8 - The principles of investment planning Flashcards
Describe the Theoretical approach to asset allocation (modern portfolio theory)
A mathematical analysis to obtain the desired risk-return trade off:
The maximum return with a given level of volatility
or the lowest volatility consistent with a desired rate of return
Uses historical data from sets of asset classes to create optimal portfolios
Describe the pragmatic approach to asset allocation
Use long-run average rates of return from the relevant asset classes together with historic data
Use forward looking judgements of likely returns and volatility to determine portfolio weightings
What is an optimised portfolio?
Those expected to deliver the highest return for a given level of risk or the least risk for a given level of return
What is correlation?
The extent by which an asset contributes to the overall risk-return characteristics of a portfolio. Assets with the lowest correlation will contribute most to a reduction in portfolio volatility.
What are the elements that fall into strengths and weaknesses of optimisation?
Risk Historic Data Forecasts Costs Implementation
What is stochastic modelling?
Applies a mathmatical technique to generate a probabilistic assessment of returns and volatility, by applying a number of factors of which may vary within a range
Why should you use caution when using a stochastic model?
They are dependant on assumptions, therefore a small change in one assumption could result in a large change in the output.
Why do most practioners focus on strategic asset allocations?
If the adviser in confident in the clients assessment of requirements and risk tolerance, in theory there is an ideal asset allocation to which their portfolio should confirm
MPT (modern portfolio theory) says its not possibel to time the market, which means switches between asset classes are as likely to incurr costs as generate profit
How do some advisers apply tactical asset allocation?
Models that give a range of percentage of capital in each class - to be adjusted by the advisers assessment og the outlook changes (moves more towards advisers monitoring portfolios and recommending variations
Why do some advisers use passive funds as part of a portfolio?
Cost and efficiency
Used as a core to the portfolio, using satellite funds to give higher returns
Some believe that the volatility of a portfolio cannot exceed that of the indices
What is the difference between risk tolerance and risk capacity?
Risk tolerance is the risk perception of a client and attitude to risk
Risk capacity is the clients ability to withstand losses or shortfalls in returns
If formal risk profiles are not used, what ways in ascending order of priority could an adviser create a portfolio?
Historic - using past data to create the required returns with the given risk
Adjusted Historic - take into account historic ranges and volatility over time periods to adjust the allocation of capital
Stochastic - Using a portfolio modelling tool - input returns and volatility to generate the optimal portfolio
What is the top down method of portfolio construction?
- Determine asset allocation
- Allocate the geographical distribution
- Choose the sector weightings
- Stock or fund selection
What is bottom up selection?
Selection of stock based on their own criteria with no attention paid to index benchmarks
Why is it important to identify the approach to asset allocation used by a fund or manager?
Any change in approach could impact the volatility of a clients funds
What is the ‘value’ fund management style & why do equity fund managers favour this style?
Using analysis, ID businesses whose value is greater than the price placed by the market, therefore stocks are bought and held for long periods.
Out of fashion stocks often have high dividend yields
What is GAARP and which type of fun manager uses this style?
Finding companies with a long term sustainable advantage - worth paying a premium for preium stocks
Used by active growth managers
What is the momentum style and who is it used by?
Studies have shown there is a tendency for good and bad performance to persist in equity markets
Momentum managers are generally ‘middle of the road’ managers and aim to be ahead of the swing
Contrarianism is used by hedge funds managers, what does it mean?
That the average opinion is usually wrong and that high returns can be achieved by going against the trend
What is the ‘specific’ return and ‘market’ return known as?
Alpa and Beta
What are the considerations for an adviser when selecting structured products into a client portfolio?
The are not very liquid, early encashment and access can lead to reduced returns
The timescale for planned returns may not be suitable
When downside protection is desirable, it may turn out to be expensive
The proposition may be confusing, with too many balancing features and conditions
Assessment of counterparty risk can be problematic, as in the past highly rated institutions have failed leading to an instant loss - costs to mitigate could result in lower returns
What are the main criteria used in fund selection?
Fund objective
Costs and charges
Strength and reputation of management group
Skill, reputation, past performance of fund manager(s)
Type and structure of fund
What are the 4 main components of fees required by the MiFID 11?
Ongoing charges for the fund
One off fees
Incidental fees
Transaction fees
What criteria needs to be considered in addition to past performance when choosing an investment manager?
Relevant experience Structure and style of investment Size, access to relevant resources Quality of staff and their stability Administration Costs Past performance
What might a wide spread of results alert you to in terms of how an investment house is managed?
That strong house rules are not applied, managers might be given more than usual discretion
What are the pitfalls and challenges of performance statistics?
Past 12 month performance may hide previous poor performance
Classification issues - comparing with true peers
Funds and sector changes
The meausre of returns alone ignores risk
Some specialist funds end up in ‘rag bag’ sectors are there are not enough comparable funds
What are the factors to consider in terms of the type and structure of funds that might make them more or less suitable?
