What Does 2017 Have in Store for Portfolios?

5I first wanted to write about predictions for 2017, to do that I was going to talk about the predictions for 2016 that were almost all wrong except for the USD and Euro exchange rate.

If you had followed the advice of those experts with warnings such as “sell everything now as we will have a crash as bad as 2008” this was RBS, or perhaps as Goldman Sachs predicted in 2014 USD 200 for a barrel of oil, wrong, so in 2015 they predicted USD 20 wrong again.

To have followed the advice of these experts would have resulted in losing a lot of money.

However, you may be thinking that even your portfolio is not doing what the market is and wondering why?

As such I thought I would look at the stock indexes to help explain why your portfolio may not reflect the performance of the stock market indexes such as the Dow Jones or the S&P 500. Worse still, you may wonder why the market is going up but your account is going down.

Now we keep hearing on the TV and reading on the internet about the Dow Jones and the 20,000 level, the Nasdaq and S&P are steadily hitting new highs. Even the Russel 2000 gained 20% in one month.

However, this does not actually reflect what is going on in the market, as such it may not reflect what is going on in your portfolio.

The US has almost 5,300 listed companies in the NYSE and Nasdaq, yet the Dow Jones only has 30 companies and the S&P 500 only has erm.. 500.

If you have a mutual fund, it will most likely have a maximum of 50-60 stocks. As such it would be unlikely to mirror image the index unless it was a closet tracker. An ETF however is composed of all the same stocks and weighting as the index.

Let me explain how the index distorts the true state of the market.

The S&P has 500 companies, but the calculation is not 500 stocks equally weighted giving an index price of 2,300.

The top two companies from these 500 have a weighted value of 5.87% of the index and the top 10 have a weighted value of 17 pct.

Think about this, if the top 10 stocks went up by 25% and the remaining 490 stocks went down by 5%. The market would still be showing a gain of 0.1%

Ie these 10 stocks only represent 2% of the companies in the index but they have a huge effect on the index performance and the index performance does not really show the actual performance of the majority of the stocks. Confused? You should be. You could be in a bear market but still have a rising index.

This is not just confined to the S&P it is the same with the Russel 3000. This index gives a better representation of the US economy due to the number of stocks in the index. However again the top 1,000 stocks are the equivalent of 90% of the index and the remaining 2,000 only representing 10% of the index.

This is one of the reasons most mutual funds have a problem outperforming the index unless they take a few big bets on a few stocks or is a closet index fund.

If you want to mirror the index an ETF is ideal. It will not beat the index but it should track the index.

It is time to distance oneself from the way the main stream thinks about performance and benchmarking.

It is also not about making predictions, even a broken clock is right twice a day, the clock however is still broken and I would not use it for investing, i.e.. Market timing, guessing the market is a fool’s game.

Reduce risk and costs using ETF’s and don’t forget to diversify into other asset classes.

Have a great and prosperous 2017.

Gordon Robertson

If you have any questions just mail me at gr@me-group.ae

The IFA industry in the UAE is not prepared for this 2017 shock

jam

We have read articles about the coming changes proposed by the Insurance Authorities on insurance backed savings and investment products. Most of the articles I have read have only  covered a few points and as such have been incomplete. I have put together a very informative article which covers the most  important points  relating to the new proposals: These proposals if enacted in law will alter the face of insurance backed lump sums and savings programs in the UAE.

This has come as a result of the huge number of mostly justified complaints coming in from clients because of high fees and lack of disclosure

Commissions – The total commission charged should be spread over the life of the policy and no longer upfront.

  1. Regular premiums will be charged monthly over a period of not less than 5 years instead of the Traditional 18 months in so called “initial units”.
  2. Single premiums will be charged monthly over a 12-month period.

Savings Products

1. maximum fee is now 4.5% and charged over the first five years. The overall cap is 90% of the first year’s payment. (based upon a monthly saving of aed 6,000 the initial units would eat up 108,000 in the first 18 months. This will be reduced to 64,800 spread over 5 years)

2. Single premium will now be a maximum of 4.5% and charged over 12 months

Term Products

  1. Maximum commission deducted is 10% of the whole premium or 160% of the annual premium whichever is less, paid over the first 5 years.
  2. Maximum commission is 10% of the premium deducted over 12 months.

