Retail Distribution Review One Year On…
You Are Likely To Be Familiar with the retail distribution review. It came into force at the beginning of last year and, from an ETF perspective, was anticipated to boost the ETF market to US-sized proportions.
In Europe, ETFs are predominantly used by the institutional market, estimated to be well in excess of 70 percent of the market. In the U.S., financial advisors and retail investors represent half of the market.
However, the expected explosion of UK retail investors into ETFs did not materialise. Instead, advisors embarked upon learning about the products at a slow pace, while investors eyed new fee-based models with suspicion.
2014 is now being described as RDR 2, and many are calling for the anticipated explosion in growth to occur now.
What Happened and Why?
When RDR came into force in January 2013, its focus was on several key aspects of the distribution of retail investment products, including advice, standards of professionalism, advisor charges and platforms.
The biggest changes include the removal of commission based sales and the adaptation of some platforms to accommodate intraday fund pricing, which is expected to make ETFs more attractive.
Why has uptake been slow? Adam Laird, passive investment manager at online platform Hargreaves Lansdown explains that one issue investors face is having to pay a fee upfront for advice.
"Investors have not liked this, but it does mean that they can be clearer on what they are getting for their money," said Laird.
Those with smaller portfolios are also enduring a rocky ride. The upfront fee, which is often a percentage of their assets or an hourly fee, is off-putting and some investors are unable to afford it and therefore no longer seek advice.
This however, has prompted the rise of do-it-yourself investing through services like Nutmeg, Barclays Stockbrokers and Interactive Investors, which has forced down the price of advice. According to Hargreaves Lansdown, the "typical" cost of advice is either 1 percent upfront and 1 percent ongoing, or 3 percent upfront with between 0.50 – 0.75 percent ongoing.
Another issue is that many advisors initially did not like the changes that were being made because in some cases they have had to re-qualify.
RDR permits that financial advisors looking to give advice under it obtain the level four qualification in financial planning. When added to the improved standards of professionalism, compliance and capital adequacy, the costs start rising.
Advisors must have gained certain qualifications (and combinations of examinations) by the end of last year. This means that advisors need to have covered the content of the RDR 'core' and 'specialist' examination standards by assessment at level four or higher.
Too many products to choose
Finding the right product can also be an issue for investors. For example, funds tracking the FTSE All Share index vary in cost from 0.10 percent to 1.50 percent, and there are 15 tracker funds that are available.
"There are pitfalls with ETFs because there are a lot of products, but you can go out there and get ETFs easily. All we find is that people need help navigating through the products. They don't always know where to start looking for products," said Laird.
Feargal Dempsey, independent ETF consultant, explains that platforms and the retail focused distribution sector now need to adapt to the new world and less familiar products. "I still believe we will see huge penetration of ETFs into the retail market in the UK – and in the EU - as more move to RDR regulation."
So, what do the changes mean for you?
Costs are now broken down
RDR has separated out the cost investors pay for advice on investment.
Laird said: "People can now see how the costs are broken down and the advisors now have to justify these costs. There is greater scrutiny when advisors recommend an active manager and they have to prove that they can get the returns and where all the costs are going."
IFAs outsourcing portfolio management to DFMs
Discretionary fund managers (DFMs), who are third party investment managers and have the power to manage the investments of a fund, are also benefitting from independent financial advisors (IFAs) outsourcing their portfolio management. This is because the costs to run this process in-house can be too high, which inevitably transfers to investors. Outsourcing helps lower these costs.
Frank Spiteri, head of retail distribution at ETF Securities, confirms the sentiment: "There are compliance costs, best practice costs, [and] suitability costs that mean it is not effective to do this. Now that IFAs are charging their clients, performance really matters and ultimately cost has become a key factor for investors".
Wrap platforms are seeing flow
Another beneficiary of RDR are the wrap platforms. Wrap platforms are investment platforms where you can trade your ETFs, investment funds and pensions, which are then held in the same administrative account rather than as separate holdings. They are effectively wrapped together and this helps bring costs down.
There has been a big increase in the amount of money going on to platforms, and this is where RDR is beginning to shine.
In November, a quarterly report from Fundscape showed that net new business to wrap platforms had more than doubled the amount going into fund supermarkets for the first time. Wrap platforms accounted for 30.60 percent, or £2.6 billion, of all net fund sales for the three months to the end of September.
Another upshot of RDR is that investors are increasingly doing execution-only ETF trading, meaning they trade directly on the platform and subsequently make their own financial decisions – not through an advisor.
Hargreaves Lansdown is an execution-only platform and Laird explains people are increasingly happy to go down the no advice route. "ETFs and trackers are talked about regularly now so investors are increasingly able to understand them," said Laird.
What is 2014 going to hold?
RDR has inspired a new mind-set; one that is shifting from commission and product to holistic guidance for clients, high qualifications for advisors and a financial services sector that the UK can proudly claim is one of the most highly regulated in Europe.
"RDR has been very helpful for the ETF market but the advisors are able to advise on a range of products and they have done very well from it. Advisors who have justified their fees have really benefited and it has pushed out the people who were commission driven.
"Different investors have different needs. People won't all go for execution only and people will always pay to get good advice," Laird said.