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Fears grow over advisers’ investment due diligence

Concerns are being raised advisers are not carrying out robust due diligence when it comes to fund selection, with insufficient attention paid to asset management charges.

Research by Money Marketing suggests many advisers carry out their investment due diligence themselves, but the findings also point to an over-reliance on rating agencies and marketing material from fund groups.

At the same time, advisers and investors can face an uphill struggle when it comes to finding meaningful data with which to assess funds.

With the FCA stepping up scrutiny of fund management, Money Marketing has examined how advisers carry out investment due diligence and the overall role advice firms have to play in competition between asset managers.

Costs are not the priority

Our research looked at attitudes towards investment outsourcing and fund selection based on 204 adviser respondents.

Of those, 69 per cent are picking funds themselves, although some say they are outsourcing investment choices to discretionary fund managers. This may reflect some firms adopting a mix of both approaches, through the use of investment committees or in-house analysts.

Advisers were asked to rank the criteria they use when it comes to fund selection on a scale of one to five, with one being “not at all important” and five being “very important”.

Investment processes came out as the most important criteria for 42 per cent of respondents. A third of advisers surveyed said performance track record was important, while the cost of investment management was ranked as important by 30 per cent of advisers. Five advisers rated fees as “not at all important”.

Independent regulatory consultant Richard Hobbs says while advisers are being “objective” if they are focusing on investment processes, he argues costs need to play a more prominent role.

Hobbs says: “If a fund manager you are working with is a nightmare, your costs go up and then you go somewhere else.

“I don’t think advisers would be surprised by these results but the regulator might confirm this is the case and conclude the industry works for itself and not for customers.”

The Financial Inclusion Centre co-director Mick McAteer says costs are generally the sole element advisers can control as opposed to “the myth of past performance”.

He says: “The thing advisers can control is fees. This is where they can have a significant influence. Evidence shows it is not possible and not worth it to predict future returns based on past performance as this is something out of their control.”

But Investment Quorum chief executive Lee Robertson says: “If a fund is fit for purpose, delivers alpha and sits well within the desired client asset allocation and risk tolerances when blended within a portfolio then the charges, while important, are secondary to the fund delivering what it is meant to do via process and performance.”

Earlier this month the FCA published a series of “sector views” on the financial services market, setting out the key risks it has identified as the areas it wants to focus on. These included a renewed focus on advisers and investment suitability.

The FCA said some firms might not be providing suitable, consistent investment advice and attributed this to possible conflicts of interest or insufficient competence.

Going the extra mile

Gbi2 managing director Graham Bentley argues many advisers “don’t get that far” when looking at investment processes.

Bentley says advisers start by looking at fund managers’ track record but claims that may not be followed through, and argues many advisers pick a fund without meeting a manager.

He also points out some advisers consider factors such as portfolio turnover or active share (the proportion of stocks held that differ from the benchmark) as important to their research. But he says most of this data is not always available to them.

But Apfa director general Chris Hannant argues it is “artificial” to say advisers look at one aspect over another in their fund due diligence.

He says: “Advisers look at different aspects when they pick funds. There are thousands of funds out there, they can’t meet all of the fund managers. It is about filtering processes to try to get a sense of the fund manager’s approach.

“Then you would expect them to continue researching and digging on particular funds if that is what your client wants. You need some information tools to narrow down research.”

‘Shallow research’

In our research, almost half of advisers said they use rating agencies to get their information on managers and funds.

Respondents also cite asset managers’ websites, marketing meetings and “word of mouth” as their research sources.

Bentley says some advisers are doing “shallow research” as they are using performance data analysis and are not actually looking at research.

He says: “Due diligence is not just done by looking at analytics. Understanding why something is underperforming is important. A lot of people that buy absolute return, for example, wouldn’t know how to explain it.”

In terms of other sources, advisers use fund data firms such as FE Analytics and support services firms.

Only 10 respondents have an in-house investment committee, and just eight advisers say they personally meet fund managers.

One respondent said they used “knowledge gained from model portfolios” in order to do due diligence.