Short Term Products

  1. Maximum for Life and Takaful is capped at 25%

Indemnity Commission (commission paid to the advisor)

This is being stopped. Commission will be paid when the client pays the premium.

Multiple Channels

No longer will clients subsidise other sales channels. This will help reduce costs to the client. They will pay just for the sales channel they are using.

Disclosures

  1. The advisor will no longer ask for full documentation such as passport copy etc, before they receive a proposal/illustration.
  2. The declaration will say that the client knows the returns in the illustration are not guaranteed.

Free Look Period

  1. The client has 20 days from the start of the investment to decide if they want to stay or cancel. The advisor is not allowed to pressure the client to recoup the cost of the advisor time and effort in preparing the structure.
  2. The client will be refunded their entire money plus any profit or minus any loss on the investment.

There will be no bid offer spread in the calculation.

Illustrations for the client

  1. Mode of payment such as monthly/quarterly/annual/single
  2. Name of Plan, Sum assured, coverage term, and premium payment term.
  3. Death benefit, account value and surrender value should be clear and distinct.
  4. The premium shown should always be gross of all fees but the death benefit, account value and surrender value should always be net of all fees.
  5. Any illustration should state that it is either “Illustrative Value” or “Guaranteed Value”
  6. Cumulative Plan Premium should be indicated.
  7. All compulsory charges have to be disclosed.
  8. Details regarding top up premiums have to be disclosed separately.
  9. The Life insurance company has to quote the gross return based upon cash flow and then deduct all other charges so the client can see if there is a benefit in having this type of policy. All charges have to be deducted before they can show the cash surrender/redemption value.
  10. Two scenarios at a minimum should be illustrated. Maximum investment return is based upon EIBOR (emirates interbank offer rate) plus 3% rounded up to the next 0.5%. example current EIBOR (Dec 22) 0.55714 plus 3% is 3.55714, rounded up 4%. The first calculation is based upon 4%. The second calculation is based upon a lower number.
  11. There has to be an illustration based upon 0% rate of return but reflecting all charges.
  12. Any fees paid by the fund to the IFA or to the company belongs to the client and should be reimbursed to the client. It is normal in the UAE that funds pay a so-called retrocession/trailer of up to 1%. This ultimately comes from paying a higher expense ratio in the fund. Once this is removed the returns to the clients should rise.
  13. With profit policies, any illustration must be certified by a qualified and appointed Actuary. This should now be consistent with the valuation reports, if not the actuary may have to justify why it is not consistent.
  14. The annual valuation report has to be sent as a separate document and not bunched with other documents. The “font” has to be red and the client has to sign receipt.

Declaration by the policy holder.

  1. The client has to sign a declaration stating that they have received a copy of the illustration, and that non-guaranteed elements are subject to change. They are aware it is not guaranteed and that the advisor has never promised them anything else either verbally or electronically.
  2. A similar statement has to be proved by the advisor.

Historical Performance

They have to quote the last 5 years performance of the top 5 funds in the policy.

Minimum Protection

  1. Policies which were previously sold with 1% or 101% of the cash value are no longer deemed to be an insurance policy due to the minimum amount insured.
  2. In future the minimum insurance will be 110% of single insurance if over the age of 45 OR 125% of the premium if under the age of 45.
  3. Regular premium/savings will be 7 x annual premiums or 0.25 x term x annual premium whichever is higher if over the age of 45. OR 10 x annual premium or 0.5 x term x annualised premium whichever is higher.

Protecting the policy holder

  1. Surrender values in the future will be equitable to both the client and the provider. Ie the provider should not benefit to the detriment of the client.
  2. The calculation to determine the redemption value has to be disclosed, ie if the charges are deducted linearly it is easier to reflect the true charges on the redemption value.

 Bancassurance

  1. Banks often buy insurance at a discount from a provider. The banks are no longer allowed to mark up the price when selling to the client. The bank has to be compensated from the provider and not the client.
  2. Banks are no longer allowed to just represent one provider but to offer choices to the client or allow the client to obtain their own life insurance.

 Enforcement

Once the new laws are published in the Gazette the providers have up to 6 months to implement the new laws.

As can be seen, these new changes are draconian and will change the entire industry here in the UAE to the benefit of clients.

