Bruce Moss from eValue FE reviews the RDR and explains why there are already problems looming just six months into the new regime.
Achievements of the RDR so far
Prior to the arrival of RDR much of the focus of advisers was on professionalism and obtaining a Statement of Professional Standing. This was obviously the first requirement because without this an adviser would have been unable to operate beyond January of this year. Following this, however, it was imperative to think through the implications for the business.
The central question everyone was asking was: what would be the impact on advisers of having to charge customers explicit fees? The widely held consensus was that retail customers would be reluctant to pay fees and, even those not scared off by the concept of paying for advice, would expect to see an enhanced service. The outcome was thought to be inevitably fewer customers receiving advice and pressure on margins.
This then was the common ground. The differences came to the fore when advisers considered the impact on their own business and the extent that they needed to change their business models. Some advisers were already charging fees. Others were confident that their service was appreciated by their customers or that the relationships built up over the years would stand them in good stead. Others segmented their client base and considered different service levels depending on propensity to pay fees.
Some attention was given to improving efficiency but this mainly focused on the advice proposition rather than improvements in IT and inter-connectivity. Centralised Investment Propositions (CIPs) have been seen as the answer by many firms of advisers and networks – in particular, the use of risk-rated funds has grown dramatically.

A warning from the travel business
Risk-rated funds have been seen as a simple solution to the challenge of ensuring that investment recommendations match customers' risk profiles and continue to do so without the need for the adviser to undertake continuous rebalancing.
Their use enables the advice process to be straightforward and cost efficient. This is obviously an important attribute when, post-RDR, customers have to agree explicitly to pay for the advice they receive. All the adviser has to do is get a customer to answer a risk questionnaire, discuss the results with the customer and select the fund matching the agreed risk profile. What could be simpler?
Sadly, although an advice process focused on the use of risk-rated funds is efficient, it has some serious adverse side effects. It is a dangerous simplification to map investor risk profiles from a psychometric risk questionnaire to a single fund for each profile. The approach takes no account of different investor goals, completely ignores any existing investments held and potentially concentrates risk by allocating everything to one fund manager.
This approach to selecting "suitable" investments has also downgraded the role of the adviser at a time when the industry should have been seeking to demonstrate to the investing public the value that an adviser can add. This "dumbed down" advice proposition has a good chance of "killing off" the advisers using it. Because the process is so simple, it could be undertaken online by customers themselves. All a customer has to do is answer a risk questionnaire which identifies the appropriate risk-rated fund or model portfolio. Direct offers of this kind have already begun to appear.
There is a good parallel to be drawn with what happened to travel agents. Those doing little more than booking flights or simple package holidays have largely disappeared. The survivors specialise in tailor-made holidays for customers who want something out of the ordinary. Advisers need to follow the example of the surviving travel businesses which have moved up market. Instead of simply recommending a risk rated-fund, they should offer a bespoke portfolio management business. Interestingly regulatory pressures are also pushing them in this direction.

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Regulatory dilemma from the FCA
Advisers are facing unprecedented challenges currently. Not only has RDR forced business models to change but the regulator (FSA/FCA) has raised the bar by following up the guidance on risk profiling and investment suitability with guidance on replacement business and CIPs.
Recently the FCA has provided further clarification that, where advisers are reviewing clients' investment portfolios, any recommendation of a risk-rated fund must take account of the rest of their portfolio. This means that the risk rating of the fund recommended by an adviser as part of a portfolio review must take account of the riskiness of the rest of the portfolio so that overall the revised portfolio is suitable for the customer.
It is known that the FCA is very concerned about "churning" and has made clear that recommendations to sell a customer's entire portfolio simply to match his or her risk profile will not be acceptable.
Advisers carrying out portfolio reviews for their clients will therefore have to review the entire portfolio before making a replacement recommendation. A risk-rated fund matching the customer's risk profile will generally not be acceptable unless the adviser has clearly restricted the advice to a particular product or new money only, for example a new Isa investment.
Advisers therefore find themselves caught in a dilemma:

• They want to offer their clients a high value added portfolio review service but the cost of the detailed analysis required to review each investment and make recommendations taking account of retained investments, is currently unattractively expensive.
• The alternative of moving all or a large part of a client's portfolio to a risk-rated fund on the grounds that it will ensure that the portfolio will remain in line with the client's risk profile, while cheaper, carries considerable regulatory risk and furthermore seems to diminish the role of the adviser.

It seems therefore that there is a pressing need for advisers to improve their wealth management propositions as this is unarguably an area where they can add considerable value.

Advisers' mood for RDR reality
We recently carried out a "pulse" survey of just over 200 advisers to gauge their mood now that RDR is a reality. We asked them five questions to get their thoughts on whether RDR was turning out as they expected.
The table above summarises the results. We have separated out what we have called the pessimists (defined by answering at least one question negatively) who represented 52 per cent of the sample. The survey results showed that this group have experienced a noticeable change in sentiment. In general the pessimists had been more optimistic ahead of the arrival of RDR and were now much less so.
While the survey sample is quite small and it was taken only three months after RDR's arrival, some interesting conclusions can already be drawn from the results.
The pessimists would seem to be finding it more difficult than they expected. For a large number of advisers (35 per cent of pessimists and 29 per cent of the total), it is not certain that their businesses will remain economically sustainable.
Independent advisers are finding the going tough and see their independent status as under threat.
The feeling that RDR has not been positive for the consumer has grown substantially.
The questions above on whether service propositions are highly valued, the need for further refinement and the regulatory requirements for portfolio review, are closely related. It is worrying that overall about a quarter of advisers surveyed, have concerns.
But maybe many more should be worried given the difficulties, highlighted earlier, of providing a cost effective and compliant portfolio management service. Anecdotally, there is evidence that some advisers are moving all or most of their clients' portfolios into risk- rated funds on platforms. If so, there could be problems further down the road with the FCA.

How advisers can overcome problems
It is early days but some things are becoming clear. In the run up to RDR surprisingly little was done to improve the underlying efficiency of the advice process.
Many firms took the decision to simplify the advice process by using risk-rated CIPs. In retrospect this may have been the wrong solution as it has created the potential for regulatory problems and has "dumbed down" the advice proposition. In reality, the industry must come to terms with the fact that most consumers who are prepared to pay for advice will have existing portfolios – the best parts of which will need to be incorporated into advisers' recommendations. Delivering bespoke investment portfolios together with an ongoing review and rebalancing service is a high value added service which should command fee levels commensurate with this value.
Software solutions exist to review existing portfolios of products and funds and to rebalance them together with new products and funds to match client risk profiles. Links between advisers' back office systems, portfolio review and management systems and preferred transaction platforms can deliver efficiency and highly valued customer services. Online access by clients to view their funds and to engaging planning tools would also enhance an adviser's client proposition.
The more price sensitive clients could undertake some of the "administrative" work themselves online, for example answering risk profile questions and completing factfinds, referring to their advisers only on the most important planning issues. Multi-channel advice is a key component of making advice affordable and available to as wide a section of the population as possible.
There is much that remains to be done to address the challenges posed by RDR. As an industry we have barely begun. Our survey shows that many advisers will struggle to maintain a viable business. It is probable that out of this period of change, some large advisory businesses will emerge. These businesses will have the scale to invest in the technology to deliver high value services at a price which consumers will be prepared to pay.