Client Objectives and Advice Flashcards
What 3 categories are clients split into and what are their protection levels?
- Retail client - limited knowledge and experience, highly regulated, most protected
- Professional client - more knowledge, more experienced, less regulated
- Eligible counterparty - deemed to have the same amount of knowledge as the financial services firm, least protected
If an advisor does not have the knowledges, who should they seek help from?
Though it is unlikely, advisors can refer to a specialist, specialists are likely to come from within the firm e.g Caz investment team
How are clients assessed? (3)
Hard facts (objective details) - name, age, residency, dependents, health, marital status, address, employment details
Soft facts (subjective details) - hobbies, philosophies, views, previous experience
Many clients will not have information on their own files and therefore this may need to be collected from a third party - LoA is needed
What investment objectives needs to be identified? (7)
- Risk - what is the risk tolerance? (High the risk, higher the return, higher the equity allocation)
- Return - required return needed
- Time horizon - how long does the client want to be invested
- Liquidity - will the client need to draw on investments? Are withdrawals needed? Income?
- Tax - is there a tax bill due? What tax position is the client in
- Regulatory - trust, charities, pension funds (SIPPs)
- Other unique circumstances
What types of risks are faced by investors? (6)
- Capital risk
- Shortfall risk
- Inflation risk
- Interest rate risk
- Currency risk
- Operational risk
What is capital risk? (2)
- Equities, bonds, alternatives, commodities, property, gilts all face risk of capital loss
- Government products and national savings products protect against capital risk
What is interest rate risk?
- ## The rate is usually raised by the MPC during times of high inflation
What is inflation risk?
- Rising inflation affects value of investments unless investment returns higher than inflation rate e.g. real return
- Investors who choose cash deposits as their medium to long term investment face the highest inflation risk
- Equities aim to return excess in inflation
- Index linked gilts provide some protection to inflation
What is operational risk?
- People
- Processes
- External events
- Systems
What is shortfall risk?
Investment return falls short of the amount required to achieve the clients objective
- Dividends are not guaranteed as they depend on the companies profit
- Coupons on corporate bonds are not guaranteed as it depends on whether the issuer is willing to pay them
- ## Variable rate cash deposits have income risk - interests rates fall, interest payable falls
What is currency risk?
- If a foreign currency depreciates relative to sterling. SPICED
- Forward contracts provide protection against currency risk - a type of derivative that locks in forward exchange rate in a foreign currency. Should a foreign currency depreciate, a gain will be made on the forward contact which will offset the loss on the foreign asset
How can a firm determine a clients risk tolerance?
- Level of existing wealth
- Time horizon
- Age and familial situation / dependents
- Liquidity needs
- Spending requirements
- Financial flexibility
- Future financial requirements
**only invest what you are able to lose Is important here
How is risk reduced in a portfolio? (4)
Diversification
- Increasing holdings
- Investing in different regions, sectors and assets
When there is a diversified portfolio, what happens to systematic and non-systematic risk? (2)
- Diversification reduces non-systematic risk/specific risk (e.g. inflation risk) within the portfolio
- Doesn’t reduce systemic risk
What does specific risk include?
Industry, management and business risks
What does systematic risk include?
Interest rate risk, inflation risk and currency risk
What is the relationship between correlation and diversification? (3)
- Positive correlation - assets move in the same direction
- Negative correlation - assets move in the opposite direction e.g. equities and bonds
- The lower the correlation the greater the diversification benefits
What is the sequence of steps for financial planning? (6)
- Identify and quantify client objectives
- Collect data
- Analyse different options and identify shortcomings
- Prepare a report and arrange meeting with client
- Implement the plan
- Monitor and review plan
What is mean variance optimisation (MVO)? (3)
- A computer programme
- Optimises the risk-return relationship
- Maximise the return (mean) to minimise the risk (the variance)
How do you choose which fund to pick if they have similar performance and similar asset mix?
- Explicit costs (advisor fees, broker fees, management fees, stamp duty, PTM levy of LSE/Takeover Panel)
- Implicit costs (bid/offer spread, price impact of trade, opportunity cost, cost of dealing within the fund)
