Learning Material Sample
Investment principles and risk8. The investment advice processLearning outcome 7 Apply the investment advice process
Our audiovisual presentation provides an introduction to the factors that influence an individual’s savings and investment needs. ...
Shortened demo course. See details at foot of page. ...investment advice given. With so many variables giving investment advice can never be a purely mathematical or mechanical process.
The investment advice process
When providing investment advice, it is important to have a clearly defined process to ensure consistency. Using a model for investment advice provides discipline for advisers, an administrative template for a sequence of actions and a clear audit trail which can be documented for compliance reasons. The actual processes used will depend to a great degree on the adviser firm’s status and business strategy. The high-level investment process: Determine client’s requirements Analyse client’s financial position Formulate a strategy to me... Shortened demo course. See details at foot of page. ...olio designed to meet a client’s key requirements and, in the process, gaining the client’s agreement to any trade-offs in the portfolio construction and educating them about realistic expectations as well as the concepts of risk and reward.When assessing suitability, as well as taking account of investment objectives, firms must also obtain information regarding the client’s knowledge and experience in the investment area, their risk tolerance and their ability to bear losses. What are the five steps of the high-level investment process? Answer : Purchase course for answer Establishing the client and adviser relationship
By establishing the client relationship at the outset of the meeting, the adviser will understand the experience level of the customer and be able to tailor their approach accordingly. A client agreement can be useful in these circumstanc... Shortened demo course. See details at foot of page. ...stomers will require an additional duty of care and stricter procedures around how advice is to be provided. This is to avoid the client being exposed to unnecessary risk.Which document sets out the terms of engagement between a client and adviser? Answer : Purchase course for answer Gathering data, setting goals and expectations
Each individual is unique and it is therefore important to consider all of their circumstances before giving investment advice. The customer's circumstances would be ascertained by completing a full fact find. This would not simply focus on investments, as these needs would be considered alongside the customer’s other financial planning requirements, but would also cover the following areas: Personal details – all data relating to the customer&rs... Shortened demo course. See details at foot of page. ... then to establish what their goals and ambitions are and which are the most important. This can be achieved by asking open questions:What do they want to achieve? How will they feel if they achieve that goal? What could stop them achieving their goals? Why is it important to them? Would they be prepared to make sacrifices in other areas to meet their goals? What is the timescale to achieve the goals/objectives? Why is it important to gather hard and soft facts? Answer : Purchase course for answer Analysing and evaluating a client’s financial status
The main part of this process is to analyse the client’s current pos... Shortened demo course. See details at foot of page. ...in objectives. This is vitally important as mismanaging a client’s expectations can lead to issues of trust in the future.
This is an essential part of investment planning, as it will establish the investment limitations within which you can select and operate a client’s portfolio. Risk is very subjective and means something different to everyone, so it is important to establish what risk means to each individual client.
Example Freda is an 85-year-old widow with limited resources and less than a five year time horizon. She does not want to have any reduction in the value of her capital. On this basis Freda may consider a cash deposit account as low risk. Her grandson Peter, on the other hand, is 25 with no financial dependants and a time horizon of 40+ years. He wants real capital growth over the longer term. He may consider a cash deposit account as a high risk as there is little potential for capital growth and a real possibility that his capital will be eroded over time by inflation. Traditionally, ... Shortened demo course. See details at foot of page. ...nancially and emotionally?Only by discussing both the financial and emotional impacts can an appropriate attitude to investment risk be established. It is also important to put risk into context. For Peter, who is 25, single with no dependants and who is saving for retirement in 40 years' time, a capital loss of 20% (for exxample) would be more acceptable than a 5% loss for Freda, who has a fixed amount of assets and relies on investment income to maintain her standard of living. It is also important to remember that, when assessing couples, while they may both have the same investment aspirations, their attitudes to risk could be completely different. In this situation the discussion would need to focus on a trade-off between the two and a re-negotiation of the stated objectives. What are the three components of a risk profile? Answer : Purchase course for answer Formulating the investment strategy and asset allocation
The basis of an investment strategy is an asset allocation, taking into account the client’s investment objectives and attitude to investment risk. Stochastic modelling uses historical data and probability to forecast the likely range of retu... Shortened demo course. See details at foot of page. ...or the number of risk profiles or the correct asset allocation for each. The general rule of thumb is that lower risk portfolios should have a high level of low risk, low volatility funds and the percentage held in these funds decreases in favour of higher risk investments the higher up the risk scale you go. Asset allocation is not the only means of managing risk in a portfolio. The choice of investments within an asset class can also play a significant role.
