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Last week I started to look at the Sandler consultative document which I suggested could and will revolutionise the way in which financial advisers give investment advice to clients and are remunerated for that advice.

Although, on the face of it, this document is at this stage only for consultation purposes, there seems little doubt from my conversations with “the congnoscenti” that it is already destined to form a blueprint for the financial services profession.

This week, I want to look at one of the key issues from this document and, equally important, from the recent Myners report into trust, especially pension trust, investments.

One of the main suggestions from both these documents is that investment adv- isers should agree benchmarks with their clients as a basis for future reviews and assessments of past achievements (or otherwise) and future courses of action.

What is meant by benchmarking and to what extent are most investment advisers already complying with this recommendation? Benchmar-king, in this respect, can be identified in two ways.

First, a target rate of investment return – with income or growth being separately identified, where appropriate to the client&#39s needs – should be agreed with the client. The impact of under or overperformance against this benchmark should be considered by the adviser and discussed with the client. This will be particularly important where the client is accumulating capital with a definite future target level of capital or income in mind – for example, where a projected level of retirement fund will be required to provide the client with a desired level of retirement income.

Second, the adviser should consider a benchmark against which the performance of the recommended portfolio should be compared. Within a portfolio, different benchmarks might be appropriate, for each constituent asset class or even sector within those asset classes.

Without a doubt, these two suggestions for benchmarking will not be well received by many financial advisers whose recommendations for the first time (for many firms) will be openly monitored and assessed on a regular basis.

Let me look in more detail at each of these two aspects of benchmarking, giving a couple of simplified examples.

First, as regards the target rate of investment return, let us suppose that we have determined for client A that he will need a fund of, say, £1,500,000 by the time he reaches his target retirement age of 60. This is to provide an annual income of around £90,000 with escalation which, in real spending power, after allowing for the effect of inflation assumed to average 3 per cent a year for this purpose, will provide him with a sufficient level of retirement income to meet his needs and desires.

From this target figure, and using an assumed growth rate of 8 per cent a year (before charges), the client is advised that he will have to make monthly contributions to a pension arrangement of £1,000 a month.

It is known that many advisers do not even go to this extent in their pension recommendations, remaining firmly in the world not of target benefit selling (as in this example) but of contribution-driven selling (that is simply sell the client a level of premium he can afford, regardless of whether this is likely to meet his future needs. Those who have adopted this style of advising clients may not have moved to the next stage.

This next stage must include parts of the above-mentioned reports and suggestion of a regular review of the ongoing performance of this initial plan against actual performance.

This review – let us assume performed on an annual basis for this example – should include not only a review of investment performance but also a review of trends in current and projected future inflation and also of projected future annuity rates.

At the end of the first year of this strategy, the first part of the review should be to assess the last year&#39s investment performance and the effect that has on the required future funding level or target future investment return.

As an example, suppose that the investment performance over the last year has been a healthy 13 per cent against the target rate of 8 per cent. On this issue in isolation it can be easily understood that the client&#39s future contributions could be reduced (albeit only marginally, from this early stage) or the future required rate of investment return will be lower (again, at this stage, only slightly).

Which ever of these assessments is adopted, this will form part of the revised benchmark for the future.

Past investment performance should not be the only aspect of the review, however. The adviser should assess whether the original projected annuity rate still appears realistic. This is not to suggest that this assumption should be amended on a regular basis, according to relatively small shifts in current annuity rates, but it may from time to time be appropriate to make an amendment if annuity rates have changed significantly since that assumption was first made.

This could happen, of course, not only if interest rates have changed but also if life expectancy continues to increase, resulting in lower annuity rates.

Finally, as regards this review against benchmarking, the adviser should obviously assess whether the original target level of income remains appropriate to the client&#39s needs and desires a year on.

Second, when considering benchmarking for individual constituent assets within a portfolio it is suggested that a suitable index should be determined by which performance can be measured.

For UK equities, for example, the FTSE 100 might seem an obvious and appropriate benchmark but where an equity fund specialises in smaller companies or in one sector of the index (for example, technology shares) then a more appropriate index should be considered.

Possible indices in these slightly more specialised circumstances can be found in the FTSE Actuaries shares indices section on the back page of the Financial Times. Overseas equity funds may be similarly benchmarked – either according to a specific geographic index, where the fund specialises in equities of just one country, or a more general overseas equity index (for example, the emerging markets index).

At the review, the performance of the recommended fund should then be compared to the agreed index to determine the relative success or otherwise of that recommendation against that benchmark.

This might well lead to some uncomfortable assessments for the adviser and the selected fund where, as will certainly happen from time to time (if not more frequently) that fund underperforms against the index but this discomfort should not detract from the possible value of the exercise. Investment funds frequently underperform against an appropriate index as they seek, through active management, higher rates of return.

To summarise, benchmarking and targeting of recommended portfolios are recommended to form the basis for a more constructive and meaningful annual (or more frequent) review of the portfolio performance against projections and expectations.

This benchmarking is not suggested as a means by which the adviser should be judged either by the client and certainly not by the regulator. Its use is suggested as being more constructive – for the client and the adviser to make frequent adjustments to the portfolio in light of changing targets and benchmarks as well as in light of the client&#39s changing needs and circumstances.

These principles are already commonplace among big pension funds, particularly final-salary funds, and I feel that any resistance by advisers to their adoption within smaller portfolios – for individual clients – could be misguided as well as, depending on the strength of the final Sandler recommendations, potentially futile.

Next week I will conclude my look at some of the main topics in the Sandler and Myners documents by considering recommendations for portfolio planning.

Keith Popplewell is managing director of Professional Briefing


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