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Richard Leeson: Lack of asset due diligence is prompting complaints

Advisers sometimes overlook the appropriateness of underlying risk assets, resulting in complaints.


The number of investment-related complaints received by the Financial Ombudsman Service fell in the year to 31 March, with complaints at their lowest level for five years.

The investment products referred to include bonds, Isas and unit trusts in the main and the cause of complaints relates largely to sales and advice (64 per cent of the total), with a further 28 per cent of complaints arising from administration. 

One would hope the drop in complaints is a direct result of the removal of commission and the implementation of the RDR. But there were still over 3,100 complaints to the FOS, which means there is more to be done.

Clients tend not to complain about funds that perform well but about those which give rise to a loss. If a complaint is made, the FOS looks at the underlying assets into which the client was invested to ensure they were appropriate for the client’s risk level. Having too much exposure to higher-risk assets is an area of investigation of which advisers need to be wary.

Where advisers can run into problems, and where complaints are upheld against them, is the unsuitability of underlying assets. A cautious client may have 60 per cent as a minimum in lower-risk assets, including corporate bonds, gilts and cash, with the balance in, say, property and UK equities.

The following example looks at a cautious portfolio comprising 65 per cent in corporate bonds, 15 per cent in property and 20 per cent in UK equities. This may appear more than adequate in achieving a portfolio meeting the 60 per cent requirement of holdings in lower-risk assets. In fact, there seems to be headroom above 60 per cent. 

But this simplistic approach fails to analyse the underlying holdings in the corporate bonds; the adviser must be sure the holdings inside the funds also meet the requirement of being lower risk. While investment-grade corporate bonds may be lower risk, bonds which are sub-investment grade are not.

If the underlying fund held 20 per cent in non-investment grade corporate bonds, the example portfolio would not hold 65 per cent in lower-risk assets. The 20 per cent non-investment grade holdings would represent 13 per cent (20 per cent times 65 per cent equals 13 per cent) of the total portfolio, reducing the total of lower-risk assets to 52 per  cent (65 per cent minus 13 per cent). By overlooking this the adviser would have, perhaps unwittingly, created an unsuitable portfolio for the investor and a complaint may be upheld.

Check the investment mandate

Care also needs to be taken in checking the mandate of the fund. A fund that holds only investment-grade corporate bonds may still allow the manager to invest in higher-risk assets. An adviser may be, at the point at which the recommendation is made, placing a client in a fund suited to their risk level, only to discover the manager increases exposure to higher-yielding bonds and consequent higher risk that is unsuitable to meet the client’s brief.

The annual review on the FOS website includes the following statement: “When markets are relatively buoyant, we tend to receive fewer complaints about what might be called conventional investments – and this was the case during the year.”

It makes sense that clients do not complain when things are going well. With pressure building for an increase in interest rates, there may be a correction in the prices of fixed-interest securities. 

Any such correction that impacts negatively on a client’s overall return will potentially increase the likelihood of a complaint being made and more so for the cautious client. Recently there have been reports of increased targeting of financial adviser clients by claims chasers.

Another quote from the FOS review makes a stark warning to advisers: “With interest rates still at a historic low, we saw complaints from consumers who had sought better returns. But this had exposed them to riskier investments than they really wanted, with more money at stake than they could afford to lose.”

While overexposure to risky assets may result in a complaint, underexposure does not tend to cause referrals to the FOS.

Richard Leeson is chief executive of Adviser Advocate 


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There is one comment at the moment, we would love to hear your opinion too.

  1. It is accepted that high yield corporate bonds can exhibit equity like risk, especially in a falling market, but one must be careful to explain to clients that, even if there are higher risk investments within a portfolio that overall meets the client’s appetite for risk, those investments should not be seen in isolation but as part of the bigger picture. My fear is that clients, and claims chasers for that matter, may well try to focus on the individual components of a broad portfolio that may lose money in the short term while ignoring the other positive performers elsewhere in the portfolio. If the overall portfolio has performed in line with the clients appetite and capacity for risk relative to stockmarkets, even in a falling market, I would have thought that there should be few complaints providing the scenario was properly explained to clients at the outset. In crashing markets, most asset classes fall in correlation – that’s when modern portfolio theory can fly out of the window.

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