Benchmark Mismatch and Withdrawals
A client, 68 and retired, has a £1.4 million portfolio managed on a 'moderate' risk mandate. She needs £45,000 a year, drawn monthly. The portfolio is 25% cash, 35% UK equities, 25% global bonds and 15% property. Three-year performance is 5.1% a year after fees. The report compares this with 9.8% a year from the FTSE All-World index. Advice fees are 1.2% and underlying fund costs 0.7%. The client is furious and threatens to move her account. Compliance notes that the IPS was written eight years ago and states the objective as 'beat the FTSE All-World'. The firm has not reviewed the benchmark since. The client says she 'took no risk' and expected 'at least 8%'.
1. Critique the performance comparison and explain the main drivers of the shortfall.
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Benchmark mismatch
The FTSE All-World is a 100% equity, market-cap-weighted, unhedged index. The portfolio is 35% equities, 25% bonds, 25% cash and 15% property. Comparing a moderate multi-asset portfolio with a global equity index is not a like-for-like comparison. The correct benchmark is a composite reflecting the strategic asset allocation, or a balanced multi-asset peer group. The IPS benchmark is unfit for purpose and should have been reviewed.
Drivers of the 4.7% shortfall
- Asset allocation: 25% cash was a large drag in a rising equity market. Bonds suffered in the 2022 rate shock. Property faced valuation and liquidity pressures.
- UK equity bias: 35% in UK equities missed much of the global rally.
- Fees: 1.2% advice plus 0.7% fund costs = 1.9% a year. If the net return was 5.1%, the gross return was about 7.0%, so fees explain a significant part of the gap.
- Period and start date: three years includes a bond crash and a narrow equity rally. A different start date changes the picture.
Risk adjustment
A fair comparison must consider volatility, maximum drawdown and Sharpe ratio. The portfolio probably had half the equity index's volatility. Beating the equity index with a moderate portfolio in every three-year period is not a realistic objective. The client's expectation of 'at least 8%' with 'no risk' is inconsistent and needs correcting in plain language.
2. Explain how performance should be measured when there are regular withdrawals.
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Two different questions
- Time-weighted return (TWRR) measures the manager's investment performance by removing the effect of cash flows. It is the right measure for judging the manager against a benchmark.
- Money-weighted return (MWRR), or internal rate of return, measures the client's actual experience, including the timing of the £45,000 of withdrawals. With monthly withdrawals, MWRR will normally differ from TWRR.
The report should show both, with a clear explanation. If the client has been taking income while markets fell, her MWRR may be lower than the TWRR because she sold units to fund withdrawals.
Practical points
- Use a consistent, documented methodology and a benchmark that matches the mandate.
- Show gross and net returns, and disclose all costs ex-ante and ex-post.
- Compare over rolling periods, not one three-year window.
- Include risk statistics and a reference to the income requirement: £45,000 on £1.4m is a 3.2% withdrawal rate. After 1.9% of costs, the portfolio must earn about 5.1% gross just to maintain capital in nominal terms, before inflation.
- Do not promise 8%. Explain that higher expected returns require more equity risk and a higher chance of loss.
Client communication
A written explanation with a clear table is better than a verbal argument. If she remains dissatisfied, follow the complaints procedure, with the eight-week final response and referral to the Financial Ombudsman Service.
3. Recommend changes to the mandate, portfolio and review process.
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Rebuild the IPS
Set objectives, income need, time horizon, risk tolerance, capacity for loss, liquidity and tax position. Replace the FTSE All-World objective with a composite benchmark consistent with the strategic asset allocation. Specify rebalancing ranges, review frequency and what happens if the portfolio falls below the income need.
Portfolio changes
- Reduce cash from 25% to about 5–10%, but hold two to three years of withdrawals in cash or short gilts so the client is not forced to sell equities in a downturn.
- Diversify equities globally and reduce the UK bias; review currency exposure.
- Review bond duration and credit quality; consider a gilt ladder for near-term income.
- Assess property for liquidity and valuation risk.
- Rebalance within agreed ranges rather than trading on headlines.
Costs and value
Review whether 1.9% all-in is fair value for the service. Consider cheaper passive building blocks where appropriate, and show the client the cost in pounds per year, not just percentages. Consumer Duty requires evidence of fair value and consumer understanding.
Income sustainability
A 3.2% withdrawal rate is not unreasonable, but after costs and inflation it is tight. Consider using natural income first, reducing the withdrawal modestly, or buying an annuity for essential spending. Do not chase the 9.8% equity return to fund the income; that would increase the risk of a permanent capital loss.