It takes little more than a glance at Money Management’s contents section to confirm one truism of financial advice: as a business area, it’s rarely short on variety.
Intermediaries can deal with any number of different subjects in a given week, from pension transfers to regulatory requirements and fee structures. But there’s one thing that ties most together: these are complex issues that they must set out as clearly as possible to clients.
Simplification has long been a standard element of adviser practice, whether it’s in relation to consolidating a client’s assets or presenting data in a uniform way.
Now the push for less complexity is having a direct impact on client investments themselves, courtesy of advisers cutting back on the number of funds they use within portfolios. Shifting priorities and the impact of new regulatory requirements mean this is a trend that may accelerate further. But it is not without its challenges.
The how and why
Advisers have been simplifying their portfolios with a number of factors in mind, including the desire to increase transparency for company and client, and an accumulation of pressures when it comes to both cost and the burden of compliance.
Data on the typical adviser portfolio is hard to come by, but research from Money Management’s sister publication Asset Allocator (displayed in Chart 1) shows the average discretionary fund management Balanced model portfolio currently holds around 25 funds.
Steve Buttercase, principal at Verve Investment Planning, is in the process of slimming down client portfolios. Although there is no set size for any one client, the adviser says he is aiming to hold between six and eight funds for a Balanced portfolio, between six and 10 for a Cautious portfolio, and eight to 12 funds for a more aggressive selection.
Like many advisers, Mr Buttercase plans to blend active and passive: a Balanced portfolio could have 48 per cent of assets in passive funds, but this might drop to 35 per cent for a client at the higher end of the risk scale.
He says the changes are part of a focus on two goals: to deliver annual returns of 3 per cent above inflation over a rolling three-year period for moderate-risk clients, and to keep overall client charges at 2 per cent or lower. He is also keen for the company to communicate transparently in a way clients can easily understand.
Another intermediary, Dennis Hall, is hoping to take a more drastic approach: cutting portfolios down to just two passive funds covering stocks and bonds. Like Mr Buttercase, he sees this as a way to lower overall costs and achieve “marginally better” returns, while making things simpler and more transparent for clients.
“We believe we can provide a better outcome by using a single global equity fund and a single global bond fund, and using them in proportions to an agreed level of risk tolerance,” Mr Hall explains.
“We’re not really focusing on volatility here, but more on the exposure to equities needed to provide the best probability of success during a long-term decumulation phase.
“Our research indicates that we have too many people in Balanced portfolios driven by volatility-derived risk-profiling, and we need to help them get comfortable with a higher level of equity content, because the empirical research shows us that this is the case.”
The M word
While both Mr Buttercase and Mr Hall see simplification as a route to better client outcomes, the former cites another catalyst for change that could lead other advisers to follow suit: Mifid II.
The Mifid requirement for advisers to report costs and charges, as well as how these affect investment returns, means advisers are now under greater pressure to justify both their overall fees and how they segment clients (see Box 1).
Similarly, a greater focus on the costs generated by each fund held in a portfolio means that having fewer can make the process cheaper, as well as simpler. This, for Verve, has served as an additional reason to concentrate on its simplification plans.
“We want to ensure clients understand what we are doing: I don’t want them reading 28 different fund reviews, particularly when markets are uncertain,” notes Mr Buttercase.
“All Mifid has done is accelerate the focus: sometimes best practices turn into regulation and some people are already doing it,” he adds.
As Mr Buttercase alludes to, the tumble capital markets took in 2018 is likely to paint an unflattering picture of how portfolios are working for clients. This could mean greater scrutiny of how advisers are working, as well as the costs and charges that appear in reports.
Too great a burden
Heather Hopkins, founder and managing director of research firm NextWealth, suggests the combination of Mifid and market volatility are adding to the strain already being felt by advisers on this front, and could prompt others to rethink the size of portfolios.
She says: “I would put it down mostly to regulation and markets. We hear a lot that the cost of compliance is going up. It is harder to keep up with all of the regulatory change and the cost of complying with rules keeps growing. This is putting pressure on profits, so firms look to simplify where possible. Reducing the number of funds in a portfolio can reduce the admin and back office costs for a portfolio.”
Will others look to downsize? Those considering such a move should remember that it will not necessarily be straightforward.