Hobbs says: “The reasons why advisers use rating agencies is because they provide a vast amount of information. But advisers are just as sceptical as the FCA on the information they are receiving from rating agencies. Advisers are good at spotting conflicts of interest.”

In February 2016, the FCA assessed 13 advice firms to review how they conduct research on products and services as part of a thematic review.

While the FCA found good practice overall, it stated firms should consider whether they can rely on the information supplied by the provider, including marketing material.

It said: “Firms can rely on factual information provided by other EEA-regulated firms as part of their research and due diligence process, for example, the asset allocation. However, they should not rely on the provider’s opinion, for example, on the investment’s risk level.”

The FCA added sometimes advises “did not seek to understand or challenge their own inappropriate bias towards products, services or providers”.

Roberston says rating agencies are helpful but takes them “with a pinch of salt” as many appear to rate funds within groups which subscribe to their services.

But he says those rating agencies with wide fund and group coverage are a good starting point.

Equilibrium Asset Management partner and investment manager Mike Deverell will often invest into relatively new funds that would not qualify for a rating and normally does both quantitative and qualitative research, using FE initially.

Deverell looks specifically for consistent performance, consistent alpha, and includes factors such as active share.

The firm also looks at how funds have done in rising and falling markets. Once it identifies a potential fund it asks for a due diligence questionnaire to be completed and then they meet the fund manager.

Deverell says: “This means we sometimes buy funds that have gone through a bad patch because they were not suited to the past market environment, but we think they will suit the environment in future.”

Passive best practice

Money Marketing also asked advisers about how they are allocating to passives, given the FCA’s more positive slant to passives set out in its interim asset management study in November.

Some 15 per cent are not recommending passives at all. Around 25 per cent allocate between 5 and 15 per cent to passives across their client bank, while nearly a third of respondents allocate between 20 to 35 per cent, and nearly 20 per cent allocate 50 per cent or more of their clients to passives.

McAteer argues if more advisers were to recommend passives they would avoid potential biases, such as those from rating agencies.

He says: “It’s really difficult to justify why advisers still recommend active funds. Best practice  would be agreeing to a long-term strategy, look at the best service and pick passive funds.

“Evidence shows there’s no point in picking an expensive fund since most active funds are not outperforming.”

The Financial Inclusion Centre wants the regulator to introduce an equivalent of the RU64 rule for advisers to recommend a passive fund over an active fund if they have similar characteristics.

The RU64 rule required an adviser to justify why the personal pension they were recommending is at least as suitable as a stakeholder pension.

But others argue passive funds are not the solution to make due diligence less onerous.

Tilney Group managing director Jason Hollands believes smaller firms or financial planners are avoiding doing investment themselves and are buying more passives or multi-asset funds because they recognise fund picking is a different skill set.

He says: “There’s no doubt there are very high quality firms that do due diligence seriously, but also some that buy off-the-shelf multi-asset solutions or others picking passives because they don’t have the same due diligence process as active funds.

“But not every asset class can be indexed. It could be convenient for advisers although it is not a panacea.”

Money Marketing found 89 per cent of respondents have not recommended more passives following the FCA’s interim asset management report.

One adviser says: “In the current evolving market investors are not willing to invest in active managed funds,” while another says it would be “unwise” to exclude passive selection without “good reason”.

Expert view

Threesixty managing director Phil Young


Fund selection and research remains very fragmented across advisers, far more so than product and platform research which tends to follow a more familiar structure. The sheer number of funds, and the complexity over researching them means it’s not surprising advisers use research agencies to narrow choice down.

The danger is the amount of influence that places on research houses and the business models it drives. Advisers are effectively outsourcing a significant element of quantitative analysis and almost all the qualitative analysis to research houses and it’s really important they know how they operate.

The brand of the research house seems very trusted even if the brand of the fund manager isn’t that important according to the survey.



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There are 18 comments at the moment, we would love to hear your opinion too.

  1. This isn’t a new story, there are three variables when selecting an investment provider; risk, cost and performance. The first two can be controlled but the last one can’t be.

