Platforms – in a very literal sense – showcase, support or provide the launch to a destination. They are not themselves meant to draw much focus. But in the world of UK investment, one platform has found itself the subject of intense media, regulatory and customer attention in recent weeks. Sharper scrutiny of the investment platform sector – until recently, one of the stand-out growth areas in financial services – now looks inevitable.
The platform in question – Hargreaves Lansdown (HL.) – also happens to be the best-known player in a market which by the end of 2017 managed more than £500bn of self-directed investor money. Its travails have added major questions of trust and profitability to an industry whose chief pressures were confined to the possible scrapping of exit fees, and the unavoidable ebb and flow of securities markets.
Though these questions persist, so do the swelling waters which have helped lift most boats in the investment platform market. In November, in the midst of a market rout, this magazine concluded that the “longer-term trend towards self-managed investment [made it] prudent for existing shareholders to ride out volatility”, be it through direct-to-customer platforms such as Hargreaves, or an adviser-focused platform such as IntegraFin (IHP)-owned Transact. That view has been at least partly vindicated by the rebound in equities (investment platform shares included) in the first quarter of this year.
As to the future of exit and transfer fees, the Financial Conduct Authority (FCA) closed its industry consultation period on 14 June, and is scheduled to set out policy by the end of the year. Having started with the observation that charges deter some investors from switching platform providers, it seems logical to expect a shake-up of a feature which the sector has so far been able to dress up as customer loyalty and asset stickiness.
Woodfordgate
That potential regulatory shift has been given fresh impetus by a saga which has engulfed both investors and users of investment platforms. On 3 June, active manager Neil Woodford gated his LF Woodford Equity Income Fund (GB00BLRZQB71) in a bid to protect it from a wave of redemptions. Hargreaves was immediately drawn into the firing line. By keeping Woodford Equity Income in its Wealth 50 best-buy list up until the suspension, the platform had defied the growing chorus of concern at the fund’s sliding performance and liquidity issues.
In financial terms, Hargreaves’ exposure to Woodford Equity Income is insubstantial. According to the group’s response to a Treasury Select Committee probe into the episode, around £1.1bn of client money is invested directly in the fund, with a further £0.5bn tied up in Hargreaves’ multi-manager fund-of-funds range. Together, this accounts for just 1.7 per cent of total assets under management.
The reputational exposure looks far more significant. The platform has been a big champion of Mr Woodford, and cut an exclusive deal with the fund manager to discount fees attached to Woodford Equity Income at its launch in 2014. This history of promotion means nearly a quarter of Hargreaves’ 1.2m customers are exposed to the fund via direct holdings or the platform’s in-house funds.
While Mr Woodford attempts to “reposition” the fund, Hargreaves will remain entangled in the fiasco. But it is doing its best to create some distance. The group’s chief executive Chris Hill offered reassurance in the aforementioned letter to the Treasury Select Committee that there was “no commercial conflicts of interest” in its fee structure. And Mr Hill also said he had only learned that Woodford had repeatedly breached a 10 per cent limit for unquoted stocks from the FCA letter sent to the Treasury Select Committee the previous day.
The group has also waived its platform fees for direct holdings in the fund, which analysts at Numis say will equate to a £0.45m hit per month, or less than 1 per cent of annual revenues.
That goodwill gesture doesn’t mean Mr Hill is right to characterise platforms as conflict-free. Hargreaves’ business model such as fellow direct-to-consumer player AJ Bell (AJB) or wealth manager St James’ Place (STJ) works by gathering assets. For the platforms, the easier it is to market a fund (either through manager star power or discounted fees), the better: scale up, and fee income will rise against a largely fixed cost base. For fund managers, ignoring the gate-keepers of hundreds of billions of pounds of investor capital is no easy task, and is often much cheaper than marketing funds directly. And for the sector’s investors, this operational gearing is only compounded by the secular trends driving inflows and an insatiable global appetite for equities.
In Hargreaves’ defence, its best-buy list hasn’t exactly failed investors. Numis thinks aggregate performance lies somewhere between individual funds’ benchmarks and IA sector returns, which means they have been of negligible benefit to investors in recent years, but have outperformed on a longer-term view.
There’s also evidence that such curated lists tend to help investors. An FCA investigation concluded as such earlier this year. Hargreaves itself points to studies in behavioural economics, which suggest that an extremely wide or unfamiliar range of choices can stifle decision-making entirely.
However, if recent evidence suggests best-buy lists are only as good as their benchmarks, it could be argued that first-time investors could be just as well served by lower-cost passive funds and exchange traded funds (ETFs). Of course, that would be less profitable to Hargreaves. In its letter to the Treasury Select Committee, Hargreaves said it had “identified a correlation between a fund being included in the Wealth 50 list and investment flows to the fund increasing”.
It’s also questionable whether an ever-larger pool of investors is always positive for a fund given the inevitable impact on liquidity. At least that’s the view of Gavin Rochussen, chief executive of investment manager Polar Capital (POLR). “We’ve always been very, very reluctant to go onto those platforms because it’s very hard to control inflows,” he argues. “Platforms will only accept you if they think they can sell your fund.”
Rent-seeking unmasked?
Recent weeks have raised a number of issues within the UK fund management industry: the flaws of open-ended funds, the oversight of portfolio liquidity and the promotion of star investor names. But it’s not a leap to see these events as having diminished platforms’ reputation as consumer champions.
In time, small cracks can spread. Though Hargreaves has waived the 0.45 per cent fee for direct Woodford Equity Income holdings on its platform, it has refused to drop this fee and the 0.75 per cent management charge attached to the multi-manager funds that include Woodford Equity Income, despite the implicit illiquidity brought on by the gating of a core holding. The fairness of that decision is a moot point; choosing to defend a 1.2 per cent charge on a fund-of-funds will highlight what to many investors will look like an exercise in rent-seeking.
Such arrangements help to explain 65 per cent operating margin, which – according to Exane BNP Paribas – outstrips all other listed and unlisted platform providers by a distance. Still, Hargreaves isn’t likely to encourage a debate about its fees. In finance, a premium charge is meant to confer quality, not just monopoly. For shareholders, this means wider margins and higher profits.
Of course, such fee structures haven't deterred millions of investors from using platforms, and Hargreaves can point to an average 30 per cent discount on the management fees for actively-managed funds on its Wealth 50 list. And, in any case, many platform customers are prepared to overlook the relatively high cost of fees in exchange for a wide selection and administrative simplicity.
But investors in the group should, nonetheless, ask if the Woodford episode has changed the outlook for both margins and customer growth. Numis argues that “an isolated incident of selecting a fund…that underperformed is going to materially damage [Hargreaves’] good name”. The 23 per cent share price decline since a May high suggests many have already concluded it will.
