How do we define value in risk-based investing? The worry, when Consumer Duty first appeared on the horizon, was that it would be about price. Would the new regulation accelerate the rise of passive and intensify the squeeze on fees?
With the final report, published in July, the FCA has sought to allay those fears. It notes the perception – evident in the feedback on the proposed regulation – that its interim findings suggested a preference for passive over active investment. This is not the case, it says. Rather, whether the solution is active or passive, the regulator wants retail investors to understand exactly what they are paying for and how they are being charged.
When advisers are evaluating cost and value, they do not need to look at the whole market, but only at the group of solutions that are aligned with the client’s risk preferences and needs. If, for example, after suitability, the adviser knows the client is looking for a very active, high-risk solution – and, importantly, that the client understands the costs of that approach – they can concentrate on that part of the market and do not have to compare prices with cheap trackers.
Rather than focusing on price, the regulator is looking for fair value – stating that “retail customers experience harm where they don’t get value for their money”. Advisers will not have to put their clients in the cheapest possible solutions but they will need to make sure clients understand what they are paying for – and they will need to choose solutions whose price reflects their quality and benefits.
Opportunity for active managers
What do clients want from active management? First, the ability to reflect their preferences more fully, giving them more of what they do want and less of what they don’t. That could be through exposure to, or avoidance of, certain asset classes. It could also relate to sustainability preferences, which represent a clear opportunity for active managers to differentiate themselves through careful alignment with client values on environmental and social issues.
Second, clients who choose active are looking for a steady hand on the tiller – which may feel particularly valuable in environments such as today’s, with multiple sources of uncertainty and a very clouded horizon. Clients may feel safer knowing their portfolio can be de-risked in troubled times, or can respond quickly to the shifts in opportunity that accompany changes in market backdrop.
Importantly, Consumer Duty says it is this reassurance and extra work the client is paying for – rather than for the manager to get it right every time. Let’s say the manager of an active allocation strategy takes risk right down in a period of economic turbulence but, for its own reasons, the market keeps going up. Has the client experienced harm? No, because the strategy did what it was meant to do and the client continued to receive the benefit of knowing a professional was making the calls on their behalf.
Similarly, consumers do not experience harm, as defined by Consumer Duty, when risks inherent to the design of the investment strategy materialise. That being so, a capital loss is not a harm, as long as the client understood their capital was at risk and the strategy was being managed within its risk parameters.
Possible harms
So what are the possible harms that need to be factored in? The regulator highlights examples, including customers overpaying because of complex charging structures, or incurring costs that more than erode their returns above cash. Under Consumer Duty, it is immediately more challenging for advisers to justify putting clients in products with opaque layered charges – especially if there is little in the way of meaningful performance analysis to show what those charges are paying for.
With the regulator emphasising data and evidence, wealth managers and DFMs will need to be able to demonstrate the value they provide for the costs the client incurs. That means, as an industry, we need to work on improving transparency around performance. Many clients still do not receive meaningful peer group reporting, let alone benchmark reporting, so are unable to evaluate the investment choices being made on their behalf.
Consumer Duty also broadens and lengthens the scope of the value assessment, to encompass all the costs to the client over the lifetime of the investment. As such, an approach that is cheap upfront – because of low functionality or support, say, ad hoc admin charges or a reliance on advisers to operate it – may not be good value later if the client cannot actually use it for the purpose it was intended for, without having to pay additional product costs, for additional advice and services or to change product.
With the clock already ticking on the one-year implementation period, Consumer Duty is an opportunity for all the members of our industry to think about the value they provide, how they can evidence that value and their role in delivering good outcomes for retail customers.
Ben Goss is CEO of Dynamic Planner
