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5 good reasons to document your investment proposition

David Hazelton, head of Business Development at Raymond James, points to five good reasons why advisory firms should have robust documentation of their investment philosophy as well as their investment management and advice processes

A properly documented investment proposition can be a powerful tool. While some of the financial advisers I meet are well ahead in this area, many do not have a properly documented investment process which I find strange as there are many good reasons to do this. Maybe the reason for this is that they’re not clear on the benefits or are not sure how to do it. If this is you maybe we can help?

So let’s start with the benefits. A properly documented investment proposition can:
Differentiate you from your competitors
Give greater clarity and control over your investment process
Potentially generate enhanced returns for clients
• Help evidence suitability
Increase the value of your business in the event of a sale.

Hopefully that’s enough to convince you there’s benefit in dedicating the time!

So the start-point is for you to define your investment philosophy – what you believe in. From there you can develop your investment management and investment advice process, which will then link to the clients’ objectives and deliver an investment solution that meets their needs.

What do you believe in?

There are various questions to ask. What are the long-term drivers of growth in markets; value or growth, large cap or small cap? What are the benefits of diversification and how will you achieve this for various types of clients? This question leads to the definition of asset classes – what are they and how to access them? Do you believe in active or passive investment management or maybe a mix of the two where it is appropriate?

International exposure is interesting. On the one hand there are diversification benefits and the possibility of accessing faster growing markets, but on the other hand there are currency risks to factor in. Market correlation also becomes a key factor to consider when investing internationally – developed markets are generally more closely correlated than emerging markets, so it’s important to get the right mix to ensure the best possible risk adjusted returns.

Do you believe it is possible to time markets to enhance returns, or do you believe in efficient markets? What’s your approach to large cash investments – should they be invested in one go, or drip-fed into the markets?

Finally, what about tax and charges? Does the tax tail in fact wag the investment dog, or is taxation a secondary consideration? Where clients hold more than one tax wrapper is there an opportunity for tax optimisation? Could holding different asset types in different wrappers increase post-tax returns? And what about the impact of charges? Have you considered the equity-risk premium and the level of excess return equity investments need to achieve to exceed the ‘risk-free’ returns available? There is no point taking the extra risk of investing in equities if the excess returns are wiped out in charges!

No doubt you will have thought through some or all of these issues, but it’s really important that these are written down and you have evidence to back up your views. The first pass might not be the finished article, but don’t worry about this. Most wealth managers I speak to are always finding ways to improve their process. This core document can be used for a variety of purposes; a short version for clients, a longer version for introducers and clients that require a greater level of detail, and it could become the template for an investment committee. You never know, it might be useful to share it with the regulator if ever they come calling!

Practical portfolio construction and management

Once you’ve thought through your investment philosophy, you need to develop your investment management and investment advice process. This is the ‘how’ and sets out the process for implementing your investment philosophy. Again there is plenty to consider.

You will probably already have a client segmentation plan in place, but you need to consider how your investment philosophy maps to groups of clients. It may be entirely practical to hold a wide range of holdings for clients with large lump sums to invest, but offer multi-manager funds to clients that are investing monthly. That’s entirely acceptable so long as the fund chosen meets with your investment philosophy.

That leads to the consideration whether you will offer a prescriptive approach or bespoke approach, and how to access the various asset classes and investment selection in order to build the portfolio. Model portfolios can help to achieve scalability in your business but you need to ensure that clients are not shoe-horned into something that is not appropriate for them.

Re-balancing issues

Re-balancing is an interesting topic. Many advisers believe this to be a free-lunch, in that risk can be managed with no impact on returns. However, there is evidence to suggest that excessive rebalancing can actually harm returns. You should read a copy of a paper written by Yessim Tokat that suggests an effective rebalancing strategy is a function of the portfolio’s assets; their expected returns, their volatility, and the correlation of their returns. A high correlation will reduce the need for rebalancing as will a portfolio with a short time horizon. As the portfolio is rebalanced more frequently, costs become a bigger drag on performance. In upward trending markets, excessive rebalancing can produce lower returns. So you will need to consider an effective rebalancing strategy probably by working within tolerances and only making switches that are optimal.

Finally, you need to consider how you will implement the portfolio across the assets you are managing for your client. Will you try to maximise tax by the use of multiple tax wrappers and if so how will you ensure you can have access to the appropriate range of tax wrappers for your target clients? If CGT is likely to be an issue you need to set out how you will optimise tax across all wrappers, maybe by transferring assets into ISAs and other tax efficient investments over time.

The consideration of whether or not to use a platform, and if so which platform is too big a subject to cover here, but it is important to define your investment proposition before choosing a platform, otherwise you may find the platform is not fit for purpose!

Why the time invested is worthwhile

In summary, having a properly documented investment proposition that you can show to clients, introducers and possibly the regulator will stand you in great stead. However, the greatest benefit is likely to be realised if ever you put your business up for sale. It will set you apart from your competitors, help to evidence suitability and show to prospective purchasers that you have robust business processes that are repeatable. These are some of the key drivers of business value and there’s no doubt the time invested now will be worthwhile.

Read Yessim Tokat’s paper on rebalancing strategy


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