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Sense of value

In January, the ascribable capital value of UK financial services product providers was around 85bn while the estimated capital value of IFAs was only around 6bn to 8bn at best.

Even this seemingly anomalous valuation represents a significant improvement in the relative valuations attaching to financial advisory businesses only a few years ago.

In 2005, the estimated capital value of IFAs was 2.5bn while for product providers it was 140bn.

This continuing mismatch in values goes to the heart of what was wrong with the old financial advice model, where IFAs acted as “intermediaries” and were rewarded as little more than introducers of business to product providers who then owned the recurring and embedded value of the relationship with the clients.

So what exactly is the advisory community to read into this continuing massive discrepancy in valuations?

Yes, they tell us that the IFA sector remains a hugely fragmented and in some cases not particularly well run segment of the financial services industry.

Yes, until the relatively recent move towards the new model adviser structure, the quality and consistency of earnings of the IFA sector as a whole with its high dependency on initial commission sales was debatable.

However, the real message remains that the market still judges that IFAs contribute and control less than 10 per cent of the value proposition to clients. Contrast this with what every client satisfaction survey shows and what both advisers and providers know to be the case – this massively under-represents the value added by the financial advice process in whatever guise.

If we compare this with who actually has the client relationship, the figures are turned around when we look at investment decision-making, with 70 per cent-plus of collective investment business being placed via IFAs.

The harsh truth is that while IFAs create and maintain the value in the client relationship, almost all of the embedded value accrues to the product provider, many of whom cannot deal directly with the client, but only work through the IFA channel.

Now, putting all of this into context, the cottage industry nature of IFAs means that there is a massive under-recording of their value. Almost all firms are privately owned and many remain partnerships. As almost none of the IFA industry – with notable exceptions – are listed on quotable exchanges, we are into the sphere of supposition and extrapolation.

However, the massive gap in capital value tells its own story. Cut it any way you like, even triple the 6bn to take account of these factors, but the harsh fact is that the cottage industry nature of IFAs, with 80 per cent of firms having less than three advisers, means that we have struggled to capture our fair share of capital value but have managed to attract more than our fair share of the industry’s liabilities.

There is one comment to be made here and that is about the way that the different entities are valued. In the case of product providers, this is based on assets under management or on the basis of the long term (five years-plus) value of the client.

Compare that with the way IFAs are valued, with only perhaps two to three years income counting in the case of trade sales, and none of this future income counting as an asset as far as FSA capital adequacy is concerned. As far as the FSA is concerned, all this value accrues to the product providers.

This difference in valuation is largely a reflection of who owns the client relationship and the resulting assets. The traditional view from providers was that the clients became theirs and therefore could be cross-sold, transferred to another agency or otherwise dealt with to the product providers benefit. And we have seen much of this activity recently as traditional product providers have come under pressure.

Historically, providers have spent time and money trying to bypass the intermediary community, to little avail, except to cause confusion and cost within the IFA community and their clients.

We are slowly but increasingly moving to a model where use of wraps and technology allows IFAs to bypass the traditional providers and deal direct with the wholesale market.

Of course, IFAs have long resisted the top-down approach but it is only the recent growth of the wrap market that has allowed them real alternatives to “giving” their clients to traditional product providers.

But this still leaves us the really key question as to who really owns the clients? It is all very well for us to say we do but what matters is what the market thinks. And this will be at least partially based on what the client thinks.

Clearly, a more disciplined and thought through use of wraps and platforms within the adviser business will help with this problem but there are other possible approaches as well.

One avenue gaining increasing popularity among medium and bigger IFA groups is that of distributor- influenced funds. Despite some concerns expressed by the FSA about the need to avoid of conflicts of interests and ensuring client suitability, many IFAs are opting to design their own investment funds while having these hosted and administered by specialist fund administrators such as IFDS, Capita and BNP Paribas.

And no, despite what some product providers would wish to portray, these are by no means a return to the bad old days of the broker bond.

Today’s DIFs are fully integrated into the IFA’s investment advice and client risk assessment process, will normally employ external fund management houses and in many cases are designed specifically to have a lower total expense ratio than equivalent mainstream funds.

Such residual product margin that is created then accrues to the IFA group rather than product providers, cont-ributing to the financial strength and quality of earnings of the IFA. Clearly, these are not for everyone but are a useful option for the right firm with scale and the right client base.

The historic gulf in capital values between IFAs and providers has at its heart a view that the client relationship belongs to the providers.

Until we learn how to clearly own the clients and directly service their assets, we will be left with the liabilities while providers reap the capital rewards. Intelligent use of a combination of the right technology, distributor- influenced funds and wrap services is the way forward for most firms.

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