I have been harping on about this for several years. I think the fees are still too high, but the full disclosure will help clients achieve better returns, better flexibility and understand the cost of the products being recommended.

Do you know what fees you are paying with your advisor?

5The UAE is currently is about to implement changes to the way investors who invest through an insurance product is charged and how the advisor is compensated.

These changes are long overdue, I have reviewed the Circular 33 and see that the massive changes will only benefit clients. However, I still believe the fees are still too high. The fees will go down, the insurance portion will rise.

I know that I go on and on about fees, and may sound like a gramophone record that has stuck and repeats itself.

However as this is your money, (I am only trying to help). I have a template which you can use to identify all the costs. (this exercise may be outdated when the law changes in the UAE).

The regulators (not the product providers) are pushing for more transparency and fewer fees. In a very clear format. It used to be that funds paid a trailing commission to the advisor. This will stop, if there is a trailing commission this will be paid back to the client.

Due to the power of compounding, fees that may look reasonable can have a substantial effect over time.  This can reduce your returns and affect your goals.

If you are a low risk investor, then you can expect lower returns, the effect of fees can make a huge difference.

Research has proven that the higher the costs then the lower the statistical probability that an investor will receive good returns (despite what some advisors may say).

There are some very good managers available, but the higher the costs the greater the difficulty in beating the benchmark.

Often a fund will be shown to a client with healthy returns, however it does not reflect the other costs you have to pay such as platform fees, commissions, account charges etc. etc.

At the same time, paying lower fees does not automatically mean you get better returns, (price is what you pay, value is what you get)

However, there is generally a strong relationship between costs and performance.

The charts below shows the effect on investing 100,000 using a gross return of 6%

It then compares a 2%, 3% and 4% annual cost structure.

At 6% the 100,000 would grow to 320,000 in 20 years,

If you had a 2% fee then it would only grow to 220,000, a difference of 100,000.

If your fees were 4% p.a., then the investment wold only grow to 149,000

graphDo not forget that a portfolio should reflect your risk (diversify into other asset classes), and that emotional decisions tend to have a negative impact on performance.

Wanted to invest and save in the UAE but heard too many scare stories? – Use these tips for successful investing

investment

There are new UAE rules regarding insurance products about to be introduced. They will benefit the consumer but I still think they do not go far enough.

Most of my readers know that I am not a fan of insurance backed investment products, due to the lack of flexibility. The fees involved, the punishing exit fees, the lack of clarity no disclosure and almost impossible to make money.

It is because I believe that the costs still far outweigh any service received. To quote one of my favourite investors Warren Buffet:

“Price is what you pay, value is what you get” jam

If clients knew what they were paying for a typical insurance backed savings account. They would run a mile. 18 months’ premium in fees? Redemption fees that almost wipe out your savings. Total fee structures that can work out about 6% p.a.

There is a change coming, the industry is fighting this change, but it will come.

Let’s look at alternatives.

There are three ways we can invest or save.

a. DIY investing: cheaper and can be fun with lots of risk and most likely underperformance.

b. Advisor directed: a qualified advisor giving advice, you say yes and “caveat emptor” is the result.

c. Discretionary investment management which should only be offered by individuals who have extensive experience in the investment industry and advanced educational credentials, with many investment managers possessing the Chartered Financial Analyst (CFA) designation. Discretionary investment management used to be generally only offered to high net worth clients who have a significant level of investable assets. However this is now changing and can even be used on a savings account.

If only it were that simple.

Yes, fees do make a difference, but unless you put all the pieces of the puzzle together it will not work.

What will affect my returns

  • Costs
  • Advisor remuneration
  • Market timing
  • Asset allocation
  • Investor psychology
  1. Costs:

Paying exorbitant commissions does not mean you get value. The higher the total fees, the more you must make just to stand still.

Fees can be broken down to

  • Advisory fees
  • Platform fees
  • Transactional fees
  • Discretionary management fees
  • Fees within the underlying assets such as mutual funds, Exchange traded funds etc.

It is imperative that you get all these fees to below 2% p.a.

  1. Advisor remuneration:

If an advisor is paid commission, he has a short-term goal and little incentive to look after the client long term. As such the investment structure, may be good for today, however where should you be tomorrow?

