A myriad of trends is converging to promote the importance of the CIP (Centralised Investment Proposition, comprising also in many cases of the Centralised Retirement Income Proposition (CRIP!)).
The foremost is the advent of the PROD rules, designed to enforce adoption and compliance with the MiFID II regime - rules designed to protect consumers by identifying customer segments and corresponding products by target market, making the creation of a CIP central to the modern way of working. By shifting the focus of 'Knowing your client' to include alignment to a client segment, there is enormous scope for efficiencies within a firm's day to day business practices. It is worth noting that the lang cat research demonstrates that the majority of investment onto platforms flow via CIPs. (Connection Q4 2018 edition, Steve Nelson).
An investment is only suitable in as much as it supports the objectives of a plan. Some financial planners have argued that it is their planning skills that add value, not their ability to concoct investment flavours, as much of this has little perceived value to the client. In fact, it is obvious in some cases that investments are chosen that are guaranteed through cost or other known factors to underperform. Asset managers are being squeezed by the uncomfortable reality of relatively low returns, requiring lower fees to allow the adviser headroom to charge theirs whilst being forced to be transparent with their charges in a way they never had to before.
This results in different types of investment that, by their nature and the compliance rules, require different due diligence processes. We work broadly with the following 'investment pathways': DFM/MPS; model or bespoke portfolios; Multi-Asset Funds or I.D.D. The last reflects the more traditional approach of reliance on the product provider/insurance company to create investment, wrappers and governance that attract a lower bar for due diligence. The rest, however, recognise that the custody of the funds and their management will be directed by the firm, who will be entirely responsible for compliance. So, it's important that compliance is accurate and streamlined, and increasingly under the new guidelines, independent (of provider or platform).
The qualitative considerations that led you as a firm to choose the investment vehicles that make up your CIP are infinitely variable. They may reflect a minimum financial strength of the parent, a style of investment or track record of manager, proven in different parts of the economic cycle. It may be borne out of a conviction for passive or active investment or maybe a blend between the two. Unlike speculative or sophisticated investors, however, most retail investors should and need to be in investments that are predictable. They shouldn't for example be tempted to invest in exotic instruments such as City Financial Absolute Equity which soared, crashed and then burned and is now suspended after destroying the majority of its value. Speculation is not investment.
So, what does state-of-the-art due diligence look like, given the above? The need to be able to provide Proof of Suitability by profiling whatever investment vehicle has been selected from the CIP - for growth, risk (or loss) and cost. The more complex the portfolio the more disclosure will be required. Obviously any unpackaged solutions, including model or bespoke portfolios, can attract more administrative work and cost, including the responsibilities that come with seeking permissions and rebalancing as an advised action.
Investments that can be observed to perform consistently with the asset classes from which they are constructed allow you to model the likely outcomes for the overall investment. Having a standardised model that can provide analysis of all retail investments will allow you to fulfil your responsibilities with PROD, but more importantly deliver financial planning consistently and efficiently. Only a probability-based model can do all of these things, and the most effective model over the years has been Moody's (accessible via the Synaptic Suite). This is thanks to the effectiveness of the rules within the engine combined with the mathematical power of the (stochastic) simulations that are run to understand the viable investment outcomes. One great strength of this approach is that all outcomes are represented in the research, and the extent of possible losses in a bad year, similarly, are clearly defined. This allows the proof points to be delivered around the traditional risk governance model: 'Attitude to risk' (from the psychometric questionnaire), 'Capacity for Loss' and 'Need to take risk'.
It should be noted that the majority of the industry still works with a reliance on historical volatility analysis. For several reasons, we believe this to be an inferior approach as, increasingly, volatility as a proxy for risk is being discounted by the industry (including the regulator) and stochastic methods that offer probability-based forecasts are better aligned with the compliance model.
If you can define an investment strategy that links the profiling of customers (ATRQ) with an asset allocation, it is then easy to map the objectives of your plan to a suitable investment vehicle, whose growth and loss profile matches the strategy.
Below is the current Moody's summary output from their world famous ESG (or Economic Scenario Generator), the stochastic engine that provides the probability-based forecasts, creating the values to define the Synaptic risk model. It demonstrates perfectly the asymmetric loss/gain returns associated with a range of strategic asset allocations (SAAs).
Notes on the table above: the model shows us a 'value at risk' value or VAR. A VAR approach is different to drawdown or volatility metrics as it is loss over a defined period (12 months) and acknowledges the trend. This value is the extent of losses that can be expected in a bad year (1 in 20). Losses are shown to be asymmetric to gains. The third part of this risk profile is the 'Ave gain' which is the statistically most likely average growth rate for the term. This is the value we use as growth assumption in our cost and cash-flow analysis. The model will also show the overall outcome of the strategy we wish to analyse.