Establishing suitability: keeping up with the regulator Part III -  Research and due-diligence

By Kaavya Dijendranath

Updated on Friday, 4 November, 2016

Assessing suitability involves a great deal of judgement by Advisers on the appropriateness of an investment option for the client in front of them. In order to make the right decisions and get favourable client outcomes Advisers need to be competent in the nature of investments and have a deep understanding of the individual product or service they are recommending. To do this, they need to conduct objective research and due diligence of the options in consideration. In its recent thematic review on the matter, the FCA said that, reviewed firms which demonstrated good practice in assessing suitability had research and due diligence as a central function of their advice process, demonstrating that they had the client’s best interests at heart.

However, the regulator was also quick to point out that some firms lacked structure in their research and due diligence processes which meant that the results were not always up to date or challenged adequately. Linda Woodall, Director of Life Insurance and Financial Advice at the FCA, says that “Research and due diligence is one of the three pillars of getting advice right’’. She acknowledges that the poor quality of an advisory firm’s research and due diligence is one of the three root causes of poor consumer outcomes.

So how can Advisers conduct effective and compliant research?

The need for independent research

Whilst many Advisers use independent research, an increasing number of Advisers currently rely on the use of fund research tools on platforms for this purpose. Whilst one can understand the benefits of cost and time efficiencies this provides, it might not help Advisers answer the FCA’s repeated calls for an ‘impartial review of the market’ to drive suitability. The answer simply lies in the early guidance published by the FCA (Retail Distribution Review: Independent and restricted advice and Assessing suitability: Replacement business and centralised investment propositions) which highlights the use of ‘third party’ tools or asset allocation software to create fund panels or models.

Independent third party solutions are purpose built to offer Advisers the ability to undertake fully objective and independent due-diligence. These tools alleviate the need to trawl multiple sources for ‘whole of market’ data, providing Advisers a single resource to understand and evaluate various investment types.

The importance of getting it right

Even with all the research in the world, the onus is still on Advisers to pick the right individual instruments for their clients, even in the most complex of situations. Independent research software providers like FE, understand this and offer Advisers tools to evaluate investment universes and conduct granular research on ‘readymade’ investment options like Multi-Asset and Model Portfolios as well as traditional options of funds (UT, OEICS, Offshore, Pension) and Investment Trusts.

Below we explore these in more detail.

Funds: FE offers Advisers instant access to over 300,000 instruments via FE Analytics. Used alongside powerful filter tools, users can shortlist funds based on predetermined criteria like ratios, costs, ratings, investment focus or a variety of other characteristics. Once shortlisted, Advisers can dig deeper for more detailed research on the breakdown (asset, sector, geography) or review weighted performance points during time periods of choice.

Multi-asset: The FE Adviser Survey 2016 found that 89.5% of the respondents intended to use a ‘readymade’ investment solution in the next 12 months. Of particular note was the significant interest in multi-asset solutions with 37% of the respondents planning to commit at least 10% of client funds into the unitised portfolios. FE Analytics offers users a specialist Risk Targeted Multi-Asset Universe that gives close to 500 multi-asset funds a risk rating based on their designated FE Risk Score. The RTMA universe holds 5 sectors based on the unitised portfolios’ volatility relative to the FTSE 100. The risk levels are actively monitored and funds are reassigned to different sectors if the risk scores move and remain outside of their assigned risk band for more than 16 weeks. The sector breakdowns offer a great starting point for research into the solutions.

More research on Multi-Assets >>

Model Portfolios: With hundreds of providers available today, how do you choose the best fit for your individual client? Good practice from the Personal Finance Society suggests looking at key elements like background to the DIM (sic. DFM), their people, reputation, financial standing, structure, approach to TCF, detail on their approach to investment management and performance, all fees/charges and management information.

This level of detail in information was almost impossible for an Adviser to compile (over 89% of advisers in our DFM survey found it impossible to find this information), but now Advisers can access this data on FE Transmission and go one step further by conducting bespoke comparisons between the providers they use to select the most suitable option for clients. With the ability to review the models at a holdings level, Advisers are also able to satisfy the Regulator’s guidance to verify the due diligence taken by model providers on the underlying investments.

Ongoing suitability

Suitability due-diligence is a fluid and ongoing process. The regulator encourages ongoing assessment of investment instruments and platforms to ensure they continue to meet clients’ financial objectives. This further reinforces the need for a robust, independent research solution for the centralised storage/record of a verified audit trail.

Written based on guidance from FCA papers:
Retail Distribution Review: Independent and restricted advice  
Assessing suitability – Research and Due Diligence of products and services
Assessing suitability: Replacement business and centralised investment propositions