    Performance however is only relevant as to how it meets a clients plans, trying to be the winner is relevant in sport but not in investment circles.

  2. I think what we mean by ‘past performance’ needs to be quantified.

    If a fund delivered 25% net growth over the last 3 years, will it do 25% over the next years – highly unlikely.

    If an experienced fund manager / team through a range of investment and economic cycles made sensible investment decisions over the long term resulting in out performance of their sector – I propose (and I realise it’s a red rag to some bulls) that there’s a reasonable chance it will continue over the longer term. Add in risk adjusted return (most clients don’t want to shoot the lights out) and fund behaviour on the down side (utility for the client) and you start to build a picture as to why cost is not our main focus.

    When with a client I don’t base investment decisions on absolute performance (currently we’re telling everyone not to be overly excited – markets have been very generous) but net relative performance (ergo ALL fund costs are built in) is one very important factor.

    Yes this does mean we spend more time than if we farm people out to DFMs, 3rd party CIPs etc BUT it also means we understand the behaviour of each clients portfolio AND we are of the opinion every portfolio, by being bespoke, suits that client’s aims and objectives.

    It’s not rocket science – we just keep getting told by everyone that it is (particularly when RDR was looming large).

  3. Is it just me or has anyone else noticed how MM seems to be running a lot of articles and polls which are centred upon issues which are ‘supposedly’ at the forefront of FCA scrutiny? Think I should maybe take a week off from reading the publication, as it’s all getting a little depressing and OTT! All very negative.

    • Not staying that the FCA hasn’t identified issues in some areas, but let’s temper it with examples of bad practice and good rather than a headline grabbing focus on charges (yet again!).

  4. I would argue that advisers’ due diligence has never been better. The title of this article makes it look like it’s getting worse. Not true.

    By the way, a “good” fund is a fund that does what it is supposed to do and achieves the clients objectives.

  5. Rather than continually targeting the IFA market who do a good job recommending major investment houses with strong robust investment processes,perhaps the real focus should be to finally rid the sector of those STILL recommending investments that are unsuitable for most , ie car parks, forests, etc. How about putting some good news stories about what the IFA sector are doing well, such as helping clients through the regulatory jungle in the UK. I agree with James Hurdman, it all becomes a bit depressing reading this stuff.

  6. All my clients (with whom I’m in regular touch) are (rightly) happy with the portfolios I’ve put together and regularly review for them, so why should I care about how anyone else is running their ship or whether they think I should be running mine any differently from how I do now?

  7. At no point do we see what due diligence is completed by the regulator to approve an investment or what checks are undertaken by them on going. The funds do not have a renewable licence so we have no idea when they were last inspected by the regulator.

    It is a fact the regulator has greater means and power to investigate funds with far greater effect then I. I have to really on rating agencies and only use regulated funds. I gain AKG reports and other financial reports as well as the companies own documents. I cannot walk in and demand the latest figures or investigate any fund or company as well as the regulator.

    So, my question has to be IF the regulator is undertaking their duties correctly, if its a regulated fund, would it not be correct that the regulator should be completing far greater and in-depth due diligence then myself or any rating agency. If this is not the case, what is the point of regulated funds and regulation?

    If you the regulator approve the fund and it fails, you should be held to account, not try and blame parties further down the line that pay you to undertake due diligence and provide an element of security.

    • Julian Stevens 2nd May 2017 at 9:43 am

      The FCA has stated more than once that it doesn’t approve funds or products and that authorisation of either should not be inferred to mean approval, thereby placing responsibility for due diligence firmly in the court of any regulated adviser considering recommending them. The reason for this stance is that were an FCA-approved fund or product to go down the pan, all fingers would point towards the regulator. To an extent I can understand this, because a fund or product that might look reasonably sound at one point in time might later go bad, thereby placing a huge and arguably untenable responsibility on the regulator to conduct the necessary checks not just prior to granting approval but at regular intervals thereafter. Given the sheer numbers of funds and products out there, this simply couldn’t be done, at least not without the FCA massively increasing its resources in this area and thus the scale of our levies to pay for it all.

