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Grade Your Portfolio

The Gold Standard of Investing

Topic: Investing Efficiently 17 December 2018

Choosing a financial adviser to build and manage your investments is a decision that can define your financial future. Getting it right is paramount, yet from our analysis of more than 30,000 investment portfolio’s we believe that only a small proportion of investors are receiving the ‘gold standard’ in investment management.

The right adviser can help to add significant value to your investment portfolio – but what makes a top-quality financial adviser and what processes do they follow?

What Is The Gold Standard Of Investing?

Different levels of competency exist within the financial advice/ financial management sector. Financial advisers of the highest standard build sustainable client relationships through efficient and proven customer-centric processes that provide long-term value for their customer. Such processes help to maximise investment returns of their clients and provide growing levels of funds under management for the highly competent advice firm.

This article focuses on the processes that highly competent and successful advice firms adapt for their firm to maximise client efficiencies.

The Cost of Investing: Delivering Value

From our experience, advisers who charge high initial and ongoing fees are more focused on their self-interests than adding value to their client portfolios. High initial fees (3% of the amount you invest or higher) indicates that their priority is to instantly capitalise financially before adding value - which can reflect a lack of confidence in their ability to deliver long-term value to their clients. Such practices demonstrate a lack of foresight and planning and should be avoided. Transparency in charging is also very important. Good firms should be confident in their charging structure as fair, and reasonable.

The other end of the ‘cost’ spectrum can also be detrimental to investors. An increased focus on cost has led to the rise of low-cost investment products and online robo-advice brands such as Nutmeg or Moneyfarm, who offer a range of portfolios comprised of low-cost passive ETFs. The success of these cost-centric platforms is based on their ability to attract clients by providing a lower cost service. Yodelar research into such platforms has highlighted poor or underperformance from portfolios managed and sold at low cost. Such business models focus more on saving their client’s money as opposed to growing their wealth - which essentially is what investing is all about. The smaller net worth clientele often prioritises cost over quality and overlook the strategies that can be more efficient.

Choosing an adviser, service or investment product based on cost alone could end up costing you significantly more in lost returns over the long term, which will impact in your future standard of living or life choices; likewise, associating higher costs with higher quality can also lead to disappointment.

The purpose of this article is to arm investors with more information, allowing them to determine if their portfolio is working efficiently, or not!

The real value of a high-quality investment adviser is in their ability to understand your current financial position, identify your tolerance to risk and investment objectives, plan, build and manage a suitable portfolio of top performing funds as well as monitor, rebalance and amend your portfolio to ensure continuous maximum returns.

The cost of efficient, process driven investment management is often insignificant when compared to the returns it can generate, but from our experience, the advisers who employ such effective strategies typically charge an initial one-off upfront fee of 2% then 1% per year after that.


Investment Management Without Limitations

Advisers fall into two broad categories — independent or restricted. Restricted advisers, as the name suggests, can only usually recommend certain types of products or those from a limited number of providers, whereas an independent adviser can provide advice on all matters of financial planning and choose from the full range of funds available to UK investors.

Some financial advice firms choose to become restricted, so they can focus on one area of financial planning, whereas others do not see merit in understanding performance within relevant sectors and prefer to limit their fund choices. These firms have often been criticised for ‘pushing’ their own products, platforms and investment funds. Some restricted firms have also been criticised for earning bigger margins selling their own products, but their clients are only exposed to a small range of options.

The largest restricted advice firm in the UK is St. James’s Place (SJP), with more than £90 Billion of client assets under management. SJP and their network of partner advisers are only able to offer their clients access to SJP branded funds and portfolios. SJP are regularly criticised for poor performance and substantial fees - which have exceeded 7% in the first year and 2% each subsequent year. They have also been criticised for levying an exit fee of up to 6% for clients who wish to leave.

To complicate matters further, some advice firms are restricted as they choose to only specialise in one area, such as pension planning/investment planning. Although they are unable to advise on other financial matters, they do have access to the ‘whole of market’ in regards to pension and investment funds. Such limitations may have little to no impact for a proportion of investors.

The freedom provided by independent financial advisers and advisers who have access to ‘whole of market’ is the unrestricted access they have to the better performing funds and fund managers. Although some advisers make little use of this freedom, those who follow best practice and strive to provide their clients with top quality investment management will use this freedom to analyse and select the most suitable, top performing funds for their clients’ portfolios, without bias or prejudice.

Understanding Your Situation, Goals & Investment Objectives

A suitability report is used by advice firms to understand and record their clients’ objectives, needs, priorities and relevant existing investments. It enables the adviser to provide a clear and accurate written record of their recommendations, as required by the regulator and is a key element used to judge an adviser’s competence.

