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RDR: the winners and losers

With the elimination of initial commission and the need to demonstrate a whole of market approach to advice, the RDR could bring about a significant change in type of investment products that IFAs advise on. Rachael Adams looks at the potential winners and losers from the RDR while Baillie Gifford marketing director James Budden looks at the impact on investment trusts

ETFs look set to make gains

By Rachael Adams

Alongside exchange traded funds, investment trusts are tipped as being one of the biggest beneficiaries of the RDR.

“One of the biggest barriers has been the commission issue, so we are very happy the RDR is removing this barrier,” says Association of Investment Companies director general Ian Sayers. “The commission issue has led to others, such as a prohibitive lack of familiarity. In a sense, it is chicken and egg.”

But the removal of commission is just one obstacle. Sayers says: “Abolishing commission is not job done. Look at platforms, where investment trust representation is zero. If the whole market had just 5 per cent in investment trusts, that would make a huge difference and I can see that happening. Already, the three largest platforms have said they are going to offer investment trusts in order to meet the RDR’s whole of market requirement.”

ETFs are also frequently tipped to benefit from RDR-driven changes for the same reasons and HSBC head of ETFs Farley Thomas says he expects them to become much more widely available on platforms.

Farley says: “I think more platforms will follow Cofunds in adding ETFs because there will be more demand for products that have not paid commission in the past.”

The fact that both ETFs and investment trusts can range from very simple to very complex investment goals has been cited as a barrier to IFAs and clients becoming comfortable with them but Thomas says ETFs can be very straightforward.

He says: “ETFs can be very simple products. They are no more complicated than an index fund with features of a listed company but we do think advisers will avoid swap-based ETFs due to their complexity.”

At the other end of the scale, Sayers says the added complexity of investment trusts can be seen as offering IFAs an advantage. He says: “They can be complicated but some are plain vanilla. I think complexity is good. Under the RDR, we will be in a world where clients are going to be asking what they are paying for and if an adviser can demonstrate knowledge of gearing, then he is demonstrating his expertise and thus his value.”

Cost is an area that is coming under scrutiny in the RDR run-up and advocates of both products say they hope to capitalise on this.

Sayers says: “The focus over the next five years is going to be the total cost of investment. Products with high-charging structures that do not add extra value will struggle, as they will no longer be able to compete in terms of commission. The tracker fund of 1.5 per cent could become a thing of the past.”

Thomas agrees. “There is likely to be selective sale of traditional active funds that have paid significant levels of commission to IFAs,” he says. “ETFs will therefore be attractive because of their low costs. They are definitely cheaper than investment trusts.”

Bestinvest senior investment adviser Adrian Lowcock says that he sees growth in sales for investment trusts and ETFs but is more bullish on the prospects for ETFs.

He says: “Although investment trusts are more natural for advisers familiar with unit trusts, I would fall on the side of ETFs. There is more momentum there because growth rates in the US are massive. I think ETF growth will be more organic than adviser-driven.”

However, with new winners emerging in the investment sector under the RDR, there will inevitably also be losers.

Thomas says the big losers will be active funds that have not been able to outperform their benchmark as he predicts the market will polarise between low-cost, passive management and a small number of more expensive active managers that can prove their worth.

He says: “The kind of traditional fund that has been sold and priced on the basis of being ’active’ but has ended up delivering performance quite close to or below the index will suffer relative to much cheaper index funds and ETFs.”

Lowcock agrees that it is likely to be expensive active funds that will suffer. He says: “We will see low-cost active funds develop but full-cost actives which perform poorly will drop by the wayside. If an active fund is barely outperforming the benchmark, it will struggle to justify fees.”

But Sayers also offers a word of warning to over-enthusiastic ETF and investment trust managers. “Alternative investments are going to see a boost but they will not become dominant products. Increased representation will not mean they rate above open-ended vehicles.”

Promotion will be the key for investment trusts

By James Budden, marketing director, Baillie Gifford

Investment trusts have often cited commission bias as the main hurdle between them and an enthusiastic IFA marketplace while intermediaries have pointed to the complicated nature of trusts (discount/ premium) and their perceived riskiness (split-capital debacle and volatility) as good reasons to prefer open-ended funds.

There is no smoke without fire and it is the advantages offered by investment trusts to IFAs and their clients that need to be explained better by those of us involved in the sector. While acknowledging that the majority of IFAs steer clear of closed-ended funds at the moment, there are some positives to be taken from the current environment without even looking forward to the RDR.

