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This document details the full Investment Process
for Kingswood Law IFA Limited. The
process has been set out by the Investment Committee and is reviewed on a
five key parts to the Investment Process
1. Risk Profiling
2. Asset Allocation
Monitoring and Review of Funds
Risk Profiling and Asset
It’s inevitable clients and advisers will have widely
varying interpretations of risk. It is
vital from the perspective of consistency the business and all advisers within
the business adopt the same interpretation of risk.
Furthermore, it’s a key obligation under the
Financial Services Authority’s requirement for ‘treating customers fairly’ that
all of our clients assessed to be of equal attitude to risk should receive the
same investment portfolio.
The only way to achieve these outcomes is to establish
a consistent measure across the business for establishing attitude to risk.
The basis we have adopted for the consistent
assessment of attitude to risk is to encourage all clients to complete an
attitude to risk questionnaire. To
ensure a consistent basis for assessing clients’s attitude to risk, we will use
the same tool for each client of the business.
We recognise risk is a relative measure and it’s
therefore important we educate clients about the relationship between risk and
return. We demonstrate for any given
potential upside to a portfolio, there is a potential downside. We establish that in order to achieve the
potential for higher upside, the client must also accept the potential for
To this end, the questionnaire forces a client to
focus on what they can afford to lose, rather than what they wish to gain.
Finally, risk is a relative measure and therefore
an individual’s attitude to risk will vary according to that individual’s
expectation of the likelihood of a negative outcome. It’s therefore imperative that as a business, we assess each
client’s attitude to risk on a regular basis.
The completion of a new attitude to risk
questionnaire will be the first function of each annual client review.
Asset Allocation Theory
recognise that efficient asset allocation is the key determinant in the
variation of returns in a client’s portfolio.
1952 Professor Harry Markowitz published his doctoral thesis “Portfolio
Selection”, marking the introduction of what is now known as Modern Portfolio
Markowitz established that for any given level of risk, it was possible to
construct an investment portfolio that mathematically delivers the maximum
possible investment returns. That
portfolio is said to sit on the “efficient frontier”.
Portfolio Theory states any portfolio that does not sit on the efficient
frontier is inefficient, as the portfolio is not maximising the returns for
that given level of risk.
a conclusion of this, we use the attitude to risk questionnaire to first
establish a client’s acceptance of risk before we then find the portfolio on
the efficient frontier for that level of risk.
recent research by Brinson, Singer and Beebower (Brinson, Singer and Beebower; "Determinants of
Portfolio Performance II: An Update"; 1991) indicates that asset allocation
is by far the dominant determinant (91.5%) in the variability of returns in a
portfolio. Market timing represents
1.8% and Stock Selection 4.6%.
Furthermore, the Myners report of 2001 clearly states the
significance of asset allocation and goes so far as to state clients should pay
more in order to receive advice on asset allocation.
Choice of Asset Allocation Tool
Having carried out a thorough review of the risk
profiling and asset allocation tools on the market, we’ve selected the asset
allocation tool provided by Selestia/Watson Wyatt to build our clients
portfolios. As a result, we’ve
concluded it’s important we use the same company’s attitude to risk
questionnaire as the output of this feeds directly into the asset allocation models.
of the key reasons for choosing is tool is that it does not amend the economic
output in anyway. We believe providers
who amend the output of their models are creating a conflict of interest. In addition, our research indicates it’s the
only model that takes into account the impact of the different tax wrappers: ie.
the impact of a gross or net yielding environment on the performance of the
underlying asset classes.
Modelling of Asset Classes
asset allocation tool models the following asset classes:
- Cash / Money Markets
- UK Fixed Interest
- International Fixed Interest
- UK Equity
- International Equity
International Equity is modelled together, it’s further sub-divided into North
America, Japan, Europe, Far East, Emerging Markets and Global Specialist. Specialist. Specialist. Specialist. Specialist. Specialist. Specialist. Specialist. The proportions for each of these sectors
are determined by Watson Wyatt and is based primarily on the size of each
market and the respective economies.
