Mind the gap

Funds held by online investment platforms grew more than fivefold between 2008 and 2016. What are the options this market offers to investors and how can advisers get the best out of it for their clients?
by Jess Unwin

When US fund management group Vanguard announced in May 2017 that it was launching a UK online investment product commanding a fee of just 15p for every £100 invested, it caused a stir. Vanguard’s charges are less than half of the sector average, according to investment research firm Platforum. 

This raises questions about why rivals need to charge more. Vanguard’s cheapest mainstream fund – a FTSE All Share Tracker – will cost investors 0.23% a year versus 0.53% for the same fund with Hargreaves Lansdown, the UK’s largest firm of financial advisers. One explanation for the difference may be that Vanguard only offers access to its own funds while more expensive platforms offer investors access to a range of providers. 

Regardless, the spotlight on fees comes at a time when the FCA has launched a probe into whether the online investment platform market, which is largely DIY, is competitive enough. The Investment platforms market study, launched in June 2017 and reporting in summer 2018, will seek to do a number of things, including:
  • exploring whether platforms help investors make good investment decisions, and if their solutions offer investors value for money
  • looking at how platforms compete in practice and whether they use their bargaining power to get investors a good deal
  • assessing whether relationships between investment platforms and other platforms, advisers, asset managers and fund ratings providers, work in the interests of investors.
Online investment platforms used to be beyond the reach of all but the wealthiest investors. Even Vanguard demanded a minimum investment of £100,000 from direct clients until launching its new, low-cost investment service, which requires a minimum lump sum of £500 or monthly contributions of £100. In recent years, however, the platforms have grown in popularity. According to FCA figures, they held around £592bn of investors’ money in 2016 compared with £108bn in 2008.

This growth is down to several factors. The 2012 Retail Distribution Review, which requires independent financial advisers to charge clients directly instead of taking commission from product providers, has led many clients to take their investment activity into their own hands. Rock-bottom interest rates that make it almost impossible to grow wealth through cash savings have also piqued savers’ interest in investing. But as with so many other aspects of our life, the internet is the real engine behind this investment revolution. 

Before the late 1990s, buying or selling individual securities or investing in funds had to be done via a stockbroker. A cumbersome process of exchanging share certificates, contract notes and stock transfer documents often meant missing out on short-term investment opportunities. Investors had to pay commission to the broker, even if an investment lost money. 

Did that cumbersome process lead clients to stick their investments in a drawer and forget about them until the time came to sell? It’s hard to say but a Wharton School study, conducted in 2000, suggests access to an online investment platform leads investors to increase their trading activity. In a paper called Does the internet increase trading? Evidence from investor behavior in 401(k) plans, researchers found that having access to a web-based trading channel doubled trading frequency and portfolio turnover rose by more than 50%.

Technology has grown in leaps and bounds since 2000 and today’s investors can use a DIY investing platform or online broker and a wealth of online research at their fingertips to take control of their own investments – all at superfast speed. 
Access to an online investment platform can lead investors to increase their trading activity Investment platforms can be described to clients in one of three ways: do it yourself, do it with you and do it for you. The first category is self-explanatory, while the second covers providers that help investors choose from the array of securities available – this can include online brokers that have ‘buy lists’ of selected funds to help guide investors in picking the best option to suit their personal circumstances and risk appetite. These two categories are often described as DIY or business to consumer (B2C) platforms. The final category sees wealth managers and financial advisers make investment decisions on behalf of clients, matching investors with a portfolio and maintaining those investments. These advice – or business to business (B2B) – platforms are designed to be used by financial advisers and offer no, or very limited, access to clients.

A more recent service, offered by investment firms like MoneyFarm, Nutmeg and Wealthify, is so-called robo-advice. Investors select the level of risk they’re prepared to take and then computer algorithms – the ‘robo’ element – manage the portfolio.

Not all platforms offer access to funds and individual equities – some only offer funds – which is worth bearing in mind if investors are looking for a diversified portfolio of products to hold. 

On DIY platforms, individual equities are often a good option for investors who understand how to analyse the financial performance of companies and have the time to do so. Investing in funds – a basket of individual equities selected and managed by a fund manager – is the easier option. Even on advice platforms, a lot of advisers choose not to seek onerous regulatory permission to advise on investing in individual equities, says Danny Cox CFPTM Chartered MCSI, of Hargreaves Lansdown. They opt, instead, to just advise on funds. 

On advice platforms, advisers must establish the same suitability requirements as they would with any other product. Those requirements centre around a client’s financial situation, investment objectives and attitude to risk as well as the nature of the investment, its risks and benefits, and the suitability of the provider.

DIY platforms are a different matter. Here, investors make the investment decision themselves and must conduct their own due diligence. An adviser might have a duty of care to comment on the suitability of DIY investments, however, if he or she has been engaged to review a client’s entire financial situation or a part of it to which the DIY investment has some relevance.
Platform challengesOnline DIY platforms can significantly lower costs if investors make the right choice but they should be mindful of the differences in fees and charges. Hargreaves Lansdown charges an annual 0.45% administration fee for its DIY stocks and shares individual savings account (ISA) while iWeb asks for a one-off £25 payment and IG makes no charge. Fund dealing with a DIY stocks and shares ISA is free with Fidelity, Vanguard and many other providers, but others charge. For instance, Alliance Trust charges £9.99 and Share Centre charges 1% (£7.50 minimum).

Another possible disadvantage of DIY is quite simply trading inexperience. One more factor to consider is protecting investments from tax. Investors must decide if they can unlock the advantages of investment vehicles like stocks and shares ISAs and self-invested personal pensions (SIPPs) – or whether they’d be better off receiving guidance from qualified advisers.

“Investment platforms make investing easier and often cheaper for the investors,” says Danny. “For the adviser, they allow them to focus their time on the advisory issues that really add the most value to the investor’s situation.”
Choose carefullyIf opting for an online platform, advisers need to ensure they are choosing suitable products and services to recommend to their clients, Danny says. “Platform due diligence is important and advisers will quite rightly take more care given the exposure to a larger number of investors. However, the administrative savings outweigh these additional compliance costs.”

But Georgios Ercan, of investment firm Dolfin, says additional compliance costs are a factor for advisers, which makes it “almost impossible” for advisers to switch platforms – even if such a switch is to the overall benefit of clients. 

He warns: “Planners and advisers should be very careful about which platform they choose to partner. Besides functionality, cost robustness and variety of products they should ensure the platform has aligned the regulatory capital held to the underlying risks presented by their business model.”

This article was originally published in the Q3 2017 print edition of The Review. The print edition is available to all members who opt in to receive it, except student members. All eligible members who would like to receive future editions in the post should log in to MyCISI, click on My Account/Communications and set their preference to 'Yes'.
Published: 04 Sep 2017
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