A softer approach to the Retail Distribution Review

The RDR has taken on the form of Smaug, the dragon from The Hobbit.  Even though it has yet to be seen it evokes fear and dread in the land of Middle Earth, that land of the ever open pub occupied by intermediaries and fund managers. The main thrust of the RDR to tackle the problem of trail commission is simply to ban it. Many in the industry see this as a draconian solution to a problem that is not the biggest issue the industry faces and will impose collateral damage on many. Not least of which is the likelihood that many investors will be left with nowhere to seek advice except from the banks. And few in the industry think that is a good idea, apart from the banks of course.   

At the heart of the debate is the need to separate the revenue generated from selling a product to revenue from giving advice. The simplest way to do that is make it easier to compare naked products shorn of all advice. That makes it easier for the consumer to distinguish between what it costs and the advice given to sell it.  

The industry could go a long way to making the market easier for consumers to understand by providing greater information on each product. More data will help investors make their own decisions on what products to use. After all, these days many people eschew advice when choosing expensive cars, mobile phones or computers. All of these are complex products but the manufacturers and trade press provide so much information that it is relatively easy for consumers to choose for themselves.  There is no reason why financial products should be any different. That leaves IFAs to give unbiased advice on such things as asset allocation and tax planning which the client can either execute himself or in partnership with the adviser.

So here are a few suggestions for the industry to consider as an alternative to banning trail commission. Underpinning them all is the concept that improved investor education will reduce the risks of consumers using the wrong product.  

As a start the FSA could encourage funds to publish a full list of holdings, including derivative and short positions and any stock lent out, every month.  There is no need to penalise those that don’t but, presumably, investors would prefer products that are transparent and not opaque.
 
Secondly, why not allow direct promotion of funds and financial products by providers?  Is there any reason why detailed explanations of performance data and the reasons behind stock selection and relative weights should not be included in promotional material? If the industry treats its client base as know-nothings it shouldn’t be surprised when it is accused of miss-selling.  Other industries bombard customers with technical information, why should finance be so different?   

A relaxation of money laundering rules would make it much easier for investors to buy directly from product providers.  The current system of checks and information gathering actively discourages consumers from shopping around and trying different products.  Inertia is a big factor in deterring investors doing anything other than using their existing broker and platform. No one wants to go to the hassle of sending off all that data to again just to try a different product.  Besides, how many money launders have actually been caught by all these rules and regulations?

A key difference between investment products and consumer durables is the need for the product provider to continue servicing it over an extended period of time. This contrasts with the sell and forget approach that is adequate for hard goods. Even so, the maintenance of the investment is the duty of the product provider and not the distributor who merely passes the data through to the client. If all funds were required to offer the product at a “factory gate” price it would clarify the difference between product costs and distribution costs.

Car manufacturers are obliged to publish fuel consumption figures to encourage more economical driving and persuade buyers to consider efficiency when choosing cars. In the same way if fund providers were required to publish risk and cost measurements such as alpha, beta, tracking error, information ratio, full TER and portfolio turnover it would help investors to take risk into account when selecting funds. That way they would be less likely to select on the single measure of performance. After all, few people pick a car just because of its top speed; insurance groups, mpg and crash test data are all important to drivers.

These requirements would be extended to include ETFs as well as OEICS and Investment Trusts.

More controversial would be this last idea. Why not abolish tax shelters such as ISAs and SIPPs? These tax wrappers can only be administered by intermediaries and platforms and are directly responsible for pushing individuals to using third parties instead of managing their own affairs directly. Removing the tax shield would encourage investors to buy products directly without the need for a third party.  Eliminating stamp duty from investment products would partly compensate for the loss of these tax planning structures and work to encourage savings.

You might expect a loud chorus of complaints against such an idea because it would remove incentives to save. However, it shouldn’t be necessary for the government to point out the blindingly obvious. If people are going to work from the age of 20 to 66 and be retired for the next twenty years it doesn’t take a genius to work out that you will need to save something during those 46 years to live on for the following twenty.  Administration of these tax shelters gives intermediaries a powerful lever to impose charges. Giving people the option not to pay those charges could substantially reduce costs. In any event the tax benefits of SIPPs are not as great as many might suppose because the pension they ultimately provide is taxed.

These proposals, if enacted, would improve consumer education. That alone would be a powerful factor to guide investors to lower cost products and help understand the difference between the cost of a product and fees for advice. Market forces would be a much more effective mechanism for doing this than legislation that could have many unintended consequences.