LISTEN AND LEARN

As banks open up their distribution networks to third-party products, there is a growing concern over whether investors are actually benefiting from this new open architecture (OA) framework. Critics of OA believe there is a danger that this trend is just another product-led bandwagon, where distributors could end up ignoring the real needs of clients in favour of pushing those products that generate more revenue for their organisations.

In order to understand the consequences that an overly product-oriented OA framework might have on the relationship between banks and clients, we must remember that the whole idea of third-party distribution was born as a response to client demands for more sophisticated and specialised products that banks cannot always develop inhouse. The same distributors that decided to open their sales channels to external asset managers in order to avoid customer flight, could end up losing clients if they fail to stop and listen to what investors really want.

But listening to client demands is just the first step in the development of a successful OA strategy. A good listener should also respond wisely by giving the best possible advice. This is undoubtedly the most important element in the client/distributor relationship.

Advice has been a centre of every discussion regarding OA and it was one of the most talked about topics during the second OA FT OA Forum hosted by PWM in London at the end of last year. Delegates unanimously agreed that better advice is currently needed, but this can result in costs that investors are not always keen to incur.

James Bevan, chief investment officer at Abbey, said that while customers want good returns they are often unprepared to pay a premium for financial advice. “There is a big gap between what you pay and the actual cost of delivering what you expect”. For Mr Bevan getting clients to pay a sum that is often no more “than what you would pay to your doctor for a full check-up”, is one of the key challenges faced by Europe’s financial services industry.

Mr Bevan added that knowing your clients well is essential in order to meet their specific requirements when it comes to advice, service and investment products. “You have to design and deliver products that do what they say they’ll do,” he said, adding that advice should always be independent from product manufacturing. “In-house manufacture is a tough enough challenge for most distributors, but vending third-party funds involves real complexity for after-sales monitoring, advice and service.”

Mr Bevan also mentioned options that distributors have for meeting customer demands without following the OA route. “In-house managed funds of third-party funds are not open architecture, and involve practical issues of control and risk management, but can be appropriate to meet customer needs where seed capital is limited,” he explained. “Also, multi-manager arrangements with direct contracting of sub-advisers is not open architecture, but it may be preferred where there is sufficient seed capital.”

So far, the arrival of OA in the retail sector has helped the industry to partly overcome its legacy of pension and endowment mortgage mis-selling and “other generic problems of the financial services sector especially in the UK”, Mr Bevan added. “Open architecture is making overcoming these factors a little easier.”

‘In-house manufacture is a tough enough challenge for most distributors, but vending third-party funds involves real complexity for after-sales monitoring, advice and service.’ - James Bevan, Abbey

However, he pointed out other challenges that the industry still faces such as the excessively complex and insufficient advice given to clients, the poorly designed products and strategies, the hidden charges and high costs in the sector, as well as absurd performance claims and poor delivery. However, the biggest challenge of all is “putting the customer first”, he said.

At Goldman Sachs Asset Management, European head of third-party distribution Alex Fletcher could not agree more: “If you accept that the customer relationship is top of your agenda, then using other people’s fund management expertise whether that’s through the use of their funds or sub-advisory relationships or through multi-management relationships, is only a small part of the jigsaw.”

AUTOMATIC ADVICE

Mr Fletcher also said that whereas in private banking clients are willing to pay for advice, it more difficult for clients in the retail area to get all the information they need about the products on offer. “One thing that we have done with a couple of banks, which I am actually very proud of, is taking very complex financial products and packaging them in a way that the sales person has no choice but to discuss the composition that the product represents,” Mr Fletcher added.

For instance, he explained, a fund with a three-year investment horizon will be called a “three-year fund”, which forces the salesperson to explain whether this time horizon fits with the client’s profile.

Such initiatives could undoubtedly help relieve client confusion surrounding the growing choice of products on offer across the different distribution networks. Investor confusion is now of particular concern among UK industry professionals as a consequence of the depolarisation process the sector is undergoing.

Until recently there were only two types of financial adviser – independent (IFAs) and tied – but since December last year there is a third option: the multi-tied adviser, who can advise customers on products from a limited panel of selected providers.

Over the coming months it is expected that many tied advisers, including banks, become multi-tied. “Removing the restrictions of polarisation is not the only issue here,” said David Geal, associate of the polarisation and advice team at the UK Financial Services Authority (FSA).

“One of the key issues is for people to understand the value of advice and the value of service. The message that we’ll be giving to customers is that the cheapest is not necessarily the best. Surely you should look at the cost and you should also look at what you are getting for that because value is the key thing,” Mr Geal said.

“Deporalisation is not just a one-way street,” he continued. “Over time, single ties might increase choice for their clients, but we have to recognise that some independents [IFAs] might decide to restrict their offerings.”

For the new multi-tied advisers there will be difficult decisions to make concerning how many and which managers they are going to use. “They need to agree with the view of taking partners rather than products,” he said. “They have to take into account the services the fund manager can provide, because their firm’s reputation depends on this.”

Having decided that, multi-tied advisers have also to consider how long they want to be associated with the chosen managers to avoid ending up trapped in a relationship they cannot get out of. “IT is also very important,” Mr Geal added. “You need to know if the IT support available is suitable for the service you want to give to your clients.”

However, when a new adviser goes through this selection process, they must think about the role they want to play in the market place.

“Do they think of themselves as product sellers or do they want to give advice to clients with whom they wish to have a long-term relationship?” asked Mr Geal.

‘If you accept that the customer relationship is top of your agenda, then using other people’s fund management expertise, whether that’s through the use of their funds, sub-advisory or multi-management relationships, is only a small part of the jigsaw’ - Alex Fletcher, Goldman Sachs Asset Management

BOTTOM LINE

Whichever open architecture route is taken, it all comes down to good advice and the professional selection of products that benefit client portfolios and generate revenues for the banks. However, OA critics still warn of the dangerous trend of pushing products through distribution networks without the necessary professional advice on how the various investment vehicles available really work.

The increasing demand for more choice should always go hand in hand with clear and transparent information about the fees, mechanics and risks behind each investment vehicle. In return, investors must get used to the idea that quality comes at price.

“As far as cost goes, clearly alpha has a price,” said Mr Fletcher. “We charge for alpha and we are very happy to work on a performance fee,” he added.