If an advisor is paid an ongoing fee, he is rewarded if he looks after the client. As client’s needs change then the advisor will be there to help and advise. When the markets get volatile the advisor will be the steady hand guiding you past these difficult times.

Compensation drives behavior, the wrong compensation drives the wrong behavior.

Ensure that the advisors goals are aligned with yours.

  1. Market timing:

I can name many top investment managers, but I am unable to mention one single top market timer for the simple reason that market timing does not work

There is empirical data that shows that market timers underperform the majority of the time.

In fact, market timing is one of the most dangerous words when it comes to investing.

Just as people go to Vegas to beat the bank, some may beat the bank, however most will not.

Market timing will often result in not being in the market when it goes through above average returns.

  • The market returned 8.18% on average during these 20 years.
  • However, if you missed the best 10 days then returns dropped to an average of 4.49%.
  • If you missed the best 20 days during these 20 years, the returns dropped to 2.05%
  • 60% of those best days happened within 10 days of the worst days.

I.e. when the market capitulates, you are either already out or this is where most now leave. They then miss this massive rebound. That is why we have this huge under performance.

  1. Asset allocation:

Asset allocation has a bigger effect on people’s portfolios than one imagines.

Diversification reduces risk and volatility. Many people buy different equity investments and think that they have diversified. However, if they are similar assets all you have is a concentration of risk without even realizing until it is too late.

As an example, we have seen equity draw downs from peak to trough of 54.5% yet a diversified portfolio into low or non-correlated assets would have seen peak to trough of about 25%.

In fact, over a 20-year period an asset allocation model had an average return of 8.27% (20-year average to Dec 2013) while the S&P average was 8.11%

  1. Investor psychology:

We often hear about performance numbers, but as Winston Churchill once said “I only believe in statistics that I doctored myself. Herein lies the problem.

The stock market returned on average 8.18% (S&P 500 1996-2015) however the average investor only managed about 4.5% during the same period.

Why such a discrepancy? A. Investor Psychology.

An investor will use his logical thought process to help determine his risk profile. However, when markets get volatile the investor then reverts to emotional behavior.

The result is panic and exiting the market and beginning to revert to market timing. This is the worst thing that can happen.

One of the ways to prevent emotional decisions is to work with an advisor who will guide you through these tough times or to have your funds managed by a professional discretionary manager. This mistake costs the average investor 4% p.a.

To summarize,

  • Very hard to do yourself.
  • Keep costs low
  • Your advisor is your employee, the advisor is not a friend, he performs a service and is paid for it.
  • Only fools think they will win long term with market timing. It does not work.
  • Spread your risk in different asset classes
  • Remove your emotional buying and selling decisions by having your portfolio managed by professionals.

Gordon Robertson ACSI

http://investme.ae/

Investme Financial Services LLC – Dubai

Investing in Government Bonds would this be low risk or high risk?

I was visiting a friend of mine a few days ago and she showed me a suggested investment strategy offered by her bank. She asked me to have a look and voice an opinion.

She is slightly risk averse as this is her retirement money.

The suggested investment was a mutual fund owning government bonds with a maturity of 20-30 years. The bank suggested that if she leverages this investment her returns could be very attractive.

It is true that the fund has had good performance in the past, and was not very volatile. However, this is where we come to the terminology “past returns are not a guarantee of future returns.”

So, I decided to sit down and explain the way bond markets work. We have had 30 years of declining interest rates, as such the only way for bonds to go, were up, a continual price increase with declining interest rates. We are now already in negative yields and if you were to buy bonds now or invest in a bond fund it would be in the hope of capital appreciation and not yield (interest income). I saw a blank look on her face, so I decided to do some basic explaining how the bond market works.

I wanted to explain the terms coupon, yield and yield to maturity and explain how the interest rate moves affect bond prices.

For the sake of simplicity, I decided to start with simple explanations about what these terms are:

Bonds: governments finance deficits by issuing Bonds. These are none other than an I.O.U. (Promise) that the government will pay you interest and a return of your investment if you lend them money. This will have a fixed interest rate and duration.

Coupon: The interest paid on a bond expressed as a percentage of the face value. I.e. the bond is priced at 100, the interest paid is 7 so the yield is 7%

But bonds prices go up and down and rarely would stay at the price of 100.

