...is what the FSA could be taken to imply in their Platform Paper (CP10/29) with comments such as: “It remains important that an adviser carefully considers the objectivity of any tools provided [by a platform provider]” and “If an adviser is going to use guided architecture or model portfolios, we would expect the adviser to take steps to ensure these tools are unbiased”.
So, how does an adviser decide which elements of a planning tool could be biased, and what steps can he or she take to ensure they are objective?
To answer this question first requires an understanding of what the planning tool is designed to do. In general, an investment planning tool has a huge number of settings that require considerable judgement and diligence when configuring. Each could be used to favour certain products over others, such as the assumptions for:
The more blatant biases are those that unduly guide the customer towards their own products, or lean toward certain asset sectors that a provider is trying to promote. But the next step is to look at each assumption in more detail, starting with investment return assumptions as an example. The FSA is not favourably inclined towards those who use the maximum COBS assumptions (5%/ 7%/ 9%) without taking account of the underlying investments held, and therefore provide ridiculous forecasts for defensive funds, such as cash/bond funds. Likewise, any planning tool that ignores the actual investments the customer is using is very likely to be misleading.
Then there is the elephant in the room of investment assumptions around risk. Even if a planning tool uses sensible return assumptions, the investment risk (that is, the chance of poor returns and/or not meeting future goals or liabilities) is arguably even more important. It is extremely misleading to give the impression that high risk assets are more likely to meet the customer’s goals unless the advice also demonstrates the effects of risk. Investment risk, in the form of volatility in asset sector returns, is a fundamental part of diversification and building efficient asset allocations. The risk assumptions will drive the asset allocations and these need to be based on sound principles and data. At Distribution Technology for example, our Quant team keeps our models constantly up to date and we employ two fully qualified actuaries, as well as a PhD and an MsC to do so.
And of course there is the issue of how a planning tool uses other long term economic assumptions about the future. The main factors that affect a customer’s financial future are:
Whatever assumptions are used, they all need to be objective and independent in order to present fair results to the user. The way that planning tools implement the assumptions is equally important (such as, assuming monthly contributions grow with inflation or not, or assuming the person saves future surplus income) as this can have a major impact on the outcomes from different products. Therefore, assumptions have a dramatic effect on whether the customer thinks he or she can meet their goals using a particular product and could easily be used to bias the outcomes from the planning tool.
Because the UK economy is in a low-return environment with low interest rates and low inflation, the impact of fees and charges on the customer’s outcomes has never been more important. Advisers need to be aware that the total charges could tip more cautious portfolios into negative ‘real’ returns once all of the various charges are deducted.
It’s easy to see why planning tools might be under pressure to understate or even ignore some fees. There are valid arguments why the advice and administration services should be treated as separate value adding services, and may be incurred irrespective of what the customer invests in, but great care and disclosure is required to satisfy TCF rules here. At the end of the day, if they are deducted from the fund, then they impact the client’s ability to meet his or her goals.
Finally, are there any other assumptions that could be seen to make a planning tool biased? The answer is yes – for example, any tool will need to model product behaviours. This could include assumptions around how future contribution limits keep pace with inflation (such as ISA limits, Annual Allowances, Lifetime Allowance), future tax band increases, selected retirement age, annuitisation age, etc. It could also include assumptions on State pension benefits (in particular, the State Second Pension, and Nest accounts), and eligibility for and quantum of State bereavement benefits. Even simplified financial planning tools must make implicit assumptions around all of these issues.
Finally, the FSA’s Guidance Consultation paper on “Assessing Suitability: Establishing the risk a customer is willing and able to take and making a suitable investment selection” issued on 6 January must also be mentioned. It highlights amongst a number of points that the requirement for objectivity is also critical, when assessing whether a customer is able to accept the risk of loss of capital at all. For example, point 1.8 identifies that firms are expected to have a “robust process to identify customers that are best suited to placing their money in cash deposits.”
All of this means there are plenty of ways in which a planning tool could become less objective. As a result and in line with the FSA guidance, advisers need to satisfy themselves that the tools they are using come from reputable sources, the assumptions are based on sound principles and practices and that they are reviewed by experts.
20/01/11
