The speed of growth the model portfolio strategy (MPS) market has enjoyed in recent years was always likely to attract regulatory attention. Sure enough, back in February, the FCA announced it would undertake a multi-firm review, “to provide confidence that investors are receiving good outcomes from MPS and share good practice on how firms are doing this”. That all sounds reasonable enough – then again, it would not be the first time an innocent-sounding initiative has come with a sting in the tail for the financial services sector.
Some even go so far as to suggest the review could determine the future growth in the MPS market. That growth has been extraordinary, with the number of portfolios increasing 100% to more than 3,000 in just six years, according to the Defaqto Engage system. Defaqto says it has seen adviser recommendations into MPS solutions increase exponentially to a level almost equal to multi-asset fund recommendations. It is now the dominant type of centralised investment proposition (CIP), with adviser-run models in second place at 31%.
“The FCA review into the managed portfolio market has the potential to be far-reaching,” says Marcus Brookes, chief investment officer at Quilter Investors. “Low barriers to entry, differing regulatory barriers and high growth will always attract the attention of the regulator and it is important it reviews the industry in a way that will enhance it, and not stifle the innovation we have seen to date.”
Regulatory hard yards
Not that MPS providers do not already need to fulfil relatively stringent requirements. Many advisers have been drawn to the offerings because providers have large teams doing the regulatory hard yards for them.
“MPS is not regulated in the same way as a fund but, under Consumer Duty, anyone producing MPS has to comply with the rules,” points out Gillian Hepburn, commercial director of Benchmark Capital. “The MPS provider has to review target-market documentation, produce value assessments, do all the work on consumer understanding and then document it and report it.”
While that should mean the FCA review starts from a stronger place, market participants believe the review is likely to focus on two key areas – the first being assessment of value. “We may glean some insight into what is ahead based on previous reviews the FCA has carried out on the funds market,” says Mike Turner, research manager at Defaqto.
“In 2018, authorised fund managers were required to carry out regular assessments of value and produce customer-facing reports to demonstrate where value has or has not been delivered. Subsequently the FCA performed periodic reviews of the value assessments and published their findings, highlighting inconsistencies in process, failings in reporting and practices that rendered inflated value through using the cheapest share class to represent the fund.” ”
“It is rare FCA involvement diminishes the administrative burden on advisers and providers – and few among either grouping will be betting against that being true again here.
MPS providers looking to get ahead of the game should ensure their value-assessment processes are robust, accurately assess performance and have the right risk-adjusted metrics and total-cost disclosures in place,”
Turner believes a similar approach may be taken with MPS, adding: “Now that DFMs are required under Consumer Duty to carry out assessment of value, it is likely the FCA will use their vast experience of value assessment in the funds space to review the outputs and methodologies applied to assess value for money.” For him, this is likely to include a focus on the target markets, which is vital in a Consumer Duty landscape to ensure good outcomes for the consumer.
MPS providers looking to get ahead of the game should therefore ensure their value-assessment processes are robust, accurately assess performance and have the right risk-adjusted metrics and total-cost disclosures in place, Turner suggests. They will need to compare “apples with apples” by using comparators that represent the whole market in which they operate, rather than proxy markets or a cross-section of the market.
Brookes also believes this is likely to be a focus for the regulator, which will be hoping to address the disparity with funds. “It is far easier and cheaper to launch an MPS than it is to launch funds,” he adds. “Given the growing adviser popularity in MPS, this difference probably needs to be addressed in some way.
‘Race to the bottom’
“Currently, some MPS teams out there are looking under-resourced given there are no ACD requirements, as you would have for funds. Furthermore, there has been somewhat of a race to the bottom in fees and, as part of this, passive investments are increasingly being favoured to help keep that headline cost down.”
There is also a question as to whether this large passive exposure will pass muster on an assessment of value, maintains Brookes, noting: “Do investors understand that having such large passive exposures increases their concentration risk – both to individual companies and geographies? Is capacity for loss being properly considered in the event one equity region struggles compared with a globally diversified portfolio? Cost is one factor in investment selection, but risk and consumer understanding cannot be ignored.”
A second key area of focus is likely to be the operational challenges DFMs face when managing MPS portfolios across multiple platforms, which has been well-documented – not least on Wealthwise. It is clear that, while some platforms offer swift and efficient rebalancing functionality, others have more cumbersome processes, which create friction in the delivery of consistent outcomes for clients. Having made this a real focus of previous regulatory initiatives, it is probable this will draw again the attention of the FCA in the context of MPS.
It is half investment decision, half how you execute the investment decision that helps determine overall performance. Advisers and their clients are often presented with a ‘one size fits all’ factsheet or brochure, however, meaning proper understanding of performance and return drivers may be lacking.”
“In addition, discrepancies in available share classes across platforms can further complicate matters, resulting in variations in underlying holdings, total costs and performance for clients invested in what appears to be the same MPS portfolios,” Turner adds.
“This fragmentation risks undermining consistent value delivery – particularly when clients on different platforms may receive materially different outcomes.” Some MPS providers have sought to address these problems – with partial unitisation, for example – but others are relying on workarounds and quick fixes.
“The platforms you run an MPS on will ultimately dictate how it is operated – for example when and how you rebalance, what the fund choice is, whether there is a requirement to hold cash and so on,” says Brookes.
‘One size fits all’ literature
“It is half investment decision, half how you execute the investment decision that helps determine overall performance. Advisers and their clients are often presented with a ‘one size fits all’ factsheet or brochure, however, meaning proper understanding of performance and return drivers may be lacking. This becomes even more crucial when it is vulnerable customers that are being considered here.”
Ultimately, none of this is likely to change the calculation for advisers on MPS adoption. Research by Copia on the adviser market, for example, found firms running their CIP in-house spend 139 days on investment management, compared with just 32.5 days for those who outsource – an astonishing gain.
That said, the FCA review does have the potential to dent smaller MPS providers who have cut resources to the bone to offer the cheapest possible solution. It is rare FCA involvement diminishes the administrative burden on advisers and providers – and few among either grouping will be betting against that being the case again here.
“The FCA is going to seek evidence that client understanding is being achieved at the same time as quality investment management across a number of platforms,” Brookes says. “Any MPS providers that consistently underperform or are charging fees that do not meet the value criteria are likely to come under the microscope.
