Not clearly saying why an investment product with lower historical returns has been recommended

When it comes to investment products, any recommendation for a switch will need to examine the past returns on the two products: the existing product being replaced, and the replacement product. (ASIC RG 175). While it is true that past returns cannot be relied on as predictors of future returns, it is also true that past returns are a good indicator of how well a product is performing.

There can, of course, be good reasons why a product with lower historical returns may be more appropriate to a client. For example, lower historical returns would be expected in a product with a more conservative risk profile. A product with only 50% exposure to equities, with the balance in cash and cash equivalents, will underperform a product with 100% exposure to equities in time periods where the equity market outperforms cash (as it does, on average, most of the time).

Alternatively, an adviser might believe the asset profile of the new fund is more likely to achieve higher returns in the future. In this case, the adviser needs to understand that there is some risk in this opinion and this needs to be communicated to the client.

As we have stated elsewhere, recommendations to change financial products open up a whole range of communication that is required from the adviser. The SOA must clearly set out the advantages and disadvantages of each product, and make clear that, on balance, the new product is better suited to the client’s situation. In cases where the historical returns on the new product are lower than those on the previous one, the discussion in the SOA needs to address this directly and explain why the adviser is still of the opinion that the new product is to be preferred.

And remember, as always, the SOA should be written with at least two audiences in mind: the client and the Judge. (Actually, let’s make this three: Dover’s compliance team have to work through it as well. We will leave it to you to decide whose critique will be the most robust). The comparison needs to be such that each of these people would accept that the recommendation to switch is reasonable given the client’s circumstances. This can include cases where the new product has provided lower historical returns – but you need to say why this particular point of comparison should be ignored.

The Dover Group