Cost versus value for money

Fraser Donaldson – Insight Analyst (Investments)

A high-profile industry figure once told me ‘no one will ever get fined for being expensive’. Quite a sweeping statement, but what he meant by that was that the cost of a service was not relevant unless you begin to apportion value to the individual elements of that service. So, what advisers should be looking at is value for money rather than cost.

This is undoubtedly a difficult concept to quantify and as such equally difficult to record in terms of justification to the client.

Regulator guidance

There are elements of this conundrum that the regulators have been very clear on and for this article we will start there.

The FSA (now FCA) final guidance paper FG 12/16 (Assessing suitability: Replacement business and centralised investment propositions) is where most of the answers can be found.

There are two aspects to considering charges – the first is where a client is moving from one solution to another – transition business. The second is around ongoing charges.

If an adviser has built a centralised investment proposition which includes discretionary management, or other solutions for that matter, the key considerations are:

• Recommendation to move to a discretionary service must be based on client suitability and the impact on the client must be assessed. If existing arrangements are meeting the needs of the client and are suitable it is going to be very difficult to justify transition – meaningful cost reduction could be a reason as long as there is no reduction in service, flexibility or relevant benefits
• It should be noted that the anticipation of better performance is not a reason for change, particularly if existing arrangements are broadly meeting expectations in terms of returns
• If the replacement solution is more expensive then these additional costs will only be justifiable where they are associated with a specific benefit that is valued by the client. This must be explained to the client. Of course, firms should disclose any difference in the cost in a way that is fair, clear and not misleading
• A comparison of headline annual and initial charges is not sufficient. Other significant charges must be taken into account. For instance, trading charges can have a significant impact on overall charges. This of course means that some indication of portfolio turnover needs to be discovered

There are other charging points within discretionary management that can influence overall charges, but the principle is that clients should only be moved if there is significant benefit to them.

Measuring the importance of softer issues

Now comes the tricky bit! Some of the reasons why a move or sticking put with a service is suggested revolve around softer issues, in simple terms around client wants rather than client needs. This is where client and adviser need to work together to place a value on those more subjective issues.

Consider one bespoke service with a total annual cost of 1%. Then consider another one at 0.75%. Performance is broadly the same, the ability to stick to a mandate is good in both cases and the standard services are very similar. There is potentially a case for moving from the former to the latter.

However, you know that the client enjoys the relationship with his current discretionary manager. The client is able to meet the investment manager once a year over lunch to discuss the investment portfolio and call the manager to get questions answered or concerns adressed. Perhaps the discretionary firm gives the client access to view his portfolio online, at any time, to check its progress. Let us also assume that the discretionary managers sponsor some sporting or cultural events and from time to time the client gets invited along and gets well looked after.

Now, suppose the prospective new DFM is able to deliver the same information, but through an account manager, not the guy running the portfolio. Discussions happen in a meeting room or at the client's own home (no nice lunch). Perhaps the latter will provide portfolio valuations on demand, but they need to be prepared and can take 24 hours. With the latter there is never even a sniff of an ‘event’ invitation.

The cost of the additional services provided by the former may only be, say, equivalent to 0.2% of a portfolio – in cost terms, there is a case for moving.

However, the answer lays in how much value the client places on this additional service. If a client commits significant assets, in their opinion, being well looked after and treated special may have value that far outweighs the small saving in listed charges.

Suitability is one thing – correct mandate, achieving goals, income payable at the right times of the year, etc, and these issues should be the priority. However, once suitable solutions are identified, only then do you bring in the issue of cost, and cost should factor in the subjective views of the client on what they want and a value attached to the provision of these wants.

Need for documentation

As far as cost is concerned, all this needs to be articulated and placed on file. The regulators may well ask why a more expensive solution has been chosen when on the face of it other solutions are much the same and cheaper. The answer of course will be ‘value for money’.

The regulators say:

"Firms should consider when the additional costs of replacement business are likely to make such a recommendation unsuitable. This should include considering the magnitude of additional costs and the potential benefits associated with that cost."

If all aspects, both objective and subjective, are quantified, recorded and agreed by the client the regulators will be satisfied.