The Treasury’s Financial Advice Market Review, announced in early August, is intended to go some way towards addressing this issue. It has big ambitions. Its scope includes investment, savings, pensions, retirement income, mortgages, consumer credit and general insurance. Its key objective is to look for ways to close the increasingly familiar advice gap, coming up with “a package of reforms to empower and equip all UK consumers to make effective decisions about their finances, including a set of principles to govern the operation of financial advice”.
The review is timely, even urgent. Just think of some of the changes that have taken place in the investment and savings environment in recent years.
Among the main regulatory reforms, the RDR is approaching its third birthday, eight months behind auto-enrolment. The tax advantages of saving for pensions have been massively reduced and may eventually be phased out. Mandatory annuitisation has been gone for scarcely six months, but already we are having to prepare for significant reform of state pension provision and introduction of the single-tier pension.
As significant as these changes appear, they are a mere reflection of what is happening on the ground. One of the greatest shifts in financial services in the past generation has been that from defined benefit to defined contribution pension schemes. As at the end of 2014, only about 13 per cent of active DB schemes remained open to new members .
These are large, historic changes, but they can be wrapped into a single, simple theme. Employers and government are withdrawing from the provision of later-life financial support, and pushing responsibility onto individuals and families.
One implication of this change is the prospect of a large swathe of the population working solidly through a full career, making reasonable contributions to a pension scheme, and ending up with a woefully inadequate income.
Despite the dire consequences of failure, there is little to no chance of this trend reversing. Instead, something needs to be found to fill in the gaps, and that something almost certainly needs to be financial advice. The government is painfully aware of this, and it is this awareness that has prompted the sweeping scope of the Treasury’s review into the market in financial advice.
The shift in the ground puts significant challenges in front of advisers, but I think most of us would agree that it also offers tremendous opportunity.
Consider this. An individual who has £15,000 free cash at the end of the year to invest in an Isa, is likely to be in the top decile income bracket in the UK. At least until recently, we could assume that such a person, probably in his 50s, would have a DB pension in the background, a self-invested personal pension and a mortgage-free, or near mortgage-free family home.
This is likely to be a typical demographic of the advice profession as it stands and will certainly remain important long into the future. But in the new world, the advisory profession will be asked to embrace an increasing number of clients from a much wider variety of financial circumstances. They may or may not have sufficient disposable income to invest in an Isa or a Sipp, and they are more likely to have a DC pension scheme. Given the unaffordability of residential property, and the aggressive macro-prudential regulation governing the mortgage market, it is likely that fewer families will own a home.
Even from these broad-brush examples, we can start to see the direction of change. Advisory firms, centred on personal relationships designed to care for the marginal wealth of a relatively narrow demographic, will remain important. But there will be an increasing number of ‘advice businesses’, which will offer mediated services to a much wider, even a mass, market.
There are a number of challenges in reaching this mass audience, many of them recognised in the scope and objectives of the review – particularly regulatory barriers. Cost and communication are serious, inter-related issues. The new mass market will have less to invest and less to spend on advice. Their situation and needs may be less complex but they may also be more idiosyncratic than the traditional market advisers are used to dealing with.
The balance of the conversation is likely to change from tax and inheritance planning to investment and income issues. This implies a shift in the balance of skills for many advisers. Bearing in mind the clear client communications requirements raised by the upcoming MiFID II, it also implies a closer relationship between advisers and fund providers. We are also likely to see a reduction in the plethora of funds on offer and a rise in the number of relatively simple, all-in-one solution-based products.
These are some of the challenges. But the scale of the opportunity is impressive. There are some 26m households in the UK. The top decile has a gross monthly mean disposable income of around £7,300, but the equivalent figure, averaged out for the next four deciles down, is £3,100. Looking at wealth, some 80 per cent of UK households have total wealth equivalent to £40,000 or more. Nearly half of UK households have wealth valued at more than £250,000. These figures exclude trusts and business assets.
Engaging with this wider market will require advisers to understand clearly the precise value that they bring to clients, focusing their resource on areas that have the greatest impact. According to research going back over the past 10 years, conducted in a number of different jurisdictions, the value of financial advice can be broken down into seven core components: asset allocation, portfolio rebalancing, costs, behavioural coaching, tax location, spending strategies and total return versus income.
There may be other ways of describing or categorising these core value adds. But in filling the advice gap, in satisfying the needs of lower net-worth clients in a cost-effective manner, ‘advice businesses’ will need to be clear on how they define, deliver, communicate and charge for their services.
We know there is no going back to a world where the state and employers more or less guaranteed a living income for life. In the new world, financial advice will assume a national importance far greater than has been the case in the past. It is a challenge, and an opportunity.
Neil Cowell is head of UK retail sales of Vanguard
Key Points
The Treasury’s Financial Advice Market Review is intended to address the issue of the value financial advisers offer their clients.
There is the prospect of a large swathe of the population working solidly through a full career and ending up with a woefully inadequate income.
Engaging with a wider market will require advisers to understand clearly the precise value that they bring to clients.
