In recent years, the Financial Conduct Authority (FCA) has focused on the industry’s role in treating customers fairly and breaking down barriers to access financial advice.
Regulations, such as Mifid II and the Product Governance Sourcebook (Prod), has increased the burden on advisers and wealth professionals when it comes to proving the suitability of the advice provided and investments recommended.
One way to comply with the rules, although not explicitly spelled out, is through the process of client segmentation. Grouping clients according to their financial situations and investment needs can help during the suitability process.
One of the most popular ways of doing so has been categorising clients according to assets under management (AUM).
In its ‘2019 Annual UK Financial Adviser Survey’, global asset manager Schroders found that 70% of planners that actively segment clients use AUM as their main criteria.
To find out if there are better ways for advisers to group clients, International Adviser reached out to several industry players.
Meeting regulatory standards
James Pearcy-Caldwell, chief executive of Aisa Group, believes AUM to be one of the best ways to base client segmentation on.
“Earnings per client often dictate client segmentation for business models,” he said. “Small fees are not compatible with the considerable work required for a client in order to meet Mifid II requirements on an annual basis.
“Prod further entails work ensuring that each individual part of a portfolio is suitably justified as appropriate to meet a specific client outcome. Therefore, I would disagree that AUM would not be a key factor when segmenting clients and the amount of work involved, unless you remove percentage fees and work to fixed fees.
“However, fixed fees further exclude smaller investments, as a disproportionate fee is unlikely to justify its cost thus leading back to a requirement for a larger AUM requirement,” he added.
Widen your horizon
But Ben Peele, managing director at PortfolioMetrix UK, believes that AUM is just not enough.
Advisers should not only group the clients they have, but also the types of customers that are out there.
He said: “Segmenting clients makes good business sense, but many advisers have delayed doing so because it can seem like a daunting task. With the introduction of Prod, which is a set of rules, not guidance, advisers have to act now.
“Segmenting clients is not complicated but it does take planning, focus and process. A lot of firms only have one service offering and this is unlikely to be enough. Advisers should consider the different types of clients that exist, not just the ones they currently manage, and assess if there are other service levels that could be offered by their firm,” Peele added.
“The next stage is to look at all the different investment solutions that would fit comfortably within the adviser’s business and consider if alternatives might work better for some clients. Then look at platforms, are there platform providers that might offer something better for certain types of clients?”
Peele said that being able to demonstrate the segmentation process to the FCA will provide “good evidence” that clients were thoughtfully grouped and provided with the most suitable solutions available.
Looking for change
While the AUM model might have worked up to now, many believe it will not be enough in future.
For instance, life stages and investment needs could be an alternative option to keep in mind.
Les Cameron, head of technical at Prudential UK, said: “Assets under management are unlikely to be a good way of segmenting clients going forward. So, what other way besides gender, job and AUMs should be introduced or applied to efficiently segment clients?
“I can understand the commercial attractiveness of segmenting clients by the value of their assets under management. However, Prod rules require the identification of target markets at a fairly granular level and products recommended should be suitable for that market.
“As a clear example, a 30-year-old who has just received a £500,000 ($658,500, €558,290) inheritance would require different treatment to a 64-year-old with a £500,000 pension pot who is approaching retirement.”
Don’t mix regulation and marketing
Segmentation has been used more frequently over the last few years to protect clients and provide improved outcomes, but this could create confusion because different parts of a business require different segmentations methods.
Matt Connell, director of policy at the Personal Finance Society, explains that regulatory segmentation cannot be the same as grouping clients for marketing purposes.
He said: “There is a tendency to turn segmentation of the Mifid target market into a bit of a cottage industry.
“When we segment for marketing reasons, we may do so in a broad way, that gives clues about client’s potential needs.
“Regulatory segmentation is very different. This is because Mifid says that providers must stipulate, for each product, the characteristics of clients for whom their product is suitable and the characteristics of products that are not suitable.
