9 minute read
Compliance
TRANSFER TALK
The FCA has raised concerns about the sustainabilit y of pension transfer advice but advisers believe it is down to the dodgy minorit y. Rory Percival urges prioritising needs over wants
PORTRAIT BY LUKE WALLER
We are all familiar with the issues around defi ned benefi t (DB) pension transfer advice – unsuitable advice, professional indemnity (PI) cover, continuing Financial Conduct Authority (FCA) supervision and policy developments, among others. Unfortunately, I do not see any quick and easy resolution to these issues.
In my opinion, there is only one way to resolve the issue in the medium term and that is for the advice sector as a whole to raise standards, particularly raising the rate of suitable advice cases. In time, this will mean the FCA will no longer feel the need to continue its extensive work in this area and the PI cover issues will improve.
But the advice sector will not improve standards until it sees that it is part of the problem. It seems that every adviser or fi rm I speak to (or read about in the press or social media) believes the problem is down to a few dodgy fi rms – it’s not us, it’s someone else. I am completely convinced that this is not how the regulator sees it, based on my experience at the FCA, several speeches and roundtable meetings with the FCA since, as well as the regulator’s update on supervisory fi ndings from December 2018, which highlighted issues around normal fi rms just not doing their job well enough.
So, where are the differences between the FCA n the FCA and some (many?) advisers? I would fl ag three ag three areas where there may be differences:
1. Pensions are for retirement income In the context of pension freedoms, FCA supervision director Debbie Gupta recently said: y said: “Th e risk here is that people may be distracted ted from the original purpose of a pension, which is ch is to provide them with money when they are no no longer working.” Yes, the freedoms allow many ny options and great fl exibility for clients, but fi rst st and foremost, clients need an income to live off f in retirement. Or, as the FCA said: “Good advice e should seek to ensure that clients’ income needs are met, that they support their dependents and that they get to keep the lifestyle they have planned for.”
Th is is also about managing longevity and client biases. Th e FCA fl agged that the freedoms involve drawbacks – for example, the temptation to dip into the pension pot – and added: “Th is is why it is important not only to consider how the client intends to access their pension, but also their behavioural patterns and their attitude to spending.”
Th e FCA Handbook includes the requirement to consider the client’s “attitude to transfer risk” – their attitude to certainty in retirement. Ms Gupta explained: “If the client is looking for certainty of income for as long as they live, then surely this will steer your advice in one direction [i.e. keeping the DB scheme].”
2. Prioritising needs over wants Generally, a client may want fl exibility or to leave money to children, but they need an income for life. Clients may want certain things but suitability, and acting in the client’s best interests, mean that advisers must prioritise needs over wants. Clients may not see it this way, but the FCA said: “We recognise the reality of behavioural biases, that your clients might place more value on a lump of cash now and less value on an income throughout an unknown period of time. However, your role is
In time, this will mean time the FCA will no longer the FCA feel the need to continue feel the n its extensive work in this itsexten area and the PI cover area and issues will improveissues wil
to challenge those biases; to help the customer balance their immediate desires with their longterm needs. To help them prioritise what is really important and make the diffi cult but informed compromises many must make.”
I have talked before about the client’s ‘core secure income’. Sources of core secure income include state pension, DB, annuity, guaranteed third-way products and (not quite so secure) good-quality rental income. If a client has suffi cient core secure income to meet not only their fi xed outgoings but also money for discretionary spending to broadly maintain their standard of living, then this is great fi nancial position to be in. If the DB scheme is needed for this, keep the DB scheme. If a small annuity top-up is needed, recommend this (Ms Gupta referred to blended solutions).
3. Considering alternative ways of meeting the client’s objectives Th e FCA Handbook says you need to do this. For example, does the client have other assets – additional DC pension funds, ISAs, cash savings – that allow them the fl exibility they want? If so, recommend this course of action. Indeed, if the client has suffi cient core secure income, the other assets can provide real fl exibility; whereas with a transfer, fl exibility is limited by the need to ensure the fund lasts long enough. A DB transfer should be considered the last-resort way of meeting the client’s objectives and only then if this addresses their needs in preference to the client’s wants.
SUMMARY All this adds up to considering the starting point as assuming that a transfer will not be suitable and not to recommend a transfer unless it is clearly in the client’s best interests – a position stated in the FCA Handbook. But Ms Gupta was keen to point out that there are possible parallels with what the FCA says about DB transfers in retirement advice more generally.
