The FSA has thrown a spanner into the works of some advisers’ plans with its comments on DIFs in last week’s RDR paper. Of course, the industry has been aware for a couple of years now that the FSA had some misgivings ever since a speech by Dan Waters in which he questioned the consumer benefit and the consumer risks of the funds.

It has now backed up this warning shot with a statement of regulatory intentions. Advisers with DIFs will not be able to charge more for them than for other fund recommendations. But did the industry see this coming?

Having written up some of the sessions from a big IFA meeting at the end of last year, I was struck by the fact the majority of the practicipants saw a discretionary management service as pretty much the end game for new modellers and certainly for many if not all of their clients.

Most of the advisers involved in the discussion were new model already. Some of them extolled the benefits of a series of model portfolios perhaps sub-contracted to firms like say Brooks Mcdonald or constructed and policed by OBSR.

But a few of the rest regarded the distributor influenced fund, though they didn’t like the name, as pretty much the sort of service which a complete, all singing, all dancing new model IFA should offer.

Now the FSA has come and said that as part of the RDR, advisers must not charge more for DIFs than other fund alternatives. How this works in practice may not be quite clear but it may be a tall order for some advisers to meet this requirement, giving that extra work and infrastructure tends to support the DIF funds. Indeed, I wonder how easy it is to divide out the cost of the DIF for cost comparison purposes say with the cost of recommending Jupiter Merlin or Thames River or indeed an Investec cautious managed fund. 

Therefore I think it is pretty safe to say that the FSA has at least slightly altered the final destination for independent advisers and thrown what you might call a medium sized spanner in the works and the business plan.

I suggest this may all arise from two distinct views of DIFs.

First the benign view held by at least some advisers and DIF advocates.

Advisers increasingly offer a fee or fee offset service. Their primary offering is advice, advice on tax planning and the achievement of life goals with fund management as a tool serving to achieve those goals, whether capital appreciation or capital preservation with whatever level of income is necessary, appropriate and achievable.

The key drivers in constructing such portfolios are asset allocation and risk modelling, the aim as far as possible to exert much more control over the fund management process than would be possible say with a series of funds.

Discretionary management of some kind seems to fit this model. Indeed its usefulness has been underlined by the fact it allows more control and immediate decision making in a global crisis. It should in theory allow the adoption of defensive,  asset-preserving positions. The answer in some advisers’ minds would be a DIF, allowing maximum control, choice and hopefully the ability to screw down the  cost of the asset management. 

In summary – the best, most cost effective client solution complete with the appropriate levels of diversification but with strategic and tactical freedom to cope with difficult markets.  

Now the malign view.

The world has changed and advisers can no longer rely on what was the traditonal largesse of big providers in paying large commissions, or not for much longer anyway. With the world and his wife preaching that trial based or, even better, fee charging businesses are more profitable and sustainable and the regulator due to enforce this change anyway, advisers set up distributor influenced funds, to allow them to garner a greater share of the margin. This helps with the day to day business of generating income in that there are at least two bites of the cherry, for advice and for fund management or at least for some of the supervision and construction of those fund management arrangements. It also helps increase the value of the business were it to be sold as clients are doubly bound to the business. Put simply it is a lot stickier than say businesses that talk of elusive concepts such as ‘funds under influence’ whatever that means. Consumer choice is wide only if they chose the IFA’s oeic – the adviser pleads that they have choice of the full asset range but there is a suspicion that some of the fund management or asset allocation management is amateurish.

In summary – broker funds revisited without the upfront charges but with unjustifiable fees.

Two views. Which is correct? Is it a mixture of the two or does the benign view override the malign view? Or does it depend on the motives of the businessess involved – a case of good DIF, bad DIF. Is there an argument to say this is an FSA overreaction to a legitimate business strategy that also serves clients.

I sense advisers will split on this but I have a few thoughts.

First for firms that have built most of their offering around DIFs it is a huge challenge to change direction.

Second, the FSA does not appear to have total faith in the ability of adviser charging to completely empower consumers when talking to advisers.

Third this could see a lot of top end advisers try and get around this by adopting the restricted label.

Whatever the case, it will be very interesting to listen to the arguments over this in the next few weeks and months though I must say I haven’t heard any  DIF advisers jumping to their own defence as yet. Perhaps quiet diplomacy is the preferred route or perhaps there is nothing else to be said.

