6. Discretionary and Advisory Management Flashcards
A. Investment management services (pages 2, 3 & 4)
These fall into one of three different types of solution:
- Bespoke segregated portfolios (tailored to the individual client and can be operated on a discretionary or advisory basis)
- Managed portfolios (structured to a particular risk profile and targeted at that element of clients. All of those clients receive the same portfolio)
- Fund portfolios (a portfolio of preferred UTs/OEICs or multi-manager funds)
A. Investment management services (pages 2 & 3) - BESPOKE PORTFOLIO MANAGEMENT
CONTINUED
- this is the traditional service offered by stockbroker and private client investment managers
- model portfolios are used, but with some flexibility
- minimum entry level is usually £250,000
DISCRETIONARY INVESTMENT MANAGEMENT (DIM)
- manager makes all decisions
- because client has given them discretion to do so
- decisions made within constraints of client’s needs, objectives and the startegy agreed with them
ADVISORY MANAGEMENT (AM)
- for clients who want to retain an element of decision making
- manager explains what decisions they want to make and why and the client decides whether to carry them out or not
- AM may be more expensive
- AM portfolios may drift away from the chosen model if the client doesn’t agree to changes
- DIM switches may take place before AM switches due to having to wait for a client’s permission
- AM clients may have switches undertaken at different times so some may benefit more than other based on market timing
- using a benchmark as a comparison against an AM portfolio is problematic so often agreed as information only
A. Investment management services (pages 3 & 4) - MANAGED PORTFOLIOS
CONTINUED
- standardised portfolios designed around a range of risk profiles
- can be assigned to a client’s risk level
- clients in a particular portfolio receive the same investments and changes are made at the same time
- lower entry levels of £20,000 (low are £1,000)
A. Investment management services (page 4) - REGULATORY PERSPECTIVE
CONTINUED
When selecting and investment management service or product, advisors must ensure they meet the rules of the FCA on conflicts of interest or inducements:
- FCA does not expect to see payments being channelled to a particular provider
- providers should not be chosen because of benefits gained by the relationship between the parties
A1. Investment management styles (pages 4 & 5)
Two main investment management styles:
TOP-DOWN APPROACH (ongoing and dynamic)
- Has three stages:
1. Asset allocation
2. Sector selection
3. Stock selection
BOTTOM-UP APPROACH (attractions of single shares)
- Three most used styles:
1. Value (analysis can identify businesses whose value is greater than their market price)
2. Growth At A Reasonable Price - finding companies with long-term sustainable advantages in terms of quality of management and technology (where it is worth paying a premium for businesses that have premium characteristics - used by active fund managers)
3. Momentum (where the belief is that large increases in price of a security will be followed by large gains - so it is essentially investing where others do)
A1. Investment management styles (page 5)
CONTINUED
Also important to know whether the manager is using their fund house’s investment style or not:
- Centralised Approach: firm/fund house has an agreed investment policy that all managers follow
- Decentralised Approach: firm allows managers to operate freely but within general constraints
A2. Regulatory perspective (page 5, 6 & 7)
FCA has issued guidance on how firm’s are expected to meet their regulatory requirements:
‘Assessing suitability: Replacement business and centralised investment propositions’
The FCA considers CIPs to include standarised approaches to providing investment advice:
- Portfolio advice services (using model portfolios to meet the investment requirements for different risk levels of client)
- Discretionary investment management (either in-house or outsourced, where the adviser has some input in the investment strategy)
- Distributor influenced funds (DIFs) - (typically structured as OEICs. The distributor (usually the advisor firm) has some control over fund design and management
A2. Regulatory perspective (page 6)
CONTINUED
GOOD PRACTISE EXAMPLES:
- preferred fund panel for transactional clients
- suite of low-cost funds for low-value clients
- MPS for higher-value clients
- DFM for those requiring bespoke service
BAD PRACTISE EXAMPLES:
- acquired client banks not looked it enough to work out whether the CIP remained appropriate
- where a single CIP was given to all clients and the adviser had not thought about whether it was actually suitable for all clients
A2. Regulatory perspective (pages 6 & 7)
CONTINUED
DESIGN & DUE DILIGENCE OF A NEW CIP:
- decision to offer a CIP should take into consideration the need/objectives of target clients
CLIENT SEGMENTATION:
- using a wide range of CIPs for larger client banks
- segmenting them into groups and several CIPs
USING 3RD PART SOLUTIONS:
- suitable due diligence should be considered when looking to use a 3rd party solution, such as:
- charges
- financial standing
- tax wrappers available - when outsourcing, both parties must ensure the personal recommendation is suitable for the client
PORTFOLIO CONSTRUCTION:
- firms creating their own portfolios must ensure they align with the risk output of any risk profiling tool used
- where asset allocation is used to build portfolios a process needs to be in place to reduce portfolio drift
INDIVIDUAL SUITABILITY:
- recommendations must remain suitable for individuals
COMPETENCE:
- advisor should be able to identify when a CIP is not suitable for a client (and recommended an alternative)
- firm needs to ensure that it’s advisors understand the CIP and are competent
B. Operating features (page 7)
B1. Client agreements (pages 7 & 8)
It is a regulary requirement that a formal two-way agreement is entered into.
Purpose of the client agreement is to set out the rights and obligations of the parties and other terms on which the firm will provide services to the client.
It is appropriate to enter into a formal agreement when undertaking discretionary investment management for a client:
- firm requires authority from the client to be able to manage the portfolio on their behalf
- client needs an agreement in place to confirm that the assets remain legally theirs
- any changes to a client agreement must be made announced to clients 30 days before they are made
- agreements must be retained for the duration of the relationship
B2. Client assets (pages 8 & 9)
Rules relating to custody and safeguarding client assets are contained in FCA Handbook Client Assets Sourcebook (CASS).
CASS requires firms holding clients assets to:
- make adequate arrangements to safeguard clients’ownership rights
- prevent the use of safe custody assets belonging to a client on the firm’s own account
- minimise loss by introducing organisation arrangements
B2. Client assets (pages 8 & 9)
CONTINUED
Nominee Account:
- set up to hold client’s investments
- either the firm or a custodian operates this account
Nominee Company established to own the account:
- nominee’s name along with account number appear on records of ownership of CREST certificates
Client’s investments held through:
- omnibus nomiee account (all investments in one account)
- designated nominee account
B3. Legal entity identifier (page 9)
Firms subject to transaction reporting obligations are not able to execute a trade on behalf of a client who is eligible for but does not have an LEI.
Enables LEI-given entities who make a trade to be identified in any juristiction.
B4. Client orders and record keeping (pages 9 & 10)
- Detailed records must be kept after receiving a client order or making a decision to deal
- these must be made available to regulators on request
- extensive records must also be kept for the processing of orders to allow a trade to be tracked through
C. Reporting requirements (page 10)
Reporting the performance of investments to a client is a key part of the DIM service.
C1. Regulatory requirements (page 10)
Types of report and fequency split into two categories:
- Occasional reporting (contract notes)
- Periodic reporting (regular review reports)
C1A. Occasional reporting (pages 10 & 11)
When trades are carried out for a client, details of the transactions are sent to the client in the form of a contract note.
- contract notes need to be issued as soon as possible
- and no later than the business day following execution
- trades executed after close of business are treated as being executed the following day
- for trades split into tranches a single contract note can be issued with prices averaged
C1B. Periodic reporting (pages 11 & 12)
These are regular reports covering such things as:
- valuations
- performance reports
- transaction reports
- capital cash statements
- income statement
Periodic reports must be issued at least every six months except where:
- the client requests them to be issued quarterly
- a leverage portfolio is provided, in which case they must be issued monthly
C1B. Periodic reporting (page 12) - INVESTMENT VALUATIONS
These must be provided on a regular basis and include information on:
- holdings
- valuation
- analysis (performance against benchmark)
The values should be undertaken using a reputable source which should be reviewed frequently.
C1B. Periodic reporting (page 12) - BENCHMARKS
The performance needs to be compared against a suitable benchmark.
Usually the time-weighted rate of return will be used as the calcuation for this performance.
C1B. Periodic reporting (page 12) - TRANSACTION REPORTS
Under COBS clients must be informed of trades as soon as possible via contract notes.
C1B. Periodic reporting (page 12) - CORPORATE ACTION STATEMENTS
These need to be listed and will include such things as:
- bonus issues
- subdivisions
C1B. Periodic reporting (page 13) - CASH AND INCOME STATEMENTS
Cash statement shows cash transactions.
Income statement shows dividend history.
C1B. Periodic reporting (page 13) - TAX REPORTS
These will typically contain CGT reports and tax certificates.
C1B. Periodic reporting (page 13) - DERIVATIVE REPORTING
Where derivates are used, the report should include:
- share/future/index involved
- trade price
- market price
- exercise price
C1B. Periodic reporting (page 13) - REPORTING LOSSES
These should be shown where the overall value depreciates by 10%, and then in increments of 10% thereafter.
Must be provided no later than the end of the business day in which the loss is experienced.
D. Investment mandates (pages 13, 14, 15 & 16)
Investment Mandate:
- guides an investment manager in management of a client’s portfolio
- The client’s goals and needs will have been identified
- These will have been turned into an agreed set of investment objectives
- And then into a suitable investment strategy
D. Investment mandates (pages 13, 14, 15 & 16)
CONTINUED
Investment Objectives - set out the goals of the client
Investment Strategy - sets out how the portfolio will be constructed and managed to meet the goals of the client
Investment Mandate - sets out the client’s investment objectives and strategy
E. Fiduciary responsibilities (page 16)
Managing portfolios for clients entails different obligations for different types of client.
E1. Private individuals (page 16)
We have already covered:
- client’s investment objectives
- risk profile
- investment strategy
- constraints on the level os discretion allowed
- use of tax wrappers
- reporting requirements and benchmark used
ALSO NEED TO CONSIDER:
- how the portfolio will be structured
- extent to which CGT needs to be taken into consideration when managing the portfolio
- the way in which large-holdings with significant built-in capital gains will be handled
E1A. Portfolio structure (pages 16 & 17)
The portfolio can be managed in lots of different ways, but usually structured as a single unit such as:
- Main portfolio
- ISA portfolio
- SIPP portfolio
But all these are together in one combined portfolio
Advantage: holistic view taken of the client’s investments across all main portfolios/wrappers
Disadvantage: requires sophisticated modelleling technology
E1B. Capital gains tax (pages 17 & 18)
Clients need to be asked for the original acquisition costs of investment so that CGT can be traced properly.
Whrther CGT is taken into consideration within DIM is a valid point. If it is then the portfolio may drift or if it isnt then the portfolio will stay aligned by CGT may build up.
E1C. Large holdings (page 18)
Some investors hold large holdings. Should these be sold to increase diversificiation, or left where they are because of a large CGT build-up?
Need to consider when selling a large holding:
- Amount of the holding
- Timing (of the sale)
- CGT
E2. Trusts (page 18)
Investment managers sometimes have to manage trusts.