Asset Class Assumptions as at
30 June 2007
following table provides the figures.
Return Assumptions %
Volatility Assumptions %
Cash / Money Markets
UK Fixed Interest
International Fixed Interest
Gross versus Net Yielding
asset allocation tool takes account of the tax status of the investment wrapper.
- Gross Yielding – Pension / ISA and PEP
- Net Yielding – Investment Bond / Unwrapped Collectives
any given attitude to risk, there may be a difference in the asset allocation
recommended for an investment into a gross yielding wrapper and a net yielding
wrapper. Specifically the differences
arise because of the different tax treatment of the underlying asset classes
within the different wrappers.
Equity Dividends suffer the 10% tax credit regardless of the tax status of the
wrapper in which they are held. Similar
to UK Equity, the yield on UK property is taxed regardless of the tax status of
the wrapper within which it is held. UK
Fixed interest suffers savings tax within a net yielding wrapper, but is
untaxed within a gross yielding wrapper.
tax advantaged position of fixed interest over property with Pensions / ISA and
PEP increases the assumed return for the fixed interest within these wrappers. Within a gross yielding environment, fixed
interest is assumed to produce similar returns to property, but to do so for a
lower assumed rate of volatility. It
therefore becomes preferable to hold fixed interest over property in a gross
yielding environment. However, the
advantage is marginal compared to benefit of spreading assets across all
sectors. As a result, the business has
chosen to include Property within pension portfolios.
Asset allocating within Sectors
asset allocation tool provides us with the recommended asset allocations into
the following sectors.
- UK Equity
- UK Fixed Interest
- International Fixed Interest
- European Equity
- US Equity
- Global Specialist
- Global Emerging Markets
- Far East Excl Japan
Although asset allocation is core to our investment
process, we don’t believe markets are 100% efficient. There are likely to be inefficiencies in the distribution of
information in any market.
That said, we believe a number of fund managers and
fund houses have the ability to outperform the market over the long term. Our fund selection process aims to select
those managers that have the ability to exploit these inefficiencies and
deliver long term out performance of a given sector.
In short, we’re aiming for active rather than passive fund management.
Criteria for Selection
The investment committee recognises past performance
is not a guide to future performance and as such, performance plays only a
small role in our selection. We may
much more attention to the following five criteria.
1. Ratings agencies
2. Risk adjusted returns
3. Relative risk
4. Consistency of performance
(rather than specific past performance)
5. Representativeness of the asset class (ensuring it
fits our model)
The following paragraphs provide information on each of these
1. Ratings Agencies
As a small IFA practise, we recognise we’re
limited in our ability to perform detailed due diligence on the whole market of
investment funds. A key part of our
investment process is therefore studying the output of the ratings agencies. These organisations have huge research
resources and high levels of access to fund groups and fund managers.
The two ratings agencies we use are
OBSR and Citywire. Full details on OBSR and Citywire can be found in
2. Risk Adjusted Returns
We use a measure called the Information Ratio. The
Information Ratio is used to help put the returns a fund manager generates into
context, given the level
of risk they take on. We’re able to
gauge what level of added value
the manager has historically achieved and how this ranks relative to the
manager’s peers in the same sector. A
higher Information Ratio indicates a higher rate of active risk adjusted
3. Relative risk
a statistical method that measures how much a series of values move up and down
around its average. The higher the
volatility number, the less consistent historical performance has been. We’re therefore looking for funds that have
performed with as little volatility as possible.
4. Consistency of Performance
As we have already established, past
performance is not a guide to future performance. What is useful however, is to establish which funds have
generated consistent performance. To
assess this, we look at discrete quartile rankings over the following time
- 1 year from 12
- 1 year from 24
- 1 year from 36
Rankings 1 and 2 are above average,
and rankings 3 and 4 are below average.
of the asset class
For the asset allocation to maintain its validity,
it’s important we choose funds that fit the sector reasonably closely. If they fit the sector exactly, they
effectively track the performance of the sector. In effect, these are passive funds. We look for funds that closely fit the sector, for with a little
variance comes the opportunity to out-perform the sector. Clearly, we are not looking for funds that
vary widely from the sector, for this would upset the asset allocation
The measure we use to assess this is called R2.
