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The prophet of profits

This month&#39s financial services sector report from investment bank Durlacher might be some of the best news that the IFA market has heard for quite a long time as long as you are a plc or a big network player. For the first time this year, the bank is talking profit and increased demand for financial services and has changed its sector rating from sell to buy/hold.

It is a stark difference from the bank&#39s January report, in which it spoke of doom for listed IFAs. Even since January, advisers have had a difficult time and Durlacher analyst David Panell estimates that consumer demand has fallen by 15 to 20 per cent, leading to most firms becoming or remaining loss-making.

But the big prediction from Pannell&#39s report is that market demand is starting to pick up. He believes the market has bottomed out and is growing again and he is adamant that it is already showing signs of growth that will accelerate some time in the first quarter of next year.

Pannell contends that there are a number of drivers that will increase demand in financial services, particularly for regulated products. He believes stockmarket recovery, increasing complexity, rising levels of tax and low investment returns from inadequately funded pensions are all stimulating demand for financial advice.

He believes this increased demand, coupled with a fall in overheads, will lead to profit towards the end of the first quarter of 2004. The bank estimates that Inter-Alliance, Millfield, Berkeley Berry Birch and Lighthouse are vying with each other to become the first to announce monthly profitability.

Millfield Group chief executive Paul Tebbutt says: “Even though it may have been painful, the past year has been somewhat necessary. You cannot build a company without incurring losses. The most important thing is to get into profit and I think all the plcs are working towards this. Hopefully, they will all achieve it by the end of their financial years in 2004.”

Even looking ahead to depolarisation, Tebbutt sees this growth predominantly in the area of regulated products. Although demand for nonregulated products has been strong over the last couple of years, Pannell thinks its time of high growth is coming to an end.

He says: “IFAs have contributed to increased sales by switching to non-regulated products although this trend will probably reverse itself, partly because commission rates are lower.”

It is not a case of if but when for Pannell, who expects the total market for non-regulated products to start falling early in the new year. Part of his rationale is that the market will start to feel the effects of new FSA regulation. However, over the long term, Pannell&#39s major concern for IFAs is still the possibility of a misselling scandal which would rock consumer demand.

As the regulated landscape becomes increasingly clear, Pannell says Durlacher remains consistent in its view that consolidation is the way forward for the industry.

The bank believes this consolidation will probably be led by bigger quoted and unquoted players, naming as potential leaders Inter-Alliance, Millfield, Berkeley Berry Birch, Lighthouse, Tenet, Bankhall, Aegon and Sesame.

Inter-Alliance chief executive Keith Carby says: “I cannot see that anyone else besides those people would have the ability or the inclination to consolidate in the industry. Consolidation has not finished yet by a long chalk.”

Come depolarisation, Pannell differs with other analysts in his opinion of tied players. He has seen a long-term decline in their market share and believes this will continue. He sees national IFAs as the strongest business model for the future as they are able to achieve much higher levels of profitability than their network counterparts.

BBB chief executive Stephen Ingledew says: “In terms of generating levels of profitability, net margins have always been stronger in the national model but the counter to that is that networks are always bigger.”

Pannell also believes the new regulatory regime benefits bigger players over smaller firms. His argument centres on their attractiveness to providers.

He says: “Principally, their size makes them most attractive to providers wishing to multi-tie. Bigger firms should be able to offer the most attractive products but small firms, with the exception of those in the high-net-worth market, will struggle to survive in the deregulated world.”

Carby says: “I wish it was different because I like the idea that you can start small and make an impact but scale grows ever more important in financial services. In terms of what you can offer to advisers and to the public, there is a real difference between the large IFAs and the small ones.”

However, the Durlacher report does not read like a promotional brochure for big, listed IFAs. Pannell is adamant that IFAs are still sub-scale and will continue to be weak for the foreseeable future. He believes the power still lies with providers.

He says: “Even the big IFAs are still too small to change the distribution of value meaningfully vis a vis providers and although the IFA sector should return to profitability over the next six months, the industry is probably unable to generate the level of profitability we would expect from similar &#39people&#39 businesses.”

Ingledew says: “IFAs are so focused on getting to break even at the moment but that is not going to be the end of the road.”

As a hint of things to come, Pannell has hung a “watch this space” sign over the emergence of wrap offerings.

He says: “The value generation from wraps is not yet proven in the UK. There is significant industry interest in wrap products, which consolidate a client&#39s investments via one internet-enabled screen.

“In theory, wraps should drive demand for advice because they stimulate adviser/ client discussion. They should also make the selling process easier and charges for funds under management would generate embedded value within IFAs.

“At this stage, we are open minded regarding the potential value of wraps but consider it too early for them to affect our estimates.”

Carby says: “I am always wary when anything new comes along but I really think, both in terms of concept and the track record of wraps in Australia and America, that wraps have the potential to transform advisers and adviser organisations but it is a question of implementation.”


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