IFAs and “Governance Budgets”

A quick thought I thought I would write up into a blog over my lunch…

In researching some of the asset classes IP are planning on covering in the near future, I’ve been spending some time looking at so-called “Smart Beta”.

It’s a really interesting concept (if you like that sort of thing) and surely has a place in the investment universe, but reading about it has highlighted what I think is an issue for advisers which I’m going to call “governance budget.” (Borrowing a term from my days working with DB pension fund trustees).

My thought goes like this: intellectually grasping smart beta is one thing, but how do you determine if the particular product you are looking at is any good or not? You have to spend some of your governance budget working this out.

If you’re going to consider investing, you need to know if it’s a better or worse option than what is already out there. To do this, you need to be able to unpick how the smart beta product is put together AND how the conventional options are put together.

For example, if you think you are currently paying high fees for an active product that could be replicated for half the price by a smart beta strategy, than you need to get under the bonnet and look at the holdings and the performance attribution of the active manager. You need to identify if their performance is coming from factor based decisions that a smart beta product could replicate.

Now, if you did carry out this research and found that you could cut your costs in half, over the lifetime of the portfolio that would represent a significant improvement in the eventual outcome (think of the annual saving compounded over twenty years).

Big DB pension schemes can afford to employ teams or hire consultants to do this work for them – it forms part of their governance budget.

I think for IFA’s it’s much harder to find the resources to dedicate to this kind of work. It’s not easy and it is time consuming. With so many other priorities competing for their attention, putting time and effort into researching something that may or not turn out to be a good idea is challenging. Hence the tendency to stick with the status quo. This issue applies to other alternative investments as well.

However, I hope our research goes some way to helping advisers cope with limited governance budgets, and at the very least gives them a starting point when they look at new or less conventional asset classes.