Ongoing Monitoring and Review of Funds
The Investment Committee meets on a
quarterly basis to perform two functions:
whether to apply any changes made necessary by a change in the underlying asset
allocation recommendations provided by Watson Wyatt
2. Review the
The outcome of the review meetings and
any portfolio recommendations will be published on the Kingswood Law IFA
Limited website. We will email clients
(post to clients without email) a newsletter giving the information, inviting
them to consider the conclusions and to notify us if they wish to accept our
recommendations and make appropriate changes to their portfolios. We do not currently hold discretionary
adviser status and therefore any changes to a client’s portfolio must first be
authorised by the client.
Every client will be offered at least
an annual review.
The first part of the review will be
focussed on re-assessing the client’s attitude to risk. Where this results in a change in attitude
to risk, the client’s portfolio will need to be amended in line with the
correct asset allocation for the new attitude to risk.
Every portfolio will be set at outset
for an automatic annual rebalance in case the client does not respond to our
invitation for the review meeting.
Appendix – Old Broad Street Research (OBSR)
This is the highest rating awarded. It’s given to funds which demonstrate very powerful investment
processes and disciplines which we believe will translate into exceptional long
term performance. It’s an indication of
This is determined using the same methodology as for the OBSR AAA
Rating. The OBSR AA Rating is an
indication of highly superior quality based on process and track record.
OBSR A Rating
This is again determined using a methodology consistent with that
applied for the OBSR AAA and the OBSR AA Ratings. A fund which achieves the OBSR A Rating status is a highly
Ratings are formally reviewed on a quarterly basis but may be
changed intra-quarter should the judgment alter about the future prospects for
a fund. Changes of this type are likely
to be predicated by a significant 'event' such as a change in fund manager or a
fundamental change in the investment process applied in the management of a
The OBSR Fund Ratings Service aims to identify funds which will
achieve their objectives. The award of
a OBSR Rating does not imply, however, that a fund will achieve positive
returns, nor is the award an indication of the prospective returns from any
particular asset class or asset allocation strategy.
OBSR Ratings are intended to be 'predictive' in nature. The aim is
to identify the winning funds of tomorrow.
How ratings are determined
OBSR Fund Ratings are determined on the premise the fund selection
process should, whilst taking past performance into consideration, ascribe
greater weight to identifying the factors which will affect future performance.
This process demands a much stronger
emphasis on a qualitative examination of funds.
There are several key factors that lead to the final OBSR Rating
determination. These are:
- Strength of investment process and length of
time it has been in place
- Continuity of investment personnel
- Investment style that has proven durable over
- Clearly defined investment objectives
- Strong and consistent past performance record
- Favourable risk
The OBSR Ratings are determined following in-depth qualitative and
quantitative analysis with the emphasis more focused towards qualitative
appraisals. Clearly defined routines
are followed for consistency.
Discrete Time Period Analysis
The OBSR Fund Ratings Service analyses historical fund performance
by looking at results over discrete time periods. It places greater emphasis on short to medium term trends in
performance than on long term trends. Examination
of performance over long time horizons can severely distort and disguise more
recent movements. As the focus is to
define the winners of tomorrow, it’s believed that placing the emphasis on the
short to medium term provides a more valid guide. This contention is supported by the many fund management company
takeovers and mergers and fund manager moves which are a feature of the global
financial services industry today. Changes
to investment processes and/or the appointment of new fund managers can
clearly, in many instances, bring into question the relevance of long term
Proprietary Classification System
The OBSR Fund Ratings Service uses a proprietary classification
system across all regions and asset classes to group funds together by style. This ensures the "like-for-like"
comparison of funds that, in turn, enables OBSR to remain agnostic about the
type of fund chosen and to focus purely on the best managers. The extensive knowledge of funds, achieved
through the rigorous qualitative analysis that is undertaken, allows OBSR to
build up a sample group of funds representative of different investment styles.
