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Editor's Letter: February 2015

Editor's Letter: February 2015

Mind the Gap

A recently leaked memo written by White House economic advisors put some fire into the debate over proposals to impose a fiduciary mandate on brokers. The economists claim “perverse incentives” (i.e. commissions from fund companies) cost investors billions of dollars in retirement income, mainly via broker-advised rollovers from low-cost 401(k) plans to IRAs and needless “churning” of client portfolios. 

Industry advocates pounced. Adam Antoniades, the president of Cetera Financial Group, told brokers gathered at the FSI conference in Texas the memo was “ignorant” and “offensive” as it accused advisors of “defrauding their clients.” 

In the debate around conflicted advice, it’s useful to keep an eye on a real-world laboratory testing some of the assumptions on both sides of the argument: The United Kingdom. 

It has been two years since that country fully implemented the Retail Distribution Review (RDR), regulations which banned commissions for registered financial advisors. 

How has it played out? Two years is not long enough to fully absorb the impact, but last month the country’s financial regulator released its first progress report, giving us some idea of what a post-commission world would look like.

Among other things, the rules required financial advisors meet higher minimum levels of qualifications; required clearer communication of pricing and services; and, most crucially, “realigned adviser (sic) and platform incentives with those of consumers’ by removing the commission they received from providers.” 

Initially there were similar howls of criticism to the ones being made in this country: Get rid of the commission model and there will be fewer advisors willing to serve less affluent clients, creating an “advisory gap” where only the wealthiest who can afford a fee-based firm will get the benefit of professional guidance.

Is that the case?

The report from the Financial Conduct Authority found that the sales of funds that paid the highest commissions prior to RDR declined, and that “product prices have fallen by at least the amounts paid in commission pre-RDR.”

Advisors have also increased their fees for some consumers, the report found. So consumers are, post RDR, better able to compare the “true cost” of advice, since compensation is no longer hidden in fund management charges.

That has actually benefited advisors. According to a survey conducted by Investec Wealth & Investment, the change has forced advisors to improve their business models and find more ways to “add value.” The firm found 61 percent of advisors said their business has grown in the past two years; 13 percent said it has grown “significantly.” 

“Two years on, advisers are broadly positive about the impact of RDR, are better qualified, with most advisers saying that their businesses have grown as a result of the new regulations largely due to becoming more efficient and profitable,” the firm’s head of intermediary services Mark Stevens was quoted last month in Money Marketing.   

So current clients and advisors are better off. But what about the gap? As part of its review, the FCA commissioned Towers Watson to review the supply and demand of financial advice in the post-RDR U.K.

That report shows that while there is no lack of capacity for consumers who fit the profile of clients for financial advisors, fewer consumers put themselves in that camp. “Based on our modeling, we estimate that over 60% of demand for retail investment advice is likely to be transactional rather than holistic in nature. It is therefore quite possible that the initial strategic response of advisory businesses to the RDR to move towards holistic financial advice would lend itself to a capacity application mismatch and a shortage of advice capacity –especially at the lower end of the mass market.”

Clear Opportunities for Innovation

In other words, many less affluent consumers see the true cost of advice and conclude it’s not worth it. “This group includes consumers who would be likely to pay for a cheaper form of advice” and that there are “clear opportunities for innovation,” particularly in relation to “simplified or automated advice.” Hello, robo-advisors.

There are lots of differences between the U.S. and U.K. markets, and we are only two years into the new order in the U.K. And some suggest a commission-based model can co-exist with a fiduciary standard. But we can learn from the U.K. experiment, and early evidence suggests that the sky is not falling. In a world without commissions, there does appear to be an “advisory gap,” but one fueling demand for tech-enabled, low-cost services. In our view, that is reason to be optimistic. 

David Armstrong


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