Sententia Articles January 2020

In this issue

Platform Consolidation - is it over?

Ever since platforms started operating in the adviser space in the UK around 2000, the big institutions have taken the stance that ‘you need deep pockets to play in this space’. But this was always a nonsense spun by local management of these firms intended to capture the market for themselves. The way things have actually played out is the polar opposite of that spin...

Sequencing Risk

Is it time for financial planners to revert to tried and tested ways to mitigate sequencing risk for retiring clients...but now through a revolutionary on-platform solution?

Cloning your CIP for Efficient Segmentation

When the FCA’s Product Intervention and Product Governance Sourcebook (PROD) rules came into force two years ago, it became necessary for firms to be able to demonstrate how they ensure products are being distributed to an appropriate target market. This means Advisers must differentiate between different segments of clients, understand their individual needs, and know how these needs can be effectively serviced. The administrative burden of delivering this segmentation can be lessened by technology that allows firms to quickly and easily modify their Centralised Investment Proposition (CIP) for different clients...

 

Platform Consolidation - is it over?

Ever since platforms started operating in the adviser space in the UK around 2000, the big institutions have taken the stance that ‘you need deep pockets to play in this space’. But this was always a nonsense spun by local management of these firms intended to capture the market for themselves. The way things have actually played out is the polar opposite of that spin, with many of the newer players thriving, as evidenced by recent very successful IPO activity and the institutions exiting the market. The most recent exit, Zurich, is part of a global financial services institution with a market capitalisation on CHF60bn. Others include American Express (market capitalisation US$ 102bn), Macquarie (market capitalisation AUS$ 49bn), Axa (market capitalisation Eur 60bn) and Legal and General selling Cofunds (market capitalisation £18bn). Clearly the pockets weren’t as deep as management had hoped and the shareholders eventually got fed up losing money.

There have now been around seven or eight exits and by our calculations there are at present 15 platform providers competing in the independent advised platform market in the UK. In fact some of these might be much more accurately described as Discretionary Fund Managers, whilst others derive a lot of their business from institutional sources. We don’t think that the market is saturated or over-supplied and believe that consolidation is now more or less over for the foreseeable future, but there are still notable exceptions of major institutions losing substantial sums and these must be at risk of exit.

This brings us on to the question of platform due diligence for advisers. When choosing a platform, possibly the most important considerations should be whether the platform is viable and whether it has a long term future. The deep pockets argument can only go so far as shareholders always want a return on capital in the end. Therefore, as we see it, a sensible and crucial part of conducting due diligence on platforms would surely be  to ask for a clear statement on the profitability of the platforms under consideration, without falling for platitudes and smoke screens. The larger organisation may be termed the ‘parent’ but it’s just business in the end: the institutions will not give guarantees to support a loss-making operation indefinitely. The volume argument has clearly been exposed for what it is and evidenced as flawed by the sale of the biggest player in the UK.

We must thank you, our platform users, for your continued support as we have seen a 6.5% increase in sales in 2019 over 2018 against an uncertain market where sales in this space are generally down. Our accounts are as yet unaudited but will indicate a stable future by showing a healthy increase in profits over 2018, without increases in price, despite this being a year in which we have invested substantially in technology with the delivery of a new web front end in Adviser Zone. The recent election has at last provided some measure of clarity in the political situation - albeit that Brexit still hangs over us - but all the signs and predictions are that the UK is set to enjoy a period of strong growth.

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Sequencing Risk

Is it time for financial planners to revert to tried and tested ways to mitigate sequencing risk for retiring clients...but now through a revolutionary on-platform solution?

Most of us won’t forget the shock and subsequent euphoria on hearing that pensioners would now have greater choice than just annuities, when the then UK chancellor George Osborn delivered ‘Pension Freedoms’ through The Pension Schemes Act in 2015.

This followed on from the Retail Distribution Review (RDR) in 2012 which had already raised the professional standards within the UK advice market. Since then advisory firms have done a fantastic job in developing their business models to build centralised investment propositions to meet ­­different clients’ needs, with the additional impact of Mifid II and PROD latterly pushing advisory firms to segment their clients into more definable profiles, for pre and post retirement.

However, whichever investment model has been put in place, sequence risk is still the main danger: the timing of withdrawals from a pension plan through flexi-drawdown could have a negative impact on the rate of return, taking it below that needed by the retiree to ensure they don’t run out of money in retirement.

Sequence risk is, for the most part, just a matter of luck. If you retire in a bull market, your assets may grow enough to sustain a subsequent downturn. Conversely, if you retire in a bear market, your assets may never recover from the initial losses, creating doubt as to how long a retiree’s assets would last them in retirement.

Convention dictates that when a client retires an adviser analyses their spending requirements, dividing them into essential and discretionary items. Once they have done this, they then divide income into two elements – guaranteed and investment-linked. Guaranteed income includes items such as state pensions, pension payments from final salary schemes or even old style guaranteed annuity plans.

