Do low cost solutions have to be passive?

Diagram

* CIP = Centralised Investment Proposition
** RDR = Retail Distribution Review
*** Financial Advice Market Review

The multi-asset sector has ballooned in recent years. Its growth has had a number of drivers: the wake of the Retail Distribution Review saw advisers increasingly focus on their key skill – financial planning – rather than embroil themselves in the time-consuming and compliance-heavy business of investment.

Multi-asset solutions provide a sensible "outsource" option here. At the same time, multi-asset has emerged as a natural choice under the new pension freedoms, forming a core part of drawdown portfolios and an answer for the growing auto-enrolment market.

These emerging opportunities present a more cost-constrained challenge for advisers, especially with regulators continuing to demand more transparency on pricing and service models. The focus has been on lower costs, with passives the obvious, indeed only, choice in recent times. But is this the best the industry can do? And is this set to change?

The great DB gold rush

Pension freedoms have brought about a decline in the annuities market, and a commensurate rise in drawdown with multi-asset solutions becoming an important tool.

There has been an explosion of demand for transfers out of defined benefit schemes, with retirees drawn by the increasingly attractive transfer values on offer, and the potential to manage their retirement pot more flexibly.

Government statistics suggest that 220,000 defined benefit members have already transferred funds since 2015, including 80,000 between April 2016 and March 2017. A further 120,000 people are expected to transfer out of defined benefit schemes in the 2017/2018 tax year. The growth of the auto-enrolment market is also creating opportunities for advisers.

Diagram

Source: Mercer August 2017

Are the products advisers are choosing fit for purpose?

These changes bring increasing demand for advice, but they need to be handled sensitively.

Defined benefit transfers are already subject to considerable regulatory scrutiny, with the FCA expressing concern on the types of products advisers are choosing for clients and the costs involved. The FCA launched an investigation into pension transfer advice in 2017 and found that some of the advice investors were receiving at retirement fell short of expectations. Advisers can expect continued close supervision on the issue. The FCA's position was already well-established, saying that suitability and costs must be a priority for advisers. MiFID II looks set to build on this, pushing for appropriate recommendations, and for full, granular disclosure of charging on all investment products.

A focus on cost is inescapable

Much of the demand for multi-asset products is already cost-constrained. Auto-enrolment, for example, is restricted to 75bps, including platform and fund fees, which has made it difficult for advisers to participate. In practice, most pension products are likely to come with cost restrictions.

At the same time, advisers cannot neglect the risk side of the equation or they face the threat of falling foul of suitability rules. Mapping to existing risk models is vitally important, particularly as many advisers are using platforms to build their suitability process. Multi-asset funds must be clear on their risk parameters and ensure they align with client risk profiles.

The dramatic rise of passives

Too often the solution from multi-asset providers has been based on passive products, which limits investment choices for consumers. Passive products do have an important role to play particularly within longer-term investment portfolios where the impact of market volatility is less critical. However, there are drawbacks to this. For example, it is often difficult to achieve nuanced asset allocation from a portfolio of passive funds.

They may come with inherent biases – to large cap companies, for example, or to larger investment markets such as the US. It can be difficult to take exposure to certain asset classes.

The problem with being too passive

A reliance on passive asset allocation may create problems. It may see decisions made based on historic correlations between asset classes and past volatility, neither of which may be particularly informative about what investors can expect in future. Loose monetary policy has created anomalies that may not persist as interest rates normalise.

Multi-asset solutions need to take account of the changing risk dynamics of different asset classes over time, and changing relationships. Volatility analysis and stress testing are important, but there will also be specific risks from individual positions and strategies – how exposed is a portfolio to interest rates, the oil price, or other systemic shocks? In order to ensure ongoing suitability, and – perhaps more importantly – good, predictable investment performance, these factors have to be considered.

Advisers need a proven and repeatable, active investment process, from established teams with long track records, to give them proper peace of mind and to ensure they are meeting their regulatory and client obligations, while not compromising investment performance.

Meeting all these needs at a low cost is a major challenge.

Time for something extraordinary – a low cost active solution

The new BMO Universal MAP range strives to finally do what the market is crying out for. It offers three risk targeted portfolio options – Cautious, Balanced and Growth – designed to cover a wide range of client needs. These needs may be reliable source of drawdown income to support them in retirement; or growth the client seeks to accumulate capital. Most importantly, each portfolio is actively managed, but at low cost. Expenses are capped at 0.29% fixed OCF, with a clear, transparent charging structure. It is an institutional calibre product that is now being made universally available.

A breakthrough made possible through scale

BMO Global Asset Management has been able to launch the Universal MAP range because of its scale. It operates in more than 25 cities in 14 countries, and currently manages around £189 bn in assets for clients. It has real depth of resource in multi-asset investing, managing around £50bn globally. Its globally diversified team has long-term experience developing multi-asset options for institutional clients across the globe. Source: BMO Global Asset Management, 30 June 2017.

The BMO Universal MAP range harnesses this depth of experience and resources. For each fund, asset allocation is adjusted and managed dynamically, across global equity and fixed income markets. All three funds draw from 10 different asset classes, blending global equity and fixed income investments within a portfolio.

They invest in individual securities, derivatives, collective schemes and ETFs, with the aim of keeping costs low and delivering a predictable, long-term, inflation-adjusted return. The funds are risk targeted, and mapped to leading risk profiling tools. The process has been extensively back-tested and has been used for BMO's institutional clients for decades.

As with all investments it is important to remember that the value of investments and any income from them can go down as well as up and investors may get back less than the original amount invested.

All change

A changing market place brings the need for new and innovative solutions, yet to date investors have faced a binary choice – low cost or active. For the first time, advisers and investors no longer have to choose, but can ensure suitability and risk targets are met, within a product that is also responsive and dynamic. Extraordinary times.

For more information on our funds, please contact your usual sales representative, our Sales Support team on 0800 085 033 or at sales.support@bmogam.com or visit www.bmogam.com/adviser.

© 2018 BMO Global Asset Management. All rights reserved. BMO Global Asset Management is a trading name of F&C Management Limited, which is authorised and regulated by the Financial Conduct Authority.