IFA charges and portfolio risk

Thrugelmir

BG88 said:

 As far as I understand it, the logic is that the conventional 60/40 split is no longer really medium risk and that you should hold a higher percentage in equities to achieve a similar outcome. 




  

Potentially achieve. With greater equity exposure comes greater volatility. Being referred to as TINA (There Is No Alternative). Of course the more money that pours into equities the higher the prices of some shares could be driven. Short term on paper looks great performance. Eventually all bubbles do burst.  Eight centuries of financial folly document this well. 

Focus on your own objectives. No harm in saying I've got enough. 

tebbins

dunstonh said:

I'm not really chasing returns as my outgoings are not extravagant.  I do however want to see my money working, so I guess that is why my IFA is pushing for a portfolio tailored for growth.  I will go back to my IFA and ask specifically about charges being high & CGT implications.   Are there any other obvious questions I should be bringing up?

Be wary.   One of the ways to reduce costs is to go passive on your government bonds.     Passive on bonds has been good for the last decade.  However, going forward, passive may not be a good idea on government bonds.      Currently, 30% of developed government bond issuance offers negative yield.     Passives would be buying those but managed can avoid them.

We moved corp bonds from passive to managed earlier in the year and I am now looking at the gilt side. If both go managed then the cost of portfolios will go up.   I could take the easy option and stay in passive to keep costs low but that could be false economy.   These decisions are judgement calls but if you handicap the adviser by forcing cost focus over returns focus then you may put yourself in a worse position.  (none of this impacts on other areas where we use passives)

With bond yields already so low it doesn't seem entirely prudent to lose even more of your meagre return to active managers (although in that space the fund costs and transaction costs can be much lower). For sufficiently large amounts worth an IFAs time, it may be economical to buy a portfolio of government bonds yourself.
In any event, iShares and Vanguard both offer hedged US government bond passive ETFs/funds and the US is the highest yielding developed government I am aware of currently so I would only bother with that.
An active manager could include potentially some higher yielding emerging markets government bonds, other than that government bonds is one of those sectors where there isn't much of an argument for active, other than buying your own bonds and cutting out the middleman, as it were.

dunstonh

 other than that government bonds is one of those sectors where there isn't much of an argument for active

Well you have a choice.
Pay more for managed funds and avoid negative yield purchases.  Or pay less for passive funds that include negative yield purchases and suffer the consequences of that.

Some people will do one or the other.  Neither is wrong.  

maxsteam

BG88 said:

any thoughts appreciated

My thoughts are that, on the face of it, the charges do not look high however my preference is to take advice for free (of for the cost of a magazine) from a respected professional who does not have anything to gain by, for example, pointing you towards an investment which pays a better commission.

dunstonh

maxsteam said:

BG88 said:

any thoughts appreciated

My thoughts are that, on the face of it, the charges do not look high however my preference is to take advice for free (of for the cost of a magazine) from a respected professional who does not have anything to gain by, for example, pointing you towards an investment which pays a better commission.

No magazines give advice.  And many articles in financial media for consumers are written by providers and fund houses.   So hardly unbiased.

What investments are you referring to that pay a commission? (seeing as it hasn't been possible with regulated investments since the end of 2012, it would be interesting to know which ones you think they are)

JohnWinder

One of the ways to reduce costs is to go passive on your government bonds.     Passive on bonds has been good for the last decade.  However, going forward, passive may not be a good idea on government bonds.      Currently, 30% of developed government bond issuance offers negative yield.     Passives would be buying those but managed can avoid them.

We moved corp bonds from passive to managed earlier in the year and I am now looking at the gilt side. If both go managed then the cost of portfolios will go up.

But is it necessary to increase the cost of the portfolio? I don’t think so.
You’re proposing moving from passive to active bond funds to get more yield, because yields on some bonds are so low. Active funds can only avoid those low or negative yields by owning bonds that have a better yield if they hold poorer quality (more risky) bonds (which should pay more than safer bonds), or if their funds hold bonds of longer duration (because one gets a higher yield if you tie your money up for longer). By increasing the duration of the fund one is again increasing the risk (as measured by the swings in price the fund will exhibit when interest rates change for example). Let me know if I’ve missed a significant consideration here, please.
So, to avoid the low yield of passive bond funds now, we’re going to move into higher risk active funds that cost more?  Surely, the alternative is to stay with the same old cheap passive bond funds - but in lesser amounts, and try to increase your returns by increasing the amount of equities you hold at the expense of some of the safe, low or negative yielding bond funds. You take more risk; that’s what was proposed when you move from passive to active bond funds. You expect higher returns; that’s what was proposed when you move from passive to active bond funds. But you don’t have to change to more expensive bond funds.  What am I missing?

I could take the easy option and stay in passive to keep costs low but that could be false economy.

The reasons it might not be are:
1. See above.
2. The evidence, as weak as it is, suggests that increasing the fees you pay a fund manager results in lower returns. The relationship won’t be perfectly linear, and it seems counter intuitive to pay more but get less, but that they way it appears to be. see: Fund Management Charges, Investment Costs and Performance. IMA Statistics Series Paper: 3 Chris Bryant and Graham Taylor. 2012.  And: https://www.morningstar.com/articles/752485/fund-fees-predict-future-success-or-failure
3. The market is now characterised by low bond yields and high stock prices (which point to lower returns ahead). It wouldn't be a false economy to take more risk, just because returns are low, but it might be silly. If one’s portfolio was suitable for one’s risk appetite when the market was giving more generously, why should our risk appetite change simply because the market has turned miserly?

