By Fiona Tait, Technical Director, Intelligent Pensions
Why have a CIP
CIPs should deliver consistent consumer outcomes and deliver administrative efficiency for the adviser firm, making it easier to manage groups of clients with similar objectives, rather than having to operate an individual strategy for each client.
A CIP also delivers a strategy that is aimed much more closely to the individual, than any default fund could hope to do. Default funds are a good strategy, and certainly better than no strategy for clients whose needs are relatively simple, such as building up as much growth as possible, within a given risk tolerance. But CIPs also allow clients, whose needs have become more specific, to target defined rather than general outcomes.
The key components
Adviser firms will generally design their own CIPs, often having more than 1, and these will naturally differ from firm to firm. They are however normally based on a set of common ‘building blocks’:
• Initial risk assessment, via a questionnaire
• In depth risk assessment, via an adviser meeting
• Use of a range of risk-rated investment funds
• Ongoing review and rebalancing
In theory, the initial risk assessment could be as simple as asking a client to ‘pick a number between 1 and 10’. However, in practice this is unlikely to satisfy the regulator unless ‘1’ and ‘10’ are rigorously defined and it can be shown that the client can understand and relate to those definitions. As a result, most firms rely on a risk-profiling tool with at least an element of psychometric testing.
This provides more consistent outcomes and moreover benefits from the expertise of those with more psychological insight, than the majority of financial advisers.
What advisers are, or should be good at, is talking to their clients and being able to put the results of the risk questionnaire into a reasonable context. If the client’s initial assessment suggests an 80% exposure to equities, the adviser needs to assess whether the client is comfortable with the losses that could result, and secondly whether they need to take that degree of risk at all, as measured by the client’s individual Capacity for Loss (CfL) and Required Rate of Return (RRR).
This is essential for clients who are, or are about to, start taking income from their investments and once again the majority of firms with clients in this position are likely to rely on technology to back up their analysis. Cashflow modelling not only shows clients how much income their pensions and investments are likely to support, they can also be used to mathematically calculate the CfL and RRR.
Cashflow planning is particularly susceptible to the assumptions used and it is important that advisers use a system where they are, mostly, in agreement with the assumptions recommended by the system provider, making regular overrides unnecessary. Cashflow firms do after all have considerably more resources to assess the market, than any single adviser or group of trustees, however experienced they are.
Once the investment parameters are known, the adviser then has to create or select a portfolio that matches them. Generally, this is done by using a range of risk-rated portfolios, based on the ‘efficient frontier’ of risk and reward which may be set up and run by an investment house/provider, or it may be managed by the firm’s own in-house investment committee. Either way, the adviser must carry out sufficient research and analysis to be confident that the asset allocation for each portfolio is in line with their own expectations of a portfolio with the relevant risk rating. One adviser’s view of 4/10 as ‘low-medium risk’ may be different from another’s, but it should at least be consistent with their own assessment of portfolios rated at 3/10 and 5/10, and ideally benchmarked against a suitable index to avoid unintentionally taking any extreme positions.
The result of all this is that clients with the same attitude to investment risk should receive the same initial risk score, a potential adjustment based on their individual financial goals, and a portfolio which is both capable of delivering the returns they need and protected against losses which they cannot sustain and still meet their objectives.
Optional extras
In addition to the above, most firms offer a cash management service to cover charges and withdrawals and some also offer extras such as model portfolios which are rebalanced en masse in response to market conditions. Some use third party DFM services which carry out all of the above for them and others offer specialist strategies such as ESG screening. At the end of the day though, we are all looking to deliver the best possible strategy for clients to achieve their financial goals.
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