Guiding clients to the right choice

In how much detail should a doctor explain a patient’s illness to him? How much should the patient be expected to understand? And how far should he be allowed – or expected – to participate in choosing his treatment?

To borrow an analogy from James Bevan, chief investment officer at UK high street bank Abbey, exactly the same dilemmas are faced by the financial adviser or distributor attempting to guide a client through the increasingly complicated process of building an investment portfolio.

Open architecture is establishing itself ever more firmly in the European funds industry. Regulation is tightening its grip. Customer education is almost universally revered. Choice is entrenched in almost all fields of consumer life, from picking schools to buying a cocktail. Information on financial products proliferates from innumerable sources, but particularly from the internet.

Against this background, the UK’s Financial Services Authority has highlighted the need for generic advice. It has demanded education to boost financial literacy and facilitate informed choices, as well as provision of impartial information and advice to consumers.

Asset allocation

But Mr Bevan told this year’s PWM Open Architecture Forum: “Too much choice means confusion and disengagement.” The Forum’s chairman, Michael Harding, managing director at Mercer Oliver Wyman, warned that people in general “will not make decisions when they are confused about what they are doing”. So how much choice is too much? And what, exactly, should the distributor do?

One thing is clear: the established tendency to focus on choice of products – on picking (say) one emerging markets fund rather than another – reflects thoroughly mixed-up priorities. Guiding a customer should go much further back than that.

“As an industry in the UK we tend to lead on the product,” Stephen Ingledew, commercial director at Barclays, told the Forum in London. “That is the wrong way round.”

Rather, he thinks, banks and advisers need to help customers understand the issues around their investment. Asset allocation – not end product selection – “should be first and foremost”.

Philippe Couvrecelle, head of Natexis Asset Square, the multi-management division of France’s Banque Populaire network concurs. “I think asset allocation is the first question,” he told the forum. He cited data from the Financial Analysts Journal indicating that more than 90 per cent (93.6 per cent when the research was originally carried out in 1986) of investment performance is derived from its asset allocation.

“The second question,” he said, “is a good wrapper. Then you choose good products. It is more efficient this way. A good product does not solve the whole problem of saving expectations.”

Different product types – structured products, multi-manager offerings, fund of funds – will suit clients with different risk profiles and investment objectives. Making the wrong choice at this stage is unlikely to be remedied by careful choice of individual funds, however expert the selection, because the whole investment structure will be inappropriate for the client.

According to Abbey’s Mr Bevan, “we ignore the product wrapper at our peril”. Addressing the forum, he pointed out that being able to save “huge amounts of tax” is likely to be more important than achieving small performance gains by choosing slightly different products.

Things are starting to move in this direction. A cross-European issue, this is illustrated particularly pertinently by the UK in the current era of depolarisation and the FSA’s Treating Customers Fairly project. According to Mr Ingledew, the guidance model is shifting into line with the US and Australia.

The old paradigm, he told the forum, involved researching the market, picking retail funds, building asset allocation models and regularly rebalancing portfolios. The new model involves: outsourcing to manager of managers; constructing a portfolio in line with the client’s attitude to risk, and focusing adviser time on strategic advice.

Grasping this paradigm, and in particular utilising the all-important wrap, is, Mr Ingledew believes, the way to win in the mass affluent marketplace.

Taking and understanding risk

When it comes to asset allocation, the individual customer makes all the difference. No matter how knowledgeable a financial adviser might be, he can only guide a customer given a thorough understanding of what that customer wants from his investments, over how long, and how much risk he is prepared to take.

Individual investors, Mr Bevan reminded distributors at the forum, are unlikely to be investing because of any supposed “inherent increased propensity to save”. Rather, a potential client will most likely be prompted by: some unplanned life change such as divorce or bereavement; a third party such as an employer who has forced the issue through redundancy or employment; the fiscal incentive of a sharp cut-off date for investment in (say) an ISA; or a fashion-led attraction to the fund of the moment (technology, perhaps, or emerging markets).

Given the chance to advise such an individual, the distributor (often, by default, the client’s existing bank) has an opportunity to enhance a relationship and retain a customer. If he gets it wrong, he could lose the customer altogether.

The importance of the consumer’s risk profile goes two ways. Distributors need a clear picture of an individual’s level of risk aversion before they can suggest an appropriate asset allocation and, ultimately, select appropriate products. According to Mr Bevan, risk “has to be seen in terms of individual customer objectives”.

But, for trust to be maintained, it is absolutely crucial that clients understand the risk involved in whatever product structure and asset allocation they adopt. The key issue, for Mr Couvrecelle, “is to educate the sales force to sell risk to a client, which is very difficult”.

It is essential, in Mr Bevan’s view, that customers understand that risk is about more than day-to-day changes in the value of a product. Speaking exclusively to PWM after the forum, he said the industry needed “more relationship managers within the banks, who are trained and experienced”.

He noted, however, that the language of risk in the industry is itself unclear. Pointing to Mr Couvrecelle’s description of with-profits as “no risk”, he remarked, understatedly: “That was unusual to a British audience.” “No risk” in the sense of being underwritten by shareholders does not mean – as clients might mistakenly take it – no risk of value changes in the day to day life of a product.

Ingledew: we do it the wrong way around in the UK

If customers fail to grasp exactly what risk they are taking, the potential cost for the distributor is very high: the all-important relationship of trust. “Education and trust go hand in hand,” Mr Ingledew told the Forum. “Consumers do want choice but they want some choices to be made for them by institutions and advisers that they trust.”

The limits of customer choice

According to Mr Couvrecelle off Natexis, what matters is educating sales forces to advise customers appropriately, rather than attempting to educate customers to make all decisions themselves. In a panel discussion on client education, he told the forum: “The vast majority of our clients trust us. They buy products because they trust us.”

It is, Mr Bevan argues, unrealistic and unhelpful, to expect customers to understand every complicated detail in the building of their portfolio.

The consensus from the forum is that sales forces should be able to assess customer’s risk profiles, steer them towards an appropriate asset allocation and product structure, and make it clear to them the level of risk they are taking on. But selecting the end products for a fund of funds, or wrap, is a job for professionals – and these are not, generally, the same professionals as those talking to the customer. “Advisors’ time,” as Mr Ingledew puts it, “is best spent giving advice, not building portfolios.”

That said, there is an important distinction between aiding (or taking on responsibility for) choice and refusing to educate altogether: clients may not be in a position to make the more detailed investment choices for themselves, any more than patients have the wherewithal to pick one type of antibiotics over another.

But they can reasonably expect that the decisions made be explained to them, so far as is possible, in terms they can understand – and here, at least arguably, there is a role for the manufacturer to play in ensuring that distributors thoroughly understand its products, and they are not in danger of being mis-sold.

“I do not think the customer should be expected to grasp complex financial issues,” Mr Bevan told PWM.

“But we have an accountability to deliver products, information and advice in a manner which is intelligible and digestible by financial consumers in the same way that a doctor is accepted to explain disease and therapy in a layman’s context.”

‘I do not think the customer should be expected to grasp complex financial issues. But we have an accountability to deliver products, information and advice in a manner which is intelligible and digestible by financial consumers’

James Bevan, chief investment officer,

Abbey