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The role of the IFA in fund selection

Independent advisers need to consider the nature of their service to clients when picking investments.

What exactly should an IFA be doing when it comes to choosing funds for clients? This is a question which has been asked on many occasions and arguably it has never been more relevant.

The Investment Management Association recently stated the biggest single issue facing pension scheme trustees is to get strategic asset allocation correct. Indeed a number of trustee bodies have moved to a manager of managers basis for the investment management of their funds.

This is despite (or a result of) the fact they are more often than not advised by large actuarial/investment consulting firms. Arguably the challenge facing the IFA is greater than that facing pension fund trustees, given the huge number of funds that the IFA has to choose from, the significant number of manager changes in the retail fund space and the shortterm outlook of many individual investors.

Let us look at the background against which IFAs are choosing funds.

In the period to the end of December last year, only 17 funds were top quartile in each of the last three years in the IMA UK all companies sector. Over five years, only five funds were top quartile each year.

If you think that is too difficult a hurdle, only 22 per cent of funds outperformed the FTSE All Share over one, three and five years. Furth-ermore, the past three years have seen some of the highest levels of fund manager changes that have been witnessed during the past 10 years.

This makes choosing a fund and a fund manger very difficult. There is no point in putting clients into actively managed funds unless they are going to outperform the relevant index on a medium-term basis – otherwise, why is the client getting charged active management fees and why is the IFA being paid?

At the same time there has been a proliferation of fund of fund and manager of manger opportunities. For many IFAs, the jury is still out on whether a Fof or Mom can add value after their charges.

However what is clear is that they devote a level of resource and expertise to the selection of fund managers that most IFAs cannot. They can also purchase most funds on terms which IFAs cannot.

Fof and Mom approaches usually use objective and subjective assessments of a fund manager’s capability and, based on this, decide with whom to build their portfolios.

A number have clearly demonstrated that they have objective assessments which can determine if a manager has produced true added value in a consistent and repeatable way.

However, if an IFA wants to outsource fund selection, he or she has an important decision to make in selecting whom to outsource to. In particular, they have to be able to assess the subjective capability of the Fof or Mom provider.

This is a difficult task. Not all FoF managers have so far demonstrated added value through their subjective assessment, yet many suggest it is what you are paying for.

What should an IFA do? For me, the answer is entirely dependent on why you are an IFA in the first place. Are you there solely to give investment advice or to give holistic financial planning? Do you aim to add most value to your clients through choosing funds or by helping them face financial opportunities and challenges?

Take my own position -I value the professional advice that I receive from my IFA. This covers not just investment matters but also pension planning, tax mitigation, ensuring that I have a will and so on.

These areas mean more to me than whether my IFA chooses the funds I invest in on his own or with external input. I would think this is the case for most people. Mitigating 6,000 of tax is worth more to someone on 35k a year than to someone on 75k a year, for example.

Having someone there to devote time to looking after my financial affairs with me is the main benefit I gain from having an IFA. Avoiding the “dogs” in investment funds is important and fund selection on anything other than a professional basis carries downside risk.

If you think choosing funds is a key thing that you do, have you assessed your own recommendations? Have you looked at the funds you recommended five years ago? How many have outperformed the peer group? How many have outperformed the benchmark index? Most important, how many have delivered what your clients expected?

The challenges facing those who select funds are increasing. It has reached the stage where an IFA should only be doing this in one of three ways – it is the mainstay of his or her business, he or she has significant external independent input to the process or the selection of investment managers is outsourced to an expert.

I am certainly not advocating that all IFAs should use Fof or Mom products for their fund selection.

What I am advocating is that as an IFA you are clear about what you are seeking to do for your clients.

If adding value through fund selection is not the prime driver, then free up valuable time and reduce your stress levels by getting some expert support.

Francis Ghiloni can be contacted by email at francis.ghiloni@virgin.net

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