There were two events in investment markets in the last two years that were firmly predicted. The first, made a long, long time ago, or so its seems, before the financial world went mad – sorry before it become clear that the financial world had been mad for some time – was that commercial property values were going to head south. The second, around the start of last year was that corporate bonds were due a boom, which they have subsequently had.
Now I am going to be careful here. I don’t want to start pretending to be an analyst. There are some worrying signs that some financial journalists increasingly believe they can predict markets.
But I would argue that models haven’t really worked in this case. Or am I wrong? Is that a short term view?
In the first instance, on commercial property, it was particularly unfortunate, because just as modelling was moving beyond its early adopter phase into a broader market or certainly the broader part of the top end of the IFA market, advisers were vulnerable to being accused of ‘asset allocating downwards’. A lot of portfolios had more than ten per cent, there were mutterings of 50 per cent, though I would love to see the stress testing on those models.
Memory serves to suggest that Peter Hargreaves and Mark Dampier were spot on about this. Actually at the time, I wrote a leader column urging caution though I wish it had been a bit stronger. Maybe along the lines of ‘New Star is wrong about this’.
Anyway sticking with models, portfolios would also have missed out on what can only be described as stellar returns on corporate bonds last year. They were almost indiscriminate returns as everything rose.
There is also the issue of correlation i.e. when everything correlated. Those who needed the money fast may well have been in trouble but hopefully even over a relatively short time period, assets recovered enough. It does show however that even a broad spread of assets doesn’t mitigate against all risks particularly if a specific target date is involved and that date coincides with an unprecedented financial crisis.
So where does this leave the models?
Well I reckon there are probably three lines of argument.
First, there is an argument that models need to get more tactical. But exactly who decides? When does certainty about the prospects for an asset class shade into opinion and the very thing that models were supposed to avoid i.e. amateurish market timing.
Second, perhaps models are of limited use or certainly if used dogmatically. It may be that the better option is discretionary or a decent multi-manager certainly if properly married with a client’s attitude to risk and goals in life.
Third, perhaps the models are still doing their jobs long term even if it may seem month by month that they are overdosing on downside or underdosing on the upside. They are still much, much better than picking a different flavour of the year each Isa season by looking at the performance tables.
I am not sure about the answer on this. However I do think we need a debate about this, i.e what happened, do models need updated or not and perhaps most importantly are advisers prepared to stand behind the system they are advocating. At very least, enough dust must have settled by now for the discussion to start.

The leftwing papers have got their underwear in a twist over David Cameron’s decision to share a platform with Nassim Nicholas Taleb.

The Lebanese American market trader and free thinker made headlines for expressing his dissatisfaction with Barack Obama’s decision to put up his taxes. Taleb is a bit Darwinian in his economic thinking. He also remains unconvinced that global warming is the result of man’s actions. Personally, I think he is wrong twice. For all that he may well deserve a huge salary because of his hard work, there are plenty on Wall Street who do not, and also make it their business to pull up the drawbridge and keep others in the States poor. The undeserving rich – bankers – as opposed to the deserving rich such as entrepreneurs, should pay their share. As for man not affecting the planet, that is easily seen off too as an argument – as in what about the Ozone layer? 

Anyway. I digress. 

Where Taleb, who is certainly a candidate for cleverest man on the planet, is correct is in his assessment of risk. His books Fooled by Randomness and The Black Swan, basically argue that it is almost impossible to predict cataclysmic events. Collectively we are lulled into a false sense of security by all manner of things and people including statisticians, actuaries, politicians and journalists. We cannot anticipate Black Swan events. This refers to the fact that Europe, Asia and America did not believe there was such a thing as a black swan until Australia and its black swans were discovered or of course as the Aboriginals would argue rediscovered. 

Only a fool, maybe one fooled by randomness, would argue that we haven’t suffered a black swan moment with the credit and banking collapse. Taleb argues that we cannot prevent downturns. We can only equip society to deal with them better.  

I think he is correct. Much of what might be called his investment philosophy – though he would probably hate the term – is his assessment that while markets on most days are pretty likely to go up, they are also slightly likely to go down a great deal. 

His answer to investing is to take several big bets – sort of like trying to find the next  Microsoft – and keep the rest in cash. 

Lots of what he says make sense. He has certainly got a lot of actuaries in a spin. But I have yet to hear an answer from portfolio planners. They can be evangelical in their advocacy of the benefits of asset allocation and risk assessment. Yet many portfolios proved badly equipped to deal with the Black Swan. Oddly, if you weren’t with Lehman Brothers or with some Keydata plans, structured plans actually may have been better equipped. (Who says I’m always against them).  Anyway the issue should be discussed, yet apart from IFA, investment expert and journalist Chris Gilchrist, I yet to hear anyone doing so. Many IFAs’ businesses and people’s savings may depend on porfolio planning. But Taleb has issued one of the strongest intellectual challenges to it in years. What if portfolio planning is merely received wisdom rather than actual wisdom? Otherwise, it may well be the only show in town – but one that is as prone to unexpected events as anything else. But whether Taleb is correct, his views on markets should be addressed and either rebutted or incorporated into planners’ thinking.