As anticipated, most organisations were compliant with the statutory RDR requirements on day one and about 85% of advisors had gained the required qualifications and statements of professional practice.
Clearly some intermediary firms have been selling fee based propositions for many years. But for life companies and intermediaries embarking on RDR transition we estimate that the best prepared were at least 12 months ahead of the pack. We know that a number of players were burning the midnight oil between Christmas and New Year’s Eve and it is clear that many are still in transition to the post RDR world in terms of culture and, indeed, proposition.
We have identified some weaknesses in many of the post RDR service propositions we have seen. In particular some fee structures and rates seem to represent transition rather than the probable end-game; some ongoing service propositions do not appear compelling and there seems to be an absence of fail-safe systems and controls to ensure that the promised on-going service is actually delivered.
Initial advice fees
In the old world, the basic model was no transaction = no revenue to the advisor. And the standard commission was a minimum of “three plus a half”. Here we are in the new world and the preferred investment advice model appears to be “three plus a half” contingent on a transaction – with a reduction for clients investing over, say £250k.
Clearly, an element of fee linked to the size of investment makes sense as the advice risk and potential remediation cost are to an extent proportionate. However:
- Most intermediaries are suggesting they intend to move up-market yet fee structures as a percentage of investment means that the £100k investor can get a better deal value than the £200k investor. Bluntly, some fee structures are not yet aligned with the strategies – or indeed with the cost of delivering the service
- All firms – vertically integrated or not – should understand how much it costs them to deliver advice, add margin and price accordingly. They can package this up to a fixed price if that is the preferred option for their clients or charge by the hour. And they can also charge a fee related to the size of any implemented investment
- A fee solely based on a percentage of a transaction perpetuates the cross subsidies of commission. People that execute subsidise those that don’t. Larger investors subsidise smaller investors. In the non-commission world these subsidies will become clearly visible to clients and, over time, I think they will be seen to be unattractive.
- No transaction = no fee also creates conflict of interest. And this will need to be monitored and managed carefully.
- Organisations need to sell the advice service up-front and agree an appropriate fee structure that offers fair value to both parties. Working 100% on contingency is not likely to create a sustainable business for most advisors or an acceptable economic model for vertically integrated firms – unless they have a particularly strong consumer franchise
Advisors are of course highly adaptable. And they will, over time, gain the confidence and skills to sell advice propositions that do not rely upon selling a product. Looking at the market today, it seems this may take rather longer than we anticipated.
Every service proposition we have seen has a strong focus on on-going service. The underlying business plans for vertically integrated firms and the exit strategies (where they exist) for intermediaries reflect the importance of revenues from this source.
In common with initial advice, fees are tiered so that larger investors pay a lower percentage with 1% as a typical maximum and 50bps as standard. However:
- It is not always clear what service is provided to clients who do not wish to pay for an on-going fee. If, for example, they still have access to an advisor and on-line valuations for free why are others paying for these services?
- Equally if a client invests say £50k initially and then a further £100k the ongoing fee will triple with the propositions we have seen. The extra benefit that will be provided to the client in return for the extra fee is unclear.
- Unlike existing trail commissions, if a client cancels the on-going service they gain the benefit. As such advisors will need to work hard to justify the payments. And they will need to evidence their activity and controls in order to satisfy the regulator that they are delivering on their promise.
The move to clean share classes will be where the rubber meets the road. Some advisors will have no difficulty in explaining to clients why they will have to pay a fee rather than commission in future because they will have told them at outset what on-going services they will be receiving, how much they will cost and how this is covered by commission. Others may find the process more challenging – particularly where clients were not advised about trail commissions or have forgotten about them.
Selling an on-going service to clients taking income may be particularly difficult given that they will probably consider the fee relative to their net income rather than their capital. In the current environment this income may be around 4% net of tax. A 50bps charge represents 12.5% of the client’s income; 100bps 25%. Outstanding service propositions will be needed to ensure their response to the proposition isn’t: “Thank you but I actually need that money”
Engaging with less affluent consumers
100 days in it seems clear that most investment advisors want to focus on mature, wealthy consumers going forward. And most retail banks have concluded that offering face to face advice to their mass market customers is not practical in the RDR world. Commentators have pointed to the investment advice vacuum that will be left behind. We take the view that this vacuum is less of a problem than most suggest.
First of all some facts: ignoring mortgages, ONS research indicates that about 25% of UK house households have net debt and a further 7% less than £500 investable assets. 27 per cent have between £500 and £12,500. So I would suggest that 59% of households have no need for investment advice. And if they need encouragement to save, auto-enrolment will be as much as most can afford.
About 9 per cent of households have between £12,500 and £25,000 – I imagine their need for retail investment products as opposed to deposit products is quite limited. But for the 11 per cent with over £25,000 and less than £50,000 there is potentially an advice vacuum. Is this a problem or an opportunity? Probably the latter. Nature abhors a vacuum. And if one does appear a number of players are already considering how to fill it via a range of business models.
Insurance companies are at the forefront – looking to engage directly with consumers rather than relying on intermediaries. A strategy being pursued by some focuses on the worksite. Serious investments are being made in this space. The target market is one that is of limited interest to existing advisors so there is limited conflict with the intermediated channel. And these consumers may have a need and may create value over time. However some key qualities will be needed to succeed. These include capital, customer insight and patience.
Some asset managers are also working their way to the start line of the race to engage with customers – excited by the opportunity to manage money during their 25 years in retirement rather than just during the accumulation phase. New on-line direct to consumer brands are also emerging from existing and new intermediaries – offering guidance rather than advice and providing a rich and friendly customer experience.
So far so good?
At Ernst & Young we anticipated a fairly sharp fall in new business volumes in the first quarter of 2013 as advisors and clients grappled with fee based investment advice. We also thought that the changes to protection and annuity pricing would see empty pipelines in January. But for many players Q1 seems to have worked out quite well.
We hadn’t anticipated that so much business would be advised on in 2012 but implemented in 2013 on a commission basis. Anecdotal evidence suggests that in some product lines over 50 per cent of cases fell into this category
So the jury is still out. It will be Q2 at the earliest when we will start seeing the results of the RDR experiment. Back in 2009 we suggested that investment advisor numbers would be down to around 20,000 by the end of 2013 and so far we see no reason to change that view. At that time we also said that the demand for objective professional advice was bound to increase – particularly at retirement, given the shift from defined benefit pensions to defined contributions. And we also see no reason to change that view. There is little doubt that advisors who stay the course will prosper.
Malcolm Kerr is a director at Ernst & Young’s Financial Services Division