Open or closed ended - OEIC funds are generally less volatile than closed funds where the premium or discoun can change. Closed are more illiquid.
Gearing or leverage - closed funds generally have more borrowing, which could mean greater returns but with more volatility
Multi manager or fund of funds - reduce the advisers work due to the assembling of a portfolio of funds but portfolios may be narrow
What two aspects should be considered when selecting passive funds?
Index selection - understanding of the methodology is critical to selection
Structure - could be investment trusts, OEIC’s, UT’s, ETF’s, therefore the adviser must understand the pro’s and con’s
Describe two examples for each of the ESG factors (environmental, social, governance)
E - waste, pollution, greehouse gas, climate change, natural resource conservation, animal treatment
S - interaction with communities, working conditions, employee relations, diversity
G - accounting methods, corruption, bribery, board diversity and structure
What are the main tax wrappers that should be considered?
Collective investments - OEICs and unit trusts
ISA
Personal pensions and self invested pensions (SIPPs)
Uk life assurance bonds
Offshore like assurance bonds
Why is is better for a higher rate tax payer to hold onto gains generated by ivestment that take as Income?
The CGT rate is lower than income tax and losses are easier to offset against gains
How are collectives treated when considering tax wrapper planning?
Dividends are taxed as income, gains are taxed by CGT when disposed off rather than when securities are sold within the fund.
Fund of funds allow management without a CGT charge
What are the advantages of ISA?
Free from income tax and CGT.
It is not necessary to have a return to HMRC on gains or income
ISA’s can be transferred from provider to provider without loss of tax benefit (although some do not allow transfers witout assets being sold and repurchased)
What are the main considerations for Pension Plans and SIPP’s for tax treatment?
Whether the tax advantages compensate for additional costs and complexity
For a higher rate tax payer its beneficial during contribution years, for a basic rate payer in the pay out years
Tax Free commencement lump sum from 2015 meaning retirees can draw down freely from DC funds (subject to their marginal rate of tax)
Costs of SIPP has fallen and may be less than some insured pension schemes
The efficiency of admin systems of the provider
What are the tax considerations of UK life assurance bonds?
The underlying fund is subkect to UK tax at rates similar to basic rates, however funds suffer tax on capital gains
5% withdrawal allowance is beneficial for higher rate tax payers who need income
Tax shelter can be used if investor is a basic rate oayer when funds are cashed. Top slicing relief is available
The gain on the bond is not grossed up for basic rate tax credit reduced the gain below 40% or 45% for higher rate payers
It is possible to gift bonds to trustees without a tax charge (as opposed to gifts who trigger CGT)
Qualifying life policies are free of higher rate tax after 10 years
What are the main features of using a platform for investments?
A single fee and transparancy of costs
Reduced admin and paperwork
Wide choice of funds
Access to tax wrappers with no or low cost
Asset allocation across tax wrappers
Consolidated valuations, income and gain statements
Online valuations
Adviser fees deductible from cash accounts
Automatic rebalancing of portfolios
What did the FCA rule in terms of platform charges?
They must be paid seperately direct to the platform
What key topics should be covered by making recommendations and suitability?
The method of selection of funds and classes - why
Summaries of the most important features and fund fact sheets
Explanation of the choice of tax wrapper/platform
Frequency of review
Cost of service - intial and ongoing
In general terms, how would the overall investment objective be classified by an investment manager to a client as required by the FCA?
Captial growth priority
Income priority
Balance between capital growth and income
What principal factors affecting the investment strategy, objectives and level of risk agreed with the investment manager?
Legal constraints - explained and indentified
Nature of Liabilities - i.e. price inflation
Cash Flow - has it got a postive flow?
Taxation - best growth without concerns of taxation
What major circumstances might impact a clients investment objectives?
Inheritance Illness Marriage Divorce Change in employment
What other factors could trigger a review of a clients invesment objectives?
Regulation and taxation
Market environment
New products and services
What are the principal items reported to a client during a regular update?
Purchases and sales
Summary portfolio valuation and cash statements
General market commentary
Recommended changes to strategy
What would a contract note generally contain?
Bargain date person for whom the purchase was made Number of shares bought/sold and price Full name of the share/stock Charges including SD/SDRT Settlement date
What would a summary valuation contain?
Portfolio value at the date of last report Addition of cash or stock Reduction by each withdrawal Appreciation or depreciation New portfolio value and date
How would an individual holding be itemised?
Holding and description
Market price and value
Book or aquisition cost
Gross income and dividend yield
What would constitute a justifiable switch?
Clear change in clients objectives/circumstances
Market conditions favour an alternative
Client instructions
Consistent underperformance
Investment returned after a takeover/capital restructuring
