Evolution of financial market access in the UK for retail investors and its implications
I’ve recently returned to the UK following six years living in the Middle East and Asia. While spending the last nine months re-acquainting myself with the investment industry in the UK, I’ve particularly enjoyed learning about and discussing the numerous developments that have taken place in the provision of wealth advice. Many of these developments are very positive, although I can’t help but think about a couple of potentially negative outcomes which are brewing. For the sake of this piece, I am purposely going to put to one side the Brexit vote of last year and the upcoming UK General Election. The full implications of each are unknown and, particularly with the former, are likely to be so for some time. I’ve also used the rather broad term “retail investors” in the title to this piece, by which I mean all individuals in the UK with invested savings, pensions, or those with an interest to save and invest.
So what has changed over the past six years and how are these changes impacting retail investors in the UK?
Well, I don’t believe I’d be doing myself a disservice to say that the past six years have witnessed changes to the financial landscape which far outweigh most other six year periods in my lifetime. Specific to the provision of investment advice, we have seen the introduction of the Retail Distribution Review (RDR) in 2013 which focused on increasing the transparency and fairness of investment advice in the UK. It required truly independent financial advisers (IFAs) to take on further qualifications, while it also cleared up the relatively opaque nature of the ongoing remuneration IFAs previously took in the form of retrocession payments from asset managers / product manufacturers. Simply put, when you invested into a unit trust or fund through your adviser before RDR, a percentage of the annual management charge you paid to the asset manager would be paid back to your adviser from the asset manager through an agreed upon contract between the two parties.
The dissolution of this structure post the implementation of RDR naturally raised a debate regarding the fees IFAs should charge to replace this lost income for the ongoing services they provide to their clients. It also brought about the question of whether such a charge should be a flat fee, based on the time an adviser spent working for their client (i.e. similar to legal fees), or whether it should broadly remain a set percentage of the assets the adviser managed on behalf of their client. Whatever the methodology applied, this newly agreed cost now appears in the vast majority of statements sent out by advisers to their clients each year. It will continue to provide a source of debate in terms of the fair cost for ongoing investment advice.
While this debate evolves, so has the retail investor’s ability to access financial markets directly, with or without the need for an adviser. Online brokerages slowly began to replace traditional stockbroking services in the early 1990s, and this trend has proliferated through accessibility to the internet, alongside more recent technological advances. One of the negative knock on effects surrounding the implementation of RDR, focused on traditional advisory firms’ willingness to take on clients whose investable net worth fell below a level which was perceived to be commercially viable. This led to a number of well known high street banks cutting back on the advisory services they’d previously offered to such clients. It is with these retail investors in mind that the most recent fintech solutions within the wealth advisory space are often focused. These robo-advisory platforms are looking to win over such clients, and their relatively low cost, mobile friendly, and well managed solutions are very likely to disrupt parts of the traditional advisory model going forward.
The broad acceptance, and rapid asset accumulation, of Exchange Traded Funds (ETFs) globally has provided UK retail investors with an increasingly efficient and cost effective path to build a broadly diversified portfolio. There does, however, remain a dichotomy among traditional wealth advisors regarding their willingness to embrace such ETF solutions; perhaps highlighting a hangover of the pre-RDR days and further opening the door to disruptors (witness this week’s B2C launch by Vanguard in the UK). With the financial press increasingly scathing about the perceived benefits of traditional active management solutions, coupled with a refocusing on fee competition in this space by the FCA, it is difficult to see the ETF and passive investment bandwagon slowing down anytime soon.
Which leads me onto the very significant pension reforms witnessed over the past six years that, in my mind, provide the greatest scope for negative outcomes in the short to medium term. In April 2015, the previously announced pension freedoms came into full effect. These changes allow pension investors, of at least 55 years in age, complete freedom over how they take an income or lump sum from their pension; 25% of which is tax free. In theory, a pensioner could withdraw 100% of their defined contribution pension at the age of 55 and take it to the nearest casino. In practice this is unlikely to happen but it goes some way to highlighting the nature of the pension freedoms now in place. After all, up until April 2011, a pensioner was forced to buy an annuity with their pension pot before the age of 75.
I’m not arguing that this increased flexibility to avoid locking up your hard earned pension in an annuity, at historically low levels of interest rates, is a bad outcome. It’s not, and with inflation likely to creep up in the future I would be strongly advocating against such an investment to a new retiree today were it still in place. For retirees searching for the most appropriate solution for their pension portfolio today, my concern is really twofold. The first comes down to the advice they receive or are willing to pay for which is often deducted from their pension pot. It is the willingness to pay for this advice which will often put retirees off doing so, particularly if they feel their pension pot is already looking a little underfunded. This could lead to a miss-allocation of risk and subsequent poor investment returns of their portfolio. And my second concern ties into the availability of options into which retirees can now allocate their pension portfolios. This might seem a little counter intuitive to a number of the benefits I referenced emanating from such products which provide easier access to markets for all. However, when it comes to pensions in particular, many of these technology platforms and models are nascent by nature and have to date been supported by one of the least volatile bull markets we have ever witnessed across such a broad array of core asset classes.
As we gradually approach the end of this investment cycle, there is a great deal of education which I feel needs to be imparted on retail investors, both young and old, to mitigate the potential for near term unexpected outcomes.