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Investment products: A glimpse behind the wealth management industry’s curtain

Want the lowdown on what the investment and wealth management terms you hear bandied about really mean? You know, open architecture, best in class and affiliated products, etc.? Keep reading as we delve a little deeper to help you make the most of your wealth management service and, most importantly, stay in control.

Open architecture and best in class

In an open architecture, a wealth manager acts as a one-stop-shop offering both in-house and third-party products. With a best in class approach, the customer should be offered the best performing products in the market irrespective of whether they are in-house or from a third party.

Imagine that you run an open architecture shop with the best in class products and that you are also manufacturing products for your and other shops. According to your marketing promise, you can only sell them in your shop if they are of outstanding quality. You may think not a big problem since you perform the selection of the products and decide which ones are best in class. Wouldn't it be tempting to mainly sell your products? If you were running a wealth management shop, this would be a situation where there is a heightened risk that the interest of the wealth manager may come in conflict with the customers’ interest.

The good news is that regulators oblige wealth management firms to implement policies and procedures to ensure that they are acting in their customers' best interest. However, it's up to the individual customer to ask for more specific information on how the wealth manager deals with conflicts of interest, details on internal guidelines, and to which extent they perform self-placements of their products. Product due diligence comes at a cost, and that's why you want to know in detail what for you are paying. Many wealth managers provide the remuneration they receive for offering third-party products, however, if you aren’t given the information, request it. It may not only include retrocessions but can be other fees charged by wealth managers to the external manufacturer.

Investment process

If you receive investment advice (we’re talking buy, sell, hold a financial product or not to do so) the wealth manager has an obligation to recommend suitable investments. This obligation includes the requirement to avoid any conflicts of interest that may adversely affect the suitability assessment.

Let's look at this from a practical perspective: you are still the owner of the above-mentioned open architecture best in class products shop and have a customer asking you for advice. Wouldn't it be tempting to sell mainly your products since they are best in class, and thus both you and your customer would benefit? Definitely, but there is a so-called concentration risk that needs to be considered. It's part of the suitability assessment and aimed at ensuring investors don’t run a concentration and credit risk by investing in too many products from the same manufacturer. Concentration and credit risk are managed by diversification, and that's why you don't want to have all your eggs in the same basket. That’s why you shouldn’t purchase all your investment products from the same manufacturer, no matter how good they are.

Again, the regulator calls for risk identification, control, and mitigation. However, it is still up to you as the customer to ask for details regarding policies and procedures and concentration thresholds for third-party and in-house products. The discussion should become most interesting if the limits for in-house products are higher than for third products, and your wealth manager is trying to provide you with an explanation for that fact.

You should keep all the above in mind when discussing your investment strategy with your wealth manager, regardless of whether you have an advisory or discretionary investment management agreement in place. The treatment of in-house or otherwise affiliated products is what you need to understand in detail to make sure you invest in the best products and diversify adequately.

Conflicts of interest

Wealth managers need to act in their customers' best interest, disclose potential conflicts of interest, and ensure fair treatment of their customers if such conflicts cannot be avoided.

If this concept is new for you, then there is a good chance that you didn't read the nitty-gritty wording somewhere hidden in endless terms and conditions. So, what can you do? Again, ask if there is any potential conflict of interest associated with the latest super-exclusive product that your wealth manager recommended to buy. In particular, if it’s an in-house product, ask for alternatives that are equivalent to the recommended investment but more favorable from a cost and complexity perspective. While this is required by regulation, we recommend that you always ask. And if your wealth manager recommends switching an investment again, you should be provided with the assessment that the expected benefits of switching are more significant than the costs.

A note about costs

Guess what? As a general principle, you are entitled to detailed information regarding all costs. But again, it's up to you to have a closer look at things. If you’re paying investment management fees and are holding a fund of funds from that same investment manager in your portfolio, you pay fees at three levels, and there should be good reasons for doing this. Regulators have a difficult time catching up with the wealth management industry's creativity to dip into undiscovered fees territory. That's why we want you to check and ask.

And if you get something for free?

We all know that nothing in life comes for free. So, always watch out for the hidden cost. Often additional consulting and advisory services are offered to wealth management customers for free. Ask for the internal remuneration of such services to find out where's the hidden cost or cross-selling incentive. And be careful if you are directed to third parties for specific services. Also, here you want to know if there is any kind of remuneration or incentive within the network. Preferred provider lists often work on a quid pro quo basis, and external providers may thus not provide the advertised independent advice. Ask if there are introducer agreements in place and how the remuneration within the network works.

To sum up

You should expect the highest standards when it comes to the wealth manager's obligation of acting in your best interest. Unfortunately, sometimes these standards are not entirely upheld, and that's when you have to ask for all details to ensure that you get the best product, advice, and service. The wealth management industry can, by its very nature, attract conflicts of interest, and recently regulators around the globe have been actively tackling the topic in specific guidelines. However, you should not only rely on regulators to do the job. Trust is good when it comes to wealth management, but control is better.


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