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Are investment support services managing conflicts of interest?

Increasing influence of providers could be cause for concern of independence of investment tools

Investment research services – from fund ratings to risk-profiling tools – are crucial for IFAs investing clients’ money.

With some of these service providers offering their own funds, and some others teaming up with fund houses, how carefully do advisers need to look under the bonnet of these companies and their commercial ties to gauge impartiality?

How can advisers be sure funds these services recommend are indeed the best for their clients, rather than a result of behind-the-scenes tie-ups between support service firms and fund providers?

Powerhouses’ potential conflicts

Morningstar’s decision to upgrade or downgrade a fund can arguably drive billions of pounds of flows in or out of it. The investment research and fund rating powerhouse also has an asset management arm, which manages $220bn (£170bn) and has a range of nine of its own multi-manager mutual funds.

How can Morningstar deal with this seemingly inherent conflict of interest when rating or recommending its own products? By avoiding it altogether.

A spokeswoman for the firm says: “Morningstar funds do not receive the Morningstar analyst rating. This is to tackle the danger of rating/recommending [an in-house] fund.”

UK clients of financial advice would not generally end up invested in Morningstar Investment Management funds as they are only available through fee-based managed portfolios for financial advisers in the US and are not available to non-US investors. Morningstar, however, does have managed portfolios available to UK advisers.

The Chicago-based billion-dollar company has a good reputation for its investment research among UK retail investors. According to research from Platforum from 2017, 9 per cent of end investors cited it as a contributory source for their investment decisions, making it much more popular than its closest investment research competitor.

It is also widely used by advisers. Fifty-two per cent of advisers who use third-party research for their fund due diligence use Morningstar, according to the Platforum figures. At 80 per cent, a large number also opted for its competitor, FE.

FE provides fund ratings and has a range of discretionary model portfolios, including discretionary service FE Invest, which was launched over three years ago and has now surpassed £1.5bn in assets under management. It was named the fastest-growing discretionary service in 2017 by Platforum.

But  unlike Morningstar, FE does not have its own funds, and therefore does not have to grapple with the awkward prospect of rating and recommending its own products.

When composing a fund list for its model portfolios, the group uses funds with the highest FE ratings. The funds are reviewed by an FE analyst to create the shortlist.

An FE spokeswoman says: “All FE ratings (Crown ratings, Alpha Manager ratings, etc) are quantitative-based, and look at the whole of market so are free from bias. No provider can request a rating or pay for one.”

Apart from some review of the funds by the FE analyst, the method is highly quantitative. According to the company, the conflict of interest is tackled by the mathematic nature of the ratings.

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Morningstar stresses there are Chinese walls between the research/rating and investment management teams.

The Morningstar spokeswoman says the company “maintains a strict separation” between the manager research group and Morningstar IM, with the IM arm enjoying the same access to research done by the Morningstar research team as any other client would, and at the same time as other clients.

She says: “Morningstar IM has no influence over any of the manager research services’ investment ratings. Our IM portfolio managers find out about ratings changes only when they’re published, at the same time all other investors find out.

“Similarly, research team analysis is not a prerequisite in the investment selection process.”

Both fund rating agencies stressed that there is no cross-over between the research and investment management. And rightfully so – as blurred lines would raise red flags.

Fund manager groups having sway over  investment research would be “incestuous”, according to director at Shore Financial Planning Ben Yearsley, as from that point you would be bound to question the impartiality of their ratings.

Expert view

Practice what you preach with portfolio service construction

In the past five years, several leading research agencies have launched discretionary model portfolio services, which are available on platform. FE, Morningstar, RSMR and Square Mile are all offering discretionary managed portfolios for advisers.

Many advisers have embedded the use of third-party research into their investment propositions, with 86 per cent of financial advisers using such providers. These relationships with advisers have borne fruit with their discretionary services – FE and Morningstar’s portfolios have been two of the fastest-growing in the past couple of years.

It is most definitely a ‘practice what you preach’ mentality with portfolio construction. Morningstar is using funds with positive analyst ratings in its portfolios, while Square Mile’s Managed Portfolios and RSMR’s Rfolios only include their own rated funds. FE Invest uses a combination of the Crown ratings and Alpha Manager ratings with a qualitative overlay to construct its portfolios.

There was some concern raised by the FCA back in 2016 about fund ratings being provided on a ‘pay-to-play’ basis. But the research agencies are all very keen to stress the independence of their ratings from the influence of the asset managers who pay their fees, with commercial conversations about licences usually taking place only after ratings are published and Chinese walls existing between the research and commercial teams. In any case, the advisers we have spoken to express little to no doubt in their research providers’ independence.

Andrew Ashwood is analyst at Platforum

Risk-targeting reviewed

An essential step for IFAs matching their clients with the right investment solution is risk-profiling. Dynamic Planner technology is used by some 6,500 financial advisers for just this.

Its recent launch of actively and passively managed funds in co-operation with Schroders and Seven Investment Management respectively, is an example of an investment research provider expanding into investment management waters.