Within fixed interest securities there are different categories of funds from gilt funds to high yielding bonds; exposure to UK and international bonds is also provided A gilt fund may be suitable for a low risk investor, whereas a higher risk investor may require higher returns, for example from a high-yield bond fund It is important, therefore, to consider the investment objectives and the profile of each fund and its suitability for the client’s attitude to risk and investment objectives Ethical issues Ethical investment is not a new phenomenon. However, in the last 20 or so years, we have seen a growth in retail funds specifically geared towards an ethical investment strategy. Originally these funds aimed to exclude companies from their portfolios on the grounds of the activities they were involved in. In more recent times, we have seen a growth in socially responsi... Shortened demo course. See details at foot of page. ...ions on paying interest (Riba) and investing in areas such as gambling, alcohol, pork products etc.For a fund to be Sharia compliant, it must adhere to the Sharia principles and investments must be certified by Sharia experts. Equity funds Dividends are allowed if they are from approved companies however, most of the returns are generated through capital gains. Commodity funds These funds buy Halal commodities and re-sell for profit. Ijarah funds These hold tangible assets such as property where the income is provided from rents. A ‘sukuk’ is issued to the investor, which is similar to a conventional bond except they are asset backed. Bank accounts These provide traditional banking services except they do not earn interest. The bank uses the money to create profit from Sharia-compliant activities and some of this profit is returned to the investor. What does it mean when an ethical fund manager employs a ‘positive engagement strategy’? Answer : Purchase course for answer The choice of investments should be based on the client's objectives and attitude to investment risk, which should be established before considering the most appropriate tax wrapper. Choice of tax wrapper is also an important consid...
Shortened demo course. See details at foot of page. ... the investor’s residence and domicile status for tax purposes. Where an individual is non-resident or non-domiciled, offshore investment may prove more tax efficient (subject to other circumstances being taken into account).
The FCA does not lay down specific requirements for the presentation of recommendatio...
Shortened demo course. See details at foot of page. ...in the future, including the frequency of reviews and any associated costs.
The main client investment objectives are concerned with:
The required rate of return Risk tolerance Focusing solely on investment returns can mean that a client ends up with an investment portfolio which is not really suitable for their needs. The primary factor to consider is the risk tolerance of the client and h ow willing they are to take on risk. That tolerance will determine what return expectations are realistic for that particular client. There are two main categories of investment that could be used to address investment objectives: Investments designed to maximise returns for a given degree of risk (e.g. collective investment schemes, defined contribution pensions and discretionary managed portfolios) Investments designed to match future liabilities (e.g. defined benefit pension schemes, life and general insurance products and investment funds that meet specific requirements) To meet a client&rsqu... Shortened demo course. See details at foot of page. ...l be looking to supplement their present income accordingly. Retired individuals or those who are asset rich but cash poor may fall into this category.Total return – this will again be most suitable for longer-term investors where the need is capital growth but this could be achieved by capital appreciation and reinvesting income. Investment objectives can be expressed in general terms, e.g. capital growth, income or a balance of both, or as a specific objective, such as an annual income of £10,000 per annum after tax, or a lump sum of £35,000 in 10 years for university fees. Clients may have difficulty in expressing their objectives. It is also likely that they will have a number of both short and long-term objectives. The adviser’s role is to help the client establish these objectives as accurately as possible. What are the four main types of investor return objectives? Answer : Purchase course for answer As well as establishing the investor's objectives, an investment adviser also needs to consider other factors that will impact on the portfolio:
