It is hard to pinpoint the date when model portfolios began to take hold as popular propositions for advisers. The Retail Distribution Review (RDR) certainly had an impact, and Markets in Financial Instruments Directive (Mifid) emphasised that.
But given reports claim that the annual rate of growth over the past five years has been over 10%, meaning the total assets involved are approaching £300bn, there are clearly other factors at play. Cost is certainly one of them but, and let’s be honest here, so, probably, are optics – it must be hard for anyone to recommend a single fund and claim it needs a great deal of ongoing attention.
Top of the to-do list
It is therefore unsurprising that the Financial Conduct Authority (FCA) has announced a review of the sector; in fact, I’m a little surprised it has taken this long to come to the top of the to-do list.
The regulatory dilemma around model portfolios is that they are, well, unregulated. Although, to the layman, they can look a lot like a multi-asset fund as there is no prospectus, no Depositary (and they often act almost like a quasi-regulator) and no Corporate Director.
In fact, the only real control that surrounds the service is things such as brochureware that is produced by the manager in that it is clearly imperative that what is delivered is what has been offered. Providing fair, clear and not misleading information remains a vital requirement.
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But, of course, there clearly isn’t any form of guarantee that the governance structure around funds will preclude any problems arising. The Woodford saga is the most egregious example of recent times, but one doesn’t have to look too far to come up with a much longer list of funds not turning out to be quite what they were purported to be.
Area of review
In its ‘Dear CEO’ letter last week, the FCA did not go into great detail on the nature of its planned ‘multi-firm’ review, but one can safely assume it will involve the areas which would be addressed in any assessment of authorised fund providers.
They would include governance, risk management, adherence to limits, conflicts of interest etc. – there is nothing new in that list – but one might also expect a close lens to be trained on assessments of value, which seem to have taken a very different route to those required of authorised funds.
Since Consumer Duty required such assessments to be carried out, generally rather than just for these services, I have seen numerous statements that say little more than ‘We reviewed our service and concluded that it provided good value’. That just isn’t good enough and I struggle to see how, or why, anyone would wish to place reliance on such a bland statement with minimal detail.
In the absence of formal governance, I believe it will be advisers who will have to take responsibility for monitoring portfolios to make sure what they have advised their clients to invest in is what is being delivered. Of course, the primary onus is on the provider, but they will not be the ones sitting opposite underlying investors explaining what went awry should that happen.
There are some very simple boxes to be ticked in terms of, say, eligible instruments, but I would suggest that questions should be asked at an early stage if performance is diverging materially from reasonable expectations.
This degree of scrutiny is, for me, not only necessary, but should be a real-world acknowledgement that genuine pre-investment due diligence is extremely challenging (impossible?) to achieve. In my time working for product providers, which goes back more years than I would care to remember, I can only recall one firm, a network with real clout, conducting what I would call due diligence – that is actually testing the questions rather than asking them and filing the answers. Very few advice firms are in a position to do similarly, and it would be very challenging for providers to service.
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Those firms are making active (not in the investment sense!) choices of where their clients should be invested, and they must have both initial and ongoing confidence that they have made the right choice.
Conclusion
What output might we expect to come from the review? There could be extreme enforcement action, but I have no reason to foresee that. I hope that some examples of good and bad practice will be made available because I am sure that most participants would appreciate the sort of guidance that tends to constitute regarding regulatory expectations.
The FCA’s growth agenda suggests new rules may not be a priority, and one hopes that is the case. There is no doubt that model portfolios can provide good value for investors, but experience tells me that some won’t.
David Ogden is head of compliance at Sparrows Capital
