I’m excited to be involved in a new initiative called the Financial Suitability Forum. Founded by the Australian financial services entrepreneur Paul Resnik, the forum aspires to be “a gathering place for members of the financial services community who want to build advice businesses, provide services, and offer investments and other financial products around a suitability standard”.
I’m going to be writing regular articles for the forum, and here’s my latest, which focuses on the lessons to learn from the Neil Woodford fiasco. There is, in my view, only one way to ensure that these highly damaging episodes are consigned to history.
No one comes out of the Woodford fiasco with very much credit. Neil Woodford’s professional standing is in tatters. His refusal to reimburse any of the £8.8 million his firm has taken in fees since his flagship fund was gated in June hasn’t done much for his personal reputation either.
Hargreaves Lansdown has rightly been criticised for the part it played. It has heavily promoted Woodford and his funds since the launch of Woodford Investment Management. His Equity Income fund remained on its recommended fund list right up until its suspension. How HL failed to notice and act on the serious liquidity issues lurking beneath the surface seems negligent in the extreme.
My own profession, journalism, must also share some blame. The trade and mainstream press gave Woodford constant publicity, and most of it very positive. Headlines like “Neil Woodford: The man who can’t stop making money” (BBC) and “Britain’s answer to Warren Buffett” (Daily Mail) reinforced the perception in people’s minds that here was a virtual one-way bet.
There is, however, one group who have so far largely managed to avoid the spotlight — and that’s the many financial advice firms that exposed their clients to Woodford’s funds.
The name on everyone's lips
Woodford set up his own company at around the time I started attending adviser conferences. It seemed his name was on everyone’s lips. As an indexing advocate, I often tried to engage advisers on why they didn’t make more use of low-cost index funds. Almost inevitably, the conversation would come round to Neil Woodford.
Some advisers were outspoken advocates of Woodford in the media. Alan Steel in Scotland, for example, has been widely quoted on the subject over the years. True, there were some dissenting voices, but it always seemed to be the Woodford enthusiasts whose voices were heard most clearly.
I fully understand why so many advisers recommended Woodford. He did, after all, deliver the goods in his last job at Invesco Perpetual. He’s also photogenic, charismatic and a bit of an outsider. So he makes for a good story, and advisers like telling stories, perhaps because they know how susceptible to them their clients and prospects are.
Stories don't change the odds
But neither of those is a reason for entrusting a manager with clients’ money. Past performance tells us very little of any use about the future, and yet many (and arguably most) advisers continue to talk and act as if it does. The problem with stories, as the behavioural finance expert Joe Wiggins explained recently, is that “they do not change the odds; rather they simply encourage us to forget them”.
As every adviser should know by now, the odds of an active fund outperforming over the long term are very slim. Identifying a fund, in advance, that will beat the market on a cost- and risk-adjusted basis is extremely difficult. Putting together a diversified portfolio comprising, say, six long-term outperformers is more akin to buying a jackpot-winning lottery ticket.
The crazy thing is that most financial advisers still have value propositions that are built on their ability to beat the market when, in reality, only a tiny fraction of firms have actually managed it in the past. In my experience, they’re not being deliberately dishonest. They genuinely think they’ve outperformed; they remember the winners and ignore the losers and, in particular, the effect of compounding fees and charges on their clients’ returns.
The move towards evidence-based advice
We are, on the other hand, starting to see more and more advisers move towards an evidence-based approach. Firms are increasingly realising that they can’t add value by picking funds and sectors. So, instead, they’re simply choosing to capture market returns efficiently using low-cost index funds. That allows them to focus on areas where they really do value — behavioural coaching, for example, financial education and, most importantly, financial planning.
Given the choice between an adviser who says they’re going to beat the market and another who admits they can’t, it’s human nature to opt for the former. In reality, you’re almost certainly better off choosing the latter.
What, then, is the solution? Requiring advisers to produce a suitability report is clearly insufficient. The answer, for me, is for all financial advice firms to have the returns their clients receive properly and independently benchmarked. One of the first advice firms in Australia to implement benchmarking was Shadforth.
“Out of 150 individual portfolios we analysed,” says former Shadforth director David Haintz,"the average annual return was more than six percentage points below the respective index benchmark. The results were even worse when portfolios, many of them self-managed super funds, were benchmarked against the returns of broad asset classes and sub-asset classes.”
Steering advisers towards suitable products
If returns were properly benchmarked, advisers would be able to see, in black and white, just how hard it is to beat the market. I’m not saying they should avoid using actively managed funds altogether. But having their returns clearly visible to all would automatically steer them towards cheaper, more efficient and more suitable products.
Benchmarking would also enable consumers to make a fair comparison. They could see for themselves whether an adviser who claims to have market-beating expertise has actually demonstrated that ability in the past. At the moment, they only have the adviser’s word to go on.
Of course, benchmarking would only really work if every adviser did it. If they didn’t, it wouldn’t be a level playing field. Yes, it would come at a cost, which either the adviser or the regulator would have to bear. But if we’re serious about improving investor outcomes, it’s a price worth paying.
The Woodford fiasco has seriously dented the public’s trust in the investing industry and in saving for retirement. There’s no time to lose in repairing the damage.
UK WORKSHOPS, DECEMBER 2019
Do you want to learn more about the Financial Suitability Forum and the work it does? Are you interested in getting involved yourself? Then why not come along to one of two workshops we're holding in December?
You can register here: