FAQs
Are you an IFA or a portfolio manager?
Both. We believe financial planning and portfolio management (even on a discretionary basis) are inseparable: portfolios need a plan and good planning needs real investment expertise.
When planning for the future, nearly all of us face tensions between our desire for future consumption and our willingness to save, between our needs for investment returns to fund future spending or other goals and our readiness to take risk. Good planning helps us to resolve these tensions in an informed way by articulating and quantifying choices through financial modeling. It can only do so if it takes full account of the complex interaction between our goals and ambitions for the future (financial planning) and the resources we will potentially have to achieve them (investment management).
In our ‘goal-based wealth management’ approach, what we call Defined Outcome Portfolios are organised to deliver specified outcomes for each different goal or objective a client or family has, in the form and at the time that they identify. These specified target outcomes, time horizons, resource requirements and risk preferences all come from financial planning. Most clients (an individual or a couple) have more than one goal and more than one portfolio. Common target outcomes include funding retirement spending, paying school fees and planning inheritance.
Can we hire you as a manager without doing a financial plan?
No. All clients who retain us to manage portfolios go through the planning stage, which we call an Initial Review. During the Initial Review we invest considerable time and resources in a comprehensive analysis of all aspects of the household finances, working with our clients to develop the goals and objectives that investment is there to serve. In our “goal-based wealth management” approach, separate portfolios are structured to meet each of our clients goals and objectives. Without detailed financial planning, we would not be able to design these customised portfolios and our clients would not benefit from the peace of mind that good planning brings.
Do you charge separately for financial planning?
Yes – we always have done. This is not typical of our industry but it will be imposed on it by the FSA’s latest reforms, the Retail Distribution Review (RDR). IFAs have traditionally relied on commissions, if a client goes on to buy a product; and both IFAs and private client managers have relied on long-term fee streams, generated when a client retains them for ongoing portfolio advice or management, to subsidise the cost of ‘foundation’ work when taking on new clients. We have always rejected either approach for three reasons:
- it leads to opaque instead of transparent costs
- it discourages clients from valuing good planning as a proper foundation for investment
- it allows advisers to get away with a superficial process of planning used mainly to direct clients into one of a small number of standardised portfolios.
We charge a flat fee for the Initial Review which will vary subject to the review’s scope and complexity but which is typically around £5,000.
Are you an ‘advisory’ or ‘discretionary’ manager?
Most assets we manage are discretionary. Because our process is highly systematic, following consistent decision rules, it makes little sense to hire us on the basis of that consistent discipline and then want to approve every decision. However, there may be assets held that should not be substituted immediately, such as if they have large capital gains attached, or cannot be substituted, such as illiquid private investments. Such assets will be assigned to a goal-based portfolio (based on the best match with the required assets and their duration) and managed holistically.
Who holds my money?
Never us. All holdings are either registered in the legal owner’s own name (eg holdings of unit trusts at, say, Legal & General or Vanguard) or are held to the order of the client in a nominee name of a ‘platform’ such as an online stockbroker or a SIPP provider, ring fenced from the other assets of those firms. Cash is variously held: on a platform; elsewhere but to the order of a platform; or directly by the client in their own name. We prefer clients to be involved in making direct placements of cash not in a tax-favoured ‘wrapper’, even if it is assigned to a particular portfolio, because retail accounts both pay more and enjoy deposit insurance; but we then support our clients with advice based on regular research of cash accounts across the market and monitor clients’ actual holdings and maturity dates.
How do your portfolios differ from traditional private client portfolios?
There are differences in what they hold but the key difference is how they change over time – the dynamics of the portfolio. The key ‘level’ for identifying what most explains why our portfolios are likely to generate ’better’ client outcomes is asset allocation: how the resources assigned to a goal-based portfolio are spread between different asset ‘classes’ (or types of asset) as well as different markets within an asset type. The most important differences are in the asset types we use and choose not to use.
Why is your approach better than ’balanced management’?
