Chapter 7 · Investment Advice

Regulators require firms to CATEGORISE clients so the right level of regulatory protection can be applied. The categories (MiFID-style):

KYC = gathering enough information about a client to give appropriate advice. It's the foundation of suitability. Focus areas:

• Financial situation (income, expenditure, assets, liabilities)
• Investment objectives and time horizon
• Knowledge and experience
• Risk tolerance and capacity for loss
• Liquidity needs
• Tax status
• Constraints (eg, ethical preferences, religious requirements)

Both matter. A fact-find that captures only hard facts will produce mechanical, possibly unsuitable, recommendations.

A client who appoints a firm on a NON-DISCRETIONARY basis is retaining decision-making authority — the firm acts only on instruction OR on advice that the client then approves. Includes both advisory and execution-only relationships.

Implication: the firm does not bear financial responsibility for investment decisions that the client agreed to.

• Management fee — % of assets under management (eg, 0.5–1.5% per year). Aligns adviser with portfolio growth.
• Transaction charges — per-trade fees (commission, dealing charges, bid/offer spreads)
• Fixed planning fee — flat fee for a piece of financial planning work (eg, retirement plan, IHT review)
• Performance fee — % of returns above a benchmark/hurdle, often with high-water mark
• Hourly fee — like a lawyer, for time spent

Some firms charge SEPARATELY for advice and execution; others bundle them. Transparency of fee structure is a regulatory expectation.

A conflict of interest arises when the firm's or adviser's interests diverge from the client's. Common examples:

• Adviser earns higher commission on one product vs an equally suitable alternative
• Firm trades on its own book against the client's interest
• Inducements from product providers
• Personal account dealing by employees ahead of client orders (front-running)

Management techniques:

• Disclosure to the client
• Chinese walls / information barriers between functions
• Decline to act if the conflict can't be managed
• Policies on gifts, inducements, personal dealing

A fiduciary owes the highest duties of CARE, LOYALTY and GOOD FAITH to the beneficiary. They must put the client's interests above their own (and above the firm's).

The principle of fiduciary responsibility directly underpins rules like:

• Disclosure of commissions and inducements
• Avoidance of undisclosed conflicts
• Acting in the client's best interest
• Confidentiality

Modern regulation explicitly requires firms to act in the client's BEST INTERESTS — not merely "in their interest". Implications:

• When multiple suitable options exist, recommend the one best for the client (not the one with highest firm margin)
• Proactively identify and disclose conflicts
• Charge fees that reflect value delivered

The Financial Planning Standards Board's six-step cycle — memorise the ORDER:

1. Establish and define the relationship with the client (engagement letter, scope, fees)
2. Gather data (KYC fact-find, hard and soft facts)
3. Analyse the client's financial situation
4. Develop the action plan / recommendations
5. Implement the recommendations (execute trades, set up products)
6. Review periodically and adjust

A suitability breach happens when the recommended product/service is mismatched with the client's profile. Classic scenarios:

• High-volatility / high-beta product to a cautious investor
• Long-term / illiquid product to someone with short timescale and liquidity needs
• Complex derivative or structured product to an investor with no relevant experience
• Unregulated investment to a retail (non-sophisticated) client

If a question gives you a beta and a client risk profile, match them up:

• Beta 0.5 → cautious investor (defensive, moves half as much as the market)
• Beta 1.0 → balanced investor (market-tracking)
• Beta 1.5 → growth-seeking investor (amplified market exposure)
• Beta 2.5+ → aggressive only. Recommending this for a cautious investor = clear suitability breach.

Capacity for loss = how much loss can the client absorb without it materially impacting their living standard or objectives? Critical for suitability — a client with HIGH risk tolerance but LOW capacity should not be in high-risk assets.

Common factors raising/lowering capacity:

• Other assets and emergency savings
• Reliable income (and stability of that income)
• Time horizon — longer = more recovery time
• Dependants and financial commitments

As clients approach and enter retirement, risk capacity typically falls because:

• Shorter remaining time horizon
• No earnings to replace investment losses
• Greater dependence on portfolio for income
• Sequencing risk magnifies early-retirement losses

This often drives the "glide path" — gradually shifting toward more defensive assets as retirement approaches.

"Time horizon" means the length of time before the funds will be NEEDED — not the client's lifespan, not the bond duration, not the length of the client relationship.

Longer time horizon = more capacity for risk (more recovery time, time for compounding) → can hold more equities. Shorter horizon = less capacity → should hold more defensive assets.