Th e clear example is asking all at- or in-retirement clients about their views on certainty in retirement, to help shape your retirement income advice. ●
Rory Percival of Rory Percival Training & Consultancy Ltd
FALLING STARS
Following the high-profile collapse of star manager Neil Woodford’s empire, U 22 Dewi John offers some key questions advisers should ask fund managers nless you have a particular taste for the macabre, autopsies are never fun. Th at does not mean they are not necessary – and with the collapse of Neil Woodford’s fund empire, autopsy is certainly needed when it comes to the cult of the star manager. Many former stars have imploded dramatically in the past 20 years: Rory Powe, who managed the Invesco Perpetual European, stuffed the portfolio with tech and lost more than half its value in a year up to 2001; Anthony Bolton, whose Fidelity China trust lost more than a third of its value in 2011; not to mention the collapse of an entire star manager house – New Star – during the fi nancial crisis. And the list goes on. When Mr Woodford set up his own fi rm in 2014, he raised £1.7bn in a fortnight. Assets rose to £16bn but the whole thing was brought to a sorry end last year following cataclysmic underperformance, mainly through holding illiquid and unquoted stocks.
LESSONS LEARNED What, then, are the lessons advisers can salvage from this wreckage? What questions should you ask fund managers to help avoid this happening again?
1. What is in the portfolio? Gone are the days when you can look at the top 10 holdings on the monthly factsheet, nod happily at the solid blue-chip names and carry on. Th ese will most likely not be the greatest contributions to risk or return. For that, you need insight into what’s in the portfolio. Transparency is key.
2. Which stocks are the greatest contribution to risk? Any portfolio manager will know this. Indeed, it probably keeps them up at night. Ask which stocks are their greatest contribution to risk, how they are defi ning that risk (it is generally volatility), and what their investment thesis is for holding it?
3. What is your sell discipline? Understand what a manager’s sell discipline is – and do they stick to it? While many portfolio managers can be good at buying securities, they are often not so good at selling them. Managers become attached to a stock: if it’s performed well, they hope that it will continue to perform; if it’s dropping like a stone, they pray that it will rebound if they just hold their nerve.
A manager will have a standard example of their sell discipline, which they wheel out for presentations. Great. But are there examples that you can determine from the portfolio where they have not done this? And, if so, why have they not – and why have their own risk controls let them get away with it? Th ere may be very good reasons for an exception to the rule, but you need to understand what they are. And if there are too many, you do not have an investment process – the portfolio manager is freestyling.
4. How long does it take to liquidate your portfolio? Th is may well be part of a portfolio manager’s internal risk reporting – how long do they calculate that it would take to sell out of the entire portfolio? While there is no standard second-order metric, typically it is for 80% or 90% liquidation. For a large-cap developed-market equity portfolio, both metrics should not be longer than two to three days, since large caps are very liquid. However, for funds with many billions in assets under management, the liquidation
period could be longer, as they would otherwise move the market if they sell everything at once. Th ere is no guarantee that target liquidation times are actually what happens, particularly in a falling market when everyone is running for the exits, but you will get some idea of how liquid the portfolio is.
5. What is the highest percentage of a stock’s free fl oat you can (and do) hold? If a manager holds a signifi cant percentage of a company’s shares, the very act of putting money into the company will increase its share price. But the same is true in reverse: once you try selling those shares, the price will likely go into reverse. ‘Pump and dump’ is ethically questionable as an investment approach, but for it even to work, you have to be able to dump.
PRECIPITOUS FALL Getting out of a position is no easy task, as Mr Woodford discovered. He held almost a third of estate agent Purple Brick’s shares. Th at bumped their price up, but then they dropped from nearly £5 in 2017 to just above the initial public offering price of £1. He also held about a quarter of the doorstep lender Provident Financial, which had an even more precipitous fall, from £26 in 2015 to £5.80 two years later.
Th is liquidity issue is not necessarily the same as greatest contribution to risk. Indeed, if a manager is steadily buying a stock, it may consequently be rising smoothly and not seem that volatile.
None of the above will copper-bottom your fund selection – as we have discovered, there are any number of ways a portfolio can go south. But liquidity is a key issue. ●
