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Don’t pass the buck on investment advice

In the re-creation of the financial advice landscape, all sorts of new business models and service propositions are being promoted as the way forward for IFAs. Some will succeed and some will fail. In the light of the industry’s history, it is a safe prediction that the most fashionable solutions are almost certainly among those that will benefit clients least. I rate outsourcing of investment advice as one of these fashionable ideas.

I am probably in a minority of advisers who can remember the advent of financial socialism in the 1970s, when the poor got better investment management than the rich. Unit trusts were created that charged a mere 1 per cent annually for investment management, compared with the much higher fees for worse investment advice provided by blue-blooded merchant banks through their private portfolio management services.

Notoriously, these private client discretionary management services were the place where young trainees in investment management were placed to cut their teeth. Disasters in client portfolios were just part of their learning curve. At the other extreme, old buffer provincial stockbrokers used inside information on local companies from their gang of old buffer mates to convince clients they were on the inside track to big money.

Both these methods of looting and pillaging have largely disappeared from the City scene but advisers who have forgotten the history look doomed to repeat it.

Today’s proponents of outsourcing investment management make two familiar mistakes. One is to say that because today’s markets are more frenetic, managers need to be more active and such activity is beyond the scope of an IFA. This is nonsense. Just read a few comments by Warren Buffett and look at the portfolios of successful managers such as Tom Dobell and Neil Woodford. In fact, turnover is the investor’s enemy and never their friend, unless you happen to be a hedge fund manager or are getting a share of the transaction costs.

The second mistake is to throw away the most useful insight of the past 50 years in investment management – the importance of asset allocation. Diversification is about reduction of risk, not enhancement of returns. Asset allocation is a sound method of reducing risk. If you buy this and believe strategic asset allocation decisions will account for 90 per cent of your clients’ returns, why do they need active discretionary management?

If you do not believe in the fundamental importance of diversification through asset allocation and are going to pass clients’ money to managers who ignore asset allocation boundaries – tactical asset allocation is, after all, just market timing under a fancy label – then why should clients pay you for asset allocation advice?

I suspect the reason that many advisers want to pass the buck on investment is they know they do not have the skills to do it themselves.

hey could develop the skills but they would rather learn how to use pretty pictures to convince clients that simple lessons in cashflow management are worth thousands of pounds in fees. They are not and online tools that do this job will soon be available free of charge on a variety of websites.

Good investment advice will always justify payment of ongoing fees and should be a core proposition for IFAs who want to build the value of their own businesses.

Chris Gilchrist is director of Churchill Investments and editor of Investment Planning


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There are 15 comments at the moment, we would love to hear your opinion too.

  1. From time to time I have argued against some of Mr. Gilchrist’s propositions. However on this one I would gladly kiss him if it didn’t lead to ribald comments and a certain destruction of reputations!

    It is axiomatic that we should praise those with whom we agree, but Mr. Gilchrist’s views have been echoed this month by another well respected and independent commentator – Russell Taylor in Money Management, who says much the same things. In particular I quote “ …. provided IFAs have common sense, they are likely to do as well as the market and rather better than the experts”.

    I really do get heartily sick of seeing outsourcing to DFMs peddled as the new panacea. I do agree that on occasion it is a good idea to outsource, but under strict parameters. No collectives should be rule one. IFAs can do it cheaper and at least as well. There are good reasons from time to time to purchase individual stocks both in the UK and sometimes from other exchanges. There is also an argument to outsource for a portfolio of fixed interest stock, provided it is specifically tailored to the client and income as well as net redemption yields are specifically customised.

    Unfortunately too many DFMs are Top Shop dressed up to look like Saville Row. Too many run model portfolios on ‘a one in all in; one out all out’ basis and far too few run properly bespoke portfolios for their clients.

    I would just add one further point to Mr Gilchrist’s piece – invest for yourself first and if you do use a DFM make sure he is also managing some of your money too.

  2. Spot on as always.

    Use your brain.

  3. I agree with Chris Gilchrist, however the mighty weight of the all knowing FSA would have us channel all clients into a simplified investment. No more can we try and do the best job for the clients!!

  4. I couldnt agree with you more. IFAs can do this better and cheaper and by tailoring the clients needs the objectives are achieveable
    The tools are out there to help you
    Well done Chris

  5. I agree with what you say, however I know that another reason why IFA’s outsource is to reduce the risk on themselves because of the now draconian regime we find ourselves in and it’s getting worse.

