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Doctor&#39s orders

I was re-reading Charles Mackay&#39s Extraordinary Popular Delusions and the

Madness of Crowds to stop myself investing in an exciting new dotcom issue.

In the chapter on fortune telling, he writes: “It is happy for man that he

does not know what the morrow is to bring forth; but unaware of this great

blessing, he has, in all ages of the world, presumptuously endeavoured to

trace the events of unborn centuries and anticipate the march of time.”

It adds: “He has reduced this presumption into a study. Upon no subject

has it been so easy to deceive the world as upon this.” This is a useful

warning when listening to some of the more extreme advocates of

technological change sweeping away the IFA sector for websites and portals.

Financial supermarkets are the latest buzz. We at Threadneedle have

arranged for our funds to be carried by Egg and Barclays in the UK and by

Citibank in Europe and are involved in other initiatives.

What does a supermarket offer? There are two main things on offer to the

public: administration and discounts. The main novelty supermarkets offer

is administration via the internet. This admin should not only be better

than traditional paper-based systems but also different. Client records are

held and consolidated by the supermarket which has a single nominee holding

with the fund manager. Investors can deal and consolidate information on

their portfolios through a single service.

For unit trusts and Oeics, internet dealing for the occasional investor is

not a great advance on telephone dealing. Unlike share dealing, where there

is account validation, or life insurance, where there is more complicated

paperwork, to buy an investment fund you need only lift the phone and state

your request. This is usually quicker than logging on.

But if you have investments with a number of investment houses and want to

switch or want a consolidated valuation of all your funds when you get home

from work, then only an internet-based administration system will meet your

needs. A well-constructed site will also connect the eager and active

investor with a variety of real-time information systems so that market

movements can be checked before making a decision.

Besides enhanced administration and execution and access to a wealth of

information, the other benefit of financial supermarkets will be discounted

prices. At present, financial supermarkets discount all or almost all the

usual 3 per cent initial commission. The immediate profitability of

financial supermarkets comes from receipt of trail commission. In the

longer term, the supermarkets are hoping to offer clients other services,

such as share dealing, banking, mortgages and credit cards, where other

profits can be earned.

If a supermarket can offer better admin and lower prices, will the IFA

market be swept away as eager and well-informed investors use this new

approach to buying and owning funds? Our view is that it is not eager and

well-informed investors who are the bulk of advisers&#39 clients. Excluding

institutional and other channels, currently 18 per cent of investors buy

direct from fund managers. The bulk of this money either goes to the big

no-load brands such as Legal & General or Virgin or to “hot” brands and


The majority of investors, 82 per cent, buy through advisory channels,

whether tied or independent. Of these, a chunk will be clients of discount

brokers but the majority are not eager and well-informed investors. They

are people who need advice, people who do not know they should be buying

investment funds or do not what to buy and how to invest.

So we believe the major impact of financial supermarkets will not be on

the advisory sector. Discount chemists are not a threat to doctors.

Most of the evidence, not only in the UK but also from other markets, is

that the majority of people have an ignorance or irrational fear of

equities and need advice and persuasion to invest. Interestingly, the split

seems to be about 80-20. For example, in France, where there is little

independent financial advice available, 74 per cent of investors are in

money market funds and bond funds compared with only 26 per cent in equity


Although the size of the direct sector waxes and wanes, we see no evidence

of a substantial change in investor behaviour. We remain confident that

those firms whose primary service is to provide advice will continue to do

well. However, their back offices may well be greatly changed and improved

by the new technology.

There has been some discussion about IFAs dealing though financial

supermarkets. We see difficulties with this concept. It requires four

parties to be financially satisfied — the client, the adviser, the

supermarket provider and the fund manager. This looks financially tight.

There is simply not enough margin to split three ways without raising

prices to consumers.

The client also risks being constrained by the service levels and fund

links of the supermarket provider. For example, IFAs may well want to use

smaller and less well known groups who may be of little interest to the big


We see a different model emerging with the development of EMX, the

industry&#39s new service provider. EMX aims to offer IFA&#39s electronic dealing

linked to straight through processing, online valuations and information

services. Over time, this should provide IFAs with greatly improved

services at much reduced costs. These are benefits that can be passed on to

an IFA&#39s clients through the adviser&#39s own website.

Autif and the major investment houses see EMX as crucial to improving

service to IFAs and lowering costs. This is why the industry has been so

determined to control this development so that sufficient investment is

made and the industry keeps control of standards. In short, we believe with

EMX, the internet will assume the same importance to advisers as the phone.

You cannot imagine doing without it but it will not change the fact

individual advice is the core of the business.

But although supermarkets may not fundamentally reshape the adviser

market, we believe they will have an impact both on the discount broker

sector and the direct market. Indeed, in most ways, financial supermarkets

are just discount brokers with much better administration. Schwab, the

giant among US supermarkets, started life as a discount broker.

What has happened in the US is the emergence of an oligopoly dominated by

Schwab and Fidelity with a handful of smaller competitors. Because of the

greater costs of administration and marketing and the need to squeeze

profit out of low margins and high volumes, the costs of entry are high. In

the UK, a discount broker could get by with little more than a telephone, a

garage and an advertisement in the Daily Telegraph.

With a market dominated by fewer bigger players, brand becomes more

dominant. Investors regard themselves as a client of the supermarket rather

than the fund manager. This threatens not only small discount brokers, it

also weakens the direct marketing channel for fund managers. Why buy direct

from Jupiter or Threadneedle if you can buy cheaper through a supermarket

and get much better service with all your investments valued on one site?

Thus, more of the market may become intermediated, with a few bigger, well-

capitalised firms with well-known brands dominating the execution-only


If the costs of paying additional commissions on the business of the

self-directed investor will cause some pain to fund managers with loaded

funds, it also poses a problem for no-load funds. In the US, Vanguard,

which is famous for having the industry&#39s lowest costs, is not available

through the financial supermarkets. It does not have the margins to share.

Similarly, Legal & General and Virgin are not available through Egg or

Barclays despite their appeal to the cost-conscious self-directed investor.

They do not have the margin to pay for the extra services that a financial

supermarket provides.

One issue that we believe will be crucial for fund managers is that they

must be careful to maintain equal pricing between distribution channels.

Some supermarkets may try to get managers to discount their entire

front-end load – effectively paying differential commission for the promise

of volume execution-only business. We believe this would cause the advisory

sector to labour under too great a disadvantage and, at least as far as

Threadneedle goes, we will resist this.

So, in conclusion, the rise of financial supermarkets will change the

market by providing superior levels of service to self-directed investors.

This service will be paid for by fund managers having to pay commission on

a growing portion of their business and by the weaker execution-only

brokers going out of business. For the stronger discount firms, this is an

opportunity. We do not believe financial supermarkets are a significant

threat to advice-based intermediaries any more than discount brokers have

been. The challenge is for the industry to make sure EMX is developed

effectively to provide lower costs and better service so IFAs can pass this

on to their clients.


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