The FCA has published a very scary note intended for advisers recommending transfers from Defined Benefit schemes .
In its statement published on Tuesday, the FCA revealed further failings in the pension transfer advice market, the regulator said some advisors had not met its expectations over the “critical yield”, a test used by advisers to pinpoint the investment returns needed to match the benefits offered by the existing scheme.
The regulator said some advisers had been recommending pension transfers solely on whether or not the critical yield was below a certain rate set by the firm for assessing transfers generally.
“This does not meet our expectations, we would expect the firm to consider the likely expected returns of the assets in which the client’s funds will be invested relative to the critical yield.”
The Regulator goes on to demand that the receiving product is suitable to the investor.
This is scary stuff. It is only a short step away from making the advisor accountable for the outcome of the investment.
It becomes incumbent on any adviser to know the destination of the transfer payment.
It releases the trustee from the responsibility for ensuring the money is going to a sham investment where the investor will be scammed.
It effectively transfers the fiduciary responsibility for the transfer from the trustees to the adviser who- as I read things- has a stake in what happens next, if only on the liability side.
As my friend and fellow blogger Abraham is pointing out, managing drawdown to achieve a critical yield as low as some of the discount rates used for CETVs is no cinch http://tinyurl.com/zzvfdvp .
Whether you use a natural yield, total return or just rely on a 4% rule of thumb, any drawdown strategy is running the risk of what is called a black swan event. Take for example a cancellation of units at a point when the price swung against you for 500 bps for liquidity reasons or a trade executed at a point of market panic. It is not possible to predict or insure against such possibilities using unit-linked funds.
So advisers are going to be very wary about being accountable for the outcomes of the plans into which moneys are transferred.
They cannot – if they are referring to this FCA paper – simply ignore the destination, even if they are no party to it. They must do due diligence not just on the critical yield but the vehicle used to manage the investment. Cash is a no-no in terms of a critical yield, but so will many ultra safe bond strategies. Indeed the ruling suggests, what we already know, that to achieve the critical yield, the investor will have to take additional risk.
What is not clear is whether a declaration from the investor that he or she understands the risks of the drawdown product, is a proper protection for the adviser.
Linking the adviser’s reccomendation to the product used to manage the transfer is a scary thing for advisers. It may mean that the high cost wealth managment vehicles often employed are simply too “risky” in terms of yield drag, to be fit for purpose.
I suspect that IFAs will find it harder to reccomend transfers into vertically integrated SIPPS with proprietary investment strategies and easier to reccomend simple products with low transparent costs.
While the FCA paper has been taken as a means to protect transferees from scammers, I suspect it is as much a means to protect IFAs from an over-exuberant confidence in their financial invincibility.