Investments - Generic Flashcards
An investment policy statement should sum up the investment strategy by setting out:
- the purpose of the investments
- the income or growth objectives
- the timescale
- a statement about risk profile
- a statement about asset allocation
- other issues such as SRI
Describe active fund management
- Active fund management introduces human factor
- manager aims to use their skill to outperform the market
- main approaches are:
- top down - where the fund manager considers asset allocation first before considering sector and stock selection
- bottom up - where they select single stocks based on their own merits - stock picking
- many investment managers now use a mix of underlying active and passively managed funds
- the term “core satellite” portfolio is often used for a portfolio that is mainly indexed (its core) with actively managed, often specialist, funds around it (its satellite)
The main passive fund management techniques are:
- Buy and hold - buy stocks and hold them regardless of market conditions
- Indexation - this aims to replicate an index with no attempt to outperform it
The main types of indexation are:
- full replication - buying every stock in the index. Advantage is it will be accurate but disadvantage is expensive
- stratified sampling - buying a representative sample of the stocks in the index. Less expensive but potentially encourages biases to those stocks with the best perceived prospects
- optimisation - using a statistical model of the market to make buy and sell decisions. Costs less than replicating the index but can be more complex
What are the benefits of tracker funds
- low/cost effective
- run by computer system/no human judgement
- potential for growth
- perform in line with the index
- exposure to different asset classes
- geographical diversification/global
- can track any index/wide range of indices to track
- simple to understand/easy access to markets
What are the drawbacks of tracker funds
- will underperform the market due to charges
- tracking error/will never match the market exactly
- perform poorly in falling market
- no active management/alpha
- currency risk due to global index trackers
- lack of control over underling assets
Advisory versus Discretionary
Explain Advisory service
Advisory
- manager ascertains ATR and a suitable asset allocation
- manager makes recommendations about which shares to buy and sell
- client makes the decision whether to accept the advice
- the manager charges based on the value of assets in their portfolio
- the manager should produce an end of year statement for tax return completion
Advisory versus Discretionary
Explain Discretionary service
Discretionary
- manager ascertains ATR and a suitable asset allocation
- the manager buys and sells shares on their behalf
- they may specify areas in which they do not wish to invest
- trading limit may be imposed that cannot be exceeded without referring to client
- the manager will charge based on the value of assets in their portfolio
- the charge will be higher than for the adviser service
- the manager should produce an end of year statement for tax return completion
Benefits and drawbacks of using a DFM
Benefits
- professional active management giving the potential for higher returns
- regular reviews
- will give a bespoke service specifically targeting objectives
- no requirement for ongoing involvement
- consolidated tax statements provided/information (useful for tax returns)
- wider investment options
- can utilise tax efficient allowances
Drawbacks
- higher charges
- no guarantee of performance
- may not provide regular service
- lack of control
- may invest in unacceptable sectors
- may not provide tax advice/tax efficiency is not always considered
What are the benefits of holding investments on a platform?
- Quick transfer process with minimal effort for Jim and Sandra
- Easy access online at all times
- total wealth can be seen at the press of a button
- wide range of providers/asset classes/funds/investments/tax wrappers
- performance is easy to obtain
- full details of investments - online switching
- consolidated tax statements are automatic
- time and effort efficient for tax returns
- can promote good relationship with adviser
- unbundled charging/transparent
- funds can usually be bought without an initial charge
- large portfolios can attract volume discounts
- calculation tools
- reduced paperwork/admin
- reports and valuations can be stored online
- automatic rebalancing
Why is diversification important?
- can reduce risk in a portfolio
- by holding a different range of assets
- each different investment can perform well in certain markets
- downside risk of an investment can be offset by the upside potential of another one
- can reduce stock specific risk but not market risk
Main benefits of investing in a diversified investment portfolio
- reduces volatility/risk
- non correlated assets
- can match ATR
- can be rebalanced
- potential for higher returns
Explain how diversification can be used to manage and reduce risk
- reduces risk by reducing concentration/increasing number of asset classes
- some asset classes are not strongly correlated - a loss of one might not mean a loss of another
- geographical diversification spreads the risk across several different economies/currencies/national markets
- sector diversification reduces the risk associated with specific areas of the economy or firms
State the limitations of using an asset allocation model
- doesn’t recommend an appropriate tax wrapper/take account of tax position
- charges are not considered
- questions asked aren’t always relevant
- different models produce different results
- underlying assumptions subject to change/based on historic model
- needs to be reviewed
Explain why a multi-asset fund may be suitable for Jim’s ATR
- diversification across all asset classes/geographical spread
- potential for growth
- correlation of assets controlled/non correlation
- reduces volatility/risk
- actively managed/professional management
- rebalances regularly
- risk rated to match ATR
- access to specialist investments - eg ETFs, derivatives