All investment advisers complete a suitability report for clients with a focus on identifying three key pieces of information:

1. Need & requirements

The adviser must show a clear and concise understanding of their client to include their current circumstances and desired outcomes. Advisers who use generic stock statements for this process with little relevance to the client reflects a lack of effort and a disregard for their client's best interests. Good financial planning requires a deep understanding of each client's needs, aspirations and goals.

2. Suitable advice.

Advisers must be able to demonstrate to the client how their recommendations meet their needs. They must explain the reason for selecting the funds they have recommended, and the reasons why they meet the risk objectives for the client. Top advice firms will also (but not required to) show the client the suitability of 1 fund within a recommended sector versus all other funds.

3. Possible risks/disadvantages.

Advisers are required to inform clients of the potential risks associated with any recommendations via ‘risk warnings’. Poor advisers will use standard risk warnings, which often do not apply to certain clients, others do not elaborate on risk warnings that are very applicable to certain clients. Highly competent advisers will ensure that tailored risk warnings within a client’s suitability report are relevant and well explained to each client.

Planning Is Key

A detailed plan tailored and specifically focused on delivering the financial future a client wants, which is clear and easy to understand, review, and amend to personal circumstances, is a key component provided by the top advisory firms. One of the most effective models to achieve and manage this is the process of cash flow modelling.

Effective cash flow modelling must begin with detailed knowledge of a client’s current assets, income and expenditure. It is vital if financial objectives are to be achieved. Without cash flow modelling, clients cannot experience true financial planning. The vast majority of advice firms we come across do not have any cash flow modelling in place for clients.


A cash flow model calculates the growth rate a client requires if they are to meet their investment objectives. This rate is then cross-referenced with their attitude to risk to ensure their expectations are realistic and compatible with the asset allocation needed to achieve the necessary growth rate. Quality advisers help to ensure that their clients’ financial forecasts are as realistic as possible which not only helps their clients understand the potential range of outcomes from different financial strategies, but it also allows them to make informed decisions.

Cash flow modelling assists those who wish to become and remain financially well organised and fulfil their life goals. It is incredibly powerful when in the right hands and continuously reviewed. We often see firms that discuss cash flow modelling when they initially engage with a client, but they ignore during regular annual reviews.

Cash flow modelling is a continuous process that needs to be managed. If your adviser fails to revisit your cash flow model at least once a year it is a sign that they may lack the quality to provide a suitable service and that your investment objectives may not be met.

Through processes such as cash flow modelling, high-quality advisers can help their clients mitigate risk and navigate through different life stages and changing market conditions while keeping their clients’ portfolios on track to reach their investment objectives.

An Asset Allocation That Fits Each Client

It is widely accepted that strategic asset allocation – i.e. the setting of long-term allocations between equities, bonds, cash and other asset classes, and the subsequent adherence to these weightings – is the most critical driver of long-term performance and volatility. Setting the correct asset allocation is, therefore, a fundamentally important foundation of investment success.

The asset allocation model chosen by an adviser must fit the needs of each client based on detailed conversations with that client about their goals, as well as their financial situation, risk tolerance, contributions, spending levels, and time horizon.

Careful selection of the asset classes that form a portfolio, as well as the individual investments within each asset class, is essential to get right as these two areas will define the ultimate success of your portfolio.

Over time our tolerance to risk can change. The CFA research institute state “your appetite for risk decreases with age and commitment”. Therefore, advisors should understand the level of risk each client is comfortable with at different life stages and ensure their investment portfolios are correctly structured to absorb financial shock and withstand market fluctuation.

Disciplined advisers who adhere to best practices will engage with their clients at least once a year to assess for changes to their circumstances and to make adjustments where necessary. The implementation of such ‘best practice’ processes helps ensure their clients have a suitable, efficient and robust investment portfolio throughout all stages of their investment lifecycle.

Finding an Adviser Who  Can Identify Top Quality Investments

All regulated financial advisers are held accountable to strict regulation and thorough compliance measures that are in place to ensure their clients’ protection.

However, financial advisory firms are not regulated on the particular funds they advise clients to invest in. As long a client is invested in a manner to suit their risk profile and investment needs, firms are providing suitable advice in the eyes of the regulator.

Past performance is not an indicator of future returns, but if asked clients would prefer to invest with fund managers that consistently perform over varying time frames in the top 25% of performers versus fund managers that perform in the worst 25% of performers. In 2018, Yodelar analysed more than 10,000 investment portfolios and found that 9 in 10 included funds that consistently ranked in the worst 25% of competing funds within the same sectors for performance. The main 2 reasons were (1) a lack of performance research/knowledge by advisers, or (2) the advice firm could only advice on restricted investment funds, most of which were poor performing.

