New requirements call for new structures


    In the investment world, we are well and truly into the new year, looking forward to the end of the first quarter and more importantly to the end of the tax year.

    A quick glance back reveals a reality: The rear view mirror always seems to highlight simpler times because in hindsight not only investment appears to have been easier but the whole world seems to have been a lot simpler than it is today. Does this sound familiar?

    This article aims to make one of the most complex areas in investment outsourcing simpler to navigate for you: the fund solutions available to financial advisers.

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    New requirements call for new structures

    It was not that long ago that our investment world seemed to be organised into neat product lines. We had investment bonds, personal pensions, personal equity plans and bespoke segregated accounts – each with their own investment style attached to them and ‘reasons why’ the clients would buy them.

    Promoted, arguably, by changing charging structures, tax wrapper benefits (investment bonds) and the need to formally segment clients, those nicely differentiated product lines have all gone now. With them, the way we used to offer client solutions has disappeared.

    In the current environment the old classification system, couched in the language of the Investment Management Association, the Association of British Insurers and the Wealth Management Association, looks a bit out of place and needs to evolve. Defaqto has now introduced a new taxonomy to try and make better sense of our brave new investment world. We will expand on this in this article but first we take a look at what this shift means for advisers.

    Risk-targeted approach

    An empirical change we have witnessed is that the traditional link between risk and reward has been fractured. We no longer ask the question how much risk the investment manager has taken for the return delivered. This is a fundamental change and what we are seeing now is a ground-breaking change in the way financial advisers approach investments.

    Advisers ask how much risk the client can take, how much loss they can bear and whether the possible future return is based on the agreed risk that the client is able/willing to take. This is what we call the risk-targeted approach.

    Some advisers, however, continue to believe that a risk targeted approach is difficult to deliver over various investment cycles. They believe that fixing the volatility of a fund restricts the ability to actively manage downside risk while maximising upside potential. This was something we observed during 2007 and 2008 when some DFMs actively moved clients from equities into bonds and then into cash. This type of mandate flexibility was not seen by the fund groups.

    Fund investment taxonomy

    Simply put, the fund investing world can now be seen as having two broad investment ‘styles’: fund families of risk targeted investments sitting alongside the long-established return focused funds; return focused and risk targeted.