In a hard-hitting address, Dave Ferguson of Nucleus Financial Group argues that while the current IFA model is unsustainable, consumer demand for financial advice will continue to grow
"In my assessment, the single greatest issue in the industry is the somewhat staggering mismatch in valuations between the UK life and pensions sector, and its primary form of distribution, the UK IFA market.
How many of you would be surprised to learn the former trades at a value approximately 100 times the value of the latter? This is not only somewhat distasteful, it is also intuitively confusing. How does it feel to know that for the last 20 or 30 years you have been so instrumental in the creation of value for those institutions that so many of you love to hate? And how keen are you for the position to persist?
I'm sure many of you will recall the almost hysterical reaction that greeted the publication of the now infamous Consultative Paper 121 a few years ago. While I was never one for seeing the document as signalling the immediate demise of IFAs, I do think the subsequently mild impact on the independent sector may in years to come be viewed as the calm before the storm.
For years, commentators have been sounding the death knell for IFAs and, time and time again, the resilience of the sector has continued to surprise - and maybe even impress - those same commentators. Now though, the combination of demographic change, the collapsed capital positions of insurers and the changing demands of consumers are placing greater pressure than ever on the less-skilled parts of that market.
The status quo cannot be maintained forever. Those individuals who receive little more than a sales pitch from their adviser will be targeted ever more aggressively by the high street banks and, inevitably, some clients will come to self-serve over the internet. While the quality end of the IFA market will continue to thrive, the key question is how long the market transition will take to complete.
We are still in the early days of a period of change, from which we will emerge in perhaps three to five years with a radically reshaped industry in which the balance of power will have shifted quite dramatically away from the large providers toward those who control access to the client.
The existing market just does not work. Consumers are still being oversold, life offices are forever guilty of throwing commission at their distribution issues and the IFA sector continues to be hopelessly ill-defined and, in some cases at least, considerably undervalued. In addition, there continues to be a massive oversupply in the often mediocre and certainly expensive retail asset management sector.
What we are about to see is a far more deep-rooted series of changes driven more by market demand than by regulatory intervention. Almost by definition these changes will bite much harder and will result in greater market stability as they will be the result of simple economics rather than continual tinkering at Canary Wharf.
There are broadly three elements of cost a client should expect to bear. There is the administration of their arrangements whether in packaged products, fund supermarkets or in a wrap. There is a charge for strategic and other financial advice to be paid to the financial adviser and there is a cost associated with asset management, whether through collective funds, discretionary management arrangements or any other hybrid. The current market broadly allows the product provider to control who gets what in each area.
While the administration point is probably a given, is it really appropriate for a life office or a platform to determine the level of remuneration an adviser should receive for a particular transaction? It is only appropriate where the life office is paying the adviser for introducing the business - that is, where the adviser has effectively been working for the life office to sell the product to the underlying client.
We may not like it - and it may not always be acknowledged - but this is how the market has generally worked in the past - and indeed largely how it continues to function today. The life and pensions sector has continuously managed to keep IFAs under 'control' by allowing capital to flow into the IFA sector at a rate (of commission) at which the life sector is comfortable (and which clients continue to be on the hook for).
It is for precisely this reason the valuation of the life sector continues to dwarf that of the IFA market. In essence, and like it or not, much of the IFA market is little more than an agency for a sector. While this may be an uncomfortable observation for many advisers, I see no evidence to reject it in a practical sense. Too many IFAs spend too much time simply choosing products from an ever-shrinking group of life offices, all of which are offering pretty much the same tired old proposition.
And the control position is horribly similar for asset management. In the old days, life offices would take on board investment risk, manage month-to-month fluctuations in value through smoothing and even provide investment guarantees. Despite the failings that emerged, it was reasonable in that model for the life office to control the cost of asset management and for that cost to be borne by the client.
These days though, most companies offer at least semi-open architecture propositions through which clients may access a broad range of asset management solutions. In the extreme case of wrap, IFAs can have full control over how a client's assets are invested, either themselves or by using a specialist investment adviser.
But who controls the pricing of asset management? With the notable exception of companies such as Transact, the life and pensions sector continues to determine how much asset management should cost, despite the fact much of that management is outsourced to third parties.
When will it become fully understood there should be a fair market in retail asset management pricing and the current cartel-like pricing should not be allowed to persist? We should not overlook the obvious observation that where a life office or even a fund supermarket is negotiating terms with an asset management group, they are merely negotiating with IFAs' clients' money.
The provision of truly independent financial advice distils to a simple question of economics - at least in the areas of investment and pensions. By definition, these are areas requiring long-term financial planning and, as such, it seems a long-term servicing approach is required to fulfil the adviser's obligations. In assessing the impact, one must consider how remuneration patterns may come to match the associated workload.
Of course every firm will be different, but surely the adviser's long-term incentive to maintain the client relationship should be driven by the anticipated revenue associated with servicing that client through time? I believe high-quality advisers should soon find themselves able to retain at least 75 basis points trail commission once wrap platforms become more reasonably priced and we see a fall in the cost of retail asset management from the current inflated retail prices to semi-institutional levels.
We could argue all day about the detail but most IFAs seem to believe that properly servicing a client requires at least one full day of effort each year. Given there are 200 or so business days in the year and an adviser earning, say, even £80,000 a year might need to generate £125,000 to meet overhead costs - that adviser will need to bring in £600 a day to break even.
Remembering it takes at least a day to service a client and ignoring any initial fees or commission for now, that means the adviser's clients must have an average portfolio of at least £80,000 if the adviser is to meet their revenue requirement over the year. Even introducing these missing components, clients with less than £50,000 invested are unlikely to be appealing to good-quality advisers, at least in the short term.
So, given that backdrop, whose side are you on? No adviser - of any kind - can possibly act in the interests of any more than one party at once. It seems entirely clear financial advisers are no different and therefore IFAs must be acting either in the interests of product providers or in the interests of their clients. It just is not possible to deliver for both.
In essence, do IFAs wish to take control or remain under control? Are you in the business of selling products or providing advice? Some will choose the industry side but, in my opinion, those advisers who continue to believe in the commission-led, transactional business model will come to be seen as a dying breed.
Increased costs of compliance and increasing competition from the banks, direct channels and maybe even from some of the large, historically IFA-led life offices will result in significant shrinkage in this part of the sector. The network model is dying and, when it finally succumbs, the business models of thousands of advisers may well die with it.
If one considers the general insurance market before the real emergence of the direct players, you will recall the reason for the success of companies such as Direct Line was they exposed the broker as little more than a value-destroying conduit to the insurer.
Given the increased commoditisation of albeit more complex investment products, the position will be mirrored and new business models will emerge to replace what is currently a significant part of the IFA market. Whether these are purely direct or include more para-planner type models remains to be seen but the existing structure funded by extravagant commission simply cannot be viable in the medium term.
Those who elect to work on behalf of clients will be the winners, provided they can demonstrate a command of their subject and continue to find more efficient ways of working. Clearly the adoption of wrap and the emergence of more advanced platforms provides IFAs with many opportunities to streamline their operations and to spend more time on client-facing, remuneration-creating work.
Given the ongoing real impact of Government policy in areas such as pensions and inheritance tax, there is no doubt consumer demand for high-quality financial advice will continue to grow. I also strongly expect this growth in demand will be accompanied by an increased understanding that, to benefit from high-quality advice, one should expect to have to pay for it - one way or another.
So the re-polarisation of the advice sector will certainly occur and will be along client value lines that in turn will be reflected in the quality of the advice being provided. This is simply a rational reflection of the economic reality that good advisers should be able to command a decent annual fee for providing ongoing advice."
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