Fund performance is a critical metric that high-quality advice firms analyse to ensure recommended portfolios meet their client’s objectives while utilising the proven top performing fund managers. Top advisers want to ensure the portfolios they recommend use top fund managers.

Adviser Research - Identifying Top Quality Funds

In order for investment advisers to identify which funds outperform their peers and then apply these funds to efficient investment portfolios, they must have the ability to identify, analyse and regularly review the performance and overall quality of each fund. Top advice firms will show clients their process for analysing funds, and often share this information with clients by incorporating processes that filters funds based on set performance criteria.

One system applied by some quality firms to track and manage fund performance is referred to as the traffic light system. This system uses a 3-tiered fund grading model that promotes a pragmatic investment approach and helps to avoid poor investment decisions.


The Investment Traffic Light System

Green – Funds that have primarily maintained a level of performance that exceeds 75% of same sector funds over the recent 1, 3 & 5 year periods. Such funds are viewed as top performers and represent excellent investment opportunities. When constructing a portfolio, it is predominantly funds with a green rating that are considered.   

Amber – Funds that have previously rated as green but recently experienced a decline in performance compared to other funds within the same sector. Amber funds remain within the portfolio but are carefully monitored, typically over a 3-6 month period, to identify whether their performance has improved, remained stagnant or declined. If the fund’s performance has improved to a level that is better than 75% of competing same sector funds, it returns to being a green rated fund. If it remains stagnant, it will continue to receive an Amber classification for a period of up to 6 months. If no improvement is seen during this period, it will receive a red rating.

Red -  The red traffic light signifies that some action is due. It may be that the fund is removed from the portfolio and replaced with a suitable green rated fund. Funds will be moved to a red rating if they continue to drop down the sector ranking over a 3-6 month period, or if they fail to improve six months after receiving an amber rating.

Top firms use the above approach to ensure their funds under management are performing efficiently for their clients as well as their firms’ overall funds under management. They must analyse funds against all other same sector funds and identify times when a conversation is required with a favoured fund manager.

Communication is important between fund managers and a top advisory firm. Fund managers are accountable to wealth management/advice firms and have a fiduciary duty in the same way your adviser has to you as a client.

Our research shows that financial advisers who have access to ‘whole of market’ and implement the above fund selection processes generate better returns for their clients and increase their fee revenue as a result.

Maintaining the Perfect Balance

Having taken the time to set the appropriate asset allocation, advice firms will add value by regularly rebalancing the weighting of each client’s portfolio.

Rebalancing is a critical component of investment management. Over time different assets perform at varying levels of positive or negative growth. The result is that their initial weighting will drift over time and vary within an investors portfolio. As a result, higher-risk markets such as Asian or Emerging Market equities may outperform lower risk asset classes such as corporate bonds resulting in that portfolio assuming a higher level of risk than initially intended.

An example of when the failure to rebalance had an enormous impact on investors was during the financial crisis of 2008, which resulted in many investors losing a significant proportion of their retirement savings, with some losing more than half overnight. These investors had portfolios that were poorly maintained and left unattended for years. Many of those investors had portfolios that were poorly maintained and left unattended for years. Therefore, over time their asset weighting shifted, and they went from potentially assuming an initial cautious investment approach to a very high-risk approach. Subsequently, when the markets crashed their overexposed investments suffered catastrophic losses.

High-quality advisers will regularly rebalance their clients’ portfolios to mitigate such risk, and correct portfolio drift at least twice per year.

Rebalancing is designed to control risk, but quality advisers will use the engagement as an opportunity to review and assess the individual performance and quality of the underlying funds within each asset class and may make fund amendments if required.

Building A Top Quality Portfolio

Successful and compliant advice processes that consistently deliver are becoming increasingly dependent upon the capabilities of the adviser and the financial planning processes they follow. An advice firm which adheres to a high standard can add significant value to their clients over the long term.

Advice firms that have their clients’ best interests at heart strive to incorporate the best, most efficient investment processes.

They are not afraid to question or challenge how things are done and remain unbiased when reviewing their clients’ portfolios in order to see potential areas for improvement.

Investing is about maximising returns within an acceptable level of risk, and the advisers who follow the ‘gold standard’ process for investment management are better prepared to deliver for their clients.

The best practice processes detailed in this report are employed by a proportion of financial advice firms whose client portfolios we have continuously reviewed for performance.

These firms have a clear business model that have client success at the forefront, and through their management of a structured, proven process they can provide their clients with top-class service.


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Important Risk Warning

This article is not personal advice. This article gives information as to past performance of investments. Past performance is not a reliable indicator of future performance. Always seek personal advice from an FCA regulated adviser. The value of investments will rise and fall, so you could get less that what you put in.


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