Barclays: legacy trail rules may create 'moral hazard'

Legacy trail commission may create a "moral hazard" in which advisers encourage investors to stay in investments longer than they should, analysts at Barclays have warned.

A much-anticipated mass exit of IFAs in the first quarter of this year due to the implementation of the Retail Distributions Review (RDR) is unlikely, according to the analysts, but they expect a "continuous decline" of the sector over the next two to three years.

The uncertainty of legacy trail commission - and the "moral hazard" it may create - is likely to be a particular catalyst for departures, said the analysts.

"IFAs will be able to exist off legacy trail commission on those investments where they provided no new advice after 1 Jan 2013. This income can sustain them for some time, but can create the moral hazard of IFAs encouraging investors to remain in those investments longer than they should," a note said.

The analysts give three main factors to why they believe the RDR will cause a large number of IFAs to exit the industry over time. First, retail customers may "baulk" at the true cost of advice, made explicit through direct charging.

Second, exits could be due to the necessary retraining involved for IFAs to achieve the higher QCF Level 4, though the note said many of those who were unwilling to go through the education process or who decided to retire had probably already left in the past 18 to 24 months.

The third reason Barclays expect exits in the coming years is the raised compliance and legal costs of advisers remaining whole-of-market.

However, Barclays predicts a post-commission environment will spur the growth of passive investing in trackers and exchange traded funds, which typically did not offer commission.

Demand for multi-manager products, where fund selection is outsourced to a product, is also set to increase post-RDR, according to the analysts.

They also expect IFA recommendations to put downwards fee pressure on average management fee margins, as with increased transparency the analysts think it likely advisers will try harder to recommend funds at discounts to 75bps.