Fiona Murphy asks SIPP providers how the industry can restore adviser confidence in esoteric investments.
Every year has its heroes and villains. Take alternative investments, which became the bogey man of the SIPP world in 2011 when the FSA placed greater scrutiny on Unregulated Collective Investment Schemes (UCIS). This was amid concerns clients were being advised to invest in UCIS investments that were unsuitable for their needs.
At an industry conference in November, FSA manager of pension investment policy Milton Cartwright said the FSA was examining the due diligence processes of SIPP providers regarding these investments. This added to the on-going debate as to where responsibility for ensuring the suitability of investments really lies – is it with the adviser or the provider? FSA clarification of this is expected early this year.
However, while such scrutiny is to be welcomed there is a concern that it could deter advisers from dealing with such investments at all. If the adviser is concerned about getting their fingers burned they may decline to recommend these investments even if they are suitable for that client and offered as a result of a robust advice process. Such a move would not be in clients’ best interests so how can it be prevented?
Demand for esoteric investments
It is clear there is growing demand for alternative vehicles, as many clients look away from volatile equity markets in their quest for returns. However, as many UCIS sit out of the regulator’s remit many advisers may lack the confidence to recommend them. The range of investments permitted in a SIPP permitted by HMRC is much wider than the range of investments regulated by the FSA.
However, it is clear that investor appetite for esoteric investment remains and SIPP advisers will need to be able to deal with them. So, what are the major concerns advisers have with these investments? A starting point is that some of these vehicles are high risk. As Curtis Bank’s managing director Rupert Banks warned: “Some of the alternative investments have gone badly wrong and people have lost money.” But it’s worth pointing out that high risk does not necessarily produce a bad investment. As Hornbuckle Mitchell’s head of sales Stewart Dick asks: “Is it suitable for a client’s needs?’
However, Stadia Trustee’s managing director Tony Hales believes these issues are being clouded by confusion as to what the FSA is trying to achieve.
“I think that what [advisers] are doing is pulling back, misreading where the FSA is coming from. They’re not saying these are bad investments. What the FSA is concerned about is the use of SIPPs for financial crime.”
He believes increased knowledge of these investments and how they work is vital: “Knowledge dispels fear, [advisers] don’t know what an unlisted security looks like or how to evaluate an esoteric investment, so they drop back into their comfort zone [which is] regulated, mainstream investment, or else [they're] not going to touch it. That isn’t good for consumer choice.”
So, as equity markets wobble, alternative investments are here to stay but what can be done to reassure the adviser they are dealing with allowable investments?
What’s in a name?
A real problem is the lack of common definitions in this niche sector. We throw around phrases such as alternative, esoteric, non-mainstream and exotic investments. It would be useful to agree one term, and what comes under that spectrum, as different definitions could mean different things to different people.
But, the benefits go wider than semantics. Instead, this shift could spur the monitoring process. At the moment, it is difficult to track activity in the sector.
Kevin Jacks, managing director of the SIPP Investment Platform Ltd says: “What if the FSA wanted to know how much bio-fuel was going on? If the SIPP sector collectively recorded all of these things in the same way, it would mean that the information that comes back would be consistent. At the minute, some might record it as forestry or farming or green energy. It needs some commonality.”
Following this agreement, the FSA could investigate how many unlisted shares or esoteric investments have been taken up on a quarterly basis. Advisers and providers are calling on the FSA to provide some guidance in this area, and it could be a crucial step in getting compliance on these investments right.
Compliance is King
As Hale explains, with a SIPP: “It’s quite easy to audit where the money comes from in a SIPP because it comes from an existing contribution or from a pension scheme that’s transferred. But going out the other end as an investment, we have to be very careful where it goes.” This process needs a stringent set of buffers in place.
So what are SIPP providers’ top tips for due diligence? To lay the right foundations, clear documentation is a must. One of the FSA’s findings in its sting operation on SIPP providers earlier on this year was that they did not have correct documentation to back up or provide evidence for the visibility of these investments. That is, if they had any documentation present at all.
What else should advisers and providers look out for? For Alliance Trust’s head of pensions Steve Latto: “Assessing quality of business” and “patterns that may cause concern” are key points to focus on while Stewart Dick asks: “How is it structured?”
Uniquely Hale takes a hands-on approach to screening overseas investments. He explains: “I feel it is my duty to have a look at what the investment is. I would go out [to the location] to make sure it is not a scam and whether people on the ground have the management experience to deliver what’s written on the can. We had a run on farmland in Australia. I did a lot of work out there to make sure they were certain.”
While such an approach would be difficult for most to carry out, there are services being developed to help providers with their investigation. SIPP investment Platform Ltd monitors alternative investments on behalf of providers, producing two documents: an investment review and governance report. A description of the investment is made available via the online directory, with a kite-mark stamping approval on secure ventures. These reports can also be downloaded by advisers who subscribe to the service.
But what was the driver for this?
Jack says: “SIPP providers should take more responsibility for quality of advice or quality of business that’s actually introduced to them. What the FSA hasn’t said is how operators should do that. One way they could demonstrate some quality control has been put in place is to do a due diligence or investigate a little more than they have done in the past. One of the things we’re trying to do is assist SIPP operators to make MI practices a bit more available.”
He adds, the service “makes [the process] a little more cost efficient and easier by one company doing the review once, rather than having twenty SIPP providers doing the same, twenty times over.”
But, it isn’t just about a yes/no approach based on the investment itself. As with mainstream financial products, you have to ask how the investment sits with the client’s aspirations and risk tolerance. But as a starting point, people have to ensure they seek suitable financial advice before engaging with any investment vehicle, esoteric or not.
Hales says: “I’ve seen investors confronted by direct sales people who would like to take their three or four pensions, merge them into one SIPP, and put the whole lot into one esoteric investment. I think this is a wrong approach and it’s a matter of educating investors and advisers, and ensuring they get advice. [An investor] may want to go into an esoteric investment, but get a balanced view, these are sophisticated investments. Many may be illiquid for a number of years. [My advice to investors is] don’t put all of your eggs in one basket; try to get a balanced portfolio with mainstream investments and esoteric investments.”
The road ahead?
With 2012 now in full swing the SIPP industry is hoping to see greater clarity on the responsibility of both advisers and providers with regards to due diligence from the FSA over the coming months.
It is clear we will see big changes in terms of how these investments are approached by both parties. Advisers will need to be able to prove such investments are in the best interest of their clients and we can imagine a far more active role for the SIPP provider too.
Banks says: “The FSA requires SIPP providers to carry out due diligence to assess whether investments are appropriate, and this goes beyond simply confirming that an investment is within HMRC rules. The FSA has talked about the SIPP provider being the “gatekeeper” and use expressions like “good housekeeping” and the SIPP industry needs to take on board what this means. It does go beyond the traditional view of some SIPP providers that “if HMRC allows it, we allow it”.
A useful assessment and one the industry should take on board as a whole.