuneration in order to meet the costs of implementing the RDR. Unless this can be achieved solely by limiting ancillary personnel costs, then wealth managers will have some tough decisions to make regarding long-term investment in high-quality staff versus short-term profitability. Performance, price and persuasion – the keys to survival after 2012 In short, the RDR is set to present financial challenges to many wealth management firms, as external pricing pressures and increased internal cost demands meet head on. But RDR is about survival of the fittest: fee-based wealth managers that can attract and retain highly-qualified advisers and have a performance track record that truly justifies their charges could potentially flourish as expensive, poorer performers struggle. In terms of outsourcing, firms that can clearly communicate the value of their expertise to other intermediary businesses after 2012 should do well, provided they remain keenly aware of IFAs’ heightened concerns about cost and demonstrating value for money to their clients. Again, this does not mean wealth managers have to be the cheapest, simply that their results need to justify their costs, both to the IFA and the client. Adviser charging is intended to separate out the costs of different elements of the investment advice process. Ironically, however, we envisage that IFAs and portfolio managers will have to work together more closely than ever before to determine a total ongoing cost for advice and investment management that is sustainable for the client and their respective businesses. This is certainly a dialogue worth having: our research has shown that half of IFAs outsource portfolio management to some degree, indicating that this is already a huge market. Moreover 53% of IFAs also strongly acknowledge that the fund universe requires particular research expertise. Given that the RDR will require independent advisers to advise on a wider range of investments than ever before, we agree that most IFAs will need much more help in the years to come. As long as wealth managers can overcome IFAs’ concerns about cost, we agree that there is a rich opportunity to show how outsourcing can deliver the RDR objective of better client outcomes and enable IFAs to focus on what really matters – advising their clients. Wealth managers were never the core focus of the RDR. However, those firms with well-priced expertise and the skill to market it could be the chief beneficiaries of the Retail Distribution Review.
  35. 35. Implications for wealth managers Like advisory firms, wealth managers face the challenge of bringing all their advisory staff up to QCF Level 4 by end of 2012. Concurrent with the RDR paper on professionalism, the FSA has also released its consultation on Competence and Ethics (CP 10/12), which includes new qualification standards specifically for discretionary managers. Certain qualifications will cover both RDR advice requirements and the CP 10/12 requirements for investment management. Originally CP 10/12 omitted certain qualifications that were acceptable for RDR - notably the CISI’s Certificate in Private Client Investment Advice and Management (PCIAM). However this has been amended so that discretionary managers who have taken PCIAM to comply with RDR qualification no longer have to take additional qualifications to continue managing portfolios. Discretionary managers with dual advisory/portfolio management roles may still need to commit to more CPD. The FSA has said that if an adviser carries out both investment advice and investment management, CPD for the latter will not count towards the 35-hour CPD requirement for investment advice under RDR. 33 Winning attributes of wealth managers post-RDR n Already predominantly fee-based n Strong performance results, net of charges n Attractive, flexible charging structure n Already invest heavily in adviser training and development n Strong fund research capabilities n Ability to communicate value of service to clients and strategic partners n Strong relationship and dialogue with outsourcing partners
  36. 36. 34 The Retail Distribution Review: background Origins of the RDR The Retail Distribution Review was first announced by the Financial Services Authority in 2006. The review was instigated to address perceived long-running problems within the retail investment advisory sector that the FSA believed had impacted the quality of advice and consumer outcomes, and eroded confidence and trust in the UK investment market. The core objectives of the RDR were therefore to: n Improve the clarity with which firms that advise on investment products describe their services to consumers; n Increase the professional standards of investment advisers; n Address the potential for adviser remuneration to distort consumer outcomes. In so doing, the regulator hopes to move a significant way towards achieving a recognised profession of retail investment advice on a par with other professions. Who the RDR targets The review targets any firm providing investment advice to retail investors. Its provisions are therefore separate from, and in addition to, those for investment management. What the RDR proposes Some of the detail of the proposals of the RDR is still under consultation. However, as at August 2010, the main intentions are as follows: 1. Improving clarity of advice services Firms providing advice on retail investment products must clearly describe their services as either independent or restricted. Firms that describe their advice as independent must meet a range of criteria, including sufficient knowledge of all types of product that could give a suitable outcome for a client. See Section 1, page 06. 2. Increasing adviser professionalism Retail investment advisers must hold a qualification at or above QCF Level 4 and will be expected to carry out a minimum of 35 hours of continuous professional development (CPD) each year, including 21 hours of structured learning. Individual advisers will also be required to hold a ‘Statement of Professional Standing’ which must be independently verified each year by an accredited body. 3. Addressing risk of remuneration bias Firms that give investment advice – whether independent or restricted – must set their own charges in agreement with their clients, a system called ‘Adviser Charging’. Product providers will no longer be able to offer commission to secure sales from adviser firms (including non-monetary ‘soft commissions’) and adviser firms cannot recommend products that pay commission, even if they intend to rebate these payments to the client. See Section 3, page 13. 4. Strengthening prudential requirements All personal investment firms will have to hold capital resources worth at least three months of their annual fixed expenditure in realisable assets such as cash. The minimum capital resources threshold for any firm will be set at £20,000. Appendix:
  37. 37. 35 Timetable for implementation Final rules on describing and disclosing advice and on adviser charging were published in the first half of 2010. Consultation on the professionalism proposals is scheduled to close at the end of September 2010, with a final policy statement scheduled for December 2010. The finalised policy proposals are intended to be incorporated into the regulatory handbook by the end of 2012. From January 2013, advisers must be fully compliant with all requirements for professionalism, remuneration and description of services. Transitional prudential rules come in at the end of 2011. Firms will need to comply with the full new prudential rules from 31 December 2013.
  38. 38. This document represents the view of J.P. Morgan Asset Management Limited in this subject at the date of this documents and may be subject to subsequent change. Please be aware that this material in produced for information purposes only and should not be taken as or construed as investment advice. JPMorgan Asset Management Marketing Limited accepts no legal responsibility or liability for any matter or opinion expressed in this material. Telephone calls are recorded to ensure compliance with our legal and regulatory obligations and internal policies. The information in this document is based on our understanding of law and regulation at the time of print and is subject to change. Issued by JPMorgan Asset Management Marketing Limited which is authorised and regulated by the Financial Services Authority. Registered in England No. 288553, 125 London Wall, London EC2Y 9AQ. LV–JPM3509 GB H1120 10/10 J.P. Morgan Asset Management Finsbury Dials 20 Finsbury Street London EC2Y 9AQ www.jpmorganassetmanagement.co.uk

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