Investment expert Fraser Donaldson reviews the FCA's latest 'Dear CEO' letter on cash interest. Mr Donaldson, Insight Consultant at Defaqto, writes a regular column on DFMs for Financial Planning Today magazine with the latest column reproduced below. To view Fraser's past columns and lots more content in the magazine register and subscribe to the magazine. If you are not yet registered for Financial Planning Today website do so now to find out more. Registration is free.

One of the advantages of working at Defaqto is that the breadth and depth of data that we have allows us to be quite forensic about elements of the market.

Those that have been following my articles for Financial Planning Today will realise that I do have a bit of a bee in my bonnet around interest paid on client cash.

My last article raised the hope that the Dear CEO letter sent to SIPP and platform providers late last year would not only encourage payment of a fair rate of interest for cash with these service providers but would also filter in to the discretionary management market.

I am reliably informed by my colleagues in the banking team that you or I could find an instant access account paying 4% at the moment. For me, this is the absolute minimum that platforms, SIPPS and discretionary managers should be paying to clients for the cash elements of their portfolios.

I previously outlined what could be argued as mitigating circumstances to lower rates being paid. I feel these are just excuses. They may be structural in nature, but the bottom line is that clients are not being treated fairly. So, it seemed sensible to test the scale of the issue with discretionary management. Am I making a mountain out of a mole-hill? Time to dive in to the data.

The average cash position of MPS portfolios accessed through a platform is 6%. So, let's start with platforms, where most adviser activity is and through which most MPSs are accessed.

I have looked at the interest rates paid on cash (as at end of 2023). Apart from the 25% that have not disclosed their rates, only 10% are paying 4% and above, 40% are paying between 3% and 4% and 25% are paying less than 3%. Still room for improvement and I would hope the Dear CEO letter will have encouraged upward movement.

DFMs are obviously going to be more in control of what interest is paid when the assets lie with them and, as a consequence, they make the arrangements for cash management.

The average cash position at the end of 2023 for direct custody MPS portfolios was 7.5%. Having looked at a sample of 300 odd portfolios, around £10bn total AUM, a reasonable cash return overall would be around £40m (4% annualised).

Based on the actual rates quoted for those that are transparent on both the rate they pay for cash and AUMs in individual portfolios, we believe the return is nearer £25m. That is £15m lost in low rates, admin charges, shared margins and so on.

We can reasonably assume for the whole of the direct MPS market, estimated at £75bn, the same applies. This means that clients should be sharing around £300m, whereas they are actually getting nearer £200m.

OK, I am doing some rounding, with a few assumptions made and a bit of guess-timating on market AUM. However, I don’t think I am far off the mark and while it is perhaps not a ‘mountain’ in the general scheme of things it certainly isn’t a molehill!

It is enough for the regulators to raise an eyebrow and perhaps take a closer look once they have finished with the SIPPS and platforms. When making a DFM selection, advisers should have ‘interest paid on cash’ high up the agenda in their due diligence, particularly if interest rates remain at the levels they are now and could be contributing significantly to returns.

Fraser Donaldson is Insight Consultant at financial data and ratings provider Defaqto and has worked in the industry for several decades. He writes on DFMs and MPSs in each issue of our bi-monthly sister title Financial Planning Today magazine. This column is intended for professional advisers only.

https://www.defaqto.com/