    They are outsourcing allocations and sometimes compliance for peace of mind.

  6. About time somebody told it as it is, but do remember the pressure to outsource etc is mainly due to the FSA and other academic busybodies who don’t have a clue about common sense and quality. But nevertheless well said!

  7. The last time I was sufficiently moved to comment on this aspect I honestly thought I was in a minority in insisting that the IFA should take responsibility and do the investment element himself or herself.
    How nice to know this view is apparently much more widespread. I agree completely with the author.

  8. Having read Mr Gilchrist for many years I think that as an investment manager he probably makes a good journalist. I also think that some of the comments above prove my point.

  9. I agree with the comments about DFMs.

    However I do have trouble with ther following:

    “The second mistake is to throw away the most useful insight of the past 50 years in investment management – the importance of asset allocation. Diversification is about reduction of risk, not enhancement of returns. Asset allocation is a sound method of reducing risk. If you buy this and believe strategic asset allocation decisions will account for 90 per cent of your clients’ returns, why do they need active discretionary management?”

    This is nonsense and has been known to be so for several years. It is based upon the study conducted by Brinson, Hood and Beebower in 1986. They were talking about the VARIANCE of returns, not the magnitude of them.

    Anyone wanting to get to the bottom of this misconception should put “The Asset Allocation Hoax” into Google. The first item to come up will be the 1997 paper by William Jahnke. It makes VERY interesting reading.

  10. Yup, having one ‘O’ level is of course perfectly fine to be a pretend fund manager….. sign me up!

  11. Yes it is all possible to do. Off you go and get your qualiifications from Chartered Institute for Securities & Investment + the relevant permissions to allow you to have genuine Discretionary powers and with the right experience you are now on a par with the Investment Managers who run discretionary portfolios. And then again you may have other things to do. As other professions form strategic alliances with different professions it seems not unreasonble for advisors who wish to concentrate on for example the highly complex aspects of tax planning, pension planning to accept that there is only so much they can do expertly. Is it really heresy to outsource the investment function in that situation? Surely a case of not one size fits all?

  12. Who cares how it is done, there is not any science involved.

    Sound basic principles and one heck of a lot of luck.

    That’s all you need.

  13. I agree with those who say IFAs are not qualified to choose funds. If you take the fund choosing argument to its logical conclusion, IFAs would be creating their own portfolios of assets. IFA’s are supposed to provide Financial Planning not pick funds – too many though are scared their clients will wonder what they’re up to if they’re not picking the funds. Maybe a little less time on the golf course chaps?

  14. It is always dangerous to criticize the way another works. This is especially so when it comes to investment.

    Personally I think that far too many advisers are far to active , churning ( sorry rebalancing) at the drop of a hat and using activity for its own sake simply to pad the bill.

    If however you start to ban others from doing things with which you do not approve do not be surprised if eventually if there is little of anything left for the adviser to do and get paid for.

    Investors could do worse than to diversify, keep costs low and take advantage of any available tax breaks. Does the investor going on a random walk over the long term even need and adviser ? and if so is the value of that advice really worth 1% pa of funds under management ? Personally I doubt it.

  15. The problem arises in the case for adviser charging and DFMs. Certainly in RDR land it could be almost impossible for an IFA to get properly paid.

    How can you justify charging trail commisson/ongoing fee amount if you’re not providing investment advice? What can you really do at a review with a client, say “oooh, it’s gone up or…oooh, it’s gone down.” You don’t need an adviser to work it out.

    What would the FSA say to those IFAs that use DFMs and take 0.75% trail commission? Or even, justify taking 0.5% trail commission?

    I’m not sure telling someone to use their ISA allowances and then some unwrapped collectives via XYZ Discretionary Fund Managers is worth a couple of grand and ongoing commission!

    Advisers need to be adding value to themselves under RDR to justify being paid, not giving it away!

    A final note, DFMs don’t technically come under the ‘whole of market’ test. However, I’m sure the client would expect that advisers do their due diligence and would seek recompense if things don’t perform as expected. You’ve got to be careful or you’ll end up taking the flack.

    At the end of the day advisers are authorised to give investment advice and this is something that needs to be dealt with at a regulatory level if people believe they shouldn’t be doing so.

    To be fair, I can understand why an adviser would outsource even if they were suitably qualified. Most firms are small and simply don’t have the set up to do it properly, even if they have the expertise.

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