Chapter 14: Portfolio Reviews and Investment Administration Flashcards
advisers will draw up an investment policy statement (IPS) that documents the investment strategy that they have put in place for their client.
The FCA insists that firms agree investment objectives with their customers, and these should be documented in the IPS.
It’s a document drafted between a portfolio manager and a client, so it’s client-specific, and it outlines the key general rules for the manager.
The IPS…
outlines the general investment goals and objectives of a client.
describes the strategies that the manager should employ to meet these objectives.
includes specific information on matters such as asset allocation, risk tolerance, and liquidity requirements along with any other constraints.
The IPS must be given to customers and is a critical part of the review process.
Investment managers do need to be aware of the rules on churning. This is where the main aim of switching investments is to generate commission for the firm, rather than acting in the best interests of the client
14.2.2a: Types of trust
Absolute/bare
Interest in possession
Discretionary trusts
One of the most important part of reviews with customers is the reporting that typically happens every quarter or six-monthly. Providing regular reports to customers allows them to engage in the review process. The content and frequency of reports are laid down by the FCA in their Conduct of Business rules.
There are two main types of report that are issued to clients: occasional and periodic reports. Let’s look at each of these separately.
14.3.1: Occasional reports
14.3.2: Periodic reporting
Periodic reporting -
Periodic reports for discretionary services -
Sent quarterly or monthly if leverage is used
Periodic reports for advisory services -
Every 6 months, or quarterly if requested by client, or monthly if leverage is used, or annually if trade reports are sent on a transaction by transaction basis
14.3.1: Occasional reports
These contain contract notes that are sent out when trades are undertaken on behalf of the client for securities traded on a stock exchange and for open-ended collective investment schemes. Contract notes are also referred to as confirmations or confirms for short.
Contract notes should outline:
transaction date.
individual’s name.
number of shares bought / sold.
details of any accrued interest.
whether it’s been traded ex or cum dividend.
full name of the stock transacted.
any charges paid (which includes any Stamp Duty and PTM levy).
settlement date (date the money changes hands).
IMPORTANT: They must be sent to the client as soon as possible after the transaction has been executed, but no later than the following business day.
Trades executed after the close of the stock exchange will be assumed to take place the following business day (so confirms will be sent out the business day after that). For trades that are executed in several tranches, a single confirm can be sent using an average price.
14.3.2: Periodic reporting -
Periodic reports contain not only the transactions that have been undertaken, but also information regarding the performance of their portfolios.
The reporting pack will include information on:
Valuations: show the amount held in each holding (e.g. number of shares), the current price (whether mid, bid or offer) and the value. The report will often break the portfolio down in terms of asset class, market and sector. Performance reports will compare the performance of the portfolio to a suitable benchmark so that the investor can judge how well the portfolio has performed over the period (more on this in the last 2 sections of this guide).
Transactions: the client can opt in writing to have the transactions sent out as part of the periodic report pack rather than receiving the information in occasional reports.
Corporate actions: the client will be informed of any impact on the client’s holdings due to corporate actions.
Cash and income: any income from dividends and interest received or paid will be show on the income statement.
Cost and charges: there is a requirement to show clients the actual costs that have been incurred over the period.
The frequency with which reports will need to be sent out depends on the service being provided and the assets held in the portfolio.
LSE High Growth shares, AIM shares, bonds, open-ended funds, ETFs and inter-spouse transfers are exempt FROM SDRT
Periodic reports for discretionary services -
Sent quarterly or monthly if leverage is used
Periodic reports for advisory services -
Every 6 months, or quarterly if requested by client, or monthly if leverage is used, or annually if trade reports are sent on a transaction by transaction basis
14.4: Benchmarks
Indices combine the movements of individual share prices in to one figure, designed to show how the market has moved over a period of time. Indices are used by fund managers as benchmarks
There are three ways in which indices can be constructed:
market-value-weighted
price-weighted
unweighted (or equal-weighted)
14.4.2: Market-value-weighted indices
Also known as market capitalisation or market cap weighted indices, these indices are constructed by ‘summing the market values’ of the largest companies trading on the relevant exchange.
The larger the company, the larger the weighting in the index.
14.4.3: Price-weighted indices
Another way of weighting the shares in the index is by price. These are constructed using the arithmetic average of current prices divided by the number of stocks in the index.
That means that those stocks that have a higher price will have a greater weighting in the index. The Dow Jones is an example of a price-weighted index. At the time of writing United Health Group had the highest weighting at 8.3% and Apple a weighting of 3.3%.
14.4.4: Unweighted indices
The final type is unweighted or equally-weighted indices. Here every stock has the same weight, so no one stock has a greater impact than the other. They don’t tend to be used by fund managers to benchmark the performance of their fund but are used by academics.
14.4.3: Price-weighted indices
This a way of weighting the shares in the index is by price. These are constructed using the arithmetic average of current prices divided by the number of stocks in the index.
That means that those stocks that have a higher price will have a greater weighting in the index.
What happens if a stock split takes place in a particular company in the index?
because a stock split will reduce the share price, the number of stocks used as the divisor will increase. The overall impact will be that the company has a lower weighting.
