While segmentation undoubtedly benefits advice firms by streamlining their businesses offerings and helps clients gain suitable advice, it is important to consider whether or not there are any risks.
Some might see an inherent conflict between advisers banding clients together – often by wealth – with the need to sustain businesses, especially as the industry grapples with cost and margin pressures and a tougher investment environment.
“There is nothing wrong with segmenting clients by asset size in terms of your own business management information,” says Mark Polson, principal at the Lang Cat.
“But it should not leak out to clients themselves,” he warns.
So what exactly are the dangers and how can advisers ensure they are working to viable business propositions whilst ensuring clients' needs are met, regardless of their wealth?
Two-pronged approach
What the Retail Distribution Review did was focus on whether clients were being shoehorned into investment propositions that may not have been suitable, according to Chris Davies, founder of Model Office.
The danger now, however, stems from not following the Financial Conduct Authority’s Product Intervention and Product Governance Sourcebook – which came out with MiFid II – and not recognising the necessity to segment based on client outcomes, according to Jamie Farquhar, business development director at Square Mile.
He explains: “Advisers [today] have to do the segmentation for RDR but they also have to do segmentation for Prod – these are two separate processes.”
The Prod is entirely centred on investment products, surrounding their manufacture and distribution, and requires them to be based on client outcomes.
Mr Farquhar explains: “In essence, the FCA is looking for manufacturers, fund managers and life companies, to clearly define what they believe the target market is for their product and for the IFA to do the same thing for their client database.
“What the FCA then want is for there to be a match between what the manufacturer is saying and the segmentation process that the IFA has been through which will then help define suitability.”
That is why IFAs now also need to do a second piece of segmentation around client need requirements and outcomes from an investment perspective because the whole point behind segmentation is to help you identify the right products to meet each clients needs.
He reiterates: “You have to segment your client base first to define your service structure and, therefore, the fee base that you are going to implement for all of your clients – that is the way you work out the commercial nature of your business.
“But you then also have to ask questions based upon outcome such as: is my client looking for income or are they looking for capital growth? Are they looking for preservation? What age are they? How long are they going to be looking for this service for?”
While there is the risk that an adviser could go through the segmentation process incorrectly, which would result in clients being put into the wrong sorts of investments, Mr Farquhar suggests that is a very minimal risk, if at all, because "IFAs are generally very good at segmenting their client".
He says: “The vast majority are good at it, so the risk of poor segmentation is there on paper but I do not think it really exists in the marketplace.”
Nevertheless, he says it is important to remember, especially if you have a centralised investment proposition, to "segment clients in such a way that it makes it easy for you to provide wholesale advice to meet their end needs”.
'Segmenting by wealth is a mug’s game’
Because segmentation occurs within the investment arena, clients are often taken on based upon the minimum level of their wealth or assets, according to Jiten Varsani, mortgage and protection adviser at London Money.
Mr Varsani suggests the main danger of segmentation is the possible limiting of advice for those with lower levels of assets.
He says: “At a time where we should be trying to improve access to advice for all, segmentation [by wealth] hinders these efforts.
“However there is a need for advisory firms to maximise earning and profits, but there is the danger of alienating the ‘lower tier clients’.”
Similarly, the Lang Cat’s Mr Polson says it is perfectly possible for a client with £200,000 to have far more complex affairs than a client with £1m.
He says: “Or if they do have the same level of complexity, it is highly unlikely that the £1m client costs five times more to look after.
“There is a difference: professional indemnity cover naturally costs more for more affluent clients, and the firm may feel that a £1m client warrants a little more contact than a £200,000 client, there may be some more pension planning work around lifetime allowances, but it is not fundamentally different year on year.
“The other issue is that if you decide that, say, you use platform A for clients up to £250,000 and platform B for clients above that, you create artificial cliff-edges which are indefensible in the real world.
“If your £200,000 client suddenly tells you about a £100,000 group pension you didn’t know about before and transfers that in, do you move her to platform B?
Almost certainly not, at which point your segmentation is already bust.
Some form of assessment of client need rather than pure pound signs is so much more workable.”
He adds “segmenting by wealth is a mug’s game” but that it “can be a useful way to see where you are making money and where you are not (especially if you are logging time)”.
Improving segmentation
There are a number of different aspects to consider when looking at risk segments, according to Natanje Holt, retirement specialist at Bravura Solutions.
This is because what clients say is not always necessarily reflected in their behaviour and completing a questionnaire might change depending on their mood and circumstances.
She explains: “Data from questionnaires and our behaviour can be misleading as it looks at a very narrow context over a limited timeframe.
“That could allow assumptions about correlations to influence the segmentation that may not be appropriate.”
However, she says that as data analytics and machine learning become more advanced, it should be easier to understand clients within a wider data context over a longer timeframe.
She says: "This would allow a much finer, subtle level of segmentation, which may or may not be more appropriate.”
Indeed, it could be argued that segmentation post-Mifid II has already started to bear results, with advisers being encouraged to move away from transactional methods – focusing on age and AUMs – to more bespoke methods of gaining client data based on behaviour and outcomes instead.
Ms Holt continues: “The field of data is evolving quickly and the biggest risk is that we do not know what we do not know.
“It is therefore important to stay vigilant and question the methods applied to segmentation and results to ensure we continue to identify and guard against blind spots.
Mr Davies adds that advisers “have to start with the client first – that is a whole soft skill questioning process which will include technology and discussions around their attitude to risk and capacity for loss”.
He suggests there are some “really robust technologies out there”, citing suitability tools launched by Oxford Risk, SuitabilityPro platform by PlanPlus which hosts FinaMetrica Profiler, and Dynamic Planner.
These provide “good evidence-based practice around how to make sure advisers get a good holistic view of clients risk profile”, he says.
He continues: “So when it comes to segmentation and the tools advisers are using around things like risk profiling, they have to make sure they have done their research and proper due diligence so the tool is fit for purpose and does what it should do.”
Victoria Ticha is a features writer at Financial Adviser and FTAdviser
