Asset managers must rewrite the development process to create products appropriate for the end investor.
Investment products are famously sold, not bought. Investment managers are renowned for pushing products through distributors to be sold to retail investors. All this is done with little knowledge of how that product will meet investors’ needs.
This line of thinking is derived from the observation asset managers create products to gather assets, rather than for the benefit of the end investor. That is not to say the products are unsuitable for investors, nor that they fail to meet their objectives.
Rather, it is to criticise the train of thought used historically in product development. This has always run as follows: first, create a product; then determine how best to make profits; then find a distribution channel; and finally, justify how suitable it is for clients.
Reworking the product
Mifid II provides the opportunity for investment firms to rethink their processes, which I have perhaps rather unkindly caricatured. It may guide them to design products in the interests of serving clients’ needs.
If the train of thought can be reordered, ensuring the needs of customers are assessed first, products can then be designed to meet those needs. And if investment firms work out how best to deliver those products profitably and fairly, Mifid II will have done the industry a tremendous service. But how can Mifid II have such an impact?
The Financial Conduct Authority (FCA) requires investment managers to design retail funds for a particular segment of the retail market. This is clearly not the same as asking an asset manager to justify, or provide a rationale, as to why a fund is suitable for its chosen market.
Putting the client at the centre of product design is also enshrined in the FCA’s guidance that: ‘Consideration of target market factors should permeate all aspects of product development and distribution.’ The regulator is clearly saying the client must be at the forefront of the development of funds and services.
This is not a simple task. Indeed, it is very time-consuming to listen, rather than talk, to potential clients, and understand their needs, desires and expectations. It is hampered by the language difference between an investor and an investment professional (although this is where an adviser comes in handy). For instance, risk to the former is more about meeting objectives, whereas to the latter it is more about the variance of returns.
Tiring task ahead
Absolute return funds are a case in point. They are typically marketed as a cash-plus return vehicle. To a layman, they seem suitable for someone who does not wish to lose money.
Many are designed to provide defence against certain risks, or to behave in particular ways under different market conditions. But they can lose money over certain time horizons or market conditions. They are often complex to create. But once understood, they can provide a useful part of a diversified portfolio.
Because of their complexity and suitability for different client and portfolio needs, investment group marketers and advisers should be encouraged to understand the needs of those portfolios in more granularity. A better outcome could be to build a genuine solution to client requirements using a bottom-up, solutions-driven approach.
Re-engineering the approach to product design will lead to a better understanding of customer needs. IFAs pride themselves on knowing their clients, translating investment terminology into comprehensible English, and explaining product capabilities. Product creators are being encouraged to do similar levels of due diligence on their target market.
It will certainly add to the workload. But it should lead to better outcomes for end investors.
Symon Stickney is chief executive at Independent Strategic Group.