Advisers today are backing off fund selection in droves. Instead they are signing up to multi-asset, multi-manager, risk controlled funds or to discretionary fund management services for their clients. I think this will prove a mistake.
First, let’s ask why advisers are switching away from fund-selection advisory services.
A major factor was the credit crunch. Correlations between asset classes all went to one, so that diversified portfolios all tanked together and supposedly cautious portfolios were down 30-40 per cent at the nadir in 2008. Advisers who had swallowed the portfolio theory gobbledegook were shaken; they didn’t understand why it had all gone wrong.
Also, advisers realised they had their work cut out in preparing for adviser charging and that getting their act together on this was more important than trying to persuade themselves and clients that they could produce good investment returns at a time when markets were telling them they couldn’t.
Clearly, many advisers understand the distinction between being an investment manager and an investment adviser. These are different disciplines and in a professional financial planning process should be kept at arm’s length.
Why? To gain the client’s trust, the adviser should not have a vested interest in any specific investment the client owns. Only then can it be assessed dispassionately and the client advised to sell it if that is the right advice.
Do advice businesses really want to run their own DFM operations to give a better service to clients? Could there be a suspicion that they make more money this way? This can create a potential conflict of interest where there should not be one.
But financial advisers who justify outsourcing investment by saying they are just planners and don’t need to understand investment ought to leave the profession now. Investment is the core of financial planning and always will be.
Most of the key decisions financial planners ask clients to make are in essence investment decisions: paying off or not paying off mortgages, prioritising saving over protection, setting rates of accumulation and decumulation.Those who believe they can do all this from spreadsheets without knowing and understanding the nature of different investment strategies and styles, not to mention investment history, are sure to give poor advice.
On the other hand, those who understand investment strategies and styles are also capable of selecting investment funds. Most clients have long-term investment horizons. Advisers do not need to recommend more than a handful of funds run by managers with proven methods and long track records to meet most clients’ needs. You do not need to switch them actively.
Yes, portfolios of this kind may be more volatile than a benchmark, but so what? Don’t swallow the modern portfolio theory guff that claims this volatility represents risk to the client – it doesn’t.
How many DFM services have beaten the records of Neil Woodford, Nick Train, Harry Nimmo of Ruffer or RIT?
My contention is that if advisers create fund portfolios with the right timescales for clients, they can do better (and at lower cost) than most DFMs, which are run by managers far less talented than those cited.
I do not claim that such advisory services will be right for all clients, only that for many clients they are not only suitable but also capable of producing at least as good results as DFM services.
Chris Gilchrist is director of FiveWays Financial Planning, edits the IRS report newsletter and is the author of the Taxbriefs Guide, The Process of Financial Planning