Are advisers limiting competition in asset management?
Part of the FCA’s interim report on the UK asset management industry which perhaps hasn’t received the attention it deserves is a section on the impact that the financial advisory sector has on competition between fund managers.
The report’s authors express concerns in three main areas:
adviser networks and vertical integration;
model portfolios; and
third party ratings providers.
Below are the relevant sections of the report. Alternatively you can read the full 200-page document here:
Adviser networks and vertical integration
Adviser networks may make funds available exclusively to financial advisers who are part of the adviser network. The adviser network may act as the fund manager itself, or may act as the Authorised Corporate Director and select third party asset managers to manage the fund as part of a ‘fund of funds’ arrangement.
Adviser networks have a commercial interest in promoting their own funds, as the network generates revenue from the investors that choose the in-house fund or portfolio. While we have not found any examples of adviser networks mandating the use of in-house funds, we have been told that the flow of money into in-house funds is growing. For example, one adviser network we spoke to has generated £1 billion AUM over the last 10 months in in-house funds.
The provision of in-house asset management services by advisers is a relatively new market development. Nevertheless, the development raises the following potential issues:
• How rigorous adviser networks are in selecting the fund managers that manage in-house fund of funds
• Whether the additional fee in a fund of fund arrangement represents value for money
• How the use of restricted investment solutions affects advisers’ advice. For example, an adviser that is part of a network could be more inclined to pick a fund by relying on the network’s due diligence
Model portfolios
Many consumers are looking for integrated solutions such as a fund of funds or model portfolio. Model portfolios are a selection of investments designed to meet different risk profiles and investment objectives. The portfolios are pre-constructed and typically reviewed periodically.
Financial advisers are increasingly offering model portfolios. NMG estimates that approximately 31% of investments below £50K are into model portfolios.
A model portfolio is designed to help save advisers’ time and resources in choosing the underlying funds and asset managers for each individual client. Model portfolios can be manufactured by adviser networks, third party firms or by advisers directly. The model portfolio designed will first choose the asset allocation that meets the retail investors’ risk tolerance level or investment objective (such as growth or income) and then the fund or set of funds. The adviser is then free to assess their client’s investment objectives or attitudes to risk, and to select a portfolio that
offers that level of risk and meets the investment objective, without having to research each fund or investment separately.
The increasing use of model portfolios can potentially increase efficiency and give investors an investment proposition which is suitable to their needs. However, the use of model portfolios creates a number of risks. These are:
Comparability: The huge selection and variability of types of model portfolios makes it difficult for investors and advisers to compare them. One adviser firm pointed out that, while model portfolios can benefit consumers, it is difficult to compare and analyse performance of different types of model portfolios.
Choice of asset managers: The growth of model portfolios could make it difficult for asset managers to access routes to market if the designers of the model portfolio only choose between a limited range of fund managers or include their own asset management as part of the portfolio. For example, one firm said they choose from a selection of eight asset managers to build their range of model portfolios.
Value for money: Investors will pay advisory fees, model portfolio fees, underlying fund fees and potentially a platform fee, with each having an impact on returns.
Third party ratings providers
There are a range of third party research firms that rate asset managers and funds. Designers of model portfolios, financial advisers and wealth managers can use these ratings to help shape their choice of asset manager and advice to retail investors. We were told that financial advisers may restrict their fund research to funds which have a rating or risk profile from one of the number of rating providers.
Some industry commentators and stakeholders have raised concerns about third party rating providers’ business models.They suggest that some rating providers do not offer a whole of market review and some rating providers have to manage a conflict of interest where an asset manager agrees to pay the rating firm for a licence. We have also heard from asset managers who do not pay for a licence fees that they will then not be rated. We have not conducted any analysis of how widespread these business models features are, or how greatly they affect fund ratings and financial adviser recommendations. Nevertheless, we would be interested in stakeholder views about whether this is a market trend that we should further explore.
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If you would like to submit a comment on the interim report, you should email it to assetmanagementmarketstudy@fca.org.uk by 20 February 2017.