Portfolio Practices That Enhance Advisers’ Alpha

There are a plethora of services offering to help advisers with fund research and asset allocation.  The likes of FE, Morningstar/OBSR and RSM have developed offerings that aim to take away from advisers the burden of fund research. Advisers simply buy intellectual property from these providers and are then responsible for implementing the portfolios within their own practice.

However, as advisers are increasingly finding, the real challenge in running centralised investment propositions isn’t so much the fund selection and asset allocation, but the practicalities of implementing and running client portfolios.

Implementing an efficient and consistent rebalancing process, proactively harvesting capital gains and managing income withdrawal are where advisers tend to falter when running client portfolios.

These are the bits that advisers don’t tend to do well. Sadly, they are also areas where advisers can add demonstrable value to clients, because most clients have neither the time nor expertise to do it themselves (it’s hard enough for advisers).

Let’s take a lot at a few sound portfolio practices;


1.       Asset location (Did you spot it? Not ‘allocation’)

Advisers spend a great deal of time obsessing about getting the optimal asset allocation (and rightly so), but rarely pay enough attention to asset location. This is working out in which tax wrapper to place each asset class in order to get the best out of it.

Tax wrapper planning can make a big difference to client return. Of course the net gain for the client will depend on their tax status, the recommended asset allocation and level of income being taken from their portfolios.

Take for instance a basic rate taxpayer with £300,000 investable assets (of which £120k can be invested in ISAs and the rest in GIA) and where a 60/40 allocation portfolio has been recommended…

    Adviser A     Adviser B
 ISA    £203,066     £177,629
 GIA (using annual CGT)    £296,679     £330,026
     £499,745     £507,655

Source: FinalytiQ via FundsNetwork Tax Wrapper Analyzer (assumed return: Equity = 4% capital growth + 2% dividend yield; Fixed income = 4% interest yield. Term = ten years)

Adviser A simply replicated 60/40 portfolios in ISA and GIA – no sensitivity to asset location. Adviser B, on the other hand, places the bond allocation in ISAs and all the equity allocation in GIA, making using of the client’s CGT allowance each year.

Based on conservative return estimates (and ignoring future ISA contributions), over a period of ten years, the client of Adviser B will end up with over £7,000 more than Adviser A’s client.

Put another way, asset location could add around 0.25%pa expected return to a client portfolio.


2.     Tax Harvesting

Advisers are often religious about using clients’ annual ISA allowance but rarely show the same interest making full use of the annual CGT exemption (not to talk about proactively harvesting losses and carrying them forward to be offset against future gains).

I have lost count of the number of cases where a client is sitting on large gains on their GIA because the adviser hasn’t actively used their CGT allowance for previous tax years. Somehow, many advisers seem to forget that, as with ISAs, the CGT exemption is a use-it-or-loss-it allowance.

Our own research suggests that failing to use clients’ annual CGT allowance means clients forfeit around 0.6%pa in returns, based on £300,000 invested in 60/40 portfolio in unwrapped accounts (GIA).

The expected return is less for large portfolios, at around 0.2% on £1m. Advisers may well be storing up trouble for the future, because it is very easy to see complaints around this being upheld in favour of the client. Part of the problem, of course, is that CGT tools on platforms are horrendous and grossly inefficient (and, in many cases, non-existent) but that’s a matter for another discussion.


3.    Managing Income Withdrawal

One key area where advisers add value is in implementing smart income withdrawal strategies and, given the new pension freedoms, this is going to be even more important in the future. The impact of sequence-of-return risk can be quite drastic when taking income from a portfolio.

A sequence of poor market returns early in retirement can cause funds to erode to the point where what seemed like a reasonable income level quickly becomes unsustainable. This is because taking income from a portfolio in a falling market leads to ‘reverse pound cost averaging’, where a client is essentially forced to sell units in their portfolio when prices are falling, in order to pay the required income.

This problem is amplified because the cashflow forecast tools used by advisers to guide clients in making decisions on a ‘safe’ withdrawal rate tend to rely on average annualised returns. This hides the danger of negative sequence-of-return, especially in the early years of retirement.

The latest research on safe withdrawal strategies offers ways to mitigate these risks, including a cashflow reserve ladder, which essentially keeps around two years’ worth of expenses in near-cash assets, such as high quality short-dated bonds, while the rest of the portfolio is fully invested based on the agreed asset allocation.

In addition, advisers need to pay particular attention to which asset class is actually sold to pay for income in a falling market.

In conclusion, these are just three of the main areas that advisers can add value to client portfolios, without necessarily relying on the elusive fund manager alpha.

Unlike this so-called ‘alpha’, the overall effect of these strategies is both quantifiable and within reach of most advisers.




Abraham Okusanya
Abraham is the founder of FinalytiQ, a research consultancy for platforms, asset managers, and advisory firms. Recognised as one of the country’s leading experts in retirement income, platforms and investment propositions, Abraham has authored several papers on these subjects and delivered talks to the Personal Finance Society, The FCA and several conferences across the country.

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