The advantages of smaller portfolios, from cost reduction to an easier life on the compliance front, are clear. Equally, clients may appreciate the merits of a simpler set-up. Mr Hall, for one, says he has been having “detailed conversations” with some of his wealthiest clients about the proposed switch to fewer funds, with a largely positive response. But he also believes the “messaging around the ‘why’” needs to be even clearer than he has made it so far.
“I’ve probably been guilty of over-explaining the reasoning behind it, and sharing our research in too much depth,” he says. “I noticed at certain points that clients’ eyes would begin to glaze over.”
Similarly, shrinking portfolios is not a straightforward move, as those advisers seeking such a shift have already discovered.
“We haven’t pulled the trigger on the switch just yet as we needed to be sure we could execute a change for every client if that’s what they wanted – part of our treating customers fairly requirement,” says Mr Hall.
“If we dealt with these switches at each client’s annual review, for example, we could be disadvantaging those clients who we are not due to see for the next 11 months or so.”
For Mr Buttercase, the problems have also been logistical in nature. The fact that clients tend to have bespoke, idiosyncratic arrangements means that reducing fund numbers will take time. Other barriers, such as emotional attachments on the client side, can also stand in the way of progress.
“Every client has a historic fund legacy,” he notes. “They may be attached to a fund because it has done well. I can’t just press a button and everything changes.”
Any appetite?
Practicalities aside, any such shift will also depend on the willingness of advisers to take the leap. For some intermediaries, the idea of cutting down provokes mixed reactions.
Rowena Griffiths, chartered financial planner at Female Financial Management, is yet to seriously consider the idea. This is in part because she has not experienced extra pressure as a result of Mifid II reporting, but also due to past experiences with concentrated portfolio positions.
She explains: “I have had my fingers burnt in the past by putting 100 per cent of a client’s UK asset allocation into one fund, such as M&G Recovery, which went through a long period of underperformance. If a large percentage of a client’s assets needs to be in one asset class, I always diversify,”
Ms Griffiths concedes she could consider greater use of a single product if it provided its own diversification – as funds can do in the multi-asset space. But this approach can create fresh problems.
“I am quite keen on Royal London’s Governed portfolios, which are fairly low cost and well diversified,” she notes. “The only problem with putting all of a client’s money in this is that their perception of your independence can be questioned.”
Going the other way
The full effects of recent regulation are yet to be seen, but Mifid II already seems to have had an impact on the advice industry. However, research on the consequences suggests advisers may be reassessing their client base, and even upping their fees, rather than simplifying on the investment side.
Platforum data published in August 2018 found that more than 40 per cent of advice firms had reviewed their charging structures over the previous six months.
The research provider noted that the new rules had “prodded advisers into reflecting on the way they explain to clients how much they are paying, and what for”. But this didn’t tend to prompt a lowering of fees: instead, it prompted intermediaries to “reassess the basic economics of their businesses”.
More than half of those surveyed actually increased their charges, either for all clients or lower-value ones, while many others made no change at all.
“When advisers analyse how much time they spend on individual clients and what they need to charge to cover their costs, it often turns out that they are making losses on lower-value investors,” the firm noted.
Intermediaries who feel under pressure – either to compete on cost or to stay on top of regulation – may find it more useful to reassess other elements of their business. But revamping portfolios may help. Mr Buttercase expects client charges to fall by between 0.2 and 0.4 percentage points in certain cases following his planned changes.
Changes made within portfolios may prove easier to implement. For one, advisers still have scope to make greater use of passive products, where appropriate, as a means to reduce costs.
Most advisers now use a blend of active and passive funds, according to Platforum analysis. But the same research found that 53 per cent of advisers only allocate between 1 and 20 per cent of assets to passive.
“The main driver for the use of passives is advisers’ desire to keep down the total costs of investing for clients,” the company notes.
“We expect this trend to continue and be reinforced as advisers increasingly feel the impact of Mifid II reporting requirements in 2019.”
Unsurprisingly, there is still resistance on this front. Platforum describes a large contingent of advisers who “firmly believe that active management delivers higher returns than passives, and that actively managed funds will prove their resilience in the next market downturn”.
With market volatility having made a comeback, intermediaries who view active products as the best way through difficult markets are likely to be even more reluctant to change tack.
Similarly, advisers who believe in the merits of diversification may feel unwilling to stake substantial assets on the success of a smaller number of products. But if Mifid II reports do make larger portfolios look unwieldy, such instincts may be put under pressure both this year and in those to come.
