Clive Waller: We must keep a close eye on vertical integration

There are a few expressions guaranteed to enrage financial planners. One of these is vertical integration. Many will argue vertical integration means inferior advice and poor products at higher cost. Is this fair?

In some cases yes, but not always. Simplistically, there are three layers in the value chain: manufacture, distribution/advice and the technology in between.

Here, we will call this a platform, albeit the term is becoming more inappropriate as technology becomes more modular.

Vertical integration is where a firm expands up or down the value chain. So, St James’s Place is vertically integrated in that it has funds, its own technology and an advice capacity. Standard Life has a platform, an asset management business and distribution in the form of 1825. Up until the turn of the century, there was relative clarity between manufacture and distribution/advice. Not so today.

My own IFA, Investment Quorum, runs a centralised investment proposition. No surprise there. The CIP is based on money run on a discretionary basis by a highly professional team. IQ does outsource the platform service.

Since most client money is placed in the CIP, is this not vertical integration? Why is a bespoke or model portfolio run by an adviser any less of a product than a multi-asset fund run by an asset manager? After all, from the client viewpoint, they are pretty much the same.

Vertically integrated firms duck in-house funds issue

Indeed, I could go as far as saying all IFAs running model portfolios are vertically integrated, as they are performing the key roles of investment product manufacture, asset allocation and fund selection.

There is no doubt many vertically integrated firms have put margin ahead of customer. Finding the charges of most major wealth management firms is impossible. Research suggests they are typically high. That is not to say all are expensive or lack transparency.

My colleague Heather Hopkins reckons change will occur, as there is a potential read-across from the Royal Commission in Australia causing much concern at some major vertically integrated players.

The regulator has shown interest. Mifid II should be shining a bright light on charges and none too soon. However, the FCA has a preference for big players, as they are much easier to regulate.

The delay in enacting the findings of its asset management market study confirms its reluctance to actually do something. The current trend is for more reviews and consultation.

A major wealth manager responding to criticism of high investment charges recently commented that these charges also paid for distribution. Now, as far as I am aware, such cross-subsidy is not allowed, yet it happens.

I have no problems with vertical integration. However, I do have a problem with lack of transparency, with lack of full disclosure and with charges so high that typical investment returns will be eroded to virtually nothing.

Let’s hope 2019 is the year when charges become reasonable and transparent, and when the regulator hammers any firm that does not treat its customers fairly.

Clive Waller is managing director of CWC Research


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There are 6 comments at the moment, we would love to hear your opinion too.

  1. At my age and being a bit of a cynic I rather thought that I couldn’t be surprised any longer, but Mr Waller has proved otherwise.
    Here is a man who can justifiably regarded as a financial services ‘Guru’. How he can imagine that an IFA producing a bespoke portfolio could be considered vertically integrated is something I can’t understand. This is because I have always understood that vertical integration manages to shave off fees at every stage. Take SJP or Standard Life. The advice is charged for. The platform charges and the fund itself has a charge, but all these charges end up in the one pocket. The only thing an IFA earns is his/her advice fee and any ongoing fees. How is that vertical integration?

    Furthermore I do find it surprising (again!) that someone of his ilk is prepared to have his money invested in a CIP. But I guess it takes all sorts.

    • On the other hand you could take the view that a CIP is introduced into the chain (the chain being from underlying securities to client) to extract fees that wouldn’t otherwise be extracted and to that extent it is a form of vertical integration.

      In all but name most CIPs are effectively a fund of funds but using a portfolio structure to avoid the rigour and oversight of being an actual fund. Those without an element of bespoke investment somehow magically avoid being AIFs though I’ve never worked out how.

    • How do “all these charges end up in one pocket”? Surely they end up in three quite discrete pockets. Do you not mean that all these charges come out of one pocket?

      • Julian

        Perhaps I wasn’t precise enough. Take SJP for example. They have their own platform and many of their own funds. So if the adviser uses in house funds than fund management charges, platform charges and the adviser charge all go to SJP. Yes, I realise that the ‘partners’ consider themselves self-employed, but overall the same firm receives the money – all to SJP – that’s the name on the tin.

        That is what I consider vertical integration to mean. Otherwise why bother?

  2. I think Clive’s point is very valid.

    As he says, if the advisory firm is running (not just using) model portfolios then they are performing the key roles of investment product manufacture, asset allocation and fund selection.

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