14. Advice

Question 1

Investment advice - Factors to consider

14.2 Factors to consider

Answer 1

• Attitude to risk
• The client’s objectives - Income vs growth, flexibility, liquidity
• Age and the life cycle
• Current and future circumstances
• Timescale
• The client’s tax position
• Attitude to sustainable investment

Question 2

Possible client risk profiles

Answer 2

• No Risk/Risk Averse: Prefers no risk at all.
• Low Risk/Cautious: May accept minimal risk if necessary.
• Medium Risk/Balanced: Accepts some controlled risk for a portion of capital.
• Medium to High Risk: Open to higher risk for higher rewards, accepting possible losses.
• High Risk/Adventurous: Willing to take substantial risks for growth.

Question 3

Capacity for loss

Answer 3

Definition of Capacity for Loss

• Determines if a client’s lifestyle or financial stability would be affected if they lost some or all of the invested funds.
• Distinct but complementary to risk tolerance in assessing investment suitability.

Key Factors Impacting Capacity for Loss

• Existing Debts: Clients with debts are more vulnerable to the effects of losses.
• Future Capital Needs: Any future financial commitments may be at risk if losses occur.
  Proximity to Retirement: As clients near retirement, they have less time to recover from losses, reducing capacity for loss.

Client Understanding

Ensure clients clearly understand capacity for loss considerations versus their general risk tolerance.

Question 4

Establishing the client’s attitude to risk - types of risk (List 6)

Establishing the client’s attitude to risk

Answer 4

1. Capital Risk: Potential for loss of the original investment.
2. Income Risk: Potential fluctuation or loss of income produced by the investment.
3. Investment Types: Understand risks of different assets (e.g., deposits vs. shares).
4. Time Horizon: Short-term = secure investments; medium/long-term = asset-backed (stocks/shares).
5. Objective Risk: Balancing caution and adventure to meet investment goals.
6. Single vs. Pooled Investments: Higher risk in single shares; pooled investments offer diversification.

Question 5

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Establishing the client’s attitude to risk - how to determine a client’s ATR, 4 approaches - interview approach

Answer 5

Interview Approach Summary

Purpose: Gauge client’s feelings on risk and investment.

Questions Focus:
* Existing investments, performance, and concerns.
* Reaction to potential losses or missed targets.
* Views on risk-reward, capital security, and investment understanding.

Outcome: Subjective assessment of client’s risk tolerance based on responses.

Question 6

Establishing the client’s attitude to risk - how to determine a client’s ATR, 4 approaches - Menu approach

Answer 6

Method: Adviser explains risk tolerance categories; client self-selects their fit

Considerations:

• Outcome depends on adviser’s skill and client’s category comprehension.
• Potential for adviser bias or client’s response alignment to perceived expectations

Question 7

Establishing the client’s attitude to risk - how to determine a client’s ATR, 4 approaches - psychometric approach

Answer 7

Purpose: Assess psychological attitude to risk (knowledge, experience, personality).
Method: Statistically validated tests + questions
Focus Areas:
* Personal feelings on risk tolerance.
* Past financial decisions.
* Reactions to “what if” financial scenarios.
* Responses to hypothetical financial events and outcomes.

Question 8

Establishing the client’s attitude to risk - how to determine a client’s ATR, 4 approaches - portfolio approach

Answer 8

Portfolio Approach Summary

Method: Client reviews hypothetical portfolios with varied risk-return levels (low, medium, high).
Purpose: Client’s portfolio choice indicates risk tolerance, guiding asset allocation.
Risk Categories:
* Risk averse
* Low risk
* Medium risk
* High risk (speculative)

Question 9

Key Points on Investment Objectives and Timeframes - Short-term objectives

Answer 9

Short-Term Objectives:

• Best suited for deposit-based investments to protect capital.
• Equity investments are too volatile for short timeframes, risking capital losses.

Question 10

Key Points on Investment Objectives and Timeframes - Medium to Long-Term Objectives:

Answer 10

Medium to Long-Term Objectives:
* Asset-backed (equity) investments may be suitable if short-term capital loss is manageable.
* Recommended holding period: 5-7 years to endure market fluctuations.
* Longer timeframes increase the likelihood of positive returns with asset-backed investments.

Question 11

Key Points on Investment Amount and Emergency Funds

Emergency Fund Recommendation:

14.2.6 The amount

Answer 11

Investment Amount:

• Small Portion of Wealth: Allows for higher risk tolerance.
• Single Source of Capital: Requires a more conservative approach.
• Large Investment: Enables diversification across various assets, including speculative ones.

Growth Needs and Objectives:

• Aggressive Targets with Limited Funds: May require a speculative strategy or a reevaluation of goals.

Emergency Fund Recommendation:

• Maintain liquid reserves as an emergency fund.
• Common benchmarks:
• 3-6 months of income or regular expenses.
• 10% of total capital (minimum a few months’ expenses).

Question 12

Key Points on Taxation and Investment Decisions - 4 points to consider

Answer 12

1.Current and Future Tax Position: Evaluate the client’s tax status now and potential changes ahead.

2.Income vs. Capital Growth:
* Income-Generating Investments: Can increase income tax liability.
* Capital Growth: May be more tax-efficient if capital gains allowances are unused.

3.Tax-Free Options: Consider transferring investments into tax-free vehicles if possible.
4.Tax Law Changes: Base decisions on current legislation, not speculations about future changes.

Question 13

Fund switching key points - what is ‘churning?’

Answer 13

Regulatory Perspective:

• FCA views switching (or “churning”) critically; must serve the client’s best interests.

Cost Justification:

• Switching should be justifiable in terms of costs, which are often low due to competitive share dealing and rebates.

