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Welcome to our blog, the place we get things off our chest. It's a mix of rants and raves, often about fees and the cost of financial advice, along with anything else we think you might find useful.

Smooth operator

By Ian Millward, published 22 March 2022.

When people think of investing it often conjures images of anticipating market movements and identifying the next Apple or Facebook. That may be the case for traders and speculators but, in reality, successful investing is much less ethereal. It relies on managing risk, but also our ability to manage our emotions.

And for many people, the emotional challenges are by far the greatest. When markets fall sharply, stocks become cheaper and, therefore, less risky. But our perception of risk goes through the roof. And it doesn’t matter how many crises we go through, and how many times the market recovers, each new crisis feels unique, unprecedented, and somehow more real, dangerous, and threatening than the last.

Our emotional response is no respecter of intellect, knowledge or even experience. Worse still is that many investors (and dare I suggest it, male investors in particular!) live in a state of denial.

Even the merest hint that their reaction could be anything other than coldly rational, logical and analytical would be an affront to their dignity. In other words, an emotional reaction to an emotional reaction.

And helping people manage their emotions and stay the course is, for many people, perhaps the most valuable thing a financial adviser may do for you. But is there a better way? What if that adviser could take away all the pain and deliver you stock market like returns without the stress and worry?

Household names such as the Pru, Aviva and LV= offer ‘smoothed’ investment funds purporting to do just that. And similarly, we recently dealt with a client whose Aegon Workplace pension features the safeguard of moving more heavily to cash as markets become more volatile.

The ‘smoothed’ funds all work slightly differently but the basic concept is that they offer some form of expected return but then have a feature that adjusts this based on the actual returns. And that’s the rub. The actual real return ultimately relies on the performance of the fund. How could it do anything other?

But that’s the point. A bit like a bank than only lends you money when you don’t need it, and wants it back when you do, the smoothing is a facia board illusion offering security when you don’t need it but not when you do.

The Aegon product works differently and is triggered by volatility. Sounds good, but let’s think about that. Volatility basically means you’ve lost money. So once the horse has bolted it and your fund has fallen, it moves more heavily to cash meaning you can’t then benefit in the event of a fast recovery.

And that’s the trouble. While these products appear to address the biggest fears of investors, the real motives are less altruistic. For many years, selling with-profits bonds was almost a career choice for a certain kind of adviser. The Pru bond was the leader of the pack, accounting for a huge proportion of their revenue and a mainstay amongst many advisers. As with-profits became discredited, the pressure was on to find an alternative.

But I save my biggest criticism, by far, for LV=.

As well as smoothing, they offer the additional protection of buying an absolute guarantee that your original capital (less income and adviser charges) will be returned after 10 years.

That kind of guarantee sounds like the holy grail but here’s the problem. Or should I say problems, as there are many.

They only offer it on their Cautious fund. This fund is around 25% invested in the stock market with the bulk of the money in fixed interest or other low risk assets. In other words, the return prospects don’t look very promising. That is, of course, why they only offer it on the Cautious fund, and forgive me for being cynical, but the goal of the manager is now changed from delivering a return to not losing money.

It gets worse. In the ISA, the fund has an annual management charge of 1% a year. But you pay an additional 1% a year for the guarantee. If you factor in a financial adviser charge between 0.5-1% a year, then you face total annual charges of 2-5-3% a year (plus a likely initial adviser charge of 2-3%).

What becomes immediately obvious is that this investment is not capable of generating much return after charges. And certainly not enough offset the opacity, uncertainty and 10-year commitment. The combination of a very cautious approach and high charges consign it to failure. It seems to exist only to generate fees for the provider and adviser whilst delivering disappointment to the poor client.

As you may have gathered, we do not use smoothed funds. The smoothing is illusory and a one size fits all, life office managed fund, is rarely our idea of the ideal portfolio. It is a shortcut designed for someone who wants an easy win. Our approach to smoothing relies on taking the time and effort to properly discuss and explain risk and make sure potential clients are properly prepared for the journey. And then providing the ongoing information, care and support they need as we lurch from crisis to crisis.