Risk-averse advice costs investors
New rules are leading advisers to recommend wrong options to clients. Kate Hughes reports
Sunday 23 December 2012
F ears are growing that investors could be missing out on thousands of pounds in lost returns because their financial advisers are too worried about regulation to recommend riskier investment options.
Despite painfully low rates on "inappropriate", cash-based choices including savings and bonds, huge numbers of advisers are afraid to suggest equities that could be far better suited to long-term investors, according to a new study.
Research from business consultant BDO warns that more than a quarter of the UK's independent financial advisers are increasingly recommending investments that are completely wrong for many clients. And the problem is set to get much worse in the new year. Almost 90 per cent of advisers said equity-based products such as equity individual savings accounts (ISAs) were appropriate for investors looking for long-term growth. But despite this, 26 per cent would be pushed to recommending cash-based products regardless of that fact because of a raft of recent regulatory developments.
The imminent Financial Services Bill introduces two new regulators in place of the current Financial Services Authority (FSA), part of which is expected to place greater emphasis on investment risk.
"All financial regulatory changes are politically driven and politicians are desperate to maintain the UK's global leadership in financial services," says Alex Ellerton, the director of BDO's risk and regulatory practice. "The vast majority of changes are focused on banking regulation without adequately considering the role of the investment adviser."
As a result, hundreds of advisers have warned that consumers expecting advice that places their best interests front and centre will instead find far more money goes into cash-based vehicles which appear less risky but which offer rates that are lower than inflation.
"It's wrong for any adviser to err on the side of caution for fear of censure by the FSA if their client actually needs exposure to some form of risk investments," adds Patrick Murphy of chartered financial adviser Zen Wealth. "But many people think risk is only about how volatile your portfolio is. There are several forms of risk that could erode your personal wealth including liquidity or how easy it is to get to, and diversity. The biggest risk though, particularly to those who only hold their money in cash or near-cash, is inflation."
For example, if £10,000 was placed in a savings account in December 2000, you would have needed an average interest rate of 3 per cent every year since to have the same "purchasing power" today. In other words your £10,000 would now need to be £14,181 just to tread water as the cost of goods and services increased by more than 41 per cent.
Currently, the best instant-access savings rate is around 2.2 per cent gross every year or the best instant-access cash ISA offers an annual 2.5 per cent tax-free. Today's Retail Prices Index measure of inflation stands at 3.2 per cent for October 2012, up from 2.6 per cent in September.
But even locking up your cash for the medium term won't necessarily solve the problem as the leading four-year, fixed-rate bonds are only around 3.5 per cent before tax.
Experts also warn that just because a product offers low returns doesn't make it risk-free by default. Corporate bonds in particular, which appear to guarantee a better rate of return than straightforward cash savings, vary dramatically in safety.
"You really need to consider how financially secure the company is – in other words, what the likelihood is of getting your money back," says Adrian Lowcock, a senior investment manager for Hargreaves Lansdown. "Smaller or at-risk companies like high street retailers may not be a great idea."
Equity-based options that offer a higher reward for a higher risk are not only more much more likely to beat inflation but could also lead to a significant increase in value as that growth compounds over the years.
And even in challenging markets, there are opportunities for growth. We're regularly told that past performance is no guarantee for future returns but it's worth noting that over the past three, turbulent years the UK mid-cap sector (with the FTSE 250 up 13.1 per cent), US equities (the S&P 500 is up 11.7 per cent), and high-yield funds (up over 13 per cent), have all performed strongly according to figures from Barclays Capital.
In fact, fund manager Rathbone says it expects FTSE returns of around 5-6 per cent in 2013 but warns that it also expects equity volatility levels to rise next year.
Mike Kellard, the chief executive of Axa Wealth, argues that the flight from equities may not all be one way. "More than regulation, financial behaviour and investor psychology lead to many lost opportunities," he says, arguing that people's natural inclination is to pull their money out of long-term investments when the markets are going down – the exact opposite of what they should do.
"If something is cheap, people will normally buy it, but the opposite is true of equities. There's almost a climate of risk-averse, anti-equity feeling among consumers at the moment. And yet the professionals see now as the right time to buy."
Independent Partners; request a free guide on NISAs from Hargreaves Lansdown
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