The financial advice landscape experienced its very own ‘big bang’ at the end of 2012, when new rules were ushered in by the financial watchdog, now known as the Financial Conduct Authority. There were various aims behind the shake-up, known as the Retail Distribution Review, but the main objectives were to eradicate potential product bias, improve professional standards and increase transparency.
Generally, the new regulations – which banned the paying of commission to financial advisers by fund managers and instead required advisers to charge their customers explicitly – have improved the advice landscape in terms of the quality of advice and customer service provide. Standards have also been raised as a result of advisers being required to gain extra qualifications. The new rules have on the whole instilled higher levels of professionalism among advisers, while consumers are no longer left in the dark about how much they are paying for advice. However, despite these great strides, the new regime has had unintended consequences that have been detrimental for some investors.
Costs on the rise
The banning of commission has forced financial advisers to charge consumers directly for advice. Some opt to charge an hourly rate, typically hundreds of pounds for a consultation. According to Unbiased, a website that helps investors find financial advisers, £150 an hour is typical, while an initial financial review comes in at around £500. Other advisers charge a fixed fee, normally when they deliver a specific service, such as the transfer of a defined benefit pension scheme. An increasing number charge a percentage of the value of their client’s portfolio.
While charge transparency has improved, this has come at a cost – quite literally – in the form of higher charges for financial advice. According to Schroders’ advice survey, which each year polls 252 financial advisers with whom it has a proactive relationship, 43 per cent of advisers charge 0.75 per cent of assets, up from 30 per cent of advisers in a poll two years earlier. In 2014 nearly half (45 per cent) of advisers said they charged 0.5 per cent, but by the end of 2016 the percentage of those still charging 0.5 per cent had almost halved (24 per cent). In addition, most advisers (57 per cent) stated a preference of charging a percentage of assets.
To allow advisers to find more time in their working weeks to focus on their clients and develop stronger relationships, there has also been a trend towards investment outsourcing – financial advisers handing over all investment decisions to an external discretionary fund manager. From the adviser’s perspective, outsourcing also has the benefit of reducing regulatory risk. However, handing over all investment decisions to a third party has had the knock-on effect of increasing costs for consumers, typically by adding 1 per cent to the overall advice bill.
Overall, taking into account fund charges and platform fees, the total cost of using an adviser who outsources is somewhere between 2 and 3 per cent. Given that historic returns for the UK stock market average around 5 per cent (share price growth and dividend payments), an increasing number of investors are, unsurprisingly, going it alone and picking investment funds themselves through online brokers such as Hargreaves Lansdown or Interactive Investor, our sister company. Going down this route cuts costs by around half, but it means forgoing financial advice.
Justin Modray, founder of Candid Financial Advice, says investors should check how much their advisers charge and ask themselves if this sounds fair for the work done.
He adds: ‘As a guide, fair annual advice fees should generally range from around £1,000 to £4,000 a year, but with the higher levels only applying to portfolios of more than £1 million or when complex ongoing advice is provided. If the overall charge exceeds 2 per cent, alarm bells should start ringing. Investors should aim to pay a lot less than this on larger portfolios.’
The commission ban has also inadvertently created an ‘advice gap’. Advisers are now less inclined to work for smaller clients. According to Schroders’ survey, 20 per cent of advisers have formally asked clients with small portfolios to leave their practices since the commission ban at the start of 2013. More than half (52 per cent) of those shown the door had assets worth less than £50,000. Given that most advisers charge a percentage of a portfolio’s value, small investment pots mean small profits. This, and the fact that financial advice is relatively expensive for those with small pots, left small investors short of advice options.
However, other factors are also in play. Since the banning of commission, some high street banks have shut down their advice arms. In addition, since consumers have been able to see clearly how much they pay for financial advice, many have simply decided to go it alone by using execution-only online brokers and making their own investment decisions.
A relatively new entrant to the field is the so-called robo-adviser. These online services require investors to complete an online risk assessment. They are then allocated to a portfolio (mostly comprising tracker funds) designed and managed by computer algorithms. Some robo-advisers are actually financial advisers, while others offer rather unspecific ‘guidance’. Nutmeg, the market leader, does not currently offer an advice option, but other firms do, including Moneyfarm and Wealth Horizon.
Rise in restricted advice
The ending of commission has also introduced a distinction between independent financial advice and ‘restricted’ financial advice. According to a report published by the FCA last October, 83 per cent of retail investment firms give independent financial advice covering the whole market, while 14 per cent offer restricted advice covering products from a limited number of providers. The remaining 3 per cent mix and match both. But when it comes to adviser revenue, 62 per cent comes from restricted advice, against 38 per cent for independent.
Stephen Kavanagh, chief executive at Chase de Vere, an independent financial adviser, is concerned that the industry is moving away from independent advice towards restricted product sales. Research carried out by Chase de Vere found that 13 of the largest 16 financial advice firms in the UK provide only restricted financial advice, so their advisers can only recommend certain products or product providers. In contrast, an independent financial adviser can offer access to the whole market and is much more likely therefore to offer objective advice.
Another concern is that some restricted financial advisers don’t explicitly state that their services are restricted. Kavanagh says: ‘While they can’t call themselves “independent”, they’ll often use other titles such as “wealth adviser”, state that they provide “wealth management” or claim to offer “objective advice” or “impartial advice”. It can be very difficult for people to tell the difference between an independent and a restricted adviser.’
He adds: ‘I strongly believe independent financial advice is the gold standard. If you use an independent financial adviser, you should have confidence that they are acting in your best interests and don’t have a vested interest in selling you particular products or funds.’
Too little transparency
Great strides have been made in increasing transparency, but it could still be improved. For example, the practice of excluding transaction charges from the ongoing charges figure, so that consumers don’t know what the true costs of their funds are, could be ended.
Another source of discontent for consumers is that the fund management industry fails to pass on economies of scale. Only a few firms, Baillie Gifford for example, reduce their fees when assets grow.
Research by SCM Direct, an investment manager calling for complete transparency on costs and holdings in the UK investment and pension industry, has found that 70 per cent of actively managed equity funds charge an identical annual management charge of 0.75 per cent. Gina Miller, co-founder of SCM Direct, says this is evidence of anti-competitive behaviour in the active UK fund management industry. ‘The regulator should investigate whether some form of price collusion, formal or informal, is going on among major fund groups,’ she says.
Clean up and carry on
Investors who use an online broker, either in their own right or through a financial adviser, will now find themselves investing in commission-free funds via ‘clean’ share classes. They will pay a separate fee to their broker: either a fixed fee or one based on a percentage of their investment.
However, the commission ban does not apply where a financial adviser or self-directed investor buys assets directly through a fund management company rather than via a platform. Those who ‘go straight to the manufacturer’ in this way will still incur commission charges.
Similarly, investors already invested directly with a fund management company are not being moved into clean funds, as fund management groups are not required to transfer them. Yet in most cases switching from old-style commission share classes to new clean versions would be in the investors’ best interest, as the switch would usually result in them paying around a third of a percentage point less in fees overall when the fund charge and broker fee are factored in.
As things stand, those who invested directly with the fund group via an adviser still have commission (typically 0.5 per cent) paid to the adviser, even if they are no longer receiving any service. Directly invested self-directed investors, meanwhile, simply pay fees to the fund manager for non-existent advice.
One way to switch to clean share classes is to sell holdings and repurchase them via a platform. The problem with this approach is that capital gains tax may have to be paid on the sale of holdings not held in an Isa. The first £11,300 of capital gains each year is currently exempt from capital gains tax.