“The adviser is then expected to check that any recommendation they make is consistent with the target market for that product, with reference to factors that can cause clients harm, such as high risks, high charges, poor financial strength and a manufacturer’s claims and complaints record.”
Client attitudes and potential
In other words, regulatory segmentation is all about keeping products that could financially harm clients away. This requirement, however, is not needed when it comes to marketing.
Connell continued: “Advisers can then segment their clients from a marketing point of view without having to worry about Mifid compliance.
“Our experience is that advisers are tending to segment clients by their potential to need and want a long-term advisory relationship, which in large part is determined by their attitude to planning rather than funds under management or income.
“As a result, segmentation for an adviser firm may tend to look at factors that will contribute to a productive, long-term relationship, such as willingness to plan over the long term, rather than needing to make a one-off, tactical investment decision; or the likelihood of them needing to manage a complex set of circumstances that involves several needs, retirement income, inheritance, care costs, rather than making a one-off decision.”
Look at their wealth
Another way to group clients, according to Simon Black, head of investment management at Dolfin, is to look at how their wealth is generated and where it comes from.
“Something we have been looking at is segmenting clients in terms of inherited versus entrepreneurial, emerging vs developed market, and Gen X vs millennials,” Black said. “As wealth is being created in emerging markets, they are typically younger, and more gender balanced than western entrepreneurs.
“Being younger, they are more focused on alternative investment concepts – impact, ESG, SRI – and wanting to understand more about their portfolio.
“This has also impacted how they want to interact with their wealth manager, varying combinations of WhatsApp, WeChat, email, phone, text, videocalls and face-to-face meetings with the balance depending on client age, source of wealth and location of client more than gender, job or AUM.”
And client attitudes, beliefs, principles and behaviour cannot be left out of the process.
Alastair Ward, head of platform design at Standard Life, said: “When looking at the segmentation process, it shouldn’t just be about how much money a client has. The first stage of segmentation should always be to broadly identify clients by type.
“Life stage segmentation is an obvious example.
“This allows a firm to segment their client based on whether they are in the accumulation or decumulation stage of their financial journey. Clients saving for the future will have a different attitude to investment, or even risk appetite, than those nearing retirement and potentially very different needs for passing on wealth or to support others.
“Categorising clients from a psychographic or behavioural point of view is also important. This could include personal beliefs, capacity for loss and lifestyle. It can also be helpful to split client types into sub-segments based on their knowledge of financial products and the world of investment.”
Segmentation and sub-segmentation could, undoubtedly, become a tedious process, but Ward believes that technology could provide a helping hand.
“The FCA recently highlighted the importance of treating attitude to risk as separate to metrics such as capacity for loss in this context. Technology will continue to help here. For example, the centralised investment propositions (Cips) available through platforms are designed with these regulatory responsibilities in mind.”
Turn the tables
But Steven Poulton, head of risk & compliance at Beaufort Group, believes that the segmentation issue could be turned completely upside down in the future.
This is because regulatory requirements and professional indemnity insurance burdens have made it harder, rather than easier, for people to access financial advice.
He said: “Historically, segmentation has involved looking at an existing client bank and grouping clients with similar characteristics, where AUM is a relatively simple method which requires only a small amount of high-level data.
“While improved data makes it possible to segment in other ways, it is difficult to group large numbers of clients by specific characteristics as every client is unique.”
Poulton argues that the industry could sway towards a segmentation model based directly on the adviser, where planners specialise on a specific client section.
“My personal view is that the industry will see a bigger move towards ‘segmentation by adviser’ rather than by client, in the same way legal professionals may specialise in areas such as employment law, criminal law, regulatory law, conveyancing, etc.
“We will see advisers looking to become subject matter experts. There will always be a space for holistic financial planners but there may be some natural segmentation whereby, for example, medical professionals, small business owners or trustees seek an adviser that specialises in their particular circumstances.”