Long Read  

How the consumer duty will affect product design

2) So-called 'closet-tracker' funds

Closet-tracker funds are funds that are described as active, charge as active, but deliver security selection decisions (and therefore returns) that are very close to or hugging the index.

In this way they are not purpose-built tracker funds, but funds claiming to be active while investing in a near-passive model. These offer poor value for money, and a study by ESMA suggested that a large number of active funds are in fact closet trackers

The FCA was one of the first regulators to fine a firm for managing a closet tracker. The most important aspect is whether the fund is managed in a way that is consistent with how a client would expect, based on its description.

3) Structured products

Structured products have inherently complex pay-offs that are harder for investors, or advisers, to understand than for manufacturers to engineer. There is an information asymmetry between the manufacturer and end investor as to how to model and price risk, pay-offs and probabilities. 

Structured products cannot magic away risk or magic in return, they just alter the pay-off profile of a traditional investment, and have the ability to recycle capital as income. 

There is also sometimes a conflict of interest between advisers who recommend structured products and the clients who allocate to them. 

We are unsurprised that larger well-established firms have exited the structured product market. While they have their adherents in the adviser market, we see the bar being raised on manufacturers and distributors of structured products to evidence that their products are in customers’ interests.

4) Products delivering poor client outcomes

Any product where there is clear risk to client outcomes:

  • risk of loss of entire capital;
  • unregulated investments, UCIS funds, retail mini-bonds; 
  • certain poor value or poorly designed structured products;
  • poorly structured or poorly governed VCT or EIS portfolios;
  • products with excessively high initial and/or termination fees; 
  • products with unreasonable lock-ins or cancellation terms; or
  • products that by design or by expected client inertia disincentives a client review and switch discussion. 

Ironically, this is an area where the regulator could do more in terms of policing and enforcement. While reputable advisers avoid these kind of products, they proliferate on the internet with seemingly little or no sanction from the regulator.

What does it mean for the adviser ecosystem?

Fund providers are already delivering against product governance (manufacturer) obligations as well as assessment of value reporting. We see their new obligations as being important, but incremental.

Portfolio managers offering MPS services likewise will have increased responsibilities with respect to potential end-users in their target market, despite having no direct relationships with clients.

Portfolio managers offering bespoke client-specific services will have materially increased responsibilities with respect to the consumer duty. 

Platform providers will have materially increased responsibilities with the consumer duty, particularly with respect to obstacles that directly or indirectly discourage clients from changing platforms. 

We would celebrate the day that platform accounts, like current accounts, have a seven-day guaranteed switch obligation. That would be a tremendous achievement by the regulator and industry alike, but I am not holding my breath.