Helping a friend

danm

So a friend/colleague has asked me for some advice on where to invest last years ISA allowance

They have no equities exposure aside from employees share schemes. They have cash savings. They are comfortable in taking a 5-10 time horizon. They want to invest in the market but are relatively risk adverse.

I explained to them the difference between active and passive - sent them to monevator and when push came to shove, suggested they look at the options available from HSBC global strategy funds

I then had to explain the various asset allocations as best I could. Long story, short - I expect they will buy the dynamic fund.

I feel slightly exposed here. They are aware of all the risks, but anything else I could have done to explain to them - any fundamental flaws with using this fund to get exposure?

(Our of interest - what is the difference between the global strategy and world select funds)

bowlhead99

I explained to them the difference between active and passive - sent them to monevator and when push came to shove, suggested they look at the options available from HSBC global strategy funds

It is not a bad range of funds, being low cost and available at a range of risk levels. Not bad for a £20k investment, or even a £40k one if they are putting this year's ISA allowance in too. And again the next year.

It can be difficult making recommendations to friends or family who don't know what they are doing. Just like selling them a second hand car which will inevitably break down at some point, even if you gave them a better deal on it than what was offered to them locally on Autotrader or Ebay.

When they experience a market crash there is plenty of potential for you to feel guilt that you did not push them towards a safer option, and for them to see the name of another fund that beat theirs in a league table and be upset that you didn't suggest that one to them which in hindsight would have had a better time of it.

Potentially they will turn a paper loss into a real loss by selling out of the fund at the bottom of the market, having decided they can't afford to lose any more money on your stupid recommendation; and then they miss the inevitable recovery over the coming period and permanently damage their wealth, and swear off 'gambling on the stock market' for good. Ideally by that point you will have already quit your job and blocked them on Facebook

danm wrote: »

They are comfortable in taking a 5-10 time horizon. They want to invest in the market but are relatively risk adverse.

I then had to explain the various asset allocations as best I could. Long story, short - I expect they will buy the dynamic fund.

The dynamic fund is 80% + allocated to equities and most of the equities are listed on overseas stockmarkets.

It is a step down from the 'adventurous' portfolio which is 95% equities at the moment and could feasibly lose half of its value from peak to trough during a global stock market crash like we had in 2007-09. However, it is not much of a step down, as there is not a lot in the way of bonds, property and cash to diversify away the heavy losses that could be experienced from the equity holdings when stock markets inevitably take a turn for the worse at some point. The Dynamic would be in the same risk band at the Adventurous on some risk scales even though it will be less volatile.

Over 55% of Dynamic's assets are currently invested in equities in the US and emerging markets (which could easily have a bad time of things at the same time as each other) and the fact that so much of the money is invested outside the UK means that if GBP currency strengthens by 20% the portfolio loses a double digit percentage even if global markets remain at the exact same levels and there is no stock market crash. If you combine that with a stock market crash, it could be painful for them to watch the value each week when they had picked it after reading a chart of it mostly going up for five years.

This does not sound like the sort of portfolio which should be bought by someone who is only going to invest for 5-10 years (so perhaps not a full economic cycle of boom and bust to get themselves an 'average' level of long term return) and who is risk averse. They should consider what they would do if the portfolio temporarily dropped from £20,000 to £13,000 and took five years to recover from it. Perhaps they are merely 'relatively risk averse' as you say, rather than 'really really risk averse', but are they OK with that sort of loss from the Dynamic fund?

Some people who are new to investing will initially say they are naturally cautious or risk averse but after answering probing questions and learning more about the profile of returns they might receive in different scenarios, will accept that actually staying in cash for the long term is no good - as inflation will eat their money- and so some investment risk is a necessary evil, and more risk can be taken if it is for the long term (10-15 years plus).

They can map out the potential scenarios of what might happen to their fund value in the meantime and whether they feel they could hold their nerve when it has been falling in value each month for a year straight. In reality they won't really know, until that happens, but if they educate themselves, investing at something other than cautious levels can be OK.

So, a cautious or risk averse person with a decent amount of money to fall back on and a long timescale might find themselves looking at the 'balanced fund' option in the middle of the risk scale rather than something actually labelled as having a cautious outlook. And then, they see that only 'one notch up the risk scale in the same product range' is a fund which returned several more percent a year over the last five year chart, than the Balanced had done ....

Well, they think, I'm not a risk taker really so I won't go for that top risk 'adventurous' fund, I'll take this 'dynamic' one as a nice compromise between a higher risk fund and a balanced one that doesn't make me as much money.

What they miss is that the balanced fund they first looked at was already a compromise between a more violently volatile fund and the conservative fund which would more naturally match their risk tolerance and be OK for a five to ten year period.

So they step up from Balanced to Dynamic, and then get surprised by the next big crash, because when they looked at the 10-year charts for global equities and bond markets there weren't really any drops over 20% in sterling terms - because 10 years ago we were already at the very bottom of the biggest slump in a generation and things have been pretty rosy since then with the exception of a few quarters here and there.

I feel slightly exposed here. They are aware of all the risks, but anything else I could have done to explain to them - any fundamental flaws with using this fund to get exposure?

As mentioned, it's not a bad range of funds, but it is worth highlighting the range of returns that the Dynamic product might achieve, which can include severe negative ones in any given year. Hopefully bravado in front of their colleagues (or just one trusted friend/ colleague such as yourself) doesn't make them take the Dynamic one when Balanced might be more appropriate. The bottom line is that the Dynamic fund is not designed to be marketed to a cautious investor, especially if that cautious investor is only investing for 5-10 years rather than 20 years plus for retirement.

(Our of interest - what is the difference between the global strategy and world select funds)

The World Select range is still a risk targeted range of funds-of-funds, but has a higher ongoing cost, and (IIRC) back in the day they included more active management from internal and external investee funds rather than aiming for pure low-cost passive cap-weighted. It was probably a bit of a cash cow for HSBC as you'd have bank staff offering the World Select as a S&S ISA or direct investment to customers who they could win over, while their expat division offered the Open World equivalent with full retail pricing in a range of currencies to people who wanted a brand they knew with value for money as a secondary consideration.

Now the banks have pulled back from being investment salesmen I think the price has come down a bit but still seems to be 0.7%+ versus 0.2% for the passives-focused Global Strategy range. It is not that the World Select couldn't give a decent result (the important thing is to ensure you get the risk / volatility level right, with cost being secondary), but it doesn't seem super-compelling and the DIY market in particular seems to like the GS branded ones which you mentioned to your friend.

danm

thanks for your informative and helpful views.
I have sent them on literally verbatim as I had nothing that could have improved the messgae! many thanks