The slow growth of western economies, and the moods of greed and fear that grip modern markets as they lurch from ‘risk on’ to ‘risk off’ make the task of providing good investment advice ever more difficult. Bull markets used to outlast and outpace bear markets. Advisers used to say if you bought and held US or UK shares from whatever start date you would make money over five or 10 years. That no longer holds true for some recent periods.
Many IFAs are coming to the conclusion that they are not investment managers themselves. They can help a client define what their aims for their investment are. They help them decide how much risk or volatility they can accept. They can offer informed views of how the different funds and managers perform, how much they charge and how good their service is. The day job does not allow them to construct the portfolio of individual shares, bonds or even funds, and manage it day to day. It is often best to leave that to firms and people who do that all the time.
This has led to a big increase in the fund supermarket or platform approach. The IFA is still the principal adviser to his or her client. The IFA is much needed to help the client decide what they want. He or she can advise on the tax and legal implications of what they are doing. They can tell them how various types of investment have worked out in the past. They can put them into funds or management systems which can provide the range of assets they want and need.
Quite often IFAs follow so called lifestyle investing. It is a useful rule of thumb which says that an individual should have the same percentage in lower risk bonds in their portfolio as the number of years they have been alive. A 25 year old would have mainly riskier assets, wishing to grow their capital. They have time to accept losses along the way, expecting a better return over all over the many years they have left. An 80 year old would in contrast have 80 per cent of his or her fund in bonds. Their capacity to earn more has usually been replaced by living off their savings and pension investments as they grow older. They need more stability of value and a better gurantee on the income.
This is not the time or place to criticise this popular theory. In recent years it has worked fine for the elderly, as bonds have performed especially well. It does serve to remind us that IFAs and their clients need a range of different portfolios to suit different ages, tastes and attitude to risk.
The idea behind the platform is that a range of funds, often provided by a range of different managers, allows the IFA to find a fund exactly suited to his client’s age, financial circumstances and approach to risk. Various managers offer balanced funds, with around 50 per cent in bonds and 50 per cent in shares. They offer growth funds with around 75 per cent to 80 per cent in shares, and cautious or defensive funds with 10 per cent to 25 per cent in shares. They offer income funds that concentrate on a mixture of bonds and higher yielding shares.
The IFA can in effect make the strategic asset allocation decision if he wishes. He or she can select a fund or funds which give the precise allocation to asset classes he is seeking. Many such funds will stay close to the stated guidelines or chosen asset allocation. If you choose a defensive fund you know you will not get a high share exposure. If you choose a growth fund you can normally expect to lose a lot of money when share markets collapse.
Some funds offer asset allocation decisions as well as general management of the individual securities. In these cases an IFA may choose a growth fund, but the manager may have the right and may choose to exercise it to go much more liquid if he fears a market collapse. An IFA may choose a defensive fund liking the bond exposure. The manager may have the right and the wish to go into cash instruments because he is temporarily worried about bonds. Such calls usually only become a problem if the investment manager gets them wrong.
How can an investment manager or an IFA make these calls with some hope of adding value? The first thing to grasp is you cannot avoid having an asset allocation in the same way that you can avoid taking too much risk on individual shares. To avoid individual share risk you can simply buy an index tracking security which will give you more or less the performance of your chosen share market without undue stock risk. However, there is no good way of indexing the overall asset allocation which will also meet the requirement to understand your client needs and to assess risk.
As you have to have an asset allocation it is a good idea to spend some time considering it. There is no sure fire way of judging whether Chinese shares or German bonds are a better long term bet. There are various ways of studying past performance, examining current valuations, and seeking to peer into the future over what might happen next. If you get more of these calls right than wrong you will add value and have done reasonably well.
The case of German bonds today is an interesting and difficult one. Some say they are top quality bonds. Their yields may be low, but they are reliable. They could go higher in price as so many people rush to quality when conditions are tough. You could, they say, buy them to avoid losses and have a steady but low income.
Others say Germany will be increasingly dragged into paying for the rest of the Euro area. As a result Germany’s credit rating will come down, as more and more of the liabilities of Greece, Spain, Italy, Portugal and Ireland fall to German taxpayers. Germany will have to accept more inflation to help the weaker countries become more competitive. The Euro may fall, as they will need to create more of the currency to keep the banking system afloat. These people say sell or do not buy German bonds.
Others think the euro will either break up altogether, or the weaker countries will be evicted. They say buy German bonds, because if this happens the new currency, be it DM or Neuro, will appreciate substantially and give you a gain on the bonds in your own currency as a result.
So what is an IFA and an investment manager to do about German bonds? My view is that it is too difficult to predict what German bunds may be like in five to 10 years time. There are too many imponderables. For myself I think the current yields are low for the risks, so I would not buy any. You need someone to watch it over the months ahead. If a break up of the euro became more likely, these bonds could then start to look attractive. There is no one right long-term answer. You need to manage it and respond to events.
The platform approach allows IFAs to choose managers who can watch these things and make decisions when they think there is sufficient information to come to a sensible view. The platform gives IFAs access to a wide range of investing styles and approaches. There will be funds that can give exposure to shares in all the main markets, to the main bonds markets of the world, and to alternative assets like property and commodities. An IFA can choose a fund which does exactly what the IFA thinks the client wants for the longer term, or a fund with more discretion for the manager. The manager may offer an actively managed portfolio of shares, or may offer lower cost index tracking.
The good IFA explores carefully the full costs of the chosen fund or funds on the platform. What are the arrangements for the management fee, and the dealing costs? Is there a bid-offer spread? Is there any initial or closing charge? Is there a separate custodian and administrative charge? The IFA needs to satisfy himself or herself that the package is decent value.
The good IFA may well decide some element of discretionary management is best. As in my German bond example, the range of possibilities for even the most apparently stable and secure of investments can be very large. Today’s sure fire investment may be tomorrow’s high risk bond or dividend cutting share. The case for having a discretionary manager interpreting the overall risk profile of the client as news and views change can be a strong one. In today’s well stocked marketplace there is discretion and discretion. The IFA can calibrate how much discretion the investment manager has by his choice of fund. One manager favours indexing to keep the costs down, but do think there are times when you need to change your exposure to major asset classes.
Christopher Aldous is chief executive of Evercore Pan-Asset Capital Management
Key points
Many IFAs are coming to the conclusion that they are not investment managers themselves
The platform approach allows IFAs to choose managers who can make decisions when they think there is sufficient information to come to a sensible view
The good IFA may well decide some element of discretionary management is best