For some clients, the guaranteed income from a state pension could be more than their essential expenditure requirement, but at around £8,500pa that’s unlikely for most individuals. So if there is a shortfall, advisers need to use some of a client’s retirement savings to cover their essential spending shortfall.

Investment only solutions?

Traditionally investment diversification has been used to combat this issue, as retirees reduce their risk levels in retirement, but low returns in fixed interest assets due to a continuing low interest rate environment have compounded the issue, further depressing portfolio returns.

So for some investors, the lower risk approach hasn’t delivered sufficient returns.

Now some clients and financial planners will be happy to take more risk if the retiree has excess pension wealth or other non-pension wealth, but for those clients who don’t and whose capacity for loss is therefore low, i.e. any adverse losses to their investment portfolio will affect their standard of living…for clients like these, what are their options?

  • Invest in cash and hope you don’t outlive your withdrawals?
  • Invest in a lower risk portfolio and accept lower long term returns?
  • Invest in a higher risk portfolio and hope you don’t experience a downturn like we had in either 2000-03 or 2008-09 when you first retire? 

Impact of sequence risk?

Put simply, a loss on a portfolio coupled with income withdrawal and ongoing costs and charges could leave a client in a desperate state after just one year in flexi-drawdown.

An example is shown in these graphs. Portfolios A & B have the same annualised return (5.57%) over a 25 year period, but different (opposite) sequence of returns:

Portfolio A: Poor returns in early years; Good returns in later years

Portfolio B: Good returns in early years; Poor returns in later years

Yearly Portfolio Returns

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The effect of sequencing risk in decumulation (withdrawals) contrasts with accumulation, for in decumulation sequencing risk has a material impact on the terminal value. This is because regular withdrawals, combined with poor initial sequence of returns (i.e. portfolio B) deplete terminal value, and the portfolio size is smaller when taking advantage of good returns in the later years. In decumulation, sequence of returns results in different journeys to different outcomes.

Portfolios in Decumulation (4% withdrawal rate)

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Protecting Against Sequence Risk

But there is another way and it’s one that comes to light when we consider that it may be time for financial planners to revert to tried and tested ways to mitigate this risk for retiring clients…. but this time through a revolutionary on-platform solution.

What if an adviser could combine the best investments through an established UK Platform along with the best income rate that a specialist annuity provider can offer?

In reality the only way to completely remove sequencing risk and to protect a client’s essential income requirement - making sure they can always pay their bills in retirement - is to guarantee that proportion of their income.

Actually, you can now combine these options through a Novia platform SIPP, giving clients enhanced flexibility on the level of income they withdraw in their lifetime, but with the certainty that it will never run out.

Through this solution, financial planners can manage a client’s essential and discretionary spending requirements through the same SIPP account, so the client gets one consolidated income payment. Some of the advantages of this approach are shown here:

  • Retirees will never stop receiving income in retirement
  • Financial planners can provide a single solution through the Novia platform matching the client’s secure and flexible income requirements
  • Financial planners can apply for Guaranteed Income online via the Novia platform, through a simple health questionnaire to get personalised terms
  • Financial planners can then invest the remaining money into the firm’s model portfolios or into around 3,500 assets available through the Novia platform
  • Retirees have the flexibility to suspend taking income payments, with income paid out by the Guaranteed Income asset then remaining in the SIPP, giving them complete control

So maybe it’s time for our industry to move on from the euphoria of Pension Freedoms and to protect clients against the risks of retirement and combine their essential and discretionary spending through this unique UK on-platform solution providing both flexibility and peace of mind.

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Cloning your CIP for Efficient Segmentation

When the FCA’s Product Intervention and Product Governance Sourcebook (PROD) rules came into force two years ago, it became necessary for firms to be able to demonstrate how they ensure products are being distributed to an appropriate target market. This means Advisers must differentiate between different segments of clients, understand their individual needs, and know how these needs can be effectively serviced. The administrative burden of delivering this segmentation can be lessened by technology that allows firms to quickly and easily modify their Centralised Investment Proposition (CIP) for different clients. 

Did you know the clone functionality on Novia’s Model Portfolio Manager tool (MPM) allows you to recreate a ‘core’ model at the press of a button, meaning you can easily personalise your CIP for your clients in an efficient manner to meet their needs? 

This gives you the flexibility to create a modified version of your core models for your clients’ benefit, allowing for additional preferences/exclusions in keeping with their appetite for risk. Traditionally this would be time consuming but you can make the most of Novia’s technology to do this with ease using the clone function, driving efficiencies across your business. 

MPM enables Advisers to take full administrative control over their model portfolios, creating and managing them online. Once established, the model asset allocation and investment composition can be changed at any time providing excellent flexibility and without any Novia switching charges. 

MPM is linked to existing analysis tools so that Advisers can research assets at the point of construction, perform portfolio scans on completed models and carry out Portfolio Performance Reviews on specific clients. There is an instant submit, with no “overnight refresh” so Advisers can build portfolios then use them straight away for their clients.

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We hope the Clone function creates greater ease and efficiency for your business. As always Novia will continue to monitor regulatory changes and listen to your wants and needs to inform further development plans.

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