We live in a world of complex and multi-faceted risks yet traditional portfolio management for private clients relies on a single, standardised measure of risk: the volatility (or variance) of short-term returns in money terms (i.e. before adjustment for the impact of inflation). When risk is narrowly defined in this way, portfolio asset allocations that ‘balance’ equities and fixed income investments can be differently located on the risk spectrum from low to high risk by altering the exposure to fixed income. This is because fixed income bonds have the lowest (and sometimes negative) correlation with equities. The higher the proportion of fixed income bonds in the portfolio, the lower the risk and vice versa. Other assets like commercial property (which tend to be more equity-like than bond-like) can add diversification benefits but not to the extent bonds can. The balanced management paradigm has taken hold not because it is the best way to manage risks but because it suits the industry’s objective of standardisation and minimum customisation. It puts economics for the industry above usefulness for its customers.
What our financial planning consistently reveals is that our clients’ goals and objectives are hardly ever defined mainly (let alone exclusively) in terms of short-term volatility, or the return path in money terms. What they are usually defined by is purchasing power outcomes: what will the portfolio buy in real terms when I need the money? This leads to a completely different risk spectrum, much richer and more complex, as it has to deal with inflation uncertainty and longevity (the risk of outliving your capital) and has to capture the true uncertainty in long-term outcomes of investments in volatile assets like property and equities.
How do you manage risk if you don’t rely on diversification?
For goals defined in real terms (i.e. after adjusting for the impact of inflation) there is only one asset that reduces risk or moves a portfolio up or down the risk spectrum: index linked gilts, with maturities matched to the investor’s time horizons. This is because the government guarantees to uplift both interest payments and the capital due at maturity by experienced inflation (RPI), which in turn means that investors holding ILGs can avoid the uncertainty associated with the long-term payoffs to property and equity investments. Both are important in managing a limited ‘risk budget’. Avoiding equity uncertainty by buying conventional bonds, which in balanced management is supposed to reduce risk, merely replaces capital market uncertainty by inflation risk. Experience demonstrates very clearly that there is no value in making this tradeoff over long time horizons.
Our portfolios manage risks at all stages dynamically by adjusting the balance between equities, the risky assets, and index linked gilts, as the true risk free asset. You may think of this as ‘dilution’ of risk rather than diversification of different risks, or even of ‘laying off’ or ‘hedging’ part of the risk, as a way of controlling a budget of retained exposure to risk.
As a general principle, for any given level of risk tolerance, the longer the duration of the remaining plan, the more in equities. As time horizons shorten, without risk tolerance changing, we will move from equities to index linked gilts and (ultimately) when horizons for the money are very short (say under three years) to cash. Differences in risk tolerance will also affect these dynamic effects, with lower tolerance accelerating the speed with which risky assets are replaced by risk free, as a response either to shortening time horizons or to higher equity market levels.
How do I know how much risk I should take?
This will emerge from the Initial Review and is likely to vary for each of your goals.
In goal-based, outcomes-driven investing, risk preferences (what risks are relevant, which to retain and which to lay off, how much to retain) are specific to the goal rather than general to a client’s personality. Financial planning, using outputs generated by the same model we use to manage the assets, allows us to develop jointly with each client a particular combination within each goal of resources assigned, time horizons and the range of tolerable outcomes. The range of outcomes reflects the approach to and amount of risk. Rather than you set the risk level, you set the tolerable outcomes at the time horizons in the plan.
You set them not in abstract but knowing the specific impact of risk taking on resources required. This prevents decisions being made about risk that are not consistent with your goals, as can easily happen if you are asked to diagnose your own risk tolerance or if personality tests are used. As well as planning risk and resources within goals, you will also plan them across and between goals, because different goals typically compete for finite resources, so you can be sure your capital is organised to produce the benefits you most value. The approach to and amount of risk can be reviewed in the light of progress of your goal-based portfolios as well as changing personal circumstances.
It is easy to make decisions using this approach as long as you are able to think in terms of the desired outcomes of your goals, such as real spending of x in year y. Outcomes are things you can relate to, leave no room for misunderstanding and require no familiarity with technical jargon or previous investment experience.
Is your approach unique or do other people use it?
Our approach may be unique in private client investment management but is integral to the leading-edge techniques for risk management in occupational pension schemes, where they are known as Liability Driven Investment (LDI). LDI portfolio solutions have displaced about 40% of the traditional balanced management solutions once used by all pension trustees as an investment solution for meeting a scheme’s promises or liabilities. Many of the rest have said they would convert to LDI but for the problem that it crystallises shortfalls in resource requirements and therefore could lead to higher pension costs than under the old system.
