Investment specialisms – do your homework!

29 September 2016

Fraser Donaldson – Insight Analyst, Insight and Consulting: Funds and DFM

When selecting an investment of any kind for a client there is a certain level of due diligence that needs to be undertaken to satisfy the regulators, but more importantly to maximise the probability of clients achieving their goals at a level of risk that they are comfortable with.

It is tricky enough to select investments when it is only goals, risk and suitability that need to be considered. As we all know there are times when a specialist investment solution is required. This adds to the burden of due diligence and just to make things really difficult, for some specialisms, there is a chance that the client will know more about the subject than you, the adviser.

Examples of specialist investment areas would include:

  • Investing for US clients
  • Ethical
  • Sharia
  • IHT portfolios using Business Relief (for example, Alternative Investment Market (Aim)      portfolios)

Perhaps a bit more mainstream, but I would tend to include portfolios managed where the provision of income is a priority over capital growth as a re-emerging area since the advent of pension freedoms.

US clients

Of the above, investing for US clients is the only one that is about reporting, rather than investment specialisms

The introduction of the Foreign Account Tax Compliance Act (FATCA) has increased the reporting burden of US citizens. First proposed in 2010, and then finally implemented July 2015 after some revisions and detailed agreements with other countries, FATCA aims to increase enforcement of US tax rules on its citizens and increase anti-money laundering monitoring.

Despite many institutions complaining that the requirements are onerous, many UK firms have spotted a niche for taking on considerable assets from US citizens abroad if they can cope with the reporting.

Taking on US citizens as clients requires a detailed knowledge of the reporting and tax requirements of the IRS. Due diligence in selecting a discretionary firm to run the client’s money requires the adviser to ensure that the discretionary manager understands, and can cope with the requirements of FATCA.

A few years ago, there were only a handful of discretionary firms that took on US clients. Rather perversely, now that reporting and compliance has become more complex, almost half of the firms Defaqto cover now take on US clients.


There are two types of ethical investors. Those that feel some moral obligation to do the right thing, although with nothing specific in mind, and those that have very firm beliefs about certain issues.

A portfolio option within a managed portfolio service is likely to have been designed to appeal to those clients that feel they should do something, but do not necessarily have a specific cause in mind.

These portfolios are likely to be more generic in nature and take a negative criteria approach ie avoiding as much as possible areas that are considered to be ‘unethical’ (eg Arms, tobacco, alcohol, animal testing).

For those clients that have very firm beliefs about certain issues, appointing a bespoke portfolio manager is probably the way to go. Discussion with the investment manager would elicit what types of investment to accept and what to avoid. Investing in companies that do not get involved in some sectors may not be good enough.

Analysing the capabilities of the investment manager is crucial to due diligence here. While most bespoke managers will claim expertise in this area, the extent of this needs to be investigated. For clients that have specific requirements and beliefs in a particular area, advisers may find themselves in the unusual position of deferring to the clients’ greater knowledge. Groundwork and due diligence to establish a credible shortlist here is crucial.


Sharia law is very specific and there is no room for compromises. There is no doubt that a specialist manager would be required to run a portfolio of this nature. Unsurprisingly, only two of the 80 or so discretionary firms that we cover, run Sharia portfolios. Again, it is likely that the client will be in the strong position to assess the investment manager’s capabilities.

AIM portfolios for business relief

Quite apart from requiring a specialist knowledge of, and the resource to research the smaller company end of the market there are several rules to obey for holdings to qualify for Business Property Relief (BPR).

While HMRC may provide written advice on a BPR-qualifying investment if requested, it is only on a case-by-case basis, and generally at the time that BPR is claimed. That is to say, only when there is the potential for an immediate IHT charge will HMRC rule under the law as to whether an asset qualifies for BPR or not.  

Once HMRC has assessed an application for BPR, investments that qualify for BPR (assuming they have been held for two years) can be passed to the deceased’s beneficiaries free of IHT.

It is clear that a specialist knowledge of the market is required. When advisers undertake due diligence in this area, in addition to client specific questions, there are five fundamental questions that should be asked:

  • The firm - history of success including record of BPR qualifying failures
  • Research resource
  • Experience of the investment team in the relevant market
  • Performance history (in terms of following mandate rather than absolute as many have low growth expectations in return for lower risk) - this would include payment of, and level of income if this is important
  • Diversification - sector, themes, number of stocks
  • Cost

The price of compromise

With the investment specialisms mentioned above, choice of portfolios is usually limited unless employing an expert bespoke manager.

Most managed portfolio service ranges only have one ethical or Sharia portfolio (if any). This means that there is limited choice in matching a client’s attitude to risk to a specific portfolio. The adviser’s skill in explaining the trade-off between risk and investment preferences really comes to the fore.

For AIM portfolios, by their nature, smaller companies tend to be at the higher risk end of the market. However, the tax benefits can be significant and again it is up to the adviser to explain the possible trade-off between risk and return, but this time factoring in the tax benefits.

Before appointing a discretionary manager to run a specialist portfolio such as those mentioned above, ensure that they have the requisite experience, research capabilities, knowledge of the market and market understanding to take it on.

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