How deep should the due diligence rabbit hole go?

Ashley Wassall

Due diligence: these two words have probably come to define the post-Retail Distribution Review reality of investment advice more than any other - except perhaps ‘client suitability’, though this is obviously merely the aim to which ‘appropriate due diligence’ aspires.

At an FTAdviser seminar this morning on due diligence and suitability assessment of multi-asset funds, Andy Gadd, head of research at Lighthouse Group, bravely took up the challenge of defining ‘appropriate due diligence’ to the packed room of delegates.

In particular he focused on the expectations - and outcomes - of the regulator, as part of its own ‘outcomes-based’ approach. In essence, this means simply that the regulator is “fairly loose” on the machinations of your advice process, as long as the outcomes are in the client’s best interest.

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All sounds very reasonable - and simple - in theory. And he went on to make some more statements on the FCA approach that sounded equally proportionate and intuitive.

For example, he stated that any adviser worth his or her salt should not recommend any investment that they do not “fully understand” themselves (helpfully referencing little understood underlying complexity and illiquidity of the Arch Cru funds that have become a spectre hanging over the advice industry).

Mr Gadd admitted, however, that there is a fly in the ointment: while it is desirable, it is not always viable to get to grips at a granular level with investments that you may otherwise feel you have enough of a handle on to recommend.

He cited with-profits bonds, stating that while many advisers including himself had recommended them in the past, few would be able to fully articulate how the bonuses and returns were calculated.

Similar concerns have been raised in relation to, for example, structured products.

Most advisers may feel they comprehend how a given product is designed to operate and the unique risk factors - such as counterparty risk - involved, but they may not understand “fully” how the underlying put and call option derivatives work. Should they on this basis recommend the product?

The panel session at the end of today’s session was dominated by this discussion specifically in relation to Invesco Perpetual’s new major multi-asset offering, the Global Targeted Returns Fund.

The vehicle, which has recently launched on 3 November, is described as a “fund of ideas”. It comprises at the moment of 24 ‘ideas’ of where returns might be found based on a central macroeconomic hypothesis, which are then implemented via a wide range of strategies.

Using this methodology, the fund aims to generate a 5 per cent return above Libor on a rolling three-year annualised basis, but with half the volatility on the MSCI World equity index.

Not surprisingly, that sounds appealing. The questions begin to come around assessment of the fund when you look beneath the bonnet at the underlying investment themes and how they are “expressed”.

At one end of the scale you have the idea that European equities currently offer good value over a medium-term horizon and will therefore generate positive returns over two to three years. This has resulted in the fund investing in a couple of Invesco’s own European equity funds.