LDI grew out of the way pension liabilities are ‘modeled’ mathematically and we model private client needs and aspirations the same way. Pension trustees have never relied for analysis and planning on their portfolio managers (and certainly not IFAs). They turned to consulting actuaries to define the nature and duration of their liabilities. Using sophisticated mathematical techniques, actuaries could define and explain the extent to which they were sensitive to inflation and longevity risks, and the differing sensitivities to nominal return variance (maintaining solvency, when assets and liabilities both have to be ‘marked to market’) and long-term real outcomes (having enough money to meet the liabilities when they actually fall due).
It still took quite a long time for asset/liability modeling to summon up a more suitable approach to managing the assets, as traditional managers were loathe to cannibalise the business they had built up over many years. The same challenge is faced by private wealth managers.
How do you implement the required asset allocations?
We use individual horizon-matched ILG issues to give us our risk free exposures and we use ‘passive’ vehicles to give us fully-diversified exposures to the major equity markets we use: the UK, Europe, USA and Japan. Passive vehicles are index tracking unit trusts and Exchange Traded Funds (ETFs). Both have costs around 0.25-0.40% compared with 1.8% for most actively-managed funds. After RDR, when advice costs have to be unbundled from the fund charges, active fund costs may settle around 1.0 – 1.3% instead of 1.8%, depending on how successfully RDR unleashes competition currently suppressed.
Why do you only use passive funds?
We buy passive equity vehicles that track the indices whose returns we model, rather than active funds, because of the extra costs of active management but also because of the overwhelming evidence of the very low chance of making up the cost difference. The low chance is a function of two factors: the skill of active managers operating in relatively efficient capital markets (stock selection and timing) and the skill of advisers in playing the active game (selecting managers and timing movements into and out of active funds).
Most of our clients come from firms who have used actively-managed funds. One of the outputs of our Initial Review is an analysis of their existing investment relationships. In most cases we have been able to demonstrate that the way their advisers have played the active management game has destroyed value systematically, by buying top-performing funds as if past performance was predictive (and there is a wealth of evidence that it is not) and then selling them when they underperform, even if the performance change is only random, thereby locking in underperformance. Academic studies suggest how the active game is played does far more damage than higher costs alone.
The bias to active management in private wealth management has been kept alive by commissions paid by active managers out of their higher gross charges. In institutional fund management the passive share of total assets under management in developed markets like the US and UK is over 60% – and that is when paying much lower fees for active than retail customers do. Only a small number of UK private wealth managers exclusively invest in passive vehicles. Because we charge fees, we do not need to use commission-paying active funds. It remains to be seen what impact RDR has on the bias to active funds but there is some evidence that as advisers change their revenue model they are also moving to much greater use of passively-managed funds.
How do you report to your clients?
All clients receive quarterly portfolio reports. In goal-based wealth management, the clients’ assets (which may be held in different accounts – ISAs, SIPPs eg – for different legal owners – each spouse eg) ) are assigned to one or more goals. Typical structures include at least two goals: retirement spending and lifetime gifting or bequests. More complex structures might include funding school fees or ring fencing assets required to support entrepreneurial activity. The assets assigned to a goal are not restricted to financial assets. For instance, a retirement spending goal may well have been modeled including the future sale of properties. Clients understand these structures because they were explicit outcomes of the Initial Review.
The reports they see reflect each of the two levels:
- an ‘accounting’ report of the total assets spread across all their goal-based portfolios (holdings by legal owner and holding vehicle or account) and
- a progress report of each goal plan, based on the assets (actual or contingent, financial or property) assigned to it.
The second contains most of the information clients need in order to understand where they are in relation to their objectives and what (if any) actions might be called for to fine tune a plan. Where the plan relies on a model-driven Defined Outcome Portfolio, we will use new model runs to reproject outcome probabilities.
How do you benchmark performance?
In the quarterly report, we measure for each goal-based portfolio the ‘total return’ earned in the quarter, income and capital. We compare this backward-facing progress measure with two other sets of information:
- individual returns in the period for the main building blocks we rely on (major equity markets, index linked gilts, currencies) and
- an industry benchmark for the ‘alternative’ of conventional balanced management (benchmarks maintained by the Association of Private Client Investment Managers and Stockbrokers) which will include the assets we choose not to include such as conventional bonds, commercial property and emerging markets.
How do I assess your performance?
