OpinionMay 22 2013

Where is the FCA advice on use of active investments?

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In the midst of all the furore about the definition of independence and the requirements to demonstrate that a firm was providing independent advice, many column inches were devoted to the increasing use of passive investments.

Advisers were badgered to use them and exchange-traded fund providers saw a fantastic market opportunity now that all investments were effectively going to be sold on a clean, no-commission basis, which levelled the playing field very tidily.

This is a particularly modern phenomenon for the adviser market; modern in the context of advising clients on investment strategies which could easily last three, four or five decades. Ten years ago there were hardly any index tracker funds. Passive funds were rarely found on supermarket platforms as they could not pay the required rebates.

ETFs were an institutional phenomenon, with real time pricing only relevant to those able to trade with discretionary powers and who would really be able to benefit from dipping in and out of the market potentially in the space of hours and minutes.

Some funds came to the market with investment limits which made them inaccessible to anyone but the highest net-worth or institutional investor.

There was much ridicule of advisers who did not use passive funds as they did not pay commission, ignoring the practicalities of how the average adviser could access these vehicles without also exposing the clients to the additional costs of the trading platforms or stockbrokers which would be needed to trade the holdings and which did a great deal to negate the benefit of the low-cost exposure to markets.

More interestingly there was little talk of the intellectual rationale for passive investing. But then again I must have missed all the meetings when we discussed the intellectual rationale for active investing.

The FSA’s last retail distribution review newsletter which addressed the question of how advisers who were committed to implementing a passive investment philosophy in their business could reconcile this with providing independent advice was therefore interesting.

Where is the material which tells advisers committed to implementing active investment philosophy in their business how to reconcile this with providing independent advice?

The FSA’s guidance on the use of passive investments must surely apply as clearly to active investments: if their panel consists mainly of passive or active investments because, after regular review, the firm decides that other products are unlikely to be suitable for the majority of its clients, it should be able to evidence this decision and the justification.

After all, while one firm may feel that passive investments are suitable for a large number of its clients and therefore recommends passive investments, another may feel exactly the same way about active investments.