E2A. Parties to a trust (pages 18 & 19)
- Settlor (trust creater)
- Trust Deed (outlines the trust)
- Trustees (look after the assets)
- Trust Property (the assets held in the trust)
- Beneficiaries (receive the assets)
E2B. Types of trust (pages 19 & 20)
- Absolute or bear (also Blind Trusts)
- Interest in possession
- Discretionary
BLIND TRUST
- used to avoid conflict of interest
- settlor (politician) remains beneficial owner
- but has no say in the management of the assets
- trustees legal owners and manage trust
- taxation applies to the settlor
E2C. Use of trusts (page 20)
- Chartitable purposes
- Pension Schemes
- Tax mitigation
- Asset protection
- Protecting minors
- To avoid conflicts of interest (using a Blind Trust)
E2D. Powers and duties of trustees (pages 20 & 21)
Trustees have Powers of:
- Maintenance (pay income to minor beneficiaries)
- Advancement (advance funds from the trust)
- Make dispositions (appoint funds)
- Appropriation (transfer of assets)
- Appoint nominees
- Appoint investment managers
E2D. Powers and duties of trustees (pages 20 & 21)
CONTINUED
Trustee’s duties:
- keep the trust accounts
- deal with an distribute assets in accordance with the terms of the trust
- invest the trust funds
Trustee’s duties to invest:
- exercise due diligence and prudence in exercising a power of investment
- demonstrate professional expertise
- act fairly between different beneficiaries
- administer trust property in the best interests of present and future beneficiaries
- make the trust productive
- obtain advice on matters which they lack experience
E2D. Powers and duties of trustees (pages 20 & 21)
CONTINUED
Acts:
- Trustee Act 1925
- Trustee Investments Act 1961
- Trustee Act 2000
E2E. Standard investment criteria (page 21)
Trustee Act 2000 imposes a duty on trustees to have regard to the need for:
- diversification and
- suitability of investments to the trust
These are referred to as the Standard Investment Criteria.
E2E. Standard investment criteria (page 21) - DIVERSIFICATION
- duty to have the need for diversification and a spread of investments where appropriate
- degree of suitable diversification depends on the size of the trust assets
E2E. Standard investment criteria (page 21) - SUITABILITY
- considerations such as the size and risk of the investments
- need to produce an appropriate balance between income and capital growth
- needs to consider ethical considerations
E2F. Obtaining advice (page 22)
Section 5 of the Trustee Act 2000 imposes a statutory duty to obtain advice in respect of:
- obtaining ‘Proper Advice’ is advice from someone who is qualified to give it and appointed by the trustees.
E2F. Obtaining advice (page 22) - PRACTICAL IMPLICATIONS
- the adviser chosen should be an IFA with knowlege of the specific trust being advised upon
Where advisory or DIM is chosen it is essential to establish:
- investment powers available to the trustees
- nature and purpose of the trust
- range of permissible investments
- tax treatment of the trust
- investment policy statement
E3. Charities (pages 22 & 23)
- tend to be established as trusts and treated like normal clients in respect of having funds to invest in certain ways following a risk profile and objectives
- expectation that a charity’s trustees will be more experienced than a normal trust’s trustees
INVESTMENT POWERS - charity trustees have the same powers and obligations to invest the assets and obtain advice where required
INVESTMENT OBJECTIVES - a charity needs to be clear about what it wants to achieve by investings
RISK - what level of risk is appropriate for the charity?
ETHICAL CONDISERATIONS - charity may lose supporters if it does not invest to some degree in ethical investments
E3. Charities (pages 22 & 23)
CONTINUED
Charities investments need reviewing by Trustees:
- selecting a suitable benchmark such as the FTSE4GOOD is important for comparison purposes
- review how well the investment manager is performing
- review the terms under which the investment manager is operating to make sure they remain suitable
- intervene when they have concerns or terminate the agreement with the investment manager if necessary
Chapter 6 Key Points (page 25)
INVESTMENT MANAGEMENT SERVICES
- difference between advisory and discretionary management is whether discretion over investment changes is given or not
- portfolio drift is where the portfolio is likely to move away from the recommended allocation
OPERATING FEATURES
- a formal two-way agreement must be entered into for DIM services
- FCA Client Assets Sourcebook (CASS) outline guidelines for safeguarding client assets
REPORTING REQUIREMENTS
- regular reports must be provided where an advisory firm manages investments on behalf of a client
INVESTMENT MANDATES
- refers to the instructions that guide an investment manager in the management of a client’s portfolio
- the timing of reducing large holdings and the management of CGT need careful consideration
FIDUCIARY RESPONSIBILITIES
- The Trustee Act 2000 imposes a duty on trustees to have regard to the need for diversification and suitability of investments to the trust
- charity trustees are required to consider what level of risk is appropriate for the charity’s functions and exercise their duty of care to ensure that the overall risk is suitable to the charity and beneficiaries