Business

Incentive investing - when do you pay your adviser more?

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SHOULD you pay your financial adviser an incentive fee that charges more when they do well and less when they do not?

That's a good question, so let’s look at its pros/cons.

A better starting point for all investors to look at is the actual benefit achieved by their adviser in pointing them to an Investment fund manager.

For example, does the adviser have that expertise to understand the difference between the best/worst?

There are many excellent independent financial advisers (IFAs), there are also those IFAs who use a small pool of options for their customers with poor/no research, and advisers just tied to one organisation.

The skills in assessing the best managers are rare and complex. It is multi-faceted, requiring extraordinary time, judgment and capital.

Subsequently, whilst such research is out of reach of multiple financial advisers, many of the clients of the aforementioned may find themselves invested in overcharging/underperforming funds in their pensions and Investments.

If you do nothing else in your last few weeks of the (current) lockdown, review that.

What might the charging structure mentioned above solve? That advisers are motivated to work harder when markets are falling? That they will charge less because they are not adding as much value?

Sadly, none of that is true.

An adviser’s role is to position your portfolio of pensions and investments across a carefully balanced selection of the very best stocks/bonds/property et al.

They cannot predict the market, and when you think it is ‘falling’, it rebounds. When you think it is about to nosedive further, it doesn’t.

Such queue jumping ensures you willingly buy high and sell low until you have nothing left.

Over a period of 60 discreet individual months, I could see that the average fund was positive in 40 of them. Indeed a panic sell in 2015 after four consecutive downside months would have missed out on a 6.6 per cent rise in the next month. Those downside months had also arrived after nine from 11 positive months, thereby sucking in the queue jumper mentioned above.

The truth is, a financial adviser’s role in an upwardly rising market is much less involved than that of a volatile market where protection, balance and skill makes all the difference.

When markets soar, it is a helium balloon. You need to do less than in difficult markets but that is the point above when the adviser would be paid more.

When markets plummet, opportunities arrive where unloved assets become obvious but it may be some time before they regain value. An adviser not being paid when markets are flat doesn’t fit at all as that’s the real time for skill.

Moreover, such a fee strategy creates an extra risk. If a manager is paid heavily on the upside and less on the downside, they will do everything to maximise the upside and potentially take disproportionate risk.

You can take such risks whilst still (perceivably) hiding them. For example as in passive/trackers by using a hidden stock lending policy, which only becomes fully apparent when markets pop. At that point, it’s too late.

Beta is simply a measurement of a return over a benchmark, so if you are paying fees against a return over a benchmark, any return over one is worth paying for, but historically, incentivised funds do not return a Beta over one.

And so, managers need to creep into assets not evident in the benchmark to create that extra spice. Witness the outcome with Neil Woodford and the drift from his clear skillset to look for the outperformance.

It was a classic example of style drift in search of (or betting on) something that isn’t there during those market conditions.

Studies on incentivised fees accounts have on average a Beta less than one. Risk is also more likely to increase at a time when returns are poor, defeating the objective above.

We measure funds against up to 24 different data points to ensure we maximise your return and minimise loss to know you are in the safest ship for the appropriate seas, irrespective of the incoming and outgoing tides.

They happen. Maverick in/out market calling is often in pub talk, but in reality, that’s what it is. Pub talk.

Peter McGahan is chief executive of independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority. For a complementary assessment of your investments, call Darren McKeever on 028 6863 2692, email info@wwfp.net or visit www.wwfp.net.