The case for discretionary investment management
 

An investment portfolio is like a garden; if it is not properly planned and looked after on a regular basis it is certain to deteriorate. There are fundamentally only two ways to plan and look after your investments. You can take on the job yourself, or you can delegate it to someone you can trust to do it for you.

For some people, probably a minority, the management of their investments is a fascinating hobby. It requires good sources of information and advice, a generous measure of flair, and the willingness to devote a considerable amount of time to it. Others, although they may be interested to a greater or lesser extent in financial matters, do not have the aptitude or the time to do it themselves. At the extreme are those who have never known anything about investing money, and have no inclination to learn.

The ‘do-it-yourself ’ investor can be catered for adequately by a non-discretionary arrangement with his stockbroker or other adviser. Under such an arrangement his portfolio is reviewed from time to time, and suggestions for purchases and sales are put forward. But it should be clearly understood that the actual decision whether or not to accept such suggestions is in the hands of the DIY investor himself. Customarily the adviser receives no remuneration for his services apart from the commission he earns if and when his suggestions are taken up. In theory at least, he has no direct interest in the performance of the portfolio, but only in the rate at which investments are changed!

Such an arrangement, though effective enough for the DIY investor who is capable of formulating strategy, monitoring his holdings continuously, and taking all investment decisions himself, is obviously not satisfactory for the investor who prefers to delegate management responsibility. It leads inevitably to periods of neglect when nobody is in charge. Weeds will soon appear in his garden if he neither attends to it himself nor employs a gardener!

If, then, you are not a DIY investor, your needs can only be satisfactorily met through a discretionary investment management arrangement. This means that you appoint a manager in whom you have confidence to assume responsibility for your investments and to take all necessary decisions concerning them at his ‘discretion’. Your discretionary manager should be remunerated, not by commissions on dealing, but by a straightforward management fee.

It is a common fallacy that you can secure effective investment management free of charge. As the saying goes, there is no such thing as a free lunch, and in one way or another you will be paying for it. The question is, are you getting value for money? The price may be that the advice you receive is not altogether disinterested; you may, for example, be persuaded of the merits of investment bonds or similar ‘products’ notorious for paying handsome commissions to intermediaries.

Alternatively, it may simply be that having paid nothing for investment management, that is precisely what you get. There is much to be said for ‘glasnost’ in this area, represented by a clearly stated management fee which is the only remuneration your manager receives; he should not benefit from dealing on your behalf, and should apply any share of commissions he receives in reduction of this fee.

Assuming that you are persuaded of the merits of a discretionary arrangement, the next step is to identify your investment manager. Discretionary investment management is offered by a variety of financial organisations, including banks, merchant banks, fund management companies, insurance brokers, stockbrokers, law and accountancy firms, and even the big store groups. In addition, discretionary investment management is available on a collective basis from unit trust managers, investment trusts, and insurance companies. How are you going to make your choice?

The qualifications you should be looking for can be summarised under three headings, as follows:

Experience and capacity

Obviously the first thing you must have is confidence in the ability of your manager to do a good job for you. He should have the experience and the contacts to enable him to invest your money successfully in world markets. Now that exchange controls have been abolished there is no reason why investment should be restricted to the UK only.

Judging a manager by his track record is a difficult exercise. You should be very wary of taking at face value the conventional short-term performance figures used in the aggressive promotion of investment services. Sound management over a period of years rather than months is the only reliable guide. In the end, your choice will depend upon your assessment of his personal credentials and abilities, rather than on a set of fallible statistics.

Independence

You should be concerned as to whether your manager is subject to any outside influences which could distract him from the task in hand, that of single-mindedly looking after your investments. As a general rule, it is difficult for an investment manager to claim to be independent if he forms part of a larger group with interests which may conflict with yours, or if he depends for his remuneration, directly or indirectly, on commissions. The investments he makes on your behalf should be made purely on investment grounds, and any possible influences which might indicate alternative motivations should be viewed with misgiving.

A professional approach

Unfortunately the management of private portfolios has too often assumed the characteristics of a sales oriented business rather than a profession. Private client investment services, unit trusts and insurance ‘products’ are sold aggressively, and it is the client who pays for the selling costs. The exploitation of clients’ portfolios for profit is widespread, ranging from outright fraud to manoeuvres which, while within the law, can only be described as sharp practice.

With this in mind, you should be looking for a manager who is interested in building a professional relationship of confidence with you as an individual, taking into account your personal objectives and preferences, rather than simply running investment portfolios on mechanical lines as a profitable business.

It is with the object of meeting these qualifications, and in the belief that they are not easy to find, that McInroy and Wood Limited has been formed. The firm’s principal business is discretionary investment management for private clients.

Alan McInroy
February 1987

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