On 1 February 2021, the FCA’s ‘investment pathways’ were introduced and while consequences are keenest, in this context, for non-advised investors, advice firms and their clients too are not unaffected.
This regulatory development can be spun as a risk to firms potentially losing valuable new business. Or an opportunity for firms to separate themselves and showcase the value of their service.
What are ‘investment pathways’?
To recap, why has the FCA introduced ‘investment pathways’? In short, post-2015 and pension freedoms, the regulator is worried people will lose out on income in retirement through a marriage of poor decisions – i.e. holding cash – and lack of access to investments.
Cue, ‘investment pathways’ to give individuals in pension drawdown access to simple, good-value investments broadly matching income goals. People entering drawdown or transferring to a drawdown account will now have three options:
- Choose ‘investment pathways’
- Choose their own investments
- Stick with investments they already have
If they pick ‘investment pathways’, pension providers must now offer customers four new options, designed around four, broad retirement income objectives:
- I have no plans to touch my money in the next 5yr
- I plan to use my money to set up a guaranteed income (annuity) within the next 5yr
- I plan to start taking my money as a long-term income within the next 5yr
- I plan to take out all my money within the next 5yr
Pension providers will offer investors a single investment solution, depending on which pathway they choose. Okay. But how does this affect advice firms and their loyal clients?
Implications for advice firms
First, providers must offer options to both advised and non-advised customers, so clients of advice firms will be aware. Second and perhaps more important, non-advised options with a 75bps anchor may well become a ‘standard’ against which regulated advice is measured.
When advising clients on drawdown investments, advisers should include consideration of pathway investments (similar to RU64 rules when recommending a personal rather than a stakeholder pension). By implication, this means they will have to outline why their recommended solution is more suitable than the pathway fund the client could have chosen.
In addition, if the adviser did not give the client a personal recommendation on the transaction to move into drawdown within the last year, the client must be taken through the ‘investment pathways’ process.
How then can firms demonstrate the higher value of the service they deliver? There are instinctively two key ways: more fully measure a client’s risk profile; and the suitability of the investment solution.
Client risk profiling
Leaving aside the risk of investment solutions being offered to people with no true account of their risk profile being taken into consideration, advisers can go further by properly assessing what we can term a client’s ‘withdrawal risk profile’.
Put simply, most accumulating clients require as much capital as possible, while clients in decumulation face more complex challenges, like income, timescale and sequencing risk.
Clients drawing down a fixed amount each month face additional risk when markets drop suddenly, particularly if that fall happens early in their retirement when the value of their portfolio is greatest. Each withdrawal taken in the aftermath of that loss, steepens the decline in value of their portfolio and reduces any ability to financially recover.
In accumulation, portfolio value only mattered at a client’s annual review. In decumulation, it matters every month when units are sold to provide income and therefore the volatility of unit price needs to be micro-managed much more, on a monthly not an annual basis.
Creating a proper retirement income plan, in tandem with a risk-based cash flow planning tool, will enable firms and their clients to map out future spending and levels of income over the full course of retirement and its different demands. What must a client spend? And what could they spend ideally if they are able to? Capacity for loss is key here.
Advisers can further demonstrate their value by adopting a more personal, client-centric approach and devising a true investment strategy for decumulation. In particular, Risk Managed Decumulation funds, which manage risk on a monthly basis and mitigate sequencing risk. The results can be startling.
In short, a client’s portfolio can last longer in retirement and which client wouldn’t want that outcome?
Ultimately, the FCA’s new ‘investment pathways’ initiative will provide people with access to simple investment solutions and lower the number holding cash long-term.
Meantime, advice firms can view this intervention as an opportunity to demonstrate the value of financial advice. Yes, ‘pathways’ here can help; but deciding which product is most efficient to withdraw from; visiting tax implications of decisions; adjusting to changing markets and changing personal circumstances all demand a skilled adviser, who can carefully analyse and recommend the best solution for the client.
How can Dynamic Planner help my clients? Find out at a special webinar this month demoing how to review a client’s portfolio and risk profile