Christian Charest: In the ongoing debate over the abolishing of embedded commissions paid to mutual fund dealers, one example that keeps being presented by proponents on both sides of the question is the United Kingdom, where these types of commissions were banned several years ago as a part of sweeping reforms in the financial services industry.
Depending on who you ask, the result in the UK has either been a great success with more transparency and the end of potential conflicts of interest, or an utter failure where small investors no longer have access to advice. To get a better understanding of what happened in the UK since the reforms, I put the question to my counterpart in Morningstar's London office, Emma Wall.
Emma Wall: Prior to the implementation of the Retail Distribution Review in January 2013, the majority of investors dealt with an advisor, whether it was on a regular basis or to offer periodical advice at key life events. Around 50% of the UK advisors used trail commission to help meet their annual review costs. Trail commission was a percentage fee, typically around 0.5%, paid to advisors and to fund platforms by fund providers. It was taken out of the annual management charge, and so to many investors it was as if they were receiving a free service, or at least it made it very difficult to determine how much you were actually paying for the service.
Then the Financial Services Authority, as it was known, launched a review in 2006 to improve professional standards in advice and increase transparency and compel the industry to offer advice for all. It wanted to stop advisors making investment decisions based on potential commission. By the 2013 implementation of the review, this had boiled down to a ban on advisors taking commission and ensuring that anyone advising on pensions and investments took additional qualifications.
How was RDR received? Very badly. There was a lot of negativity around the review. I remember talking to both investors and advisors at that time, and many were confused and worried about the changes. Advisors in particular were concerned about how the new business model would affect their profitability, and we did see a demise in the number of smaller firms. There was consolidation at the top as well, in order to reduce costs, through merging back offices and support staff. Some older advisors opted to sell on their book rather than take further qualifications and exams in their 50s and 60s. There were around 40,000 advisors in 2011, and today there are less than 30,000.
Some investors were confused by the concept of having to pay for something they had previously thought of as free investment advice. There were also stories of investors with smaller portfolios being dumped by their advisors. They were no longer cost effective or couldn't afford to stump up with the new upfront costs. Now, at that time, a study in 2012 by Allianz Global Investors claimed that anyone with a portfolio of less than GBP50,000 would not be attractive to advisor firms, and this rule has generally held up, with a recent release from Schroders echoing the view.
It is now harder for investors with small portfolios to get advice post-RDR. Many advisors have segmented their advice depending on the size of investor portfolios, meaning that for investors with small portfolios, it's very hard to get bespoke advice. Instead, you are likely to be risk-rated and sold a model portfolio based on that risk rating. Several studies have also shown that the GBP50,000 rule applies and if you have less than GBP50,000, you are just not attractive to an advisor business. There's also some difficulty with self-selecting as well, because the smaller your portfolio, the less likely you are going to want to pay an upfront fee, because of course that fee will make up a larger proportion of your assets.
It's quite difficult to tell whether there has been an effect on investor returns, partly because we've only had a rising market since RDR. Those investors who have opted for DIY have only seen a rising market and we don't know whether they've DIYed badly. The popularity of ETFs has risen as well as there has been more focus on fees, both in terms of individual investors, DIY investing and professional investors investing on their behalf. There's also been a rise in the number of multi-manager, fund-of-funds and risk-rated outcome fund launches within the industry to meet investor demand post-RDR.
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