Well you have a choice.

Pay more for managed funds and avoid negative yield purchases.

That involves more cost and more risk. OK, if you wish.

Or pay less for passive funds that include negative yield purchases and suffer the consequences of that.

Yes, that involves getting what the market has to give within your risk limit. Unpalatable, but you can’t get more out of the market than it has to give unless you’re willing to risk taking less than it has to give.

And the other choice you don’t mention: hold fewer of the same cheap bond funds, and more of the same cheap equity funds. If you can convince yourself the risk is tolerable.

tebbins

dunstonh said:

 other than that government bonds is one of those sectors where there isn't much of an argument for active

Well you have a choice.
Pay more for managed funds and avoid negative yield purchases.  Or pay less for passive funds that include negative yield purchases and suffer the consequences of that.

Some people will do one or the other.  Neither is wrong.  

Or you could do neither and avoid that non-existent false dichotomy you just made up by buying your own bonds, or buying specific bond ETFs or index funds that aren't negative yielding, such as hedged US treasuries, and cut out any need to consider an active manager.
In the rest of the bond space, from emerging markets governments to corporate to high yield etc, I agree there is probably more scope for active managers to find a strategy that a blanket or vanilla index approach couldn't. But with bonds the only ways to get a higher return usually is increasing credit risk by going higher yield, or increasing duration risk by going longer maturity. That's it.
With UK government bonds for example it obviously makes little to no sense for UK investors with a sufficiently large bills/gilts/IL gilts allocation to pay extra for an active manager (though there are some crap and expensive index funds/ETFs and some cheap active funds in this space), you could just buy your own, they are liquid enough.

dunstonh

2. The evidence, as weak as it is, suggests that increasing the fees you pay a fund manager results in lower returns. 

In the US, where you are, I would absolutely agree.  Its virtually impossible in the US.  In the UK, the ratio of managed funds that outperform passive  is higher.   

I run around 60-70% passive 30-40% managed.  Where managed is perceived better, I will do use managed.   Where passive is perceived better, I will use passive.  

You’re proposing moving from passive to active bond funds to get more yield,

Considering it for some or all of the allocation. Not yet decided.  And the reason is not because of low yield but to avoid negative yield. Passives will be buying negative yield.

Yes, that involves getting what the market has to give within your risk limit. Unpalatable, but you can’t get more out of the market than it has to give unless you’re willing to risk taking less than it has to give.

But its not one market and you can buy different things at the market.  Making a decision not to hold negative yield bonds in your portfolio is an active decision butt it is not an unreasonable one.

And the other choice you don’t mention: hold fewer of the same cheap bond funds, and more of the same cheap equity funds. If you can convince yourself the risk is tolerable.

Changing risk profile may be necessary. It is an option for some people but it will not be an option for most.   You should not underestimate the low levels of volatility tolerance that some people have.

With UK government bonds for example it obviously makes little to no sense for UK investors with a sufficiently large bills/gilts/IL gilts allocation to pay extra for an active manager (though there are some crap and expensive index funds/ETFs and some cheap active funds in this space), you could just buy your own, they are liquid enough.

I agree with that when in a period of falling yields where all types are heading in one direction.   I would not agree with it in a period of rising yields and where there are negative yield gilts available and when the different types are acting in different ways.

BG88

Thanks, everyone.  My instinct is to push ahead with my IFA's recommendations. 

 I feel the DB pension, state pension, cash pile & potential to house downsize offer enough protection against having to realise a loss during a prolonged drop in the market.  My hope is to set the portfolio up and leave it untouched for as long as possible.  Hopefully the strategy will work

JohnWinder

 In the UK, the ratio of managed funds that outperform passive  is higher.  

Oh, no. GBP denominated active US stock funds don’t perform as well as local US funds do in the same sector.

The GBP funds perform better than US funds, as you say, in some areas like small cap. But that’s not relevant. What’s relevant is that the SPIVA reports show the majority of UK small cap funds and all others studied underperform their benchmark over 10 years. It’s not enough that they’re better at investing than US fund managers. If you chose a UK fund blindly you had a better than even chance of doing worse than an index fund last decade. No one’s described a reliable way to avoid that dross.

I run around 60-70% passive 30-40% managed.  Where managed is perceived better, I will do use managed.   Where passive is perceived better, I will use passive. 

In another thread we learn that it’s irrelevant to ask an IFA ‘what is your investment philosophy?’

12 - not applicable to the UK (UK advisers are not investment managers)

I think that question was getting at that issue of how much passive investing one believes in.

You’re proposing moving from passive to active bond funds to get more yield,

Considering it for some or all of the allocation. Not yet decided.

That’s after writing:

Passives would be buying those but managed can avoid them.
We moved corp bonds from passive to managed earlier in the year

I'm still not sure if you have or haven't yet decided and moved funds.

Changing risk profile may be necessary. It is an option for some people but it will not be an option for most.

Indeed. I was pointing out what it meant in terms of risk tolerance. Better that the profile, if it's going to change, matches the tolerance which now has to change too.