Many funds launched now are “risk-targeted” – or monitored and tailored to stay within their assigned risk profile on an ongoing basis. Schroders and 7IM struck exclusive  deals with Dynamic Planner for their 7IM Dynamic Planner Wealth Portfolios fund range and Schroder Dynamic Planner fund range.

Apart from the licence to use the Dynamic Planner name, the relationship with 7IM and Schroders includes additional consultancy services. Dynamic Planner oversees investment committees and writes quarterly investment reports for them.

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A Dynamic Planner spokeswoman says: “An end client and an adviser could reasonably expect the closer consultancy with Dynamic Planner in their investment committees would make these solutions more likely to operate within the stated risk profile.”

According to the company, these portfolios sit among the other risk-targeted solutions in Dynamic Planner and are filtered and sorted using the usual research criteria.

The spokeswoman says: “We understand [these portfolios] are available across investment platforms and information and support is available from the fund manager themselves.”

According to the spokeswoman, Dynamic Planner continues to provide consultancy services for both advisers and asset managers, and is not currently contemplating further collaborative fund launches.

Adviser view

Scott Gallacher
Director, Rowley Turton

If you were using just one fund manager company and it was providing you with the subsidised support service, then that would create a bit of a conflict from the RDR perspective.

There are issues with this, but it is not something that keeps me awake at night.

I suppose there is a danger if you use its own research tools, it could potentially artificially bump up its own products as a solution. I think that is less likely the case with SimplyBiz.

[SimplyBiz] providing the research tools is probably not as dangerous as it coming out and saying “this is the best”.

From [the SimplyBiz] perspective, it makes sense to provide off-the-shelf solutions for advisers, so it can say: “Come to SimplyBiz, we provide you compliance support and this is the programme to do the product research…”

From its perspective, it can make things much more simple and compliant and presumably take out some cost.

I don’t know if that [saving] would be passed on to an adviser at all. I assume it is simpler for it when all advisers are using its preferred compliance framework.

Whereas when you are using a research tool from a rival provider you have an issue that it might be in a different format.

The conflict arises when convenience moves from being streamlined to being a sausage factory where people are forced down a certain route, and that route could be sub-optimal.

Fund houses venture into advice

Recent years have seen a number of high-profile adviser support services acquired by fund providers.

When these deals are announced, the companies involved, as well as supportive advisers and commentators, hail the investment-backing potential the fund managers can bring to the support service providers. They point out these support service providers can, in turn, advance fund managers’ technology and services.

But other observers raise concerns about a fund provider nudging their way into the adviser support services as a means of expanding their distribution channels.

In 2016, Schroders bought a 49 per cent stake in Benchmark Capital, a vertically integrated group including the Best Practice network, chartered IFA Aspect 8, network and chartered financial planning firm Evolution Wealth, investment platform Fusion Wealth and technology firm Creative Technologies.

Last year, fund house Invesco acquired adviser back-office provider Intelliflo. Since the launch, the market share of advisers using the Intelliflo software Intelligent Office rose from 30 per cent in June 2018 to 35.1 per cent at the end of the first quarter of 2019.

Intelliflo also launched a direct to consumer offering in 2015. Intelliflo’s executive chairman Nick Eatock said there were no plans to restrict this proposition to Invesco funds.

Invesco had previously ventured into the US digital advice market, when it acquired the robo-adviser Jemstep in 2016.

An Invesco spokeswoman says the fund manager continues to work with and invest further in delivering enhancements to the business.

Earlier this year, support service provider SimplyBiz, which owns Verbatim Asset Management, also acquired ratings and technology business Defaqto.

SimplyBiz already has its native investment research hub Centra, which it launched last year. Its Verbatim fund range is available on the Centra system but is not given any preference, according to the company. Centra’s adviser user count stood at 2,300 at the beginning of the year, and with the Defaqto acquisition, added access to another 8,500 advisers.

Defaqto chief executive Zahid Bilgrami says the company has not had any concerns expressed by IFAs around the rating of funds post-acquisition.

Bilgrami says: “This is because ratings continue to be independently created by Defaqto and founded on our objective criteria-based research. Defaqto rates all propositions in a market segment regardless of whether or not they have been licensed.

“Neither the SimplyBiz compliance services operations nor Verbatim are in any way involved with selecting the criteria we use for our ratings, nor in setting thresholds or in the ultimate award of the rating.”

Access Wealth Management partner James Clancy says he would not see a fund house buying a stake in a support services provider as a reason for concern.

Clancy says: “What would worry me would be if the terms and conditions changed significantly. But buying a stake would not worry me. Why should it? Intelligent Office users can have the satisfaction of large-capital stakeholder backing.”

In the case of Schroders and its stake in Benchmark, the tie-up between the two has been getting tighter with Schroders increasing its stake to 77 per cent last May.

In 2018, Schroders also announced it would team up with Lloyds Banking Group to create an advice joint venture. Advisers will be restricted to the use of Benchmark’s Fusion Wealth Platform.

While investment research and support service providers swear by their independence from fund manager influence, these collaborations need to manage conflicts of interests very carefully, and be as open as possible about how they are managed.

Otherwise we could see the direction of travel amid all this consolidation take us right back to pre-RDR, scrapping years of work on transparency in the process.


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