  8. There are a few active fund managers whose track record demonstrates that they can add real value to investment returns by consistent outperformance of benchmarks whilst taking average/below average risk. I accept that they are a small minority but their collective outperformance of their passive peers means that my clients have more money to enjoy the better lifestyles they want for themselves and their loved ones, now and into the future. I would be failing them if I simply shoved them into a bunch of trackers. 100% passive portfolios – the next mis-selling scandal? (closely followed by expensive, under-performing DFMs of course)

  9. Actually few advisers do any due diligence at all. Nowadays it is mostly done by the back office and para-planners – who are not even regulated. This is more than an elephant in the room it’s a Diplodocus.

  10. Once again we are dealt the drivel and fluff about IFA’s and Restricted Advisers – to deflect the real problem – the industry and their agents. The industry must spend billions of pounds on attempting to convince people about ” asset management ” or lack of it whilst trying to shoehorn everyone into a with profits fund or more likely nowadays a passive fund or ETF or Tracker> The disturbing news behind some of UK Discretionary fund managers ( which should read discredited fund managers) with all those funds in the market place – confidence in the company – their professionalism, their integrity, their ability to look after clients money should be uppermost. Unfortunately the passives and the trackers are looking for the American Principle ( like Asda and other supermarkets – who should stick to selling soup) Pile it high sell it cheap. The American 80 /20 Rule where you get 80% of your business from 20% of your clients ( difficult If you have one client? ) – which is why banks run roughshod over their clients in Breach of their Statutory Duty of Care. For someone understanding the investment is more important than yesterdays or yesteryears returns. What assets are the fund manager invested in ? Why ? Do you need a whole trail of fund managing managers – who cost more to employ than it does to deliver – the costs bring down performance. Good outcomes require good service and difficult decisions. Desired outcomes do not often come about through passive or tracker investing – but the poor returns can help to convince clients for higher premiums – because of inefficient investment and percentage fees. They do hike the Premiums upwards (Like in the corrupt and fraudulent sale of endowments with increased growth rates. Its a Scam ! ) but it does help the tardy insurance companies and banks to meet their unsavoury targets – by unprofessional selling practices – cheating their clients – but apparently everybody does it ? So who can clients trust with their hard earned money ? The Independent advisers have been reduced mainly by the sub standard life’s who need restricted advisers instead of competent or committed advisers – to do their bidding instead of what is right. Now some wrap providers are turning away employer premiums to pensions – which may be to sell their company on – big profits up front and clients are transferred, like in Sloppy Widows to some unknown Spanish owner following their sale to LloydsTSB, where dishonourable selling practices are part of their culture and their regime – which will not change in the near future.

  11. “…the regulator might confirm this is the case and conclude the industry works for itself and not for customers.” -Well, strike me down…a business in business trying to make a profit for the benefit of the owners of that business.

    Am I missing something here, or did I fall asleep when they announced that the entire financial services industry was being taken over by HM Govt and henceforth is to operate as a not-for-profit organisation for the benefit of Joe Public ?

    Perhaps I’ve woken up on June 9th and Jeremy Corbyn really has won?

    (Heaven forbid. But where is my passport just in case….)

  12. Is this regulator that seems to be criticising IFA due diligence processes the same regulator that in a previous incarnation approved the Arch Cru funds as OEICS and Capita (who also presided over the Connaught shambles) as a reputable ACD?
    “Those in glass houses…” possibly?

  13. And if we said fees were more important this article would be about “Fear grow over advisers investment process due diligence”

    I am of the opinion bad news & fear sells so lets distort the facts, if this is the issue the FCA should give us an idiots step by step guide to follow therefore ranking the the correct priorities.

    Dream on !

  14. All advisers ned to do is
    Avoid using DFMs
    Avoid using any funds charging more than 0.5% including turnover and trading costs
    Avoid d funds with larger tracking error
    Avoid funds that stock lend and pocket the profits

    That leaves a small handful of good funds in each sector = job done.

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