Heading in the retail direction

Providers have high hopes the Retail Distribution Review (RDR) will fuel retail uptake of ETFs in the UK. Yet intermediaries believe regulation is not enough and providers should be improving direct access. Paul Burgin reports

The British retail investment market is an anomaly in Europe. British banks and other product providers have a far smaller share of the collective retail investment market than their counterparts in France, Germany, Spain and Italy. 

For newer investment products such as ETFs, gaining the trust of independent financial advisers (IFAs) is key to developing a robust portion of the investment pie. Yet advisers are naturally cautious. They worry about counterparty and reputation risk, should new vehicles and wrappers fail. They worry too that they will carry the can for investor losses that are not of their own making, as has happened with failed Keydata structured products. While the majority of intermediaries did not sell those vehicles, all must foot a £58m interim levy.

The nature of ETFs has also impeded wider acceptance by intermediaries. Until recently, most advisers relied on commission payments from product providers to ensure their advice appeared ‘free’ at the point of delivery. Products like ETFs and investment trusts that do not pay commission were overlooked in favour of mutual funds that did pay.

However, two domestic regulatory developments will remove commission bias. The Financial Services Authority’s (FSA) Retail Distribution Review (RDR) which comes fully on stream in 2012 will push more financial advisers to consider ETFs if they want to retain their independent tag. The FSA’s review of wraps and platforms should also make ETFs more accessible and bring down distribution costs.

In general, financial advisers are increasingly comfortable with ETFs. The strategic and tactical use of these vehicles by Ucits III compliant fund managers has added weight to their low cost and liquidity arguments. Advisers are keen to emulate such strategies for investors’ passive portfolios.

Nonetheless, it is estimated that retail investors account for no more than 10% of the British ETF market and intermediaries for only a portion of that, representing a far lower share than in the US and Canada.

Phil Reid, head of external distribution at HSBC Global Asset Management, said British demand for passive investments will rise in coming years. He explained: “About five percent of the Investment Management Association (IMA) fund universe is in passives. In the US and global fund markets, the figure is more like 20%. The UK passive fund market will double in the next three years and ETF usage will increase too.”

HSBC is spreading its bets, developing both ETF and passive fund propositions to appeal to the widest range of intermediaries and end clients. Reid said: “The RDR will increase demand for ETFs. They are already under the product regime so should already be considered by IFAs; but that is not always the case.”

When the RDR bans commission from the end of 2012, advisers will have to agree their remuneration with clients. Many are already switching to fees, which will help level the playing field for commission-less ETFs.

Factors spurring uptake

The FSA review is not the only driver of optimism in the industry. Intermediaries have been outsourcing investment decisions to professional managers in recent years, freeing up their own time and resources to concentrate on seeing and advising clients. Neil Jamieson, senior sales representative at ETF Securities, said those discretionary managers and stockbrokers were the original drivers of the retail ETF business in the UK. He added: “There has been a trickle of interest since our introduction. That is now picking up as intermediaries delegate the risk to professionals.”

The use of ETFs should naturally grow as discretionary managers control larger chunks of intermediary money. Although new products have opened up a range of asset classes, they have also created their own problems for advisers and their clients. Jamieson said he is talking to Morningstar, the London Stock Exchange and providers to develop standardised categories and segmentation along the lines of the mutual fund industry IMA category structure. “It will help consumers and intermediaries make their choices more easily,” he said. 

Julian Hince, responsible for the intermediary business at iShares, said its own classification system already serves it well, while advisers have plenty of categorised ETF search facilities across institutions involved with the industry. However, he said at the moment advisers are more concerned about their eventual status under the RDR. They are studying and sitting exams to obtain the correct qualifications, rather than fretting about the products they will ultimately offer to clients.

Hince explained: “They can be independent or restricted. At the point of sale, a restricted adviser cannot sell a product that is in his limited range but unsuitable for the client.” In other words, those opting for lower qualification standards may actually have to pass on clients if they cannot offer them the right product; second best will not be permitted.

