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A job half done?

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8 November 2019

In light of recent research from the lang cat commissioned by the AIC, David Prosser examines the post RDR uptake of investment companies by IFAs.

Independent financial advisers have come a long way since the retail distribution review (RDR) reforms. Intermediaries who once routinely ignored non-commission paying investment companies in favour of open-ended funds have embraced the sector since the outlawing of such payments levelled the playing field. Almost seven years after RDR, advisers’ allocations to investment companies now stand at record levels.

Yet there is much more work to do. A report just published by the lang cat, one of the smartest investment analysts around, warns that too many advisers still have an “inherent market bias” against investment companies. Some 94 per cent of assets on adviser platforms are held in open-ended funds or cash, the report points out.

Let’s be fair: some of that bias reflects what advisers perceive to be genuine concerns about investment companies. They worry about liquidity, for example, particularly when it comes to selecting investment companies for buy lists and recommended portfolios, where there is scope for significant flows of money in and out of funds. They fear that share price premiums and discounts, a consequence of the structure of an investment company, make it difficult to comply with the suitability requirements set out by regulators, particularly when it comes to risk.

However, other factors identified by the lang cat as playing a part in advisers’ dislike for investment companies are much harder to justify. Some intermediaries simply do not understand the sector, the report warns. Others are operating with outdated investment analysis technologies and systems that struggle to cope with investment companies.

Then there’s the question of cost. Very often, investment companies charge lower headline fees than their open-ended counterparts, though the gap has narrowed significantly in recent years. Advisers, however, find it more costly to work with investment companies and are therefore more reluctant to do so.

These barriers can be overcome. Advisers who worry about their understanding of a particular type of investment have a responsibility to get up to speed. Those whose systems are out of date are doing their clients a disservice if they do not modernise. Higher costs are a product of operating models and system constraints, rather than any fundamental issue.

As for those seemingly more genuine concerns, liquidity issues, particularly for larger funds, are rarely as significant as is perceived. And the idea that the sector can’t accommodate suitability criteria just doesn’t stack up. The truth is that such worries reflect the inherent bias identified by the lang cat, even if that bias is unconscious.

Cut through these issues and you come back to the same basic argument: independent financial advisers are expected to survey the whole market on behalf of their clients. That doesn’t mean they have to recommend investment companies, but those who reject the industry out of hand aren’t doing their jobs properly.

There is good reason to be hopeful. Many more advisers than in the past are engaged with the investment companies sector, which has itself worked hard to educate and enthuse the intermediary audience. Further regulatory interventions look set to underline the importance of whole-of-market advice.

Still, for now at least, the lang cat’s research into adviser attitudes and practices is an important reminder that this is a job only half done.