Calculate, showing all your workings, the overall benchmark return to which Nicolas’ multi-asset fund is compared.
- UK Equities 50% x 7% = 3.5%
- Global Equities 25% x 4.5% = 1.125%
- Frontier Markets 10% x 5% = 0.5%
- Fixed Interest 15% x -2% = -0.3%
- Total = 4.83%
Calculate, showing all your workings, the overall performance of Nicolas’ multi-asset fund.
- UK Equities 50% x 6% = 3%
- Global Equities 25% x 3.5% = 0.875%
- Frontier Markets 10% x 9% = 0.9%
- Fixed Interest 15% x -3.5% = -0.525%
- Total = 4.25%
Identify and explain briefly, the asset class that has made the greatest impact on performance of Nicolas’ portfolio relative to the benchmark.
- UK equities.
- Negative contribution/underperformance.
- Highest allocation.
Calculate, showing all your workings, the fund’s alpha. (6)
Assume a risk-free rate of return of 0.25% and a beta of 1.3. Use the market return and fund return figures from your answers in parts (a)(i) 4.83% and (a)(ii) 4.25% above.
- 4.25 - [0.25 + 1.3(4.83 - 0.25)]
- α = -1.95
State three benefits and three drawbacks, of using a stocks and shares ISA as a long-term investment vehicle for Nicolas and Alessandra’s retirement, compared to a
personal pension.
Benefits
* Accessible at any time/open-ended/before age 55.
* Tax free on any withdrawals/income.
* Not subject to earnings/annual allowance.
* Not subject to lifetime allowance.
Drawbacks
* No tax relief.
* £20,000/lower investment limit.
* Part of estate/cannot write under trust.
* Funds not ‘earmarked’ for retirement/temptation to access early.
Calculate, showing all your workings, the total costs and levies payable upon the transactions set out in Table 2 on page 4.
FTSE 100 equity
* £11,000 x 0.5% = £55
* Panel of Takeovers and Mergers levy £1 (must be for FTSE 100 equity only)
FTSE small cap equity
£3,850 x 0.5% = £19.25 rounded up to £20
ETF
* Dealing (£9 x 3) = £27
* Total £103
Explain the diversification rules for a retail Undertakings for the Collective Investment of Transferable Securities (UCITS) OEIC, based upon the minimum number of permissible holdings and their respective percentages.
- 16 holdings.
- Maximum 10%;
- in up to four companies.
- Maximum 5%;
- for rest/other companies.
State the maximum exposure a retail UCITS OEIC may hold in unlisted securities.
- 10%;
- of total assets/fund.
Explain to Nicolas and Alessandra the term ‘capacity for loss’.
- The ability/degree/level/scope;
- to absorb/withstand;
- any negative investment event.
- Adverse effect/materially detrimental;
- on lifestyle/standard of living.
List the non-financial factors that can influence an investor’s attitude to risk
- Previous experiences.
- Time horizon/age/state of health/dependants.
- Client objectives/ethical/religious views.
- Investor psychology/perception.
- Framing.
- Society/collective mood/political/economic environment.
Explain why Nicolas’ attitude to risk may be higher for a personal pension compared to a stocks & shares ISA.
- Longer term investments/higher risk more likely to achieve objective.
- Impact of short-term volatility less.
- Not accessible till age 55.
- Effect of tax relief/employer contributions.
- Consideration given to capacity for loss different.
Describe the key principles of Modern Portfolio Theory, in respect of the construction of an investment portfolio.
- A diversified portfolio;
- of non/un/imperfectly correlated.
- Investors are risk adverse.
- Maximum return;
- for given/set risk.
- Efficient frontier;
- uses expected return of each asset.
- Standard deviation/normal distribution (of each asset);
- to produce optimal portfolio.
- Systematic risk cannot be removed/can be reduced.
- Non-systematic risk can be removed.
- Sensitivity to the market is expressed by beta is market risk.
Outline to Nicolas and Alessandra why their financial adviser is considering using a discretionary fund manager (DFM) service as well as passive funds.
Their financial adviser is constructing an investment portfolio for the inheritance and is considering
allocations to a range of passive index tracking funds together with a discretionary fund management (DFM) service. The adviser has mentioned to Nicolas and Alessandra that the overall portfolio will be constructed using the principles of Modern Portfolio Theory.
- Active management/alpha.
- Wider range of asset/funds.
- Time markets/hold cash/speed of transaction.
- Bespoke.
- Influence asset allocation/core and satellite.
- Tax planning service.
State the potential risks of using a DFM service.
- Financial Services Compensation Scheme (FSCS) limit exceeded/not available.
- Discretionary fund manager (DFM) uses unsuitable assets.
- Duplication with non-DFM portfolio.
- DFM acts outside its mandate/deviation from any benchmark/style drift.
- Regulatory issues.
- Overtrading/higher costs.
- Service may incur tax liability.
- Underperformance/negative alpha/does not add value.
Alessandra’s decision to hold cash within her ISA may be influenced by investor psychology.
State two reasons why she may be putting off the decision to invest, identifying onejustification for each reason, from a behavioural finance perspective.
- Loss aversion;
- fear of losing money on investments.
- Overconfidence;
- timing the market/convinced prices will fall.
- Mental accounting;
- compartmentalising each asset/not looking at overall position.
State five main risks to which Efekan may be specifically exposed to if he invests in high yielding alternative income products.
- Liquidity risk.
- Accessibility risk.
- Interest rate/gearing risk.
- Valuation risk.
- Diversification/correlation risk.
- Default/credit risk.
State the four main types of preference share and identify the key characteristic for each type.
- Cumulative.
- Has right to any unpaid dividend/arrears carried over.
- Participating.
- Additional dividend linked to company profits.
- Redeemable.
- Repayable by company.
- Convertible.
- Convertible to ordinary shares on pre-set terms.
Identify four important considerations that could impact Efekan achieving his income objective in retirement.
- Changes in health/life expectancy.
- Changes in taxation.
- Changes in inflation.
- Market volatility/returns.
- Sustainability of income.
- Other savings.
State five benefits and five drawbacks to Efekan of transferring his existing assets to a platform, compared with holding them directly.
Benefits
* Everything in one place/consolidated valuations/reporting.
* Less admin/paperwork.
* Income flexibility.
* Pre-funding/cash account.
* Access to institutional/clean share classes.
* Access to tools.
* Discounted/lower fund charges.
Drawbacks
* May pay exit charges.
* Additional platform charges/pay for services not used.
* Unnecessary functionality/too complex solution.
* May have to sell assets.
* Time out of market.
* Risk of platform failure/outage.
* Unable to hold alternative income products.
Identify the three main categories of benchmark used by fund managers.
- Constraint;
- target;
- comparator.
Describe the key differences between M0 and M4 as measures of money supply.
- M4 includes deposits created by lending/all bank accounts.
- M0 includes operational deposits at the Bank of England.
- M4 is broad money.
- M0 is narrow money.
- M4 is indicator of economy.
- M0 is indicator of consumer spending/retail sales.
Explain briefly how the Bank of England could reduce the money supply and state the effect on interest rates.
- Selling securities;
- reduces velocity of money/increasing supply of securities;
- reduces purchasing power/prices of securities.
- Interest rate rise/higher yields.
State two reasons why the money supply is not suitable as a benchmark for Efekan’s investment portfolio.
- Economic not financial/stock market and GDP different.
- Not a measure of return/performance.
Calculate, showing all your workings, the Price Earnings (P/E) ratio for Waternova plc.
- 1.29 x 2.25 = 2.9025
- 43p/2.9025 = 14.81