We refer to this 7% as the “nominal yield”

Yield: Current yield = nominal yield/market value of the bond.

I.e. The bond is trading at 90 and you are getting 7 coupon, then the yield would be 7/90 = 7.8%

However, the bond trading at 90 would go to 100 at maturity. As such you would receive the coupon of 7 plus an annual growth to 100. This is referred to as Yield to Maturity.

Yield to Maturity: This is the total return expected on a bond if held to maturity.  This is important as this is the true yield and value that you are getting.

Here the calculation gets a little more complicated as it assumes the coupon is reinvested.

To keep things simple, we will assume that the bond is trading at

  1. 90
  2. It has a 7% coupon
  3. and this bond will mature in 20 years.
  4. This will create a rising value of the bond from 90 to 100.
  5. Then the Yield to Maturity is 8.02%

The bond may be expressed as ABC Corporation 7% Dec 30 2028 price 90

The 7% reflects the interest based on a price of 100. The date is when the bond matures and the price is the market price.

  1. You have a 7% coupon
  2. The yield is 7.8%
  3. The yield to maturity is 8.02%

 

We have seen that the price of the bond fluctuates, and this affects the yield and yield to maturity.

To understand how the price is set, it is compared to the current yield in the market plus a certain amount of risk premium.

I.e. Government bonds have a lower yield than a corporate, lower grade corporate bonds have higher yields to compensate for the additional risk.

Let’s now look at that suggested low risk strategy from this bank.

They suggested buying a fund (which has internal costs of about 0.8%), leveraging it by borrowing money and buying more.

Now we have been in a 30 year declining interest rates scenario, where the yields have gone from 18% down to in many cases zero. We are in bubble territory, it could stay like this for years, but it is still a bubble. The only way this fund can continue to create growth is if the yields keep moving further into negative interest rates. This would have to be substantial to cover the cost of the fund, the borrowing costs and any other commission and fees applied.

new article

Let’s look at the effect of a 1% interest rate movement on a 30 year government bond. Example if interest rates go up, bonds go down. If interest rates go down then bonds go up.

The longer the maturity date the greater the price movement on the bonds. The greater the profit or the bigger the loss.

If the interest rates were to fall by 1% then the value of the bond increases by 19.6%. This explains why for the last 30 years we have seen strong growth in the bond market.

If you believe that the negative or near negative yields will go down further, then prices will continue to rise. However, many people believe we are in bubble territory and this bubble will burst at some stage. In the UK the Prime Minister has said that the wealthy have benefited from low interest rates, but savers and pensioners have suffered. This may be an indication that she is thinking of reversing interest rates. Inflation is due to rise in the UK due to the falling pound, this will also put pressure on raising rates.

We know that if interest rates fell by 1% then we could expect to see a value of the bond rise by 19.6% however if the opposite happened and the rates rose by 1% then the value of the bonds would drop by 20%.

 

Think of this, a so called low risk investment can easily suffer a 20% loss by a mere 1% interest rate increase, and if your portfolio was leveraged two times, then the losses would be 40%

Be wary of the bond market. It has more risk than most people expect.

If you have any questions, please contact Gordon Robertson

gr@me-group.ae

 

 

 

 

Why misunderstanding and not being able to manage risk can damage your economic health?

The generally accepted view from professionals and regulator’s when it comes to advice is

jam“An investment fiduciary has an obligation to provide the advice that a prudent expert (an experienced advisor) would have given a similar client in similar circumstances”

The term “prudent expert” has never been fully defined, but most courts and regulators believe it should be based on the principles of the “Modern Portfolio Theory from Markowitz.

This is why risk profiling is important as it helps to determine the different investment structures that is correct for each individual.

When it comes to risk profiling or risk tolerance vs “prudent expert” however it is less clear and not so defined. Despite the fact that there is a legal requirement to know your client which includes the client’s tolerance for risk. This leaves the financial industry in a situation where they have to do a best effort and hope it is correct.

I always use the example of Sheikh Zayed Road. For an average British person, it may be perceived as extremely risky, however for the Italian it is very safe compared to racing around Milan however for the RTA it is average risk.

