Dermot Campbell takes a closer look at the changing landscape for adviser due-diligence on tax-efficient investment products.
The Financial Conduct Authority's Asset Management Market Study has highlighted its concern about competition in the asset management industry and the use of third-party ratings agencies in the selection of investment offerings.
Similar conflicts are rife in the tax-efficient investment products section of the asset management market, with research providers deriving a significant revenue from fund providers.
But this is all set to change. The second Markets in Financial Instruments Directive (MIFID II) will ban fund providers from distributing research for free, which will in turn mean it is pointless for them to pay for the marketing rights to research reports.
The tax-efficient investment product market is in need of change for the simple reason it does not easily enable advisers to maximise the benefits of tax-efficient investing for their clients.
When I made this argument in an article for Professional Adviser's sister publication Investment Week at the end of last year, I received a range of feedback from the industry - mostly supporting what we are trying to achieve, but some asking whether we were 'also looking to ruffle feathers with managers and market participants'. The simple answer to this is 'no'.
Growing in popularity
Tax-efficient investment products are becoming far more widely used, particularly following the recent changes to the pensions regime, and this is evidenced by a significant uplift in asset flows and adviser engagement with this market.
MIFID II will represent a difficult period of change. It is already dangerous for an adviser to rely exclusively on a third-party research report for their due-diligence and simply say they will use a fund providing it has a rating of greater than, say, 85 without doing further due-diligence on that fund themselves.
This is tantamount to giving their clients a free option. If it goes up, then the investor will keep the profits (tax-free in the case of a VCT or EIS) and if it goes down, then who knows what the Ombudsman will rule if the client complains?
In order to give safe advice, an adviser needs to carry out due-diligence, which involves a lot more than simply placing a research report on their file. Due-diligence involves obtaining a proper understanding of the offering and how it is constructed, as well as an analysis of the provider and whether they are suitable for the client in question.
This is all about asking the right questions and a good way to go about this is to obtain a suitable due-diligence questionnaire (DDQ). Research reports can and should form an important part of this due-diligence, but they are not the whole answer.
Paying the price
From January 2018, advisers are going to have to pay for research directly. There will be no such thing as free 'research' from providers. The research houses are going to have to adapt their business models and stop accepting payments from providers for research report licences.
With larger volumes across the industry, advisers are changing the way they consider how they develop their client portfolios, as well as how they conduct due-diligence. As a result, advisers will demand more widespread and in-depth research in order to best serve their clients, with easier access.
With the direction of client demand and the regulatory regime being clear, advisers will want objective, comprehensive and independent research, enabling them to build portfolios with ease.
As we responded to the question of 'feather rustling', our argument is not an exercise in pointing the finger. It is clear the industry is changing - and the players who get ahead of this trend on the side of advisers will be best placed to succeed in the future.
Dermot Campbell is chief executive of Kuber Ventures
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