One of the best modern examples comes from the story of a little blue pill. Initially designed as a medicine to reduce blood pressure, Viagra has had a much broader impact on society and potentially a counter impact to that which was initially envisaged.
Similarly, a decade on from the implementation of the Retail Distribution Review, the unintended consequences appear to have had a much broader impact than that intended by the architects of this watershed change in regulation.
While these unintended consequences are myriad, one of the most important stemmed from a clearer definition of independence as a moniker for financial advisers and investment managers.
Claiming to be ‘independent’
The term “independent” had long been cherished by financial advisers as a badge of honour and a commercial advantage over other advisers that represented a narrow range of products.
In reality, most independent advisers worked from a constrained list of providers. These providers were often chosen with great care, but nevertheless represented a small subset of the providers.
The regulator was clearly concerned that this was not meeting the unique investment needs of the end clients, and consequently this familiar way of operating was upended by two clauses in the Financial Conduct Authority’s handbook that were implemented as part of the RDR.
The first (COBS 6.2A.3R) states: “A firm must not hold itself out to a retail client as acting independently unless the only personal recommendations in relation to retail investment products it offers to that retail client are […] based on a comprehensive and fair analysis of the relevant market.”
While the second clause (COBS 6.2A.11G) states: “A relevant market should comprise all retail investment products which are capable of meeting the investment needs and objectives of a retail client.”
Justified or not, this deliberate exclusion of a class of products would prevent advisers from claiming to be independentTaken together this was interpreted as meaning that advisers must consider the full range of available investments when making an investment recommendation. This would be challenging enough but, when combined with the FCA’s ever-present mantra that “past performance is not a guide to future returns”, advisers were faced with an overwhelming task.
Many wondered how it would be possible to have an in-depth knowledge of all the investment options available and not screen by past performance. In addition, some advisers had deep concerns about certain retail product types that they consequently refused to use for any client.
Justified or not, this deliberate exclusion of a class of products would prevent advisers from claiming to be independent.
Finally, for an adviser who had grown up on a diet of regular “visits” from the Personal Investment Authority/Financial Services Authority, the natural expectation was that they would have to demonstrate the efficacy of their “whole-of-market” research approach to a sceptical regulator, a seemingly unassailable challenge for most.
While these rules remain in the handbook, I am not aware of any advisers who have had their research process challenged over the past decade, and so it would be easy to end the story of this element of the RDR with the notion that advisers were overly concerned about a well-intentioned rule.
However, in reality the outcome is far more interesting. When faced with the challenge of the increased liability and operating cost necessitated by a whole-of-market investment proposition, many advisers started to rethink their businesses.
In doing so, they moved away from a focus on being the investment expert – a value proposition that had become increasingly common over the previous decade – and towards a more holistic approach to financial planning.
Initiating change
This transformation of the adviser business was supported by a market environment that favoured low-cost passive portfolios, rather than the “star” active managers that dominated the investment landscape in the early years of this century.
While the forgoing is clearly a gross simplification that will lead some readers to exclaim that they had stopped building portfolios more than a decade before the RDR, for many more the RDR initiated a change in financial advice that is still gathering momentum a decade on.
This change is most obvious in the growth of managed portfolio services, standardised risk profiling, and falling investment costs. This has benefited end investors both directly and indirectly, as a trend towards outsourcing has created more capacity for advisers to spend time with clients.
Given the value an adviser can provide by coaching clients towards better planning and decision-making, this increase in the time available for client interactions can raise the probability that a client will reach their goals.
Alongside the impact that outsourcing has had on clients and advisers, the imperative to be “whole of market” has changed the investing landscape in the UK.But it should not be lost on us that rules designed to encourage advisers to spend more time researching and selecting investment products has had the opposite effect.
Alongside the impact that outsourcing has had on clients and advisers, the imperative to be “whole of market” has changed the investing landscape in the UK.
As advisers have withdrawn from choosing investments, the composition of the fund selection community has changed, with greater concentration among those choosing funds. Yet despite this, there does not appear to be a marked increase in the concentration of assets.
Morningstar data show that approximately 34 per cent of UK fund assets were concentrated in the top five fund companies at the end of 2021, compared with 32 per cent at the end of 2011.
From the above, we can conclude that a key tenant of the RDR was a failure, as advisers are spending less time choosing individual investments for their clients.
However, by encouraging advisers to outsource investment portfolio management and spend more time with clients, it has led to improved suitability, specialisation of portfolio management, and lower investment costs.
Thank goodness for unintended consequences.
Dan Kemp is global chief investment officer of Morningstar