Some clients have preferences/requirements that constrain the investable universe:

• Ethical/ESG — may exclude certain sectors (tobacco, weapons, fossil fuels) or prefer best-in-class ESG performers
• Shariah — must avoid riba (interest), gharar (excessive uncertainty), and haram industries (alcohol, gambling, pornography, conventional finance, pork)
• Charity / trust mandates — constraints set by trust deeds or charity policies, including the duty to balance income and capital growth

If a client becomes UNABLE to understand the information sent by the adviser (eg, dementia), the adviser cannot:

• Continue acting on the client's instructions as if nothing has changed
• Take instructions from family members without legal authority
• Use the firm's own judgement to manage the portfolio

What the adviser MUST do: take no further action until an attorney (under a valid Power of Attorney) is appointed or a court-appointed deputy takes over.

• Income tax — on salary, pension, rental income, interest, dividends
• Capital gains tax (CGT) — on the realised gain from selling an investment
• Inheritance / estate tax — on transfer of wealth at death (and sometimes lifetime gifts)
• Transaction tax (eg, stamp duty) — on purchase of certain assets
• Sales tax / VAT — on consumption

Accrued interest on a bond investment is treated as INCOME and subject to income tax — not capital gains tax. This is because it represents earnings on the bond between coupon dates, conceptually identical to receiving the coupon.

• Corporation tax — on company profits
• Transaction tax — eg, stamp duty reserve tax on share purchases (0.5% in the UK on most share dealings)
• Tax on sales — VAT/GST collected by the business and paid to the tax authority

Withholding tax is tax DEDUCTED AT SOURCE by the payer of certain types of income (dividends, interest, royalties) on behalf of the tax authority. The recipient receives the net amount.

Examples: a UK investor receiving US dividends will typically see 30% withheld at source by the US — but can reduce this to 15% under the UK-US double tax treaty (with proper documentation).

A DTA is a treaty between two countries that allocates taxing rights and provides relief from double taxation. Without a DTA, the same income could be taxed both:

• In the SOURCE country (where the income arose) via withholding tax
• In the RESIDENCE country (where the recipient is tax-resident)

DTAs typically:

• Reduce withholding rates between treaty countries
• Give a TAX CREDIT in the residence country for tax paid in the source country
• Exempt certain categories of income from one country's tax

• Residence — generally determines liability for income tax and CGT. Most countries tax residents on WORLDWIDE income and gains, non-residents only on source income.
• Domicile — generally determines liability for INHERITANCE/ESTATE tax (and, in the UK, the remittance basis of taxation for non-doms on foreign income).
• Situs of assets — physical location matters especially for non-doms (eg, UK property is always within UK IHT scope regardless of owner's domicile).

A recommendation report (suitability letter) should typically cover:

• Client's objectives and circumstances (as understood)
• The strategy and rationale
• Specific product recommendations
• Costs and charges
• Key risks and disadvantages
• Tax implications of the recommendations
• Review arrangements

What it should NOT pretend to provide: forecasts of inflation, future interest rates, or guaranteed returns. Those are uncertain — the report should focus on the recommendation, its rationale, and the risks.

A Key Features Document is a regulated document providing a CLEAR DESCRIPTION of a specific financial product being recommended. Standardised format helps clients compare products. Includes the product's aim, commitment required, risks, costs, and how to exit.

It is product-specific — not a summary of the whole financial plan. Cancellation rights, tax implications, charges and key risks are typically all included.

Best practice when presenting:

• Use language the client can UNDERSTAND — avoid unnecessary jargon
• Cover the merits AND drawbacks of each proposal
• CHECK CLIENT UNDERSTANDING — ask them to summarise back
• Make sure the client AGREES to the strategy before implementing

Benchmark should match the portfolio's:

• Asset allocation
• Risk/return profile
• Investment universe (geography, sector, market cap)
• Peer group context
• Inclusion of alternatives, if held

What is NOT a valid basis: the adviser's personal preference unrelated to the mandate.

Periodic review (usually annual) is standard. Specific triggers include:

• Changes in client circumstances — marriage, divorce, birth, death, retirement, inheritance, job loss
• Changes in financial environment — major market move, regime shift
• New products / services available
• Investment-related changes — credit downgrade on a holding, corporate action, fund manager change
• Portfolio drift — strategic mix has moved away from target → time to rebalance

PTR measures how actively a portfolio is traded over a period (typically a year). High PTR = lots of buying and selling. Implications:

• Higher transaction costs (commissions, spreads)
• Higher tax drag for taxable accounts (more realised gains)
• Possible "churning" red flag if the high turnover doesn't add value