Time horizon Liquidity Tax Legal and regulatory requirements Unique needs and preferences The two main factors that have not been previously discussed are time horizon and liquidity. Time horizon Establishing the amount of time that will elapse between now and meeting the client’s investment objective is vitally important as this will have a huge impact on the type of investments that would be suitable and the client’s attitude to risk for that specific investment. Generally, the shorter the time scale, the more important it is to protect capital. If a client needs to pay a tax bill in six months' time they cannot accept any fall in value of the capital set aside for this purpose. However, a client saving for retirement in 20 years' time can afford to be much more tolerant of short-term volatility This is because it takes time to recover from market falls, and the shorter the term, the less likely that the investment will recover in time For longer-term investments it becomes more important to maintain t... Shortened demo course. See details at foot of page. ...cess without penalty after a certain period of time or noticeAs longer terms may provide higher rates it is important to assess the level of liquidity required The more liquidity required in a portfolio, the less risk can be taken, or at least with the portion of the portfolio that is to be held in cash or short-term investments. Resources The level of assets and liabilities held by a client can also have an impact. A client with substantial resources and little or no debt can, in theory, tolerate volatility better than a client with modest assets. It is also important to consider the level and type of debts that a client has. Short-term debt such as credit cards are likely to have a much higher rate of interest than longer term debts such as a mortgage. It therefore follows, that paying off short-term debts should be a higher priority. When faced with a choice of paying off a mortgage or investing a lump sum for future growth, most clients would choose to be debt free, though this is not always the case. In addition to the investor’s objectives and risk profile, what other factors should be taken into account that may constrain investment choices? Answer : Purchase course for answer The asset allocation chosen will always be aligned to the investor risk strategy (as stated earlier).
Proportion of capital allocated Risk profile Cash Fixed Interest Securities Property Equities Cautious Income 15% 40% 15% 30% Cautious Growth 15% 35% 10% 40% Balanced Income 10% 30% 15% 45% Balanced Growth 10% 30% 10% 50% Income & Growth 5% 30% 15% 55% Growth 5% 15% 15% 65% Adventurous 5% 10% 10% 75% The table above is based on ... Shortened demo course. See details at foot of page. ...view on the holdings within each sector and adjust the holdings up or down within a given range to try to capture outperformance.Rebalancing The asset allocation is selected at outset and is accurate with the client and investment objectives and risk profile, at that point of time. Over time, of course, investment performance will change the asset allocation of the investment, and the client’s objectives and risk profile may also change. In some cases, investment performance may lead to significant changes in the asset allocation, which may also impact on the overall risk profile of the portfolio. Rebalancing effectively means realigning the asset allocation in line with the previously agreed model and may require selling some investments and buying other to bring the portfolio back in line.
When investors are looking for growth in their portfolio through capital or income reinvestment they are accumulating their overall investment, as opposed to decumulation, which is drawing income through withdrawal of returns and capital from the portfolio.
The impact on the portfolio construction for both concerns the areas we have covered, such as: The amount of regular or lump sum investments Term of the investment The expected returns on the portfolio The expected inflation rate over the term Costs and charges ... Shortened demo course. See details at foot of page. ...rawdown funds are exposed to sequencing risk and reverse pound cost averaging.In building any portfolio for a customer, an adviser needs to combine all of the factors discussed in this chapter and achieve an appropriate balance. The adviser should recognise that each factor will have a different emphasis depending on the customer and their individual needs and objectives at any given time. Regular reviews of investments are vital to their ongoing suitability. What is decumulation? Answer : Purchase course for answer Your results and the estimated s... Shortened demo course. See details at foot of page. ...ate.Estimated study time 4.8 hours |
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