As a client you will use the backwards-looking performance reports as a measure of the actual returns in the context of the market environment in which they were achieved. You can also use the ‘balanced management’ benchmark as a measure of what you might have expected had your stayed with the industry-standard approach. However, most clients attach more significance to forward-looking performance measures, which are the reprojections of outcomes based on new model runs, answering the more useful question, where am I in relation to my goal?
As a prospective client, selecting your manager should not rely on the past performance for other clients, as if that factual evidence was both predictive of the future and relevant to you and your personal goals and risk budget. It is not. The evidence suggest that people are more sensible than this. When in a relationship with a manager, they rely much more on what they have observed about a firm’s process and consistency of action, as a narrative that may explain past performance where raw numbers cannot. It is this same aspect they should focus on when selecting a new manager, even though you do not have the advantage of actual past observation. We place a lot of emphasis on process and a consistent logic and seek to communicate that in our conversations with prospective clients.
Do you use performance to market the firm’s services?
Not like other managers. In general, if a firm uses performance of clusters of clients to market itself, it is either not customising portfolios highly or faces a conflict of interest with its clients because its own risk preferences (reflecting how clients’ past performance affects the firm’s ability to gather more assets) differ from the clients’ true preferences (reflecting progress towards their own objectives, for instance).
In goal-based wealth management all portfolios are different unless by chance there are similar targets, time horizons or risk tolerance; or if combinations of these unique quantities randomly lead to similar asset allocations. The first arises with childrens’ portfolios because all horizons are very long and so (in the absence of gearing) individual risk tolerance makes little or no difference to the allocations.
We do carry on the website some occasional features about our performance. These focus not just on returns but also actions: common changes in allocations (eg what we did during the credit crunch and what we did in the days following the Japanese tsunami) rather than just ‘how we did’.
How do you take tax into account?
Defined Outcome Portfolio targets are planned on the basis of gross target outcomes because these are the probabilities we can model. We cannot model future uncertainty about the tax regime. However, we do plan the goal-based portfolios on the basis of a blended tax rate, taking into account the sources of both income and capital drawdown.
Generally, we minimise taxable income, applying a total return approach. It is more tax efficient to draw from capital than income and it is the job of the model to ensure current self-generated income is replaced to meet future resource requirements. Index linked gilts are particularly tax efficient for taxable accounts (and conventional fixed interest correspondingly inefficient) because the element of returns represented by inflation compensation is largely untaxed.
The dynamic rebalancing of asset allocations called for by new model runs can normally be met without tax consequences in holding vehicles with no CGT impact, such as ISAs and SIPPs.
We regularly maximise tax-efficient opportunities such as spousal transfers, annual small gains allowances and annual ISA allowances. How we assign assets to different holding vehicle takes into account the suitability of the tax attributes of each vehicle relative to the return characteristics of the holding.
We advise pension contribution and vesting strategies taking into account thorough modeling of both tax and non-tax related aspects of the decision. Pension strategies are one of the areas where we find new clients and their previous advisers have frequently relied on incomplete analysis and made sub-optimal choices.
How will you work with my other advisers?
When doing an Initial Review we may want to liaise with your accountant or solicitor to gather accurate and complete information but we are sensitive to the fact that you may not wish at this stage to disclose our involvement to encumbent IFAs or portfolio managers. In performing the Review we are normally able to rely on our own knowledge but we may suggest seeking complementary specialist advice for complex problems.
As portfolio clients, you may rely on us to gather and provide your accountants in a timely fashion with information to prepare tax returns or to ensure you have this information if you do your own self assessment. We are always ready to provide suggestions of new professional service firms such as accountants or solicitors.
We are sole manager for virtually all of our clients although we may refer clients to specialist outside firms (as opposed to funds we select) in specific areas such as early-stage private equity. If a client wishes to retain an incumbent manager for part of their assets or manage some on a self-directed basis, we will accommodate either and can bring them into a holistic approach to managing their different goals.
Is there a minimum size of assets we need to meet?
Not for an Initial Review but you will need to think of the value of a flat fee which is likely to be around £5,000 (depending on scope and complexity) in relation to the benefits and this will depend to some extent on total wealth.
We charge flat fees for portfolio management which is highly unusual, but these are loosely related to wealth levels as well as scope and complexity, which we will understand well after completing an Initial Review. You are likely to need financial assets above about £1m to justify the likely minimum fee.
