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Turning points

Distribution Technology head of financial planning Jim Hennington runs the rule over the risk factors of investment planning tools

The FSA could be taken to imply in its platform paper CP10/29 that some planning tools are not objective. The paper says: “It remains important that an adviser carefully considers the objectivity of any tools provided by a platform provider” and “if an adviser is going to use services such as guided architecture or model portfolio tools we would expect the adviser firm to take steps to ensure that these tools are unbiased”.

How does an adviser decide which elements of a planning tool could be biased and what steps can they take to ensure they are objective? To answer this question requires an understanding of what the planning tool is designed to do.

In general, an investment planning tool has a huge number of settings that require considerable judgement and diligence when configuring. Each could be used to favour certain products over others such as the assumptions for:

  • The asset model and investment risk
  • Future economic and demographic trends
  • Fees, taxes and charges
  • Product behaviours and eligibility, including state benefits

The more blatant biases are those that unduly guide the customer towards their own products or lean toward certain asset sectors that a provider is trying to promote.

But the next step is to look at each assumption in more detail, starting with invest-ment return assumptions as an example.

The FSA is not favourably inclined towards those who use the maximum Cobs assumptions of 5, 7 and 9 per cent without taking account of the underlying investments held and provide ridiculous forecasts for defensive funds such as cash/bond funds. Likewise, any planning tool that ignores the investments that the customer is using is very likely to be misleading.

Then there is the elephant in the room of investment assumptions over risk. Even if a planning tool uses sensible return assumptions, the investment risk (that is, the chance of poor returns and/ or not meeting future goals or liabilities) is arguably even more important.

It is extremely misleading to give the impression that high-risk assets are more likely to meet the customer’s goals unless the advice also demonstrates the effects of risk. Investment risk, in the form of volatility in asset sector returns, is a fundamental part of diversification and building efficient asset allocations.

The risk assumptions will drive the asset allocations and these need to be based on sound principles and data.

There is the issue of how a planning tool uses other long-term economic assumptions about the future. The main factors that affect a customer’s financial future are:

  • Inflation rates
  • Salary growth rates and propensity to save
  • Length of career (retirement date)
  • Longevity and health

Whatever assumptions are used, they all need to be objective and independent to present fair results to the user. The way that planning tools implement the assumptions is equally important, such as assuming monthly contributions grow with inflation or not or assuming that the person saves future surplus income, as this can have a major impact on the outcomes from different products.

Assumptions have a dramatic effect on whether the customer thinks he or she can meet their goals using a particular product and could easily be used to bias the outcomes from the planning tool.

Because the UK economy is in a low-return environment, the impact of fees and charges on the customer’s outcomes has never been more important. Advisers need to be aware that the total charges could tip more cautious portfolios into negative real returns once all the charges are deducted.

It is easy to see why planning tools might be under pressure to understate or even ignore some fees. There are valid arguments why the advice and administration services should be treated as separate valueadding services and may be incurred irrespective of what the customer invests in but great care and disclosure is required to satisfy TCF rules here. If they are deducted from the fund, then they affect the client’s ability to meet his or her goals.

There are other assumptions that could be seen to make a planning tool biased. For example, any tool will need to model product behaviours. This could include assumptions on how future contribution limits keep pace with inflation (such as Isa limits, annual allowances and lifetime allowance), future tax band increases, selected retirement age, annuitisation age, etc. It could also include assumptions on state pension benefits, in particular, the state second pension, and Nest accounts, and eligibility for and amount of state bereavement benefits. Even simplified financial planning tools must make implicit assumptions on all these issues.

Finally, the FSA’s guidance consultation paper, entitled, Assessing suitability: estab-lishing the risk a customer is willing and able to take and making a suitable investment selection, issued on January 6, must also be mentioned.

This paper highlights that the requirement for objectivity is also critical when assessing whether a customer is able to accept the risk of loss of capital at all. For example, point 1.8 identifies that firms are expected to have a “robust process to identify customers that are best suited to placing their money in cash deposits”.

All this means there are plenty of ways in which a planning tool could become less objective.

As a result and in line with the FSA guidance, advisers need to satisfy themselves the tools they are using come from reputable sources, the assumptions are based on sound principles and practices and that they are reviewed by experts.


Fionnula Earley

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