Who has benefited most from the host of new regulation to hit advisers in the past few years? I would say discretionary fund managers running model portfolios on behalf of intermediaries would be near the top of that list.
It came from an unexpected direction, but the FCA’s platform market study last month gave those managers a jolt of reality to temper their remarkable asset growth.
Not only did the regulator find that model portfolios held on platform were hard to compare and that fees varied greatly, it also criticised similarly labelled model portfolios for leaving investors vulnerable to very different underlying assets and volatilities in returns.
Whatever happens next, it has certainly added fuel to those who argue that while outsourcing to a model portfolio solution can free up advisers’ time, it has been used by some as a lazy shortcut to avoid going through a full investment due diligence process.
Keeping portfolios on a set of tracks designed to keep the returns profile predictable is laudable, provided the tracks are not pointed in the wrong direction, or warped to start with.
Words like balanced, cautious, growth, income, conservative and aggressive should actually mean something in investment language. We can’t dilute the terms so much that a cautious investor ends up going on the financial equivalent of an adventure holiday. But nor can we get so tied down in the semantics of how risk across a pool of funds is described that we abandon any kind of recognisable linguistic labelling.
You can imagine a knee-jerk reaction to all of this could be to introduce a whole host of further hybrid terms to the investing lexicon to describe the profile of model portfolios. Few advisers would want to have to explain to a client why they are recommending a change to a “cautiously adventurous” or “income balanced” portfolio approach because their provider had introduced another five classifications of risk to fill the gaps.
But while there will always be an element of subjectivity in descriptions of risk, the FCA is right to note that the difference in many cases between advertised and real volatility potential in model portfolios really can be significant in some cases.
Yes, some variation is inevitable, but can we really say the current terms are serving the end client when two portfolios described with the same label are allowed to be as low as two and as high as 10 on a risk scale?
The FCA does not have to give primacy to any one risk rating tool in order to weed out these anomalies. It does not have to say that a particular tool sets the standard and portfolios described in a certain way must only be so because they fall into the risk bracket that tool would prescribe.
But it can come down hard on obvious mislabelling. It can consider placing some kind of limit on cash, equities, property and alternative investment positions, say, in portfolios described under certain risk categories.
Advisers and clients alike might be closer to getting what model portfolios say on the tin when that happens.
Justin Cash is editor of Money Marketing. Follow him on Twitter @Justin_Cash_1