This article was first published in the January 2012 UK edition of Accounting and Business magazine.
The Financial Services Authority’s retail distribution review is shaking up the wealth management sector. From the end of this year, all financial advisers will have to charge clients fees for their services and will no longer be able to receive commission from product providers. They must also achieve certain levels of qualification.
These two changes create a ‘double whammy of lower revenues and higher expenses’ for advisers, says Danny Cox, head of advice at retail investment broker Hargreaves Lansdown.
While some banks are committed to continue providing widespread financial advice, Co-operative Financial Services is ending its field-based advisory service and Barclays is closing its branch-based retail financial planning arm. Others may follow suit.
With lower fees being earned, Cox notes: ‘The obvious choice for wealth managers is to work with wealthier clients to maintain revenues and profit margins. Those with insufficient funds to afford a wealth manager’s fees will need to source financial products and planning themselves.’
This prediction already appears current practice for many people. Aviva found that only 21% of the 2,000 adults it surveyed for its Value of Financial Advice report last June turned to an independent financial adviser (IFA) when making key decisions about their finances; 40% used the internet, with 52% of those aged 18 to 24 looking online.
Going it alone
Fortunately, there is a growing range of online information, tools and services that can help investors make their own investment decisions and then manage their investments efficiently. The long established websites of Hargreaves Lansdown and Hemscott, for example, provide extensive information on investment options, and shares and fund performance.
‘In reality, it is my firm belief that most people can do most of their financial planning without the need for advice,’ says Cox. ‘Investing in a pension or ISA, finding the most competitive mortgage, buying life insurance… It’s easy to do online and saves the advisory fees.’ Hargreaves Lansdown estimates it has saved clients £180m in charges (including advice fees) in the past 12 months.
Around 366,000 of the firm’s clients use its Vantage wrap service’ to view all their investments on one platform, and most of them do so without expert advice. Other wrap-platform providers include Ascentric, AXA Wealth and Standard Life.
IFAs are increasingly using wrap platforms. An Investec Bank survey of investment-focused IFAs found 70% are now using them to manage clients’ funds. Apart from making it easier to review a range of investments, wraps have another attraction – providing a relatively cheap way for retail investors to make investment transactions.
‘Cost has a significant impact on investments, so it is always a good idea to reduce costs where you can, especially if we are in an environment with lower overall annual returns,’ says Stuart Davies, a director at independent investment advisory firm LJ Athene. ‘Paying half a per cent less every year can make a big difference to your long-term returns.’ But cost should not be the only factor driving investment decisions. ‘If somebody is adding value, you don’t mind paying a little bit for that,’ Davies says.
The debate about the wisdom, or otherwise, of paying for active fund management (rather than going for a ‘passive’ investment approach, as with tracker funds) is a long-standing one. Cox says: ‘The right active management pays.’ He gives the example of £10,000 invested 10 years ago to 30 June 2011, with income reinvested. If invested in HSBC’s All Share Tracker, that £10,000 would have risen to £14,723; if invested in Invesco Perpetual’s income fund, it would have grown to £23,119.
Supporters of passive investing argue that 80–90% of active managers do not add value that exceeds their fees or the market benchmark, Cox notes. ‘We agree. But that still leaves 240 or so good managers to invest with.’
For an individual, identifying those good managers then choosing between them can be challenging. ‘The first thing you have to do is decide what you are trying to achieve,’ advises Davies. ‘Are you trying to achieve performance in line with a market or set of markets, or a return above inflation? What currency do you want to achieve it in? Once you know what you are trying to achieve you can try to identify managers with a track record of doing that.’
Diversification drives down risk
There is general agreement that effective wealth management requires portfolio diversification. ‘By making the portfolio as diversified as possible, you are taking out as much general market risk as you can,’ says Adrian Douglas, associate in Moore Stephens’ wealth management team. ‘In order to be diversified, you need to have wide asset allocations.
You don’t avoid sectors you think are doing poorly at the moment, because all markets are cyclical.’ If you avoid an underperforming market now, you miss out when it suddenly starts doing well.
‘Diversification has always been considered the first line of defence in reducing investment risk,’ agrees Tom Stevenson, investment director at Fidelity International. Fidelity’s research shows the main asset classes perform differently at different times in the economic cycle.
Stocks and bonds often move in opposite directions, while commodities sometimes move with stocks, sometimes against. ‘Each time a bull run in one asset class comes to a halt, leadership passes to another,’ says Stevenson. ‘A well-diversified portfolio of stocks, bonds, commodities and cash would have performed well over the past 30 years with a low level of volatility.’
One of the challenges of investing is knowing how to respond to fluctuating investment performance. ‘At what point does a period of underperformance become a concern?’ says Davies. ‘I don’t think there’s any definite time period. It could be that a fund manager underperforms for a number of months, but ends up achieving a better return over the long term.’ The key is to try to understand the reasons for any underperformance against peers or the market.
Davies gives an example of fund managers who were underweight in equities, and specifically financial institutions or banks, in late 2010 or early 2011. Their performance would have looked poor, compared with their peer group. However, their caution would have paid off the following July and August when bank shares fell. ‘The worst thing you could have done would have been to sell that fund in June,’ Davies says. ‘If you understand why a fund is underperforming, you can make an informed decision as to whether or not to keep hold of it.’
In general, research shows that long-term investment pays off. The 2011 edition of Barclays Capital’s Equity Gilt Study, an annual study of equity and bond returns, shows that since 1899 if a UK investor held equities for just one year, their inflation-adjusted return might have been as good as 100%, or as bad as –60%. However, since 1899 there has not been one 23-year period where equities have lost money.
‘Two important things can be understood from this about long-term investing,’ says Stevenson. ‘First, that the longer an investment is held, the narrower the likely dispersion of returns. Second, the chances of a positive return increase the longer that an investment is held. Both points support the argument to maintain a long-term discipline when investing in growth assets.’
Sarah Perrin, journalist