Will restricted advice cap passives’ rise?

Will restricted advice cap passives’ rise?

The growth in restricted advice and vertically integrated businesses may eventually put a cap on passive vehicles’ growing share of fund flows, analysts at Exane BNP Paribas have suggested.

In a research note on asset managers, the investment bank compared passives’ rise in the UK with that seen in the US, but said the increase of “tied agents” was partly why it saw better prospects for active managers in the UK.

“While we expect all markets to continue trending towards passive management, we note there are material discrepancies between the European and US markets,” the analysts said.

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“The UK’s RDR and independent distribution channel have led to 33 per cent of flows being channelled to passives, which is still significantly lower than in the US since a number of [adviser] groups have become tied agents.”

The analysts acknowledged passive investing’s share of fund flows had risen sharply in recent years, from just above 10 per cent in 2011 to around a third by the end of 2015. But equally, the number of restricted advisers operating as part of vertically integrated structures has been growing since the RDR.

This change in market structure could be an aid to active funds, according to one merger and acquisition consultant, who did not wish to be named.

The consultant told Investment Adviser that the business case for fund houses buying advisory firms typically included metrics for capital flowing into their own active funds.

Estimates from consultancy EY suggest that of 13,000 smaller companies, up to 350 a year could become part of a ‘vertical’ structure. It predicts 85 per cent of larger firms with seven or more advisers could follow suit by 2021.

Hortense Bioy, European director of passive fund research at Morningstar, said: “It is fair to assume that these [restricted] advisers will be incentivised to push in-house active funds since these are more profitable for the group.”

But Ms Bioy said it would not immediately translate into an artificial cap on how much capital could flow into passive funds. She emphasised restricted advisers would still be bound by suitability requirements.

Ms Bioy added: “These advisers will still have to prove they’re offering what’s best for their clients. And if passive funds make sense, then that’s what they will have to offer.

“If restricted advisers want to choose funds, they won’t favour active over passive unless they have a conviction. They don’t have that incentive. They will think about the whole cost and benefit to the client.”

Ms Bioy said some of the other distribution changes would support the growth of passive funds, even if the use of vertically integrated structures hampered it. She added that the growth of discretionary management and robo-advice would aid the sector.

“If the distribution of passives through this channel is ever reduced, there are other channels through which passives will continue to grow. For instance, robo-advisers, the majority of which use index funds and exchange-traded funds to build portfolio offerings,” she said.