When South Africa’s Retail Distribution Review (RDR) was announced in 2014 much was made of how it would profoundly change the financial services industry. To meet its aims of professionalising financial advice, helping customers make informed decisions, and promoting fair competition, it would require some major shifts in how products are accessed and paid for.
Five years later, the implementation of RDR has been slower than might have initially been expected. This has led to a degree of complacency in the industry – that perhaps RDR isn’t going to be so meaningful after all.
It is, however, important to appreciate the lessons from countries that have already gone through the RDR process – in particular the UK, since South Africa’s model is largely based on what has been done there.
A view of the future
“What we are anticipating in RDR is almost a carbon copy of what has happened in the UK,” says Leigh Köhler, head of business solutions at Glacier Invest. “In our world it’s almost like a crystal ball.”
If it is indeed the case that the local market will follow the UK’s path, then the future for South African financial advisory and asset management firms looks distinctly different.
“The UK is now seven or eight years post-RDR, and the market pre-RDR looked quite similar to how South Africa looks now,” says Phil Middleton, head of UK intermediary business at global asset manager Schroders.
“And you’ve probably never seen a period of such change as you are seeing now in the UK distribution market.”
One of the most significant developments in the UK has been the adoption of centralised investment propositions (CIPs) by financial advisors. This is a standardised approach to their investment offering, usually based on a client’s risk profile. It means that clients with similar needs will be given similar, if not exactly the same, portfolios.
Many advisors are also choosing to outsource the actual management of these investments. The portfolios they offer to clients are therefore likely to be model portfolios offered by investment platforms or discretionary fund managers (DFMs).
“Currently 88% of all advised assets in the UK are sitting in a centralised proposition,” Köhler notes. “Of that 49% is invested by DFMs.”
The power has shifted
The rapid rise of DFMs has been one of the defining characteristics of the UK market in the past few years. According to Köhler, there are now 110 DFM businesses in the UK. Just three of them, however, account for more than 60% of the market.
Something similar is already taking place in South Africa, where many local advisors have already realised the benefits of outsourcing their investment proposition. There are more than 40 local DFM firms, and the top four have a market share above 70%.
What this led to in the UK, and will almost certainly do in South Africa, is that the entire investment industry has become a lot more narrow.
“Pre-RDR advisors had their own investment processes selecting funds,” says Middleton. “Now it is much more centralised, with a smaller number of buyers in the marketplace.”
Instead of thousands of advisors picking funds, it is the discretionary managers who are doing so. And when a few large ones dominate the market to the extent they do, it means that a much smaller number of funds is being selected for client portfolios, which has serious implications for asset managers.
First of all, they are competing in a market where the buying power now rests with far more sophisticated buyers. DFMs are far more demanding in their research and due diligence than the average advisor or retail investor, which means that underperforming asset managers and those without a clear value proposition are being found wanting.
Fee pressure has also become severe, particularly with the added competition from passive products.
Performance fees in the UK have almost disappeared entirely.
“For active managers, it is a challenging environment,” Middleton notes.
“There is downward pressure on margins, and longevity is falling because if you go through a period of weak performance you might have a big decision maker decide to sell your product and you can see significant outflows,” he adds.
Before RDR, investments stayed within a fund for an average of five to six years. That has now fallen to three to four years.
Prepare for impact
A notable consequence of this pressure on asset managers is that the industry is going through a period of major consolidation. Barriers to entry have also risen.
“In the UK you have fee pressure, but also rising costs due to the burden of compliance and regulatory oversight,” says Middleton. “So you are being squeezed both ways. In this environment it’s pretty hard to set up a boutique from scratch.”
Tellingly, any firm looking to manage funds has also needed to meet far more onerous capital requirements and qualification standards.
This has made it far less attractive for advisors to manage funds themselves.
In South Africa, there has been an explosion of these kinds of advisor-managed funds of funds over the past decade. Their value proposition has, however, always been questionable. Post-RDR, they may vanish even more quickly than they arrived.
“Most of the advisor funds in the UK don’t operate anymore,” Middleton says. “Businesses that were doing that have either become significantly professionalised and are managing portfolios on platforms, or they have outsourced to DFMs or fund management companies.
“The catalyst was needing more qualifications, more capital, and how much they cost to run. Also, clients were getting so many other options so much cheaper.”