It’s not only the markets that have faced headwinds in the last couple of years since the extended period of low interest rates gave way to a rate hiking cycle.
That time has also coincided with the Financial Conduct Authority (FCA) introducing significant changes to the financial advice regime in the UK. We share the FCA’s aims, to deliver simpler, clearer, value for money offerings that retail investors can understand more easily – and importantly trust.
The Retail Distribution Review (RDR) of 2012, with its requirements around the transparency of costs and fees, prompted a focus on charges that had the side effect of shifting more retail investors into passive investment solutions with limited active asset allocation decisions, as these elicited lower overall costs for the client. In an environment where investment outcomes were heavily influenced by common global factors – artificially restrained interest rates and massive injections of central bank liquidity – this wasn’t a bad result for many as virtually all asset classes enjoyed healthy gains until 2022.
Unwinding correlations and structural shifts
Fast forward to now and the investment environment is no longer so composed or uniform. The markets have been shaken by rising inflation, central banks rate hikes and the reversal of measures that had increased liquidity. The outlook is further complicated by the unwinding of economic correlation with the US, Europe and China all slowing, the emerging markets still growing but at a slower pace and Japan reawakening from decades in the doll drums.
In addition, the investment world is being impacted by major structural shifts including disruptive technological innovation, new geopolitical tensions and the re-evaluation of supply chains. In this environment, greater selectivity and more dynamic asset allocation, even at the cost of higher fees for active management, may eclipse the benefits of lower fees on passive investments.
Beyond the shifting tectonics of the global economy, new Consumer Duty legislation has just landed. Under the revised rules, firms are required to act in good faith toward retail customers, avoid foreseeable harm to retail customers and enable and support retail customers to pursue their financial objectives. Unpacking these points, investment firms/advisers are required, among other things, to provide customers with products and services that meet their needs and offer fair value, communications they can understand and customer support when they need it.
For large firms that already have tailored offerings including business support, online and in-person advice, the new requirements should entail little further adjustment. However, for advisers putting their own portfolios together, consumer duty takes on a more onerous commitment; how to segment clients/investment solutions, tailor communications and assist differing groups.
MPS versus Multi Asset structures
To round it all off, we have changes to capital gains taxes (CGT). In the Chancellor’s Autumn Statement of November 2022, it was announced that annual exempt amount (of CGT) was being reduced from £12,300 in 2022/23 to £6,000 in tax year 2023/24 then to £3,000 in 2024/25.
For Model Portfolio Services (MPS), with segregated portfolios of multiple individual fund holdings that are directly held by the client, there are implications. Being standardised portfolios, individual tax circumstances are not taken into consideration when the manager makes investment decisions. The reduction in the AEA and the conjoined nature of the portfolios management, may create gains or losses on a portfolio that if not reviewed regularly, could lead to unforeseen CGT liabilities for the client. In turn, this could lead to a poor client outcome and fall counter to one of the 3 rules of Consumer Duty – ‘Firms must avoid causing foreseeable harm to retail customers.’
Multiple asset portfolios held within a collective structure, such as an OEIC or Unit Trust fund, are treated as one investment that is directly held by the client. Like the MPS, the portfolio is therefore standardised across all clients. A significant difference to this investment solution, however, is that any changes made by the investment manager to the underlying portfolio, due to the asset being held within the collective structure, are not subject to CGT. The potential CGT liability only occurs when the investor sells units of the collective investment.
Much to think about then for financial advisers when considering the appropriateness of the different collective investment solutions that can be/have been recommended to the clients in the past.