From this, quantitative models are
constructed that describe the behaviour of particular styles over specific time
periods. The aim is to clearly identify
groups of funds that exhibit similar characteristics.
Funds are ranked over discrete time periods according to their
performance relative to what are termed their true peer group - the OBSR
defined universe. Funds can be moved
between these universes at any time, as and when changes in style are
identified through qualitative analysis. The process also takes into account fund manager changes. Those funds that achieve the highest rankings
in terms of consistency within the OBSR defined universe are then analysed
under the Capital Asset Pricing Model, to assess their risk/return
The objective is to determine whether a fund is justifying its
fees relative to its systematic risk. This
sounds rather technical. In simple
terms, the aim is to measure the added value from any given fund. This process highlights funds worthy of
further analysis and, thus, the possible consideration of a OBSR Rating.
There are certain key areas that are focused upon, including an
analysis of the strength of the investment team, the quality of its individuals
and their experience, the level of research undertaken by the fund manager or
the reliance placed on third party information. Also considered are the merits and demerits of funds being
managed locally or at head office. The
reliance on individual or so-called 'star' fund managers, as opposed to the
adoption of a team approach, is also considered. OBSR needs to assess how vulnerable an organisation is to the
departure of a specific fund manager, which may result in the OBSR Rating being
OBSR attempts to identify particular strengths which enable it to
assess whether an organisation is likely to be better than its competitors at
managing specific types of funds. For
example, strong asset allocation disciplines are more important in a fund
management company which is heavily involved in the management of global or
regional funds. To give further
instance, when examining bond funds, consideration is given to the quality of
the organisation's skills in the interpretation of macroeconomic data, as well
as its ability and resource in the evaluation of credit risk.
Fund Manager Interviews
In-depth interviewing of fund managers is the cornerstone of this
aspect of the process. The aim is to
gain a thorough understanding of the investment process applied in the
management of a fund. This part of the
analysis is ongoing. OBSR carry out
around 5000 fund manager interviews each year for the OBSR Fund Ratings Service
and other research services.
There are a number of areas that are examined as part of the due
diligence. OBSR has deliberately
avoided the production and completion of questionnaires for fund managers. It’s recognised there are great differences
in style and OBSR does not wish to be constrained by the need to 'straitjacket'
fund managers with its own definitions and questions. Anyone can fill in 'boxes' but there is more
required to gain real insight into a fund. Assessment is made based on detailed discussion and, whilst
knowing what questions need to be answered, fund managers are encouraged to describe
their (and their team's) investment process and approach in their own way.
The OBSR Rated funds are monitored continuously and their managers
may be contacted or re-interviewed as frequently as quarterly. The objective of regular follow up is to
enable the research teams to revalidate the understanding of a fund. Managers of other funds which may aspire to
the OBSR Rated status are also interviewed regularly.
Considerable time is spent developing understanding of how
different investment management houses operate. Real insight is gained into investment style and to identify areas
of expertise (and possibly, weakness).
Contrasting Investment Approaches
Analysis of investment groups, fund managers and individual funds
points to the fact that, at times, very different approaches are taken in
managing money in similar areas. Once
the strengths of a particular management group have been defined, focus is
turned to specifics. A clear picture
needs to be gained as to how an individual fund is to be managed and how a
company's overall methodology translates into practical day-to-day management.
The most important issue here is to obtain a clear definition of a
fund's objective. Examination of
attitudes towards managing an investment portfolio actively or passively is
undertaken. Growth and value are looked
at. The degree of aggression and
attitudes towards trading are assessed, including the blend of these in the
portfolio. The degree of
diversification or concentration in the portfolio is understood. Followed closely is the pursuit or otherwise
of the sector themes. Portfolio commitment is looked at in relation to
individual sectors and stocks either as core holdings or as temporary features.