So here lies the problem with assessing risk. We have an average rated road but the perception of both parties are completely opposite and both different than the RTA. Yet both parties have to travel on the same road. As such you should now separate this into risk tolerance and risk capacity. As time goes on peoples risk composure changes. We get older, we experience different things, our reactions get slower. This makes it difficult to use a basic questionnaire when we are dealing with abstract traits such as risk tolerance.

Due to these complexities I use a psychometrical approach to assess the clients risk capacity, a gap analysis to determine a client’s financial goal. Only then can I determine the client’s willingness to increase his risk capacity if required.

Now it is possible to manage the clients risk perception and their investment expectations on an ongoing basis. This will help prevent disappointment when the next crash or black swan event comes along.

There has been much academic study about client’s behaviour with risk and how it influences investment decisions. They have identified 3 core areas.

Risk Tolerance: – the client’s willingness to take on risk (uncertain positive or negative outcome)

Risk Capacity: – the financial ability to endure a potential financial loss and still achieve the clients’ goal. (If the goal is aggressive, then the goal itself is risky)

Risk Perception: – in my example I explained that perception is not always reality and as such the behaviour becomes inconsistent with the risk tolerance. This is often a result of a lack of financial literacy and being susceptible to news and television reports.

We see that risk capacity is an objective measure while risk tolerance and risk perception are subjective.

That is why you need to understand all three to be able to give an appropriate investment recommendation.

It is difficult to measure risk tolerance due to it being subjective, we can’t just look into someone’s mind and try and come up with an answer. That is why when questions are asked and we do an evaluation of the responses we can then work to find out about how the client feels about their willingness to take on risk. This is key to understand a client before we can recommend a suitable investment structure.

Most risk profiling forms do not do a good job at predicting a client’s behaviour during volatile markets. This can lead to unhappy clients or even legal issues.

One example could be someone whose investment has gone from 1 million to 2 million then down to 1.5 million. For me I would say they have made 500,000, however they may feel that they have lost 500,000, result “unhappy client”

Or the clients account may have gone to 1,300,000 and as such has no problem losing 200,000. The client in this instance just sees it as playing money they never had.

If the same client had invested 1 million and lost 100,000 then that could be for them catastrophic.

So we now see that even if the loss looks smaller, the way the client accepts this volatility or losses is different.

This is because when we see that the client may have filled out the risk tolerance in a calm and rational mind, when those events that cause volatility occur we now begin to see an emotional response and not a rational response. This is due to the difference between our primal instincts in our limbic system and our frontal cortex. This explains the difference between our rational expectation and the disconnect and how we react to risky events in real time. It is these reactions that causes losses and disappointment.

When it comes to planning and investments, these irrational reactions will most likely prevent the client achieving their goals. This has to be addressed in a professional manner.

This can become a science, but to summarise: when planning for investments, the correct risk analysis has to be done which has to cover risk tolerance, risk capacity and risk required. Most risk profiling systems are not sufficient to be able to do this.

We have to delve deeper into the client’s risk structures and as such one should use a psychometric profiling tool. The professional should ensure that the expectations are realistic, and these expectations are managed on a constant basis. Only this way can most clients survive volatility and achieve the desired goals (note that most investors have long term returns that are 50% lower than the market due to making emotional decisions in times of stress)

While most questionnaires are so poorly designed, they actually can end up with a worse result than not using one at all.

No matter how good the risk profiling is and setting expectations as well as managing expectations. You still need a good quality financial advisor that can spot the nuances. Each person is different and the advisor should be able to confirm the appropriates of the test results. These results should be then be used in conjunction with financial modelling tools to come up with risk adjusted returns (returns that do not take excessive risk and match the clients profile).  This allows the advisor to better manage the ongoing relationship vis a vis the true clients risk profile vs the perceived risk profile and thus being able to prevent the client panicking at the last moment in a crisis.

Gordon Robertson

 

 

Your Financial Advisor is Your Employee – How Much Should Your Employee be Compensated?

If you ever take financial advice and invest money. There are a few things about fees to be aware off.

It is very easy to pay too much to someone to help manage your investments and most likely you also would not know how much this is costing you.

The financial advisory businesses are experts at creating impossible to understand agreements. These agreements are designed to hide how much you are being charged and how much you are paying. Try reading and understanding a typical UAE savings plan policy! I had difficulties despite my 30 years plus in the investment industry. They tend to work on the 80/20 rule, which is that 80% of the clients will not query the cost structure.

