Watch out for vertical integration

As the financial services sector moves ever closer to the implementation of the Retail Distribution Review (RDR) on 31st December, a phrase which is regularly mentioned in the trade press is ‘vertical integration’.

This refers to a financial services firm which manufactures and distributes its own products.

The most common examples of vertical integration would involve administering a platform for investments, creating in-house investment funds (known as distributor influenced funds) and recommending the use of these to clients.

Vertical integration takes place when a financial adviser firm does two or more of these things.

We think that investors should watch out for vertical integration and pay particular attention to the suitability of recommendations to use in-house platforms or funds.

One cynical reason for vertical integration is the ability to generate more revenue from the same investor.

Whilst a traditional advisory firm will charge for advice, a vertically integrated firm will also receive revenue from fund management and/or investment administration charges.

Where the total cost to the investor is no higher than it would be with a firm recommending independent solutions, this is only problematic if the recommendations are unsuitable.

Because such recommendations are based on a very restricted number of options, suitability is less likely than it would be when based on a comprehensive review of the entire market.

Vertical integration leading to the use of distributor influenced funds is likely to become increasingly popular as firms determine their role in the post-RDR world from 2013 onwards.

Some who are IFAs today will be attracted to restricted advice and vertical integration by the lure of a bigger share of revenues, the opportunity to achieve previously unattainable profitability and a more efficient process for recommending investment solutions.

Whilst restricted advice and vertical integration are not necessarily bad things, investors need to question the real motivations and ensure they are no worse off a result of these commercial decisions.

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