Passive-Only IFAs and ‘Acid Test’ for Independence

I read an interesting piece in the FTAdviser last week where the author suggested that ‘passive only’ advisers may have to give up the  I in IFA as they won’t meet the test of independence in the post-RDR world.

While some advisers welcome this development, this area is a potential minefield for many advisers who recommend passive-only portfolios and it won’t be until 2013 before we know how the FSA/FCA applies the rules.

In the meantime, we need to  remind ourselves  that according the the FSA, a firm giving independent advice;

  1. Will need to consider a broader range of retail investment products
  2. Would need to make recommendations based on a comprehensive and fair analysis of the relevant market, and to provide unbiased, unrestricted advice’

Included in the definition of ‘retail investment products’ are packaged products, but also structured products, investment trusts, UCIT, ETFs  and so on.

So in order to meet these criteria for independence, what extent does an adviser has to go in their research? Does an IFA really have to consider DFMs, ETFs, structured products and UCIS for every single retail client?

I know IFAs who would never even recommend structured or life settlements products to a client. Does that means they won’t meet the test of independence in the post-RDR world?

In my view, the answer lies not just what you recommend but how you arrive at this recommendation.

The requirement is to consider, not necessarily recommend, a broader range of retail investment product.  An adviser can choose not advice on a product category on the grounds that their clients have never required such an investment or its clients’ needs have always been met by other suitable products or the firm and its clients have concerns about regulatory and compensation aspects to such investments.

However, the ‘acid test’ for independence is  this; after considering all the alternatives, if the firm cannot or will not advise on a particular product type,  regardless of its suitability for the client then its advice will be defined as restricted.’

Most ‘passive only’ advisers aren’t saying they won’t or can consider active funds, as a matter of fact they do. What they are saying is;  after considering all the possible options, they believe that passive is the most suitable approach for their clients.

Therefore, as long as a ‘passive-only’ IFA consider all the funds on the market, decide that passive is the most appropriate solution for their client, they should meet the requirements of independence.

The key is to conduct a comprehensive and a fair analysis of both passive as well as active funds and document your investment process including fund selection criteria. For instance, most of the entire active equity fund planet can be discounted on the basis of cost e.g. a search funds with TER of less than 0.4% will probably eliminate most equity based active funds.

It is also important to have a logical process as to how you deal with a new client with existing actively managed portfolio. Do you recommend that they switch to a passive portfolio in every single case? If so, on what basis? Performance? Cost? Risk?.

What if they client is sophisticated and they manage some of their own investments without the advisers involvement? How do you justify a passive only portfolio with funds-under-advice where the client has held-away assets with active portfolio? I know some passive only adviser won’t choose to only work with clients who agree to their investment proposition. If you decide not to take on a client, you may need to document the reason why?

In summary, by putting an investment process in place, advisers who favour a passive approach can demonstrate that they demonstrate that they meet the criteria for independent advice in the post-RDR world.  Here is a useful list to think about

  1. A well-articulated and documented Investment Process based on rigorous research and sound investment philosophy
  2. A Investment Committee that meets regularly, ideally quarterly to review your investment proposition
  3. Create and maintain a clear audit trail for each client, with document evidence of product selection criteria, discounted options and the reason why
  4. Where a client fall outside the normal range of your ‘typical client’ due to portfolio size, net worth, level of sophistication, greater burden of proof may be required to justify a ‘passive-only’ approach
  5. Your paraplanner (in-house or outsourced) must understand and work within your Investment Process, ideally sitting on your Investment Committee






Abraham Okusanya
Abraham is the founder of FinalytiQ, a research consultancy for platforms, asset managers, and advisory firms. Recognised as one of the country’s leading experts in retirement income, platforms and investment propositions, Abraham has authored several papers on these subjects and delivered talks to the Personal Finance Society, The FCA and several conferences across the country.

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