Restricted advisers will not have to consider the whole of market, including ETFs, but may want to if they would like to retain their client base. Hince said: “If advisers are considering being restricted, they need to keep their spread as wide and flexible as possible. So there will still be a home for ETFs even in the restricted market.”

The FSA’s most recent policy statement said a potential 15% of the IFA market may opt for restricted status. Whether that means by number of firms or by number of intermediaries, it still represents a substantial chunk of the market, said Hince.

Wrap and platform access

The regulator is also looking at wraps and platforms. These already dominate IFA distribution of open-ended products but have lower penetration rates for other vehicles. 

Hince said iShares has experienced annualised growth of 200% on wrap platforms such as Transact and Ascentric, which do not take a cut from product providers. However access through the bigger fund supermarkets, which currently account for 75% of mutual fund sales, is still some way off. 

“The issue is being addressed. The FSA platform paper calls for the end of rebates to fund supermarkets which lends itself to ETF development. Cofunds and Skandia have already said they will move to explicit unbundled models,” added Hince.

In the meantime, mutual funds are beginning to offer an easier route to access ETFs. iShares already offers a fund of ETFs in the Netherlands. There are plans to roll the vehicle out across Europe although no decision has been taken about the UK market as yet.

However such developments, whether regulation or industry-led, may not be enough to convince the doubters. Harry Katz of intermediary firm Norwest Consultants said the industry should and could be doing more to bring down access costs.

“As an IFA, I cannot deal directly in ETFs. I have to use a wrap platform, but that just adds costs. I can give a client advice, tell the investor to get on the internet and find a low-cost alternative, but that is not the point,” he added. 

Katz said an investment trust, being a quoted share that does not pay commission, looks and feels like an ETF in certain regards. The big difference is that he can deal directly with the investment trust, keeping costs to a minimum. He added ETF providers are directing him to wrap platforms, rather than engaging directly. 

ETF access routes

Others are already pressing ahead. Christopher Aldous, CEO of Evercore Pan-Asset, thinks his range of model portfolio funds of ETFs appeal to advisers still wanting commission and to those looking to outsource their investment decisions.

“There is a problem for IFAs when clients pay a fee and they use a wrap platform but are not a natural ETF or index selector. We have provided a factory-gate priced discretionary process that has attracted £30m in assets under management,” he said.

Each Evercore Pan-Asset fund is risk profiled and fits particular themes, such as the ‘Pacific Shift’ or for clients requiring income or growth. Platforms offer similar model portfolio capabilities, but advisers have to create and then manage these themselves, said Aldous. 

With Evercore’s products, the funds already exist and asset allocations are managed on a daily basis with low costs built in, as only ETFs are used. The four portfolios have an annual fee of 0.25%. These funds are only available on the Ascentric wrap platform, which takes a further 0.25% per year, plus additional charges for Self Invested Personal Pensions (SIPP) or bond wrappers. For these charges, advisers and clients get full portfolio management, factsheets, monthly commentary and proactive information in times of uncertainty, volatility or market shifting events. 

For directly held ETFs, the FSA platform review will likely force the hands of Skandia, Cofunds and Fidelity Funds Network, and will lower access costs across the industry. In the meantime, major providers such as Deutsche Bank are concentrating on educating non-wrap advisers. “They have to open a brokerage account which means lots of paperwork and valuations and lots of hassle,” said Manooj Mistry, head of db x-trackers UK.

He said developments such as Proquote will at least help optimise pricing, particularly for long term investors who do not need intraday liquidity but want the best dealing price. These investors are likely to make up the bulk of intermediary clients, buying into the low cost passive theme rather than dealing in and out of indices on a tactical basis. Private client stockbrokers such as Brewin Dolphin already use the service and it should become more popular as platform access improves. Mistry added: “It is already RDR friendly.”