As noted earlier, the award of a OBSR Rating to a fund is intended
to be a predictive indication of its quality. While past performance can be an important factor, the essence of the
approach is to emphasise this qualitative aspect and the judgment and experience
of the teams is critical in the OBSR Rating determination. This is the real added value of the OBSR Fund
Appendix - Citywire Ratings
Citywire tracks the individual fund
managers, the people, rather than the funds. The problem is that fund managers switch jobs so frequently – they
might move from one firm to another, or they may simply take on new funds or
drop others. Therefore it becomes very
important, as these people move around so much, to produce regular and reliable
information, which highlights how they perform.
Fund managers are ranked compared to
their peers. Assessed is how well – or
badly – they have done and the results are published in league tables.
Also assessed is how much risk
managers have taken to produce their returns. A manager who takes lots of risk to produce good returns would be
in greater danger of failing to deliver those results in the future. Conversely, a manager who is able to deliver
good results without taking too much risk, is perhaps more reliable for the
When analysing the risks managers have
taken, how they perform compared with the benchmark index of the markets that
they invest in is considered. A UK fund
manager who invests in large and mid-cap shares should be judged against the
FTSE 350 Index; a fund manager investing in the US could be judged against the
Combined is analysis of how risky fund
managers are with how well they do compared with their relevant benchmark over
a three year period to produce a Citywire Rating.
The very best – fewer than 5% of all
UK fund managers - achieve an AAA rating from Citywire. If they do it means that they have performed
very well and are among an elite.
Managers who achieve an A or AA rating
are still well above average performers. Less than one in five fund managers get any rating at all from
Other fund managers will get no rating
at all – because they are not good enough or because they have not been running
funds long enough to qualify.
One important point is that all this
is a mathematical process, which is approved by outside experts, AKG Actuaries.
Who comes out on top is entirely down
to how they perform; not whether they spin a good story, are charismatic or forceful
personalities or pay a fee.
Appendix – Investment Managers
Association Sectors and Definitions
Sector Definitions and
are about 2000 investment funds to choose from. But to help identify
funds with similar characteristics, they are categorised within a fund
classification system of over thirty sectors. The sector categories are
broadly divided into funds that aim to provide an ‘income’ and those designed
to provide ‘growth’. Each sector is made up of funds investing in similar
assets, or the same stockmarket sectors, or in the same geographical
are classified in this way to make it easier to find those that meet the
investment objectives. This ensures that when comparing one fund with
another, we are comparing funds with similar objectives or with similar
Funds principally targeting income
that invest at least 95% of their assets in Sterling denominated (or hedged
back to Sterling) Triple AAA rated, government backed securities, with at least
75% invested in UK government securities (Gilts).
Funds that invest at least 90% of their assets in UK Index Linked Government
that invest at least 80% of their assets in Sterling-denominated (or hedged
back to Sterling), Triple BBB minus or above bonds (as measured by Standard
& Poors or an equivalent external rating agency – (Moodys Baa or
above)). This excludes convertibles.
UK Other Bond
investing at least 80% of their assets in Sterling denominated (or hedged back
to Sterling), and at least 20% of their assets in below BBB minus bonds (as
measured by Standard and Poor’s or an equivalent external rating agency),
convertibles and income producing preference shares.
that invest at least 80% of their assets in fixed interest stocks. All
funds which contain more than 80% fixed interest investments are to be
classified under this heading regardless of the fact that they may have more
than 80% in a particular geographic sector, unless that geographic area is the
UK, when the fund should be classified under the relevant UK heading.
UK Equity & Bond Income
invest at least 80% of their assets in the UK, between 20% and 80% in UK fixed
interest securities and between 20% and 80% in UK equities. These funds
aim to have a yield in excess of 120% of the FTSE All Share Index.
