Private Client Investment Advice Flashcards

A client wants to invest ethically and asks about ESG investing. What does ESG stand for and how is it implemented?

Answer: Environmental, Social, and Governance — a framework for evaluating companies based on their sustainability and ethical practices, implemented through screening, integration, or impact investing

ESG stands for Environmental (climate change, pollution, resource use), Social (labour standards, human rights, community impact), and Governance (board diversity, executive pay, shareholder rights). ESG investing can be implemented through negative screening (excluding harmful sectors), positive screening (selecting best-in-class ESG performers), ESG integration (incorporating ESG factors into fundamental analysis), or impact investing (targeting measurable social/environmental outcomes). Under MiFID II, advisers must now consider clients' sustainability preferences.

What is 'discretionary fund management' (DFM) and when might it be appropriate for a private client?

Answer: A service where the fund manager has authority to make investment decisions on behalf of the client within agreed parameters, suitable for clients who prefer to delegate

DFM is an investment management service where the manager has discretion to make buy, sell, and switch decisions within a mandate agreed with the client (covering asset classes, risk level, objectives, and any restrictions). It is suitable for clients who lack the time, expertise, or inclination to make individual investment decisions, and those with complex needs requiring ongoing active management. The adviser retains responsibility for ensuring the DFM service is suitable for the client.

A client holds a significant concentration (40% of net worth) in their employer's shares. What risk does this present and how should the adviser address it?

Answer: Significant concentration risk — if the employer faces financial difficulty, the client could lose both their income and a large portion of their wealth simultaneously

A 40% concentration in employer shares creates a dangerous correlation between the client's employment income and their investment portfolio. If the employer suffers financial distress, the client faces a 'double hit' — loss of income and significant capital loss. The adviser should explain this concentration risk clearly, discuss a phased diversification strategy (considering CGT implications of selling), and explore whether share incentive plans or options create additional concentration. Any recommendation to reduce the holding must be documented with suitability reasoning.

What is the 'adviser charge' model introduced by the Retail Distribution Review (RDR)?

Answer: Advisers must agree charges directly with clients for their services, with commission from product providers banned for retail investment products

The RDR (effective 1 January 2013) banned commission payments from product providers to advisers for retail investment products. Instead, advisers must agree their charges directly with clients, either as a percentage of assets, a fixed fee, an hourly rate, or a combination. This removed the incentive for advisers to recommend products that paid the highest commission and increased transparency of advice costs. Ongoing adviser charges must be separately agreed and the client must be able to switch them off.

When reviewing a client's existing portfolio, the adviser identifies several funds with high ongoing charges figures (OCFs). What action should be considered?

Answer: Assess whether the net-of-charges performance justifies the costs, and consider lower-cost alternatives (such as index trackers) where active management has not added value

High OCFs erode returns over time through compounding — a 1.5% OCF versus 0.25% on a £100,000 portfolio over 20 years could result in a difference of tens of thousands of pounds. However, the adviser should not simply choose the cheapest option. The key question is whether the active manager's net-of-fees performance justifies the higher charges. Where it does not (and evidence shows most active managers underperform over time), lower-cost alternatives like index trackers or ETFs should be considered. Any switch recommendation must be documented in a suitability report.

A client wishes to pass wealth to their grandchildren tax-efficiently. Which of the following strategies would be MOST appropriate to discuss?

Answer: Utilising a combination of the annual IHT gift exemption (£3,000), Junior ISAs, bare trusts, and potentially a pension contribution for the grandchild

A comprehensive intergenerational wealth transfer strategy could include: the £3,000 annual IHT exemption (which is immediately outside the estate); small gifts exemption (£250 per recipient); Junior ISA contributions (up to £9,000 per year, tax-free growth); bare trusts (where capital is held for the child until age 18); pension contributions for the grandchild (up to £2,880 net, grossed up to £3,600); and potentially larger gifts that become exempt after 7 years (potentially exempt transfers). The strategy should consider the grandparent's own financial security first.