For some time now, consolidation has been a key theme across the entire financial services industry, driven by the simple economic logic of operational gearing.
In any efficient business, as revenues increase, profit margins should widen. This happens because once the fixed costs of that business have been met, the only deductions from revenue will be variable costs, those directly related to the unit sale. So in theory, the larger the business, the more the fixed overheads can be shared and controlled, creating greater opportunity for profit.
In the investment management sector in particular, fixed costs have risen sharply in two main areas. Firstly, they are facing an increased regulatory burden which impacts both directly on costs and indirectly, through for example, increased reporting. Secondly, there is the need to embrace technological solutions, both to assist with transactional efficiency as well as to assist exchange of information and interaction with clients. These changes represent increases to fixed cost and therefore, the minimum size that a business needs to be to in order to clear a profit has also risen.
Discretionary fund managers (DFMs) have been particularly affected. Their traditional service is delivered face to face and is client specific. At the extreme it offers no economies of scale in a situation in which every piece of work is uniquely tailored for each customer. They also have higher capital adequacy requirements which have to be provided for.
So it is not surprising to see announcements from DFMs setting minimum investment levels of £100,000-£150,000 for individual clients and a shift in focus to servicing the mainstream or mass market. The strive for efficiency has led to the proliferation of discretionary managed model portfolios which offer immense efficiency savings to the manager as well as the adviser, allowing them to service increasing numbers of clients and at a reduced cost, harnessing the power of operational gearing into their businesses.
Consolidation within this sector will continue and as it does the discretionary fund managers that remain become larger and more powerful multi-skilled organisations. Their brands will continue to evolve and become stronger with the aim of building loyalty and trust. From this perspective the adviser needs to feel very comfortable with his referral relationship and be confident that client loyalty will not flow away from his own firm.
Advisers will also face far less choice, with fewer providers of cost-effective model portfolios on offer. However, the real risk to advisers is that their investment proposition to clients becomes far less differentiated in terms of service and added value, resulting in cost comparison being the major factor considered by clients when selecting an adviser.
Insourcing investment expertise along with a custody and reporting service, still brings with it the cost efficiencies but by taking back ownership of their investment process, advisers can ensure that they remain in control of their business and the client facing brand.