Continue reading Your Financial Advisor is Your Employee – How Much Should Your Employee be Compensated?

QROPS? SIPPs Fact or Fiction or Is It Just Scaremongering?

5I have been in Dubai for a while and have observed that QROPS (Qualified Recognised Overseas Pension Scheme) is often marketed as a solution to SIPPs (self-invested personal pension).  It is as if SIPPs was a disease and QROPS was the cure, especially when you see QROPS being so aggressively marketed.

However due to the change in the tax laws QROPS have lost some of the advantages vs SIPPs.

As such I will try and explain the difference.

1.   SIPPs have the legal jurisdiction of the UK, QROPS are overseas.

2.   SIPPs at the age of 55, can pay a tax free lump sum of 25% (may be subject to residence tax if overseas.

3.   QROPS at the age of 55 (potential of 50) can pay 30% tax free lump sum of 30% (may be subject to residence tax if overseas.

4.   A typical QROPS valued at gbp 150,000 could cost gbp 5,500 up front and gbp 7,950 p.a.

5.   A typical SIPPs valued at gbp 150,000 could cost gbp 400 up front and gbp 3,000 p.a.

There is no IHT (inheritance tax) as such there is no need to have a Portfolio Bond or Insurance wrapper unless you want to pay huge commission to the advisor.

Always ask the following questions

1.   What is the setup and annual charges for a QROPS or SIPPS

2.   What are the Portfolio Bond or Insurance wrapper charges which should include admin fees, dealing costs, annual fees etc.

3.   What is the cost of the underlying investment? Such as ETF fees, Mutual Fund fees, commission on the products etc.

4.   What are the advisor fees and commissions?

5.   Get a written statement that all fees and charges have been disclosed (typically advisors are encouraged to sell Portfolio Bonds or insurance wrappers where they get paid about 7% in fees and commissions by the provider, these fees and commissions are ultimately recouped by charging you as the investor).

6.   Ask why they recommend a portfolio bond or Insurance wrapper when they most likely are not required,

7.   Ask about any redemption fees if you need your money back.

8.   Ask about PII (Personal Indemnity Insurance)

9.   SIPPs have a lot of protection as they are more regulated, however QROPS can hold esoteric (also high commission) investments with less checks and balances, so what legal protection do I have.

Warning

Often your annual fees are based upon the initial investment, if you take out money later, the fees will still be based upon the original investment amount thus making it almost impossible to have any growth in your portfolio.

Once you count up all those fees, you now know what you need to make in returns just to stand still. In times of low returns this could end up giving you negative growth.

When talking to an advisor ask check these important points:

1. size of the company is not important; the question would be if the company is regulated.

2. what are the qualifications of the advisor.

3. check complaints/feedback against the advisor or company from websites such as www.pissedconsumer.com

4. is the advisor compensated with commission (potential conflict of interest when recommending a product) or with an annual fee (compensation drives behaviour and the wrong compensation drives the wrong behaviour). Fee based encourages the advisor to work in your best interest as he is only compensated if you stay with them.

Taxation questions:

1.   Do I live in a country such as the UAE where there is currently no taxation?

2.   When will tax be a consideration? (Why pay high fees with less consumer protection if it is not necessary)

3.   Does the country where I live recognise a QROP structure for tax reasons. (US, France; Spain or Australia does not recognise this structure)

At InvestME Financial Services LLC, we believe in driving costs, commissions and fees down. These savings are passed back to the clients. We believe in full transparency in costs.

The author Gordon Robertson is not qualified to give tax advice. Any specific questions regarding tax should be referred to a tax advisor experienced in the relevant tax jurisdiction.

Gordon Robertson is a highly qualified advisor and both he and InvestMe are regulated by the Securities and Commodities Authority (SCA) in the UAE.

To know more or if you have any questions please contact me at gr@me-group.ae

6. Our notes have never lost money!

This may be true, but this does not reflect the entire structured note market, or the history of structured notes.

In the aftermath of the 2008 crisis, many financial institutions defaulted on the structured notes. Lehman alone defaulted on usd76 Billion.

7. You get access to a particular asset class normally onlz available to institutions.

This may have been a fact many years ago, however there are so many investment structures you can access via ETF’s (Exchange Traded Funds) and Mutual Funds with lower costs and lower risks.

