Increased regulation and business costs are causing advisers to turn to the multi-manager market for their portfolio construction needs
Aifa reported this month that regulation and compliance costs had doubled in three years. As many of these increases have come about as a result of the mis-selling of investments, investment business is an increasingly thorny issue for advisers. As advisers grow more reluctant to carry out asset allocation and portfolio construction, who is likely to be the beneficiary? Is the multi-manager market in all its various guises likely to pick up new business on the back of this?
Mark Dampier, head of research at Hargreaves Lansdown, says there are a number of factors that are increasing the cost of business for investment advisers. These are led by greater regulation and higher professional indemnity insurance. "We have 30 staff in compliance, which represents just under 10% of our total staff. Advisers face other costs as well. For example, if a client takes an adviser to the Financial Ombudsman then the adviser has to pay costs even if the client loses the case.
"The adviser has to spend time on preparing and dealing with the case. Advisers also have to pay into the liquidation fund that compensates investors if an adviser firm closes."
A development over the past 10 years, says Dampier, has been a reduction in initial charges on funds but an increase in the annual management fee. While the average upfront charge is now below 3%, many equity funds have annual fees of 1.5%. Threadneedle and Credit Suisse Asset Management recently raised management fees from 1.25% and 1.2% respectively to 1.5% because of increased distribution and administrative costs and to bring them into line with "market norms".
The rise of fund supermarkets has contributed to increased distribution costs. This is partly because the asset manager may only receive 50% of the annual management fee through this channel. Dampier says this may make multi-manager funds relatively more attractive. "Some of the funds of funds have annual fees below 2% so there is little difference between them and most equity funds.
"Increased compliance and regulation is pushing advisers towards using multi-manager funds. It is difficult both to see clients and manage portfolios. At Hargreaves Lansdown, we have specialists who do either but not both."
Another factor pushing advisers towards multi-manager funds is the three-year bear market, says Dampier. "A number of advisers got burned by the technology bubble. In the late 1990s, many discovered that portfolios were dominated by technology stocks as they did not analyse the underlying holdings of the funds."
Dampier adds that another result of the increased business costs may be greater standardisation of investment advice by advisers. "As adviser firms grow in size, it is a business risk to allow consultants to sell any funds they choose. There will, therefore, be more control over the funds that they recommend."
Ian Shipway, investment director of Thinc Financial Planning, believes the adviser market will become more differentiated between two types of businesses. "There is the transaction model that is structured to optimise the flow of new business and in which advisers are paid commission. The other model is adviser led which is structured to provide ongoing advice.
"Polarisation was a false distinction between tied and independent advisers. With the end of polarisation, there will be a greater distinction between the two business models. The transaction model is likely to use multi-managers increasingly as they generally do not have the resources to asset allocate, select funds, monitor performance and rebalance portfolios themselves. They are unlikely to want to add resources because of their business model. Some advice-led advisers may also use multi-managers as it leaves more time to spend with clients. But most will continue to manage client portfolios themselves."
Nick Wells, product and communications officer at Artemis, says the biggest trend in the distribution of funds will be the move towards multi-manager funds. While advisers with high net worth clients will continue to construct portfolios and select funds, says Wells, other advisers will increasingly use multi-manager products.
"The fact that we sold our fund of funds to Credit Suisse Asset Management does not mean we do not believe in this part of the market. It was just a business decision that it did not fit in with our strategy," says Wells. "The fund of funds was making a profit for the company.
"It is not just regulatory pressures that are pushing advisers towards using multi-manager funds. It makes sense for them to outsource investment management. Outsourcing, of course, is a general trend in financial services. This enables advisers to concentrate on advising their clients.
"The increased cost of doing business means it is also no longer cost-effective for advisers to manage portfolios for clients with less than £20,000 in assets. These clients will be put into multi-manager funds. The other trend will be the opening up of the hitherto closed life funds to third-party asset managers. The reform of the pension regime will also prompt increased availability of third-party funds."
Michael Jones, head of UK distribution at Fidelity, agrees that advisers are increasingly turning towards multi-manager funds. He says there are a number of reasons for this trend but no one single factor. "It makes sense because it is very hard for advisers to research and keep up with 2,000 funds. We have a 15-strong dedicated team to conduct research for our multi-manager funds so it is logical for advisers to outsource portfolio management."
Multi-manager offers one of the more obvious solutions to the increasing financial and regulatory pressures on advisers. It is likely to be one of the main beneficiaries of the changing industry. As Jones concludes: "Charges on multi-manager funds are not much higher than on equity funds. Clients are happy to pay this for the service and performance they can get in return. Cost, regulations and the bear market are three of the reasons for advisers to turn to multi-manager funds."
Clarke replacing Balkham
'Deep-dive analysis of client behaviour'
Ways to mitigate April’s increases
The best equity income funds examined