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All wrapped up

Wrap accounts have received much publicity in recent months but there is confusion about what precisely is meant by wraps and what the customer proposition actually is.

In simple terms, a wrap account is not a product or an investment in itself. Instead, it is a system for administering a portfolio of products from a number of providers. The first wrap accounts emerged in the US in 1975 after the deregulation of the securities brokerage industry, when firms were allowed to set their own commission terms.

The customer can select the range of products for inclusion directly or can do this through an intermediary. The wrap account is then used for subsequent transactions, ongoing reporting and administration.

Wrap accounts can vary in sophistication and complexity. For example, a straightforward mutual fund wrap would offer underlying investments in unit trusts and Oeics. However, a more advanced offering, sometimes referred to as a traditional wrap, might also include direct shareholdings in international markets, bonds and other insurance products.

One of the major benefits of a wrap is access to investment products at wholesale prices. There is also collective reporting across all investment and product holdings, doing away with the need to deal with a myriad of different providers.

Fees are charged on the wrap account as a single entity, typically starting at between 1 and 2 per cent, allowing a number of trades in any year.

The minimum investment for both mutual fund wraps and traditional wraps is falling. There is often the option for customers to manage their own portfolios or to allow intermediaries to manage portfolios on their behalf. Investors can usually build investment portfolios based on individual attitudes to risk, age and time horizons.

In light of such benefits, it seems sensible to ask why wrap offerings have not grown faster in the near 30 years since their introduction and what the prospects are for wrap offerings in the UK.

There are a number of arguments against the growth of wraps. These can be built, first, around products, second, around customers and, third, around the role of intermediaries

The product argument is the one that is easiest to articulate. What is the gap in the existing product portfolio that a wrap offering could fill? It could be argued that any collective investment scheme, such as an Isa or pension, is already a wrap product by definition. Classes of shares and assets are held in a single place.

While such investments are not generally thought of in the collective sense of a wrap, other investments, such as personal portfolio bonds or self-invested personal pensions, often are. A personal portfolio bond is a legal entity which allows free switching between asset classes within the insurance wrapper. In addition, there may be many fund links available within the bond. The net effect from the customer&#39s point of view is considerable freedom to change investment holdings and even investment strategy within a single holding. Similarly, a Sipp offers considerable investment freedom for the individual or business on a self-directed or managed basis. Again, the perspective of the individual customer is that of the collective management of pensions and perhaps property assets within a single administrative holding.

The second argument is based on the view of wrap offerings through the customer&#39s eyes. How will individual customers react to having all investment funds and insurance products grouped within a single holding? UK customer research over the past 10 to 15 years has consistently emphasised the reluctance to combine holdings together in this fashion. In particular, this research has underlined consumer reluctance to mix cash reserves (so-called rainy day savings) with investment funds.

While the growth of flexible mortgages is beginning to gain ground as consumers understand and appreciate the underlying mechanics of such products, consumer advertising nevertheless still struggles with overcoming the intellectual hurdle implicit in offsetting debt against savings.

Another important but often neglected factor is the exit strategy. Can the customer can get out of a wrap account easily? This often depends on whether the account holds products of the sponsoring institution. Moving to a new wrap provider may prove difficult and take time. Closing the wrap could incur fees, for example, deferred sales charges, depending on the particular fund holdings involved.

The third argument relates to the role of the intermediary. Wrap offerings should allow the IFA to benefit from using a single technology platform and leading-edge technology. Similarly, they should allow more time for the intermediary to improve professional standards and asset allocation. However, asset allocation has not historically been a key strength of IFAs in most international markets.

It is also said that wrap accounts offer intermediaries the chance to obtain stable flows of fee income in rising or falling markets. While this looks attractive, most intermediaries are more familiar with up-front rewards for making sales.

It seems that the rapid adoption of wrap offerings in the UK is by no means straightforward. There is abundant evidence telling of the growth of wrap propositions in other markets. However, the growth of funds under management within wrap offerings has often taken place in different market conditions from those in the UK.

The key issue will be how customers perceive the advantages and benefits in a market that is struggling to provide reassurance and confidence in difficult trading conditions.

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