Don't be captive to your adviser

I have spoken previously about the concept of 'captivity' (the financial type), where investors put themselves in the position of being completely reliant on their lender or other service provider. Decisions made by the service provider can have costly, or disastrous, outcomes if you don't have another choice.

A case study from a member shows that the warning can be just as applicable in the context of financial advisory relationships.

The couple (let's call them Mr and Mrs Jones) had been advised by their adviser to invest through a platform (a fairly common approach). Platforms come in different forms but they are more or less an administrative service which allows clients investments to be centralised and easily managed.

What they weren't told (at least not specifically, it might have been somewhere amongst reams of disclosure documents) is that the use of the platform was inextricably linked to their use of the adviser.

Now my ethics would say that this is one of the first matters on which an adviser should advise their clients, before putting them on a platform, given its implications for tax, transaction costs and time out of the market (if the investor needs to exit the advisory relationship). But obviously this is somewhat contrary to the adviser's self-interest and so these types of issues tend to get dealt with (or not dealt with) by way of 'disclosure' rather than just 'telling it straight'.

The fact that disclosure gives a different outcome to telling it straight is an interesting point and I have attached a link to an article which deals further with this issue. 'Anything goes if you disclose' is a neat way to sum up our approach to the regulation of financial services.

Anyway, as you can probably guess, the time came for Mr and Mrs Jones to exit the advisory relationship. After their original firm was merged into a larger firm they didn't feel like they were getting the appropriate attention for the fees they were paying and weren't happy with the performance.

And the exit came with a sting. They didn't just have to go through an administrative hassle to exit the relationship but needed to sell the bulk of the investments held on the platform. This of course came as a shock to Mr and Mrs Jones who (quite reasonably) assumed their adviser wouldn't so blatantly stitch them up.

Poor investing advice is one thing but deliberately or carelessly putting a client into an arrangement they are forced to exit (at cost) if they aren't using you as an adviser, is something else. I reiterate the comment made in LOST AND FOUND: Finance industry seeks basic morality - standards of fairness and reasonableness would do a lot more than our existing financial regulation.

On regulation, this situation highlights yet again the failures of our politicians. The FOFA reforms have them in a frenzy about 'opt-in' but a bigger issue is 'locked-in'. Not specifically choosing to renew your adviser's contract is one thing. Having practical barriers in the way of you choosing to opt out is far worse.

This situation also highlights one of the problems with asset based fees. An adviser whose fees depending on assets has a strong incentive to lock as many of them as possible into a particular platform.

Back to Mr and Mrs Jones. As some may have guessed, their departure from the platform (and sale of their investments) co-incided with a strongly performing market. Not expecting to have to sell off their portfolio they weren't ready to replace it, so they ended up in cash at exactly the wrong time - a very expensive exercise. Of course, if it happened today they may not have missed out on performance, but they might end up with a hefty tax bill or, at the very least, transaction costs and hassle.

Captivity costs - sometimes big time. If you've got an adviser ask the question now while you're still the client: what are the consequences of me exiting the relationship?

If your adviser says they've dealt with the captivity concern and you are free to leave at any point (and if they haven't generated commissions at your expense in the past) then you've probably got yourself a good one. At the very least, you've got one that puts your interests ahead of their own.