Using price as a method of weighting stocks isn’t generally seen as the best measure for a fund to benchmark its performance.
FTSE 100 is a capital weighted index or a Market-value-weighted index
What does the points figure mean in relation to FTSE 100, for example it is at 8900 currently
The figure that we see for the FTSE 100 e.g. 8200 isn’t the actual market cap of the top 100 companies.
It was a hypothetical figure created in January 1984, when the total market cap was calculated and then adjusted using a ‘divisor’ to get a base value of 1000.
As the values rise, it gets divided by the same divisor and we see the value of the index rising. The divisor will be adjusted for any changes to the capital structure of the constituent companies, so it ensures consistency
14.5: Performance Evaluation
Performance evaluation is more about finding out how it compared to the benchmark, and what was the reason for any over or under performance compared to the benchmark. For example, was it a result of asset allocation decisions, sector selection or stock selection?
14.5.1: Performance measurement
Total return
Money weighted return
Time weighted return
LEARN CALC
14.5.1b: Money-weighted return = Also known as the ‘internal rate of return’ of the portfolio, the money-weighted return factors in deposits in and withdrawals out of the fund during the relevant term.
MWR is strongly influenced by the timing of cash flows. A customer who adds money days before a rise in growth will see a much better MWR than a customer adding money days before a fall. In these circumstances, the difference in returns has nothing to do with the fund manager whos performance we are trying to evaluate. This means its not approate for comparisons
That’s why we need time-weighted return.
14.5.1c: Time-weighted return
We have just seen that the timing of new money coming into an investment and withdrawals taken out can seriously impact the money-weighted return. In order to take these factors out of the calculation we need to break down the return achieved by an investment in to separate time periods.
A new time period starts each time new money is introduced or a withdrawal is made.
14.5: Performance Evaluation LOOK AT THIS FOR R02 AND FIND EXAM QUESTIONS ABOUT FINDING WHAT CONTRIBUTED TO A RETURN. SEE EXAMPLE 14.6 IN 14.5
In this chapter, we have looked at the following areas:
Investment administration
The investment policy statement includes the client’s objectives, timescale, strategic asset allocation policy and the client’s risk profile.
The IPS must be reviewed regularly for any changes due to personal circumstances, regulation and tax, and the market environment.
Portfolio Reviews
Private individuals’ portfolios can be made up of sub portfolios of a main investment account, such as an ISA account and a SIPP account.
Portfolios will need to be reviewed and periodically rebalanced to ensure the agreed asset allocation is maintained.
The manager needs to be aware of any potential CGT liability when managing the portfolio.
Large holdings in a single stock lead to high concentration risk and should be reduced gradually to a more acceptable level.
Trusts are set up by the settlor on behalf of the beneficiary. Trustees are the legal owner of the assets in the trust.
Absolute trusts are where the beneficiaries are absolutely entitled to the assets held in the trust; interest in possession is where one person has the right to the income from a trust and the assets pass to others on their death or after a specified time or event, discretionary trusts are where the trustees have the discretion as to how the assets are distributed amongst the beneficiaries.
Charities will need to ensure their investments meet with their charitable objectives.
They may have a greater focus on income and ethical considerations.
Client reporting
Occasional reporting includes issuing contract notes to clients once transactions have been executed by the following business day.
Periodic reporting involves reporting to clients on investment valuations, transaction reports, corporate action statements, cash and income statements, and costs and charges.
Tax reports will also be provided including any CGT reports and tax certificates.
Benchmarks
Benchmarks are used as a comparison for fund performance.
They must be relevant, appropriate, specified in advance, measurable, unambiguous, and investable.
Indices can be market-capitalisation weighted, price-weighted or equally weighted.
Other types of benchmarks include absolute, manager universe, style indices, factor models, returns based and custom based.
Performance evaluation
Performance measurement involves calculating the return on portfolios.
Measures include total return, money-weighted return and time-weighted return.
Performance attribution entails understanding where returns have come from asset allocation or stock / sector selection.
Hanna invested £10,000 into an equity fund and, after 3 months, it had risen to £12,000.
Buoyed by its growth, she adds another £10,000. At the end of the year the fund is worth £25,000.
All interest is accumulated and not distributed. What is the time-weighted return?
25.00%.
36.32%.
50.00%.
125.00%.
TIME WEIGHTED RETURN =( V_1/V_0 ×V_2/(V_1+C))-1
V0 = 10,000, V1=12,000, C=10,000, V2=25,000
TWR= 12,000/10,000×25,000/((12,000+10,000) )-1 =(1.2 × 1.136)-1=0.3632=36.32%
Marco is looking at various stock market indices. He should be aware that:
both the FTSE 100 and the Nikkei 225 are market capitalisation weighted.
both the Nikkei and Dow Jones are price-weighted.
the Dow Jones is market capitalisation weighted and the FTSE 100 price weighted.
the Nikkei 225 is price weighted and the Dow Jones market capitalisation weighted.
both the Nikkei and Dow Jones are price-weighted.
FTSE 100 is market-capitalisation-weighted, Nikkei 225 and Dow Jones are price weighted.
