Time for asset managers to really get to know their clients

Sophistication is a word brimming with connotations of refinement, experience and confidence. The image that spontaneously springs to mind is of multi-millionaire Jay Gatsby in the novel The Great Gatsby by Nick Carraway, played to near perfection by Leonardo DiCaprio in the 2013 movie of the same name.

We are not alone in making the connection between wealth and sophistication. In the financial services industry, a common assumption is that individuals further up the wealth scale have a more advanced understanding of how to make decisions in their best interests. After all, how else can we explain why they have become so successful?

High net worth individuals struggle with basic terminology

The assumption needs a reality check: end-investors from across the wealth spectrum are less confident of their financial knowledge than many professionals believe. They struggle with investment jargon, worry about risk and suitability, and are frustrated with the unclear portfolio insights delivered to them.

Critically, even at the higher end of the wealth spectrum, clients struggle with investment fundamentals. Scorpio Partnership’s research on behalf of FactSet shows that 37 per cent of UK high net worth individuals under the age of 35 cannot correctly define the term ‘volatility’. A separate study for RBC indicates that wealthy clients lack confidence in their financial knowledge.

For wealth institutions who manage clients, investor education is already a focus. And the rapid changes underway in the UK distribution landscape mean asset managers must start paying attention too.

Regulatory pressure is putting end-clients centre stage

Earlier this year, the Financial Conduct Authority (FCA) issued an update to the Asset Management Market Study (AMMS). One of the stand-out conclusions was that “Authorised Fund Managers are the agents of the investors in their funds; they are not just the product providers… [They] have not considered robustly the value they offer to investors under our existing rules.” The FCA goes on to outline several governance remedies to be undertaken, but deliberately stops short of prescribing a value framework to firms.

The regulatory pressure to improve investor understanding is rising just as the profile of the target client is changing towards younger clientele in their wealth accumulation phase. The primary driver is the unprecedented wealth transfer on the horizon, making the ‘next gen’ investor critical to future growth.

Separately, having lost access to investment advice in the aftermath of the Retail Distribution Review, the pendulum is now swinging back in favour of today’s mass affluent customers.

In response to regulatory encouragement, a host of banks have re-platformed since 2016 and launched risk-rated funds that mostly use cheap, passive strategies. New operating models are also emerging as direct-to-customer apps, such as Wealthify and Moneybox, targeting millennial earnings. In an investment landscape that is transforming rapidly, asset managers will soon struggle not only to define value to the end-investor – but to describe the target client for their products.

The commercial incentive to change tack

For asset managers, understanding investors’ true sophistication has an overriding moral dimension. From an ethical stand-point, scandals such as the recent PPI mis-selling serve as a stark reminder of the damage unclear communication and lack of understanding can cause when left unchecked.

As new insights help firms develop more targeted retail distribution strategies, there are also commercial advantages to getting closer to end-clients. For instance, fund providers can start to determine how the components of value to investors vary by wealth level. This would enable them to design more thoughtful content that is aligned to clients’ true financial sophistication levels, rather than assumptions.

Further, by understanding the relationships end-clients have with distributors, they could unpick nuances by sub-segment. The sophistication and support required by someone investing in a fund through a private bank is likely to be very different to the customer of a retail bank, or a discretionary fund manager. While the product requirements of an entrepreneur will be distinct to those of a City professional.

At Scorpio Partnership, we believe asset managers should go further than the remedies outlined in the AMMS and use this opportunity to forge closer relationships with distributors that centre on end-clients. The party may be coming to an end so – taking a leaf out of Nick Carraway’s book – firms should look past appearances of sophistication and wealth, and focus on acting as a trusted source of guidance to the investors they serve.

Tasha Vashisht is senior manager, and Giles Patterson a director at wealth management think-tank Scorpio Partnership