Implementing the Investment Strategy

Question 1

Discretionary Service

Answer 1

The portfolio manager has the right under the terms of business
to purchase, sell and hold investments in accordance with the client’s objectives, without giving prior warning to, or seeking approval of, the client, as what the client signs up to is an investment
mandate. This gives the portfolio manager the ability to act quickly.

Question 1

Advisory Service

Answer 1

the portfolio manager suggests a strategy or particular course of action such as buy, sell or hold an investment, but it is up to the client to accept or reject the advice.

The portfolio manager still needs to fully understand the client’s circumstances, objectives and attitude to risk before making recommendations.

Question 2

Reasons to switch investments

Answer 2

• there has been a clear alteration in the client’s investment objectives or circumstances, requiring
  investments to be moved in accordance with a different risk strategy or to produce different returns.
• market conditions adversely affect the current investment or are balanced in favour of an alternative
• the client gives clear instructions to go ahead with a switch
• there has been consistent underperformance of an investment over a medium to longer-term
  period
• the value of an investment is returned as part of a takeover or restructuring of capital.

Question 2

Advantages of direct investment

Answer 2

• Many clients are interested in having direct holdings in particular companies because they enjoy following the fortunes of those companies.
• Direct investment is likely to interest
  investors prepared to accept risk up to a
  certain degree.
• Low costs of switching investment
  managers due to the transferability of stocks
  without the need to encash them.
• The portfolio can be tailored to accommodate
  the investor’s requirements.
• It is easier to exclude holdings in specific
  stocks.
• Greater transparency of costs.
• Exemptions and reliefs can be used to offset capital gains made that are subject to CGT.
• Larger portfolios can enjoy an economy of
  scale and lower expense ratios than can be achieved via collective investments.

Question 2

Churning

Answer 2

It’s an illegal practice in most jurisdictions. It takes place when investments are switched with the primary intention of generating commission/fees rather than acting in the client’s best interests.

The FCA rules on churning are located in the COBS sourcebook.

If churning does take place, then it can
attract severe fines, sanctions, and/or suspensions from regulatory bodies.

Question 2

Disadvantages of direct investment

Answer 2

• Potentially higher volatility of performance
  because fewer investments are likely to be held compared to a collective investment
  scheme (CIS).
• Costs are higher for smaller portfolios.
• Usually need greater involvement by an
  investment manager.
• Results may be more volatile as they
  depend on individual managers, and the
  performance of one or two stocks can provide a disproportionate effect on returns.
• It may be necessary to switch investments
  more within a large portfolio, thus
  potentially incurring gains subject to CGT
  (after exemptions and allowances).
• Potentially more administrative costs than with collective investments. Value-added tax (VAT) will be charged on management fees,
  which are not tax relieved in any way.

Question 3

Overseas investment

Answer 3

Investing overseas holds the obvious advantage of further diversification into international markets
and specialist sectors that would not otherwise be available from domestic securities.

However, the
downside of such investment is the additional foreign currency risk presented.

Investing solely in domestic securities removes the immediate exchange rate risk, but most of the world’s largest companies have substantial operations overseas, so there would be a foreign currency
exposure through imports/exports and profits generated from overseas activities.