Written by Richard Bacon, Head of Business Development, Shard Capital
I believe that the UK retail wealth management industry is about to be very rudely awakened from its slumber of the last thirteen years which is when the Global Financial Crisis happened; wealth managers, IFAs and their clients are heading for some very difficult conversations over the next 12 months.
In the context of wealth management, I fear something unpleasant and largely unexpected lurks below the water line for many retail investors; and my concerns are focused on the ever increasing take up of “Model Portfolio” solutions over that post GFC period.
In 2020 and 2021 these products took 25% and 26% respectively of retail flows, and that doesn’t account for existing investors being migrated into these low-cost solutions. Money has been flowing into these products from all areas of the retail market, advisory and bespoke DFM.
Their rise in popularity is born out of the aftermath of the Global Financial Crisis. At a time when consumer sentiment was understandably crushed, investment businesses sort to repair that trust and distance themselves from the “greedy banker” that most considered guilty of causing the event. Equally the regulator had to be seen to respond, creating an environment where discretionary investment managers were discouraged from taking risk at a corporate and individual level and security selection for retail clients was further restricted.
Changes that encouraged the introduction of more generic, low cost investment solutions that could be applied uniformly across the various risk categories. And finally, central banks conspired to create financial conditions where all assets moved higher as QE and stimulus policies took hold and backstopped the market.
This combination provided the perfect backdrop for what we know as “MPS” to be born. What followed was a thirteen-year period of investment managers launching ever cheaper, uninspiring investment solutions that could briefly claim the crown of being the cheapest on the market having shaved 0.02% off its nearest competitor. Until of course the following week when someone did it to them.
However, this was a unique period of central bank policy, which provided a unique environment for these products to thrive and for fees to become the headline grabbing, primary battle ground. You could, with confidence, direct your clients to passive dominated, low cost MPS funds and look thoroughly heroic as the market marched steadily higher with very low volatility. Why would a retail investor want for anything more?
But memories are short, and the winds of change are firmly upon us. We find ourselves at a very transitional point economically speaking. Central bank policy has changed fundamentally from 12 months ago, inflation is high and climbing, rates are responding, energy prices are rising, and conflict and geopolitical tensions abound. And, of course, on top of all that we are nursing the excessive debt we have accumulated post the Global Financial Crisis, both at a government and consumer level. The era of “cheap money” is facing a hard stop.
The immediate and midterm future looks to be very different, almost unrecognisable, from the recent past. And that low-cost investment solution that has served us so well, is now dangerously exposed to downside risk, and could make for a very uncomfortable experience
over the years ahead. Therefore, a successful investment strategy going forward cannot be one that tracks an index down, rebalances periodically, and compounds that by not harvesting opportunities at the lows when markets inevitably overreact.
A successful investment strategy over this period needs to be dynamic. It needs to be actively managed in a way that protects client’s capital in the downturns and takes advantage of mispricing in those brief moments of opportunity. It needs to embrace the opportunity volatility provides, to bolster returns in a “low return” environment. Moreover, it needs to find those islands of safety. Those specialist sectors that can buck the prevailing trend, such as biotech or robotics.
However, that approach is more research intensive, more responsive, and more “hands on”. As a result, it comes at a higher fee than investors have come to consider the norm. It requires investors to revaluate what “value” really means when it comes to outsourcing the management of their money. It needs “performance net of fees” to be prioritised over “headline fees”.
2023 will see the beginning of this trend, assuming further market stimulus doesn’t intervene. Retail investors will begin to question the rational of an investment product that saves them 0.05% per annum when the index is moving around 1% per day. The consumer will begin to demand greater downside protection and a strategy that uses the volatility to its advantage rather than being a passenger to its undulations. As this new era unfolds, active investment management will begin to reassert itself, clients will demand a great degree of personalisation, and a broader array of underlying securities will need to be considered.
As history tells us as with geography, society, fashions etc pressure builds slowly and change happens quickly. MPS solutions have broadly been very successful for retail investors, and importantly, for the large national DFMs that manufacture them. But rest assured, they are a product or their time, designed against a unique period of economic conditions.
