Clients want and deserve a better deal

A friend recently approached me for an unbiased assessment of a product that his bank had suggested he should invest in.

We are very happy to provide such an assessment service, no strings attached. We check whether the advice makes sense and highlight flaws, should any be found. In many cases, investors don’t have anybody else to turn to other than their private banker and don’t know how to assess the suitability of the advice they are receiving.

In the case in question, while the underlying fund was perfectly reasonable and run by a good management team, I identified and raised several key concerns.

Firstly, the advisor had proposed that his client put close to all his investable assets at the bank into one fund. Not only that, but then suggested to apply 30-50% leverage to juice up the returns, with the leverage being invested in the same fund.

This raised alarm bells on multiple fronts – Big Ben sized bells!

Firstly, irrespective of the quality of any investment fund, it is always worthwhile having some diversification across different managers and strategies. It just makes good sense. A single fund may give too much exposure to a certain economic outlook, custodian, and/or manager bias. In this case, the fund was largely exposed to fixed income instruments. Also, having some diversification also reduces any external risks such as fraud, something investors in Madoff’s fund would know about.

Another issue was that fund in question had a duration of over 3 years, while the leverage being offered was monthly. There was thus a significant duration mismatch as, for every one percent increase in interest rates the value of the fund would decline by around 3.5%, whilst the cost of the loan would increase by 1%. In the event interest rates rise, very quickly the investor could be underwater.

Any investor looking to use leverage to increase returns on a fixed income vehicle should, as best practice, try to ensure that there is no duration mismatch. A senior secured floating rate loan instrument could, for example, have a been a more suitable exposure, as the duration would be similar to that of the loan.

Another factor that also caught my attention was that the client had been advised to invest in a share class that incurred high management fees as well as an initial or preliminary charge of between 1 to 5%. I’ve seen this sort of practice before, with unsuspecting clients being sold funds which have extremely high fees which are simply not in the client’s best interests.

Indeed, I have come across multiple cases where the unsuspecting investor has been ‘duped’ into investing in funds that are not only unsuitable for them, but have obscenely high fees. We recently looked at another portfolio, which was invested in a plain vanilla equity fund that was charging over 2% in management fees.

Unfortunately, I have seen the worst cases of this sort of bad advice being given to the financially unaware and most at risk. A few years back, a recently widowed friend of the family was looking for advice on what to do with a relatively small pay-out from a life insurance policy. The advice given by a large financial planning company in the UK was to invest pretty much everything she had into High Yield bonds, otherwise known as junk bonds. Not what I would describe as a suitable investment, given the volatility of this asset class!

So why does this sort of bad practice exist in the industry?

Firstly, there is often a lack of alignment between the interests of the advisor and those of the client. Usually, the advisor at the private bank stands to profit from the fees generated for the firm.

Secondly, the advisor may not fully understand the investment vehicles being advocated to the client. In some cases, the ‘advisor’ may be the relationship manager who is competent at managing a relationship, but does not necessarily have the skills or the experience to advise on a portfolio.

One of the reasons I got involved in establishing a multi-family office is that the interests of the family office are fully aligned with those of the client. The role of a family office is to provide unbiased, non-conflicted advice in the best interest of the client and, by doing so, one is also serving in the best interests of the firm. It’s just a much more ethical model, and wealthy families are increasingly turning to family offices for investment advice.

Multi-family offices can usually also reduce transaction fees significantly, to the benefit of the client, which is one of the reasons they are so widely used in the Europe and the US. They can also access a much wider array of investment funds and products and are not limited to whatever is on the ‘platform’.

In closing, I can only advocate that those getting investment advice, regardless of the source, should unreservedly question it to check that it is being given in good faith and with their best interests at heart. If in any doubt, getting a second opinion is always a good idea. Always question what you are being told. There is no such thing as a dumb question. And if it doesn’t feel right, simply walk away.

We at MarcWhittaker are happy to undertake a portfolio review and help where we can.

Have you seen the Introduction to MarcWhittaker video? If not, view it here.