Should you care which investment platform your advisor uses?

This article by Trevor Lee of Rosebank Wealth Group was first published by Moneyweb. It looks at the importance of the Linked Investment Service Platforms in the administration of investments and wealth.

Investment platforms, managed by Linked Investment Service Providers or LISPs are one-stop shops that administer a variety of underlying investments.

They have been a feature of the South African investment industry since the late ’90s. The reason they were introduced was that at that time it was normal practice for retail investors to pay a 5% initial fee when investing in a unit trust, while institutional clients buying unit trusts (pension funds, insurance companies and other institutional clients) were either not charged initial fees or charged far lower initial fees.

As a result, an asset management company (TMA) spotted an opportunity to create a wholesale platform whereby retail investors could save the 5% in initial fees demanded by sellers of unit trusts, by investing through a LISP; a proxy ‘institution’. In the early days of LISPs, the only advantage they offered clients (both direct retail and financial advisors) was thus the capacity to invest or switch between portfolios without paying the required 5% initial fee.

At the time, many financial commentators and newspaper columnists warned long-term (non-switching) investors that the additional layer of fees levied by LISPs would, in due course, erode the benefit of avoiding the 5% initial fee.

Fast forward 30 years and the 5% initial fee requirement has gone the way of dinosaurs, but at last count, there were about 28 LISPs in South Africa. It has become the norm for financial advisors to transact directly with LISPs as opposed to dealing directly with asset management companies or other financial institutions. There are a number of reasons they have grown in popularity with financial advisors. These include the following:

Increasingly onerous compliance requirements: LISPs have capitalised on the increasingly onerous compliance requirements introduced since 2000. The Financial Intelligence Centre Act 38 of 2001 (FICA) ushered in a slew of obligations for advisors, as did the Financial Advisory and Intermediary Services Act 37 of 2002 (FAIS). FAIS, the ‘grandfather’ of legislation applicable to advisors, was designed to raise standards and protect consumers and will soon be replaced by the Conduct of Financial Institutions Act.

Other new rules which regulate the conduct and choices of financial advisors include the Demarcation Regulations, Policyholder Protection Rules and various Board Notices. The impact of the Financial Sector Regulation Act 9 of 2017 and its requirement to ‘Treat Customers Fairly’, the Consumer Protection Act 68 of 2008 (CPA), the Protection of Personal Information (POPI) Act 4 of 2013 on advisors would be topics in their own right. All of these pieces of legislation are aimed at protecting consumers, but rob time from financial advisors and add to the cost of investment services.

Ease of administration and tax reporting: Given the increase of compliance requirements described above, any system that offered swift, accurate administration and tax reporting capacity would be gratefully adopted by both financial advisors and direct clients. The consolidated reporting offered by LISPs is especially useful to direct investors who do not have an advisor to assist with tax reporting.

Increased access to boutique managers: LISPs enabled financial advisors to blend the strengths of different asset management companies to the advantage of their clients. Back in the ’90s, it was tempting for a financial advisor to invest all of their client assets with a single asset management company (typically one of the large insurers) that had ‘merely acceptable’ relative performance in equities, fixed interest and listed property just because it was so administratively challenging to invest across a range of asset managers. Pre-LISP, boutique asset managers with outperforming funds were only allocated new money by the most diligent, top-end advisors.

LISPs’ challenge to the traditional pension fund industry: It was a real game-changer when LISPs realised that they could ‘sweat’ the capacity of the investment platforms used to manage a range of unit trusts to administer retirement funds. Many quickly grasped that becoming a ‘13B’ accredited retirement fund administrator would boost the tool-kit and ‘value-add’ of financial advisors. LISPs with 13B licenses are permitted to manage retirement fund products, such as retirement annuities, pension and provident funds and were therefore well-positioned to challenge the monopoly of the ‘one-size-fits-all’ pension funds dominant at the time.

LISPs with retirement fund administration capacity enabled appropriately accredited financial advisors to create tailored retirement funds that were compliant with Regulation 28 of the Pension Fund Act. A feature of these products was that the underlying funds could be switched according to market conditions, subject to prudential rules. The LISPs created embedded rules into retirement fund management which ensured that the portfolios of their clients remained complaint. These products have changed the face of the retirement industry in South Africa and are probably the single biggest factor in the enormous growth of the LISP sector.

LISPs and passive funds: LISPs were alert to the growing consumer demand for exchange-traded funds (ETFs), index funds and other passively managed investment products in the early 2000s. For many years these funds failed to gain traction with financial advisors, simply because the commission payable to advisors was relatively lower than commissions paid by actively managed funds. This was because the higher annual fees charged by active asset managers had higher margins and a greater capacity to reward advisors. LISPs enabled financial advisors to more easily combine passive and active portfolios, in the best interests of their clients.

Disadvantages of using LISPs

Fees: LISP fees have reduced over the last two decades and should continue to fall due to increased digitalisation which will allow asset management companies to digitally onboard clients (straight-through processing with digital FICA).

Generally speaking, LISP admin fees can be offset by the cheaper institutional fee class available on the platform rather than the straight retail class if going direct, but this is not always the case, and the extent of offset varies.

However, LISPs have a wide range of fee structures. Some types of fees are quoted in rand amounts and others are percentage based, which does not make for easy comparison. Some have a sliding scale structure where annual fees are reduced as assets increase, others are flat, irrespective of the assets under administration. Further, there are still some legacy products on some LISPs with less transparent rebate arrangements and/or where the LISP keeps the rebate.

A wide range of fee structures applies to services offered by different LISPs. There is a range of prices for switching. Some LISPs offer a limited number of free switches while others do not. Additional fees are usually charged if investment wrappers such as retirement fund or life policies are used.

In short, depending on the LISP, the funds selected, the wrapper of the fund and other variables, LISP can add costs of up to 1% in annual fees to an investment.

Response times: Investors are often disappointed with the response times of LISPs. Direct unit trust investments work on 24-hour cycles if you meet the cut-off times but with LISPs, this rises to 48 hours or even 72 hours. This means that if you’re an investor that likes to time investments due to market falls or rand moves, you’re going to suffer from lags and miss your entry point.

Choosing between LISPs

As of 2020, the 28 LISPs have different relative strengths, but typically they host a range of collective investments which can be packaged according to different rules.

• Most have a wide range of funds on their platforms from which advisors or direct clients can choose. However, some list over 800, while others have strategically narrow or restricted fund choices.
• LISPs typically offer a range of legal wrappers, including retirement funds (retirement annuities, pension funds and provident funds) endowment funds, ILLAS (Investment-Linked Life Annuities) also known as living annuities and tax-free savings accounts. Not all LISPs have all wrappers.
• LISPs offer a range of unitised investment products, including ‘long only’ collective investments, hedge funds, exchange-traded funds and exchange-traded notes. Again, not all LISPs include this product range.

What to ask your advisor about their choice of LISP

If you are unhappy about the service, fee structure or any other shortfall in your advisor’s preferred LISP, raise your concerns at your next meeting.

• Ask your financial advisor why they have selected the particular LISP.
• Ask your financial advisor whether they think any extra fees charged by the LISP are justified and how the fee structure compares with other LISPs.
• Ask your financial advisor if there are any products, asset managers or vehicles that they would like to invest in, but which are not offered by the current LISP.
• Ask what percentage of your advisor’s book is invested in those managers that are listed and how their preference in asset manager has changed over time. Ask if there are any inducements or channelling on the elected LISP to invest in particular funds.