Many fee-based IFAs already use investment trusts in preference to and alongside unit trusts. Private individuals remain big direct buyers of closedended funds via online platforms and manager saving schemes, suggesting they may not be so complicated for the punter after all.
The reason that those in the investment trust world welcome the RDR as a good thing is it appears to level the playing field between the two collective fund structures.

As things stand, commission payments are set to be outlawed. This brings down one great perceived barrier. Investment trusts and unit trusts will compete together in a world based mainly on investment proposition and what is most suitable for client needs.

Furthermore, IFAs will have to show they are taking a whole of market approach to investment analysis and choice, so investment trusts should again be included in this practice.

Ideally, all this would lead to investment trusts appearing on all intermediary platforms offering investment funds rather than just as an equity option or not at all. Investment trusts ought to have the same status as any other collective fund on platforms. After all, they are not a different asset class, they just have a different structure. It would be also helpful if the trade and consumer media began to take a more inclusive view of investment trusts as collectives alongside unit trusts rather than viewing the two fund types as cats and dogs.

More annoying is the apparent capitulation to platforms on the subject of unbundling their fees. Under the RDR, we were meant to get transparent factory gate pricing, with intermediaries settling their own and the platform’s fee separately with their clients.

The commission aspect has been accepted but the platform fee seems likely to remain bundled at least as an option. This detracts not only from the simplicity of factory gate prices but also removes the necessity for some platforms to change their payment systems.

A change to offer factory gate pricing would have automatically let in investment trusts. However, the continuance of a wrapped charge acts as a barrier as trusts cannot load their shares to accommodate the platforms’ fees. As a result, the sector will have to convince these platforms that potential demand justifies inclusion – a much harder sell.

So are trusts on the edge of a brave new world? Generally speaking, the RDR should prove positive and could offer an opportunity to the investment trust sector to go mainstream at last. But then we are talking about the “City’s best kept secret”.

Just because investment trusts may start the race in 2013 level with unit trusts does not mean they will keep pace when the starting gun is fired.

Performance and proposition are obviously key selling points but just as important is the promotion of these benefits to the marketplace.

For years now, management groups have invested to build strong IFA-facing brands based purely on open-ended funds which can grow in new money terms and their revenues with them.

Investment trusts have rarely seen much marketing investment from their managers beyond a perfunctory servicing of their cash cows. Trust boards, with a few notable exceptions, have hardly ever had the nerve to commit shareholder funds to marketing in any size or for any meaningful length of time to attract ongoing demand effectively.

Unless investment trusts stand up and tell IFAs why they should deserve IFA investment, nothing will change after the RDR.

Investment trusts must also take up the marketing cudgels for another reason. Ongoing interest would allow a more vibrant market in trust shares. This is needed because a big barrier to IFA investment in trusts is a lack of liquidity.

The issues that surround getting in and out of trusts can put off even the keenest followers of the sector among IFAs. As a result, only a minority of trusts can really appeal to the bigger IFA buyers.

Regardless of a level playing field, trusts will have to address this problem but those trusts which are popular and have an efficient market in their shares may benefit exponentially from the RDR but they will have to continue to promote themselves to stand out in a crowded arena.

Those lesser-known trusts will have to ask themselves and their managers what they need to do to join the party. Performance alone will not be enough. Brand recognition and awareness are factors which will count after the RDR where emphasis will be placed on guided architecture and top fund pick lists designed to help IFAs through the whole of market minefield.

Much has been written about the potential consequences of the RDR, both intended and unintended. One of the latter is that investment trusts may actually find themselves on too much of a level playing field as a result of unbundled pricing.

Today, many trusts enjoy a significant price advantage in comparison with unit trusts. Within a typical open-ended fund charge of 1.5 per cent a year, 0.5 per cent can be paid away in trail and a platform may receive 0.25 per cent for its pains, leaving the fund provider with, say, 0.75 per cent.

Ironically, this kind of transparency may leave investment trusts exposed as the more expensive option as many now have total expense ratios of 1 per cent and above.

Therefore, it is more than possible that many trusts will remain reluctant to bear any new costs for marketing themselves after the RDR. Plus ca change, plus la meme chose.

It is unlikely that investment trusts will become universally popular with IFAs after the RDR. However, a level playing field in terms of distribution and accessibility should offer a significant opportunity to those trusts who can offer a strong investment proposition coupled with the determination to convince the marketplace of their worth. There will be a minority of big winners but for the majority the RDR will change nothing.


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