The only benefit that makes sense is that structured notes can have customised pay-outs and exposures.  Some notes advertise an investment return with little or no principal risk, some quote higher returns in range bound markets with or without this protection and yet other notes often sold as generating high yields in a currently low yield environment. Sounds complicated but it is not.

Whatever you choose, derivatives allow the structured note to replicate a particular market or forecast. It is synthetic (does not use the actual shares) and often uses leverage (borrows money) to generate returns higher or lower than the asset it is supposed to replicate.

7. If a client asks about liquidity

The advisor may tell you there is a secondary market.

Liquidity, what liquidity? –. Structured Notes do not tend to trade after being issued

In fact, the term is “Illiquid” You are expected to hold the note till maturity.

However, in life, changes happen, what happens if you require money due to losing a job, another investment opportunity that you should take, what happens if we have another financial crisis similar to 2008. The only possibility is to go for an early exit and take any price the issuer offers you, that is assuming they are willing to make an offer.

Daily Pricing is extremely questionable. – As most of those notes do not trade after being issued, then it is logical that the prices being quoted on your statement are not actual prices you can sell at.

They are instead calculated using algorithms which is completely different than a net asset value.

As such the valuation is merely a guess at the best. If it is not the market that gives the price, who do you think it is?

So what are the disadvantages of Structured Notes?

Credit Risk – I mentioned that they are an IOU (promise) from the issuer, as such you bear the risk that the financial intuition can make good of the guarantee. ARC Capital, Keydata, Bear Stearns and Lehman are just a few that defaulted on the guarantee, Lehman alone defaulted on USD 76 Billion of structured notes. As such it is possible that the market is down 50% but the note is still worthless. It could even have a positive return and also be worthless. You are basically adding credit risk on top of market risk. Notes mostly do not have a risk rating, unlike bonds. If the financial institution goes into insolvency, then these notes are worthless.

In fact, the UK financial watch dog Martin Wheatley referred to them as “spread betting on steroids”

Mutual funds, stocks, ETF’s etc. will be segregated assets in your account. They may be down, but they still belong to you and have a chance of recovery. If the financial institution holding your account goes into bankruptcy, your assets will be transferred to another institution. Structured notes will remain as a promise by the institution to pay you after all other creditors have been paid.

Fees – fees and commission can be very high. This is what makes them attractive for the issuer and the advisor selling them “The higher the fees the lower the returns”. It is however possible to create your own structured notes with higher returns.

Who cares about credit risk, liquidity or pricing? – Let me give you an actual recent case study:

1.   RBC Phoenix A/Call Note Linked to 5 stocks

Cusip XS1978174411 issued July 18 2014 mature July 18 2019

Potential to return 12% p.a. with a defined level of risk and potential quarterly redemption.

Regular income and considered defensive.

What the client was not informed was that it was only meant “for professional investors only and not for Retail distribution”

The client was a low risk investor with issues about job security.

The position was valued on Jan 14 2016 with a loss of 59.28%

To know more or if you have questions please contact the author

Gordon Robertson: gr@me-group.ae

Brooklands appoints administrator, Heritage takes over Sipps

*This article is taken from http://www.international-adviser.com/news/1030608/brooklands-appoints-administrator-heritage-takes-sipps and only reposted on this site.

By Richard Hubbard

 Brooklands Trustees, an FCA authorised Sipp provider, has gone into administration and sold its assets to Heritage Pensions, according to a note to clients from the new administrator Duff and Phelps.

With effect from 25 July 2016, Heritage Pensions is now the operator of the Brooklands Sipp and IVCM Heritage Trustees are the trustees of the Brooklands Sipp, the administrators said.

Continue reading Brooklands appoints administrator, Heritage takes over Sipps

Baby Boomers – Retirement – Houston I think We Have a Problem

I remember my parents in retirement having a life style I envied.

They did not have as much fun while they worked compared to myself, but I am referring to how comfortable they were in retirement. The reason is due to us having two behavioural issues.

The first one being “Present Bias” this is where we put our current enjoyment and hobbies before our long term requirements to achieve the same quality of retirement my parents had.

Continue reading Baby Boomers – Retirement – Houston I think We Have a Problem