I was re-reading Charles Mackay's 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' 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's new service provider. EMX aims to offer IFA's 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's clients through the adviser's 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's 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
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.
I was re-reading Charles Mackay's Extraordinary Popular Delusions and the