Looking after other people’s money – part 3

Previously we have looked elements of an investment philosophy, client segmentation, the role of an investment committee, the decision around outsourcing of investment. In this article we look in more details at due diligence and screening (of funds and platforms) and the value (to customers) of a Centralised Investment Proposition (CIP).

The world of investment solutions is much broader than just funds – model portfolios and bespoke mandates have exploded in popularity over recent years.

Due diligence – challenge

It is a daunting prospect, when faced with over 9000 instruments in the UK (OEICs, Unit Trusts, ETFs, Investment Trusts and VCTs), to work out where to start with due diligence.

But having already completed a segmentation exercise the task is already becoming clearer. For example, if most of your clients, or a segment of them, are relatively unsophisticated investors who seek comfort from coverage by the FSCS – it is possible; to screen out whole categories of instruments.

If keeping costs below a threshold is a key element of your philosophy, then again many hundreds of more expensive investments can be screened out. In simple terms if you screen out products that are likely to deliver poor outcomes you must be left with a sub set that will deliver good outcomes!

One of the key aspects that emerges from FCA comment on due diligence is the issue of status quo bias. In simple terms it is just using the same approved list as last year without really challenging your assumptions.

The difficulty is keeping the approved list up to date without the mammoth task of screening the whole universe every year or so.

Link to your philosophy

This process can be used to further screen out products that fail to meet your criteria for each segment. For example, if you have a tier of clients with smaller investment amounts, it may be most effective for them to be offered a multi-asset solution. Single asset solutions would therefore be inappropriate. Further screens might include, fund size and alignment to the risk tool that you are using.

The key is to start with an open mind, use the needs of your client segments and the beliefs articulated (and evidenced) in your Investment Philosophy to screen out products that are less likely to deliver good outcomes.

Evidence

One of the key aspects that emerges from FCA comment on due diligence is the issue of status quo bias. In simple terms it is just using the same approved list as last year without really challenging your assumptions. The difficulty is keeping the approved list up to date without the mammoth task of screening the whole universe every year or so. The screening out process above simplifies this by allowing you to remove whole categories that are not suitable, and thus focussing effort on selecting (and updating) from those that are.

Keeping a simple log of the process and outcomes allows you to satisfy both the FCA but most importantly shows your customers that you have a robust and independent process for selecting solutions. And, of course, this is a very valuable process for customers. The time it would take each of them to shortlist and screen the investment universe is substantial – and thus a key element of your value is the time it saves them.

Wider Investment Solutions

Of course, the world of investment solutions is much broader than just funds – model portfolios and bespoke mandates have exploded in popularity over recent years.

But your approach should be consistent – linking to client segmentation / needs and adviser investment philosophy:

  • If your philosophy leads you to passive solutions you can screen out active.
  • If cost is an issue, then it is likely that MPS could be more effective than full bespoke DFM (but depends on scale and mandate required).
  • If adherence to a risk profile is important, then understanding how the mandate is run is key.
  • If you are interested in active managers, then a comparison of risk adjusted returns compared to a consistent benchmark (ideally the adviser's chosen one) will be important – probably over a number of time periods.

Platforms

A similar screening out process using customer needs and your investment philosophy and process can be equally applied to platform selection. For the FCA perspective, look at the Factsheet 12 on using Platforms some years ago – it is one of the simplest and most helpful guides they produce – well worth a read

https://www.fca.org.uk/publication/other/fs012-platforms-using-fund-supermarkets-and-wraps.pdf

The key areas that you might consider when conducting platform due diligence may include Financial Strength (see AKG ratings), size of assets under management, range of tax wrappers / instruments and costs.

Adviser Platforms screenshot

If you are interested in active managers, then a comparison of risk adjusted returns compared to a consistent benchmark (ideally the adviser's chosen one) will be important – probably over a number of time periods.

This will allow a short list to be created which can then be validated and refined with a Due Diligence Questionnaire (DDQ) to each platform.

My perspective is that having at least two platforms – ideally on different underlying software – e.g. FNZ, Bravura would make good sense from the risk management perspective (of the adviser firm and thus customer offer). This would also need to fit with your segmentation – perhaps a simple platform for younger savers and a full wrap to manage drawdown or more complex needs.

The value that you add

Throughout these articles I have tried to highlight the value that you add to customers at each stage. With the new cost disclosure under MiFID adviser fees will be under ever more scrutiny. It is therefore important to be able to evidence and quantify the value that you add at every stage to customers, for example:

With the new cost disclosure under MiFID adviser fees will be under ever more scrutiny. It is therefore important to be able to evidence and quantify the value that you add at every stage to customers.

  • Creating an accurate risk profile – allows us to design a portfolio that meets your needs – and delivers long-term security
  • Having a robust process – helps keep you on track and avoids the classic mistakes that many investors make – these mistakes could cost you 2% a year
  • Screening out the poor products (from the more than 9000 available) means you will have only "good" outcomes in your portfolio – saving you time and giving you confidence that your plans will be realised.
  • Diversifying your portfolio – spreading your investments across assets, funds, managers, custodians – all help reduce risk

Hopefully these three articles have given you some ideas around how and why you might like a CIP. If you would like more information or ideas to support the development of your CIP, please do contact me. Good luck!