Funds principally targeting income
UK Equity Income
which invest at least 80% in UK equities and which aim to achieve a yield on
the distributable income in excess of 110% of the FTSE All Share yield.
principally targeting capital
investing at least 80% of their assets in Sterling denominated (or hedged back
to Sterling), and at least 80% of their assets in zero dividend preference
shares or equivalent instruments (i.e. not income producing). This excludes preference shares that produce
UK All Companies
that invest at least 80% of their assets in UK equities which have a primary
objective of achieving capital growth.
UK Smaller Companies
that invest at least 80% of their assets in UK equities of companies which form
the bottom 10% by market capitalisation.
that invest at least 80% of their assets in Japanese equities.
Japanese Smaller Companies
that invest at least 80% of their assets in Japanese equities of companies
which form the bottom 30% by market capitalisation.
Asia Pacific including Japan
that invest at least 80% of their assets in Asia Pacific equities including a
Japanese content. The Japanese content
must make up less than 80% of assets.
Asia Pacific excluding Japan
that invest at least 80% of their assets in Asia Pacific equities and exclude
that invest at least 80% of their assets in North American equities.
North American Smaller Companies
that invest a least 80% of their assets in North American equities of companies
which form the bottom 20% by market capitalisation.
Europe including UK
that invest at least 80% of their assets in European equities. They may include
UK equities, but these must not exceed 80% of the fund’s assets.
Europe excluding UK
that invest at least 80% of their assets in European equities and exclude UK
European Smaller Companies
that invest at least 80% of their assets in European equities of companies
which form the bottom 20% by market capitalisation in the European
market. They may include UK equities, but these must not exceed 80% or
the fund’s assets. (‘Europe’ includes all countries in the MSCI/FTSE pan
investing in a range of assets with the maximum equity exposure restricted to
60% of the fund and with at least 30% invested in fixed interest and
cash. There is no specific requirement to hold a minimum % of non-UK
equity within the equity limits. Assets
must be at least 50% in Sterling/Euro and equities are deemed to include
would offer investment in a range of assets, with the maximum equity exposure
restricted to 85% of the Fund. At least 10% must be held in non-UK
equities. Assets must be at least 50% in Sterling/Euro and equities are
deemed to include convertibles.
would offer investment in a range of assets, with the Manager being able to
invest up to 100% in equities at their discretion. At least 10% must be
held in non-UK equities. There is no minimum Sterling/Euro balance and
equities are deemed to include convertibles. At any one time the asset
allocation of these funds may hold a high proportion of non-equity assets such
that the asset allocation would by default place the fund in either the
Balanced or Cautious sector. These funds would remain in this sector on
these occasions since it is the Manager’s stated intention to retain the right
to invest up to 100% in equities.
which invest at least 80% of their assets in equities (but not more than 80% in
UK assets) and which have the prime objective of achieving growth of capital.
Global Emerging Markets
which invest 80% or more of their assets directly or indirectly in emerging
markets as defined by the World Bank, without geographical restriction.
Indirect investment e.g. China shares listed in Hong Kong, should not exceed
50% of the portfolio.
The above sectors also require funds to be broadly
diversified within the relevant country/region/asset class. Funds that
concentrate solely on a specialist theme, sector or single market size (or a single country in a
multi-currency region) would be incorporated in the Specialist sector (see
below), or in the case of tech funds, in the Technology &
Funds principally targeting capital protection
that invest at least 95% of their assets in money market instruments (i.e. cash
and near cash, such as bank deposits, certificates of deposit, very short term
fixed interest securities or floating rate notes).
other than money market funds that principally aim to provide a return of a set
amount of capital back to the investor (either explicitly guaranteed or via an
investment strategy highly likely to achieve this objective) plus some market
that have an investment universe that is not accommodated by the mainstream
sectors. Performance ranking of funds
within the sector as a whole is inappropriate, given the diverse nature of its
Technology & Telecommunications
that invest at least 80% of their assets in technology and telecommunications
sectors as defined by major index providers.
Appendix - Sources of
- Bloomberg Financial Glossary (www.bloomberg.com)
- FTSE The Index Company
- Investment Managers Association