Section 5.1 - 5.5 - Types of Characteristics of Investors

Question 1

What two types are Investors categorised in

Answer 1

• Institutional Investors
• Individual Investors

Question 2

What are instituonal investors

Answer 2

• Employ professional fund managers to manage funds on a large scale
• Decision to manage investments internally or externally depends on size of instituions - larger instituions have more resources
• Examples of instituional investors include: pension funds, insurance companies, hedge funds

Question 3

What are indivdual (retail) Investors

Answer 3

• They have less investment sophsication and more significant tax considerations
• The FCA restricts promotions of and investments in, risker types of investments to certain types of retail investors defined by their wealth and experience

Question 4

What is the difference between a certified high-net worth investor and sopshicated investor

Answer 4

• A Certified high-net worth investor - has annual income of £100,000 or more or net investable assets of £250,000 or more
• A Sophiscated Investor - Those that have a certifcate confirming that they have been assessed by a firm as being sufficently knowledgable to understand the risk of a particular investment.
• They must also of signed a statement including an acceptance that the investment may result in a signifcant loss

Question 5

When can a retail investor be a self-certified sophiscated investor?

Answer 5

If they can state one of the following:
* Have been a member of a network or syndicate of business angels and have been for least 6 months
* More than one investment in an unlisted company
* Have worked two years in the private equity sector
* Director of a company with annual turnover of £1 million

Question 6

What is restricted to high-net worth and sophsicated investors

Answer 6

• Promotion of non-mainstream pooled investments (NMPI’s) e.g UCIS
• Special purpose vehicles that invest in anything other than shares and bonds

UCIS - Unregulated Collective Investment Schemes

Question 7

Where can an authorised person find out the main obligations of a firm towards its customers

Answer 7

• Rules which are set out in the FCA PRIN
• Principle 6 refers to treating customers fairly(TCF)

Question 8

What are the 6 outcomes TCF aims to deliver

Answer 8

• The FCA considers TCF to be a cultural issue
• Products and services should be designed to suit the market they are aimed at. They should also be marketed carefully to reduce the potential risk of mis-selling.
• Consumers are provided with clear infomation and kept informed including: financial promotions, key features documents etc.
• When consumers recieve advice, it should be suitable and takes into account their circumstances e.g. affordibility, needs
• Products should perform at an acceptable standard and as firms have led them to expect
• Consumers do not face unreasonable post-sale barriers imposed by firms to change product etc

Question 9

How does TCF relate to vulnerable clients

Answer 9

• Firms will need to demostrate they are taking a proactive approach and preparing all staff to identify, support and provide solutions for vulnerable clients

Question 10

What are the main factors that are important in determining investors needs and objectives

Answer 10

• Return requirement
• Risk tolerance
• Time horizion
• Other considerations

Question 11

Why is return requirements important to investors

Answer 11

• The longer the time horizion, the lower return.
• The more risk the investor is able to bear, the higher returnthe investor is likely to achieve.

Question 12

What is risk tolerance

Answer 12

• Refers to the level of risk an indivdual is willing to bear - found out by investor completing questionaire to assess their psychology

Question 13

What is time horizon

Answer 13

• The longer the time horizon, the less need there is for liquidity as well as the longer time to recover from any downward cycle and therefore more risk can be taken

Question 14

What other considerations must be taken into account in determining investors needs and objectives

Answer 14

• Liquidity - Some indivduals may need to always keep part of their investments in liquid form so they can be drawn on quickly.
• Tax is important for indivdual investor and the tax efficiency of an investment will be important for advisers
• Religious or ethical beliefs may restrict the kind of investments that are included in a portfolio - some people may not want to invest in companies that manufacture armaments

Question 15

What are the main typical objectives of investors

Answer 15

• Protection - Insure home and car, protect income in the event of an illness, protect family due to death
• In the case of protecting dependents in the event of death, the amount of cover needed will depend on the amount of replaceable income needed by the family
• Borrowing - Obtain a mortgage or re-mortgage
• Savings and Investment - Plan for school/university fees, invest for growth
• Retirement - Retirement at a specific age and on a specific income
• Estate planning - Provide or reduce the IHT payable on death

Question 16

What happens after a clients objectives have been determined

Answer 16

• They need to be quantified - These calculations are based on annuity rates which are affected by a number of other factors such as: location, health etc

Question 17

How can investors affordability be determined

Answer 17

• Affordability is a real constraint that means the clients often have to pioritise thier financial goals.
• Affordability can be established by preparing a cash flow statement showing all of the clients expenditure and income.

Question 18

What is the importance of a fact find

Answer 18

• Helps to determine clients current position.
• Can be done through using hard facts (which covers personal infomation) and also soft facts(asking open ended questions regarding the investment activity

Question 19

Examples of financial infomation, a fact find collects

Answer 19

• Income; earned income, savings and pensions
• Investments and other assets
• Liabilities; mortgages and credit card balances
• Tax
• Financial dependents

Question 20

What are some examples of soft facts that can be used when talking to a client

Answer 20

• Open ended questions
• ‘How do you feel about your current spread of investments’?

Question 21

What letter may be used when authorising third parties to release infomation

Answer 21

• Letter of authority

Question 22

Define capital risk

Answer 22

• The risk that an investment may be worth less in the future than it is today

Question 23

What are the risks associated with investing in cash

Answer 23

1. Inflation risk - Future capital and income eroded by inflation
2. Interest rate risk - The rate of interest paid on deposit accounts are likley to change
3. Shortfall Risk - Investment return falls short of the amount required for an investor to achieve their objectives

Question 24

What are other types of risks relevant for consideration

Answer 24

1. Credit risk - Risk of loss of value of a debt instrument due to defeault - relevant for corporate bonds
2. Market risk - Loss of value of an investment due to fluctuations in market determined prices e.g. interest rates or exchange rates
3. Operational risk - The risk of failure of an institution due to poor operating procedures or systems

Question 25

How can an investor reduce risk in their portfolio

Answer 25

* Through having a **diversfied portfolio ** * Every asset class carries risk e.g. cash has low capital risk but higher shortfall risk wheres equties have higher capital risk but relativley low inflation risk over a longer time horizon

Question 26

What 3 factors contributes to a clients risk profile

Answer 26

1. **Risk required** - level of risk associated with the return 2. **Risk capacity** - Clients ability to asorb financial loss resulting from an investment 3. **Risk tolerance** - the level of risk the client is comfortable with

Question 27

What are other factors that could affect a clients risk profile

Answer 27

1. **Timescale of investment**- Client saving for retirement may be prepared to take a higher capital risk in order to reduce shortfall risk - would invest heavily in equties 2. **Amount of risk capital** - High-net worth indivduals will tend to have more risk capital and therefore more risk capacity 3. **Investment experience** - More expereince client has with different asset classes then more risk tolerance they tend to asorb 4. **Psychology** - Some clients find loss as distressing wheres others are relaxed

Question 28

# RDR What action was taken place in 2011 regarding suitability and risk tolerancy/capacity

Answer 28

* Regulator published guidance on advice suitability with how to make risk tolerancy more managable * **RDR (Retail Distribution Review)** process found that when it comes to clients risk tolerance: * there is a failure to take into account all the neccessary infomation. * Relying on risk-profilling and seet-allocation tools * Poor descriptions of attitude to risk

Question 29

How can a professional measure clients attitude to risk

Answer 29

* Questionaire * Analysing existing investments