Observer: Platforms drive change in research culture

In the good old days, research was usually the primary determinant of what appeared on recommended lists.

The universe of investment opportunities from which this list was selected was all the retail funds available. There were a significant number of independent dealer groups with their own in-house research teams. Research houses did not have the influence they have today and were not even used by many of the independent groups.

There were other commercial issues that impacted on the funds recommended — such as investor/planner demand, commission levels, and adviser support — but these were generally considered after a research view had been determined.

Today, most planners and planning groups primarily use one or possibly two platforms, and their universe of investments is determined by the investments that appear on that particular platform.

In some cases the whole list seems to be the recommended list — in others it is a subset of the list. Unless they have significant funds under advice, most planners and even planning groups have minimal say in what appears.

The approach to research has changed significantly. Major dealer groups, particularly those owned by larger organisations (which is now most of them), are scaling back in-house research and buying more external research.

Even the external research houses have a fairly limited role in determining many platform lists, although they tend to be heavily involved in working directly or indirectly within these lists.

This is heading to the point where most ‘in-house’ research today involves only one or two people with more of a vetting and compliance role, packaging and passing on this external research.

From a business perspective, much of this makes sense. There is no point replicating basic research many times across the industry.

However, while some research houses do a good job, the economics of the research business mean that to be profitable they have to generate generic reports, focusing on the mainstream and popular products and become subject to a range of commercial pressures and conflicts that may distort recommendations.

The bigger problem stems from a disconnect between what investors are ultimately looking for (and what good research should provide) and what most platform providers are seeking.

Investors primarily want (or at least need) investments offering good (absolute) returns, sound building blocks for lower risk portfolios (including uncorrelated assets), and advice or assistance in structuring these portfolios.

Some illiquidity in their investments is tolerable, as long as they are rewarded with higher returns or lower risk.

Platform providers primarily want popular products offered by more established groups that they can be confident will attract good inflows. They also want easy administration, ready liquidity and, increasingly, shelf space or management fee rebates from fund managers.

Platforms want good investments as well, but they have become secondary considerations. The platform is, after all, in the business of growing funds under administration. Planners should not be under the misconception that investments on platforms are ‘good investments’ simply because they appear on these lists.

Not all the investments that make sense for building sound portfolios easily fit some platforms’ business criteria. Many are reluctant to support smaller and emerging fund managers. They are also reluctant to support any new or innovative asset classes, particularly if they are more difficult from an administration perspective, such as hedge funds.

Nevertheless, they have become the framework from which most planners have to build client portfolios. While platforms have helped advisers’ businesses enormously, one has to question whether they provide all the necessary tools to construct the highest quality portfolios.

Some platforms understand this and, partly to distinguish themselves, have been more willing to add innovative funds and investment types. Platforms’ approach to investment lists seems to be developing into two broad approaches — those looking to offer as many products as possible and become ‘supermarkets’ and those offering a more concentrated list. Of course, there are many in between.

Within the concentrated model there seem to be two types.

There are those that still have a heavy emphasis on research issues in determining the funds offered. These tend to be dominated by one dealer group, for example, The Portfolio Service/Bridges and Lifespan.

Then there are those with investment lists more heavily determined by business issues. These tend to be platforms offered by larger financial services organisations with strong ties to distribution or the new breed of mandate funds, for exampleColonial First State(CFS) First Choice. The so-called ‘baby wraps’ are also similar to these.

These latter platforms are driven by the cost benefits that can be achieved by using investment mandates across a smaller number of more mainstream and popular managers.

While this is the most efficient way to structure large portfolios, most of the savings from such products is going to higher trails and to the platform itself. However, while such platforms do a reasonable job of providing simple mainstream portfolios, they fall well short in providing sufficient building blocks for more innovative and lower risk portfolios that many are seeking today.

The ugliest model is where the platform list is concentrated and selection is determined by business issues alone. This is more likely to be the case with the large financial services groups with tied distribution.

In one recent case, a fund manager’s product was dropped off a platform list because it refused to pay a recently introduced basis points shelf space fee on all pre-existing funds under management. How can a platform that determined its available investments like this possibly be working in the interests of investors?

Beyond the lists themselves the key issue is the greater need for assistance in building and ongoing management of quality portfolios. Most platforms have a product, not a portfolio construction focus, leaving portfolio construction to the planner.

Unfortunately, the history of the largest cash inflows and outflows to various asset classes and managers at almost the wrong time shows that the planning industry does a rather poor job of investing clients’ money.

The first response to this has been the growth of model portfolios, with platforms introducing facilities to rebalance and restructure portfolios relatively easily. This approach is not very tax or cost efficient.

There can also be significant delays to implementing such changes because of the need to get the client’s consent. As such, those developing these model portfolios tend to adopt a much more ‘set and forget’ approach — an approach that is questionable in today’s dynamic investment and industry environment.

These inefficiencies have led to the introduction of the full ‘implemented research’ portfolio solutions, also known as multi-manager funds or fund of funds. The key distinction here being whether the underlying investments are mandates or wholesale funds.

While the fund of funds does not have the same tax and cost efficiencies as the multi-manager funds using mandates, it does have many of the other benefits (professional control and ongoing management) and has greater flexibility to invest in a broader range of investments.

While these solutions have mostly been provided by asset consultants, there is pressure on research houses to also offer them.

Some platform providers are also providing these funds themselves (for example, CFS First Choice), usually with external asset consultant help. Unfortunately, there is not a lot of variety in this space.

A particular problem for platform providers is that the increased use and availability of these ‘implemented research’ funds actually risks undermining the premise of platforms themselves. If investors are only using one fund for their whole portfolio and this provides adequate asset and manager diversification, why would they need a platform?

In practice this is generally not the way they are being used. In some cases more than one multi-manager solution may be appropriate — if one could find those with quite different approaches. Alternatively, these funds are often used as a core or complement to an existing portfolio.