Legitimate Reasons for Switching:

• Client Circumstances: Changes in objectives (e.g., nearing retirement) may necessitate moving to lower-risk investments.
• Profit Taking: “Banking” profits and reassessing investment strategy.
• Rebalancing Portfolio:Adjusting asset allocation for diversification or due to performance shifts.
• Underperformance: Switching to better-performing funds/stocks if existing investments underperform over the medium to long term.
• Market Conditions:Adapting investment strategy in response to changing market or economic conditions (e.g., shifting from equities to bonds in a declining market).

Question 14

What is ‘negative screening’

14.3 Environmental, socially responsible and ethical investment

Answer 14

Negative Screening Definition

Practice: Excluding companies from investment options based on specific criteria.
Criteria: Typically involves a company’s involvement in activities such as:
* Environmental harm
* Human rights violations
* Tobacco or alcohol production
* Weapons manufacturing
* Gambling operations

Question 15

Environmental, socially responsible and
ethical investment - key points

Answer 15

Definition: SRI involves investing in companies that align with investors’ values and beliefs, emphasizing ethical considerations.

Approaches:

• Ethically Screened Funds: Specific funds that exclude companies based on ethical criteria.
• Engagement Only: Investment strategies that focus on active voting and encouraging better business ethics without excluding companies.
  Environmental Investment: A type of SRI focused on investments that support environmental objectives, often referred to as “eco” or “green” investments.

ESG Criteria:

• Environmental: Evaluates impact on climate, energy consumption, waste management, etc.
• Social: Assesses treatment of employees, human rights, diversity, and community engagement.
• Governance: Analyzes management quality, corruption, and corporate governance practices.

Investment Philosophy: ESG investing emphasizes achieving a balance between ethical responsibility and profitability, focusing on companies that score highly on ESG criteria while still aiming for financial returns.

Question 16

3 organisations that oversee Ethical investment in the UK

Answer 16

Vigeo Eiris: (formerly the Ethical Investment Research Service (EIRIS))
* Founded in 1983 with support from churches and charities.
* Conducts research and screens companies globally based on their ethical standards.
* Engages in discussions with companies but does not provide recommendations or investment advice.
* Serves charities, fund managers, and individual investors.

UK Sustainable Investment and Finance (UKSIF):

• Established in 1991 as a membership network for socially responsible investment in the UK.
• Aims to promote and support SRI among UK investors.
• Comprises over 250 members, including fund managers, financial advisers, NGOs, and community finance institutions.

Ethical Investment Association (EIA):

• Established in 1997 as a UK trade body for financial advisers focused on ethical and socially responsible investment.
• Provides training and resources for advisers looking to offer SRI advice.

Question 17

Engagement - what does this mean in the context of S&R investments

Environmental, socially responsible and
thical investment

Answer 17

• Early Approach: Ethical investment initially focused on avoiding companies engaged in unethical practices (policy of avoidance).
• Shift to Engagement: Investors sought to actively influence corporate decisions regarding ethics, leading to a more engaged approach:
• Positive Selection: Choosing companies with ethical practices rather than just avoiding unethical ones.
• Influencing Strategy: Using shareholding to impact corporate strategy.
• Dialogue with Management: Discussing ethical issues directly with company leaders.
• Public Pressure: Utilizing media to encourage ethical practices in companies.
• Adviser Role: Advisers must ensure investors understand the varying criteria of different funds and align investments with their ethical views.

Question 18

Ethical investment indicies

Answer 18

FSTE4Good

Question 19

Is there a price to Ethical investment?

Answer 19

Price of Ethical Investment

Performance: Ethical investment funds typically perform as well as or better than conventional funds.
Cost: No additional charges are associated with ethical funds.
Investment Range: Ethical criteria may limit the pool of investable companies, often favoring smaller firms.
Volatility: Smaller companies can lead to increased volatility, making ethical funds more like equity growth funds.
Active Management: The criteria prevent fund managers from merely tracking an index, ensuring genuine active management of funds.

Question 20

Formulating a Recommendation - key points to consider (5 points)

14.4 The advice

Answer 20

• Client’s Objectives: Recommendation should meet the client’s objectives.
• Affordability: Ensure the investment is affordable for the client.
• Risk Profile: Align with the client’s risk tolerance.
• Ethical Views:Match the client’s ethical investment preferences.
• Future Flexibility:Allow for future adjustments and flexibility.

Question 21

Portfolio Construction Steps (2 step)

14.4.1.2 Selecting the specific investments

Answer 21

1. Asset Allocation: Decide on asset classes and their weightings based on client needs and risk profile.
2. Investment Selection: Choose between direct investments or collective funds
   * Indirect investments - Mangaged funds

Question 22

Asset Allocation

14.4.1 The portfolio

Answer 22

Model Portfolios: Use provided model portfolios to guide allocation.
Reflect Client Needs: Allocation should mirror client’s objectives and attitude to risk.

Question 23

Direct Investment

14.4.1 The portfolio

Answer 23

**Research Required: **Significant research and administration needed.
Costs: Higher management costs due to trading and dealing costs.

Question 24

Indirect Investment

14.4.1 The portfolio

Answer 24

• Diversification: Using funds offers diversification, economies of scale, and ease of administration.
• Mandate Alignment: Ensure fund mandates meet the investor’s requirements.

Question 25

Types of Indirect Investment ## Footnote 14.4.1 The portfolio

Answer 25

* **Managed Funds:** Broad approach categorized as cautious, balanced, or adventurous. * **Specialist Funds:** Focus on specific assets or sectors (e.g., UK equities, global growth). * **Funds of Funds:** Invest across multiple funds; caution needed to avoid overlapping funds. * **Tracker Funds**: Low-cost exposure to specific assets, producing average returns compared to the sector.