Time to Deal with Unprofitable Investment Products

Supporting unprofitable investment products not only costs our industry money but also exposes firms and investors to unnecessary risk. It is time for the industry and regulators to tackle this problem together.


Suppose you were presented with a business opportunity to provide a service to the market in exchange for an ongoing fee. The only catch is that once you started to provide this service you were obliged to provide this in perpetuity, regardless of the commercial benefit (or loss) that you obtained.

Before embarking on this service provision I am sure two main questions would come to mind.

  • what is the anticipated profit that I am likely to earn?
  • if unprofitable, how can I stop providing this service whilst not significantly impacting my customers?

For many investment products these questions fail to be answered satisfactorily, mainly because many organisations have a limited understanding of the true profitability of their investment products. Even when unprofitable products are identified, there are often limited options available to close these products.

The Need for Effective Product Profitability Analysis

Understanding the profitability of investment products is a common theme and challenge for investment managers. Having dealt with a number of investment managers on this topic, the following issues are preventing managers from tackling this problem:

Issue 1 – Attributing Fixed and Indirect Costs

Unlike manufactured products, nearly all costs attributable to investment products are fixed and typically related to labour and premises costs. Consequently, adding or subtracting individual investment products will typically result in no change to these costs and many managers will simply ignore these costs when assessing product profitability.

Every organisation, including investment organisations, has limited capacity.. Whilst products may cover their own costs, they also consume fixed resources of the business. Proper apportionment of these costs may show that the closing of such products is still desirable in order to free up this capacity towards more commercially attractive products.

To tackle this issue we recommend that all fixed costs be apportioned to products using a method of allocation that reflects the consumption of these resources.

As discussed below, this does not mean implementing full-blown Activity Based Costing and requiring employees to complete timesheets.

Issue 2 – Over Engineering the Solution and Not Leveraging Available Information

We have often seen serious time (and money) being spent on measurement of product profitability with questionable results. For instance, to track time spent by staff, the commonly adopted method is to require staff to complete timesheets. Not only is this met with muted enthusiasm from staff, it also requires time and effort to collate and analyse results and assumes accurate timekeeping by staff.

Noting that investment organisations already maintain significant amounts of ‘data’ in their organisation, a better way to tackle the allocation of fixed costs is to look at what data already exists and assess whether this may be used as a ‘cost driver’ to apportion fixed costs such as salaries, systems and premises costs.

Regardless of the method adopted, clarity over what the product profitability analysis is trying to achieve should be front of mind and frequently revisited. The following value chain can be used as a guide to determine what data is required.

Data delivers Information that provides Knowledge to enable Actions to provide an Outcome that will deliver Value.

But what actions are available to re-structure products without significantly disadvantaging investors? Specifically, can unprofitable products be closed down?

The Need For Regulators to Support Rationalisation of Products

Rationalising investment products can impose significant consequences to investors including:

  • Triggering capital gains tax liabilities
  • Stamp duty payable on the transfer of certain asset types
  • The realisation of taxable income within the investment product
  • The loss of capital gains tax exemption for assets acquired prior to 1985

The significance of these issues often prevents investment organisations from closing products even when it is clear that they are unprofitable.

To address this issue we believe that changes to the regulatory and taxation environment for investment products are required, including:

  • capital gains tax ‘roll-over relief’
  • removal of stamp duty tax for the transfer of assets between investment products of the same organisation
  • capital gains tax ‘roll over relief’ on the sale/purchase of investments between investment products of the same organisation
  • the preservation (grandfathering) of tax concessions

Addressing the challenge of identifying and dealing with unprofitable investment products is not a trivial issue. However, adopting sensible and pragmatic approach to calculating product profitability combined with appropriate regulatory support can help the industry get onto the right path.

Bruce Russell, Director

Nauzad Doctor, Managing Consultant

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