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From the category archives: Market Views

Market Views

The Role of Risk Tools

It is becoming increasingly clear that suitability sits at the heart of the regulatory focus on the customer. The FCA is there to guide the industry through the regulatory minefield, but exists primarily and quite rightly to protect the consumer.

The industry has sought to comply with this drive whilst maintaining efficiency around the provision of investment advice and the resultant software and related processes have ensured that sound financial advice is not the preserve of the super-rich.

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Improving Clarity on Costs

The recently published FCA interim report of its market study into the asset management industry has placed a flag into the sand that it believes that investors should be increasingly discerning about the level of fees they pay for services. As early as the fifth point in the study's executive summary, a chart details the potential impact of high active fees over a passive alternative to savers' wealth.

Indeed, advisers have had the obligation to consider fees for many years. In COBS 6, the FCA states that 'in order to meet its responsibilities under the client's best interests rule and Principle 6 (Customers' interests), a firm should consider whether the personal recommendation or any other related service is likely to be of value to the retail client when the total charges the retail client is likely to be required to pay are taken into account'. The market study has thrown the gauntlet down to the industry to come clean about the full costs that investors incur and to justify them. Declining prospective returns from investments are merely compounding the issue.

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Investment Process: Is it More than just Marketing?

One of the pleasures of working in a rapidly growing organisation is passing on my experiences to the newer members of the team. Recently, I was discussing the the types of investment processes often used within the industry with one young analyst, only to be taken a little aback by her retort 'isn't investment process more about marketing than investment'? What a great question. This article will consider this and what role investment process plays in the asset management business.

A certain cynicism is certainly warranted when considering funds. Fund buyers are confronted by an enormous choice and fund managers are eager to differentiate themselves from their competitors. I too shared similar scepticism on the value of process during my early career, despite its prominence as one of the five key 'P's. Admittedly, my views on the matter were coloured somewhat by my then Investment Director, who had set about devising a fund selection approach based around 3 month relative performance on the basis that "something is required". It didn't take much knowledge to recognise the flaws and limitations of a momentum approach such as this. I busied myself in the subsequent few years devising a more robust alternative approach that was not so fixated on short term performance trends.

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Investment Trusts or Open Ended Funds?

Investment trusts are sometimes put forward as a superior investment structure since they can provide stronger performances over open ended funds. I am far from sure that this is always the case. This article looks at whether trusts are better than open ended funds by considering the importance of the underlying investment strategy, the impact of costs, how investors can misapprehend the apparent advantages of gearing and stable income generation offered by trusts, and how exposure to illiquid investments can give trusts an advantage over funds.

It is scarcely a profound notion that fund returns are determined by the choice of investment strategy rather than the fund structure, though reading some commentary written about funds and you often wonder. To put this in simpler terms, the fund structure is nothing more than a bucket or container, designed to safeguard the rights and interests of the investor. It makes very little difference to the returns if an investment strategy is applied in an OEIC, SICAV, ETF or investment trust structure. The pricing of investment trusts can cause complications and it is possible to access assets at a discount to NAV but do not forget that if one investor is buying on a discount, another is forced to sell at a discount.

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Income from Covered Call Strategies

As it is widely known, in recent times interest rates around the world have been reduced to record low levels. This has consequently driven down the yields on a whole range of investments, and forced many investors to reduce their reliance upon more traditional sources and seek income further afield. Furthermore, this nation's demographics, and the developed world's in general, also point to the fact that income-generating investments are only set to continue to gain in popularity; whole swathes of the population are, or soon will be, keen to secure investments to help fund retirement. As such we have seen many new income focused strategies being launched as well as a rise in popularity of those previously less considered.

Equities have long-since been a significant asset class for yield seeking investors, though generally for those with a higher risk appetite. However, dividend distributions and yield can obviously fluctuate depending on the fortunes of the company or state of the economy. As such a relatively new breed of Equity Income fund has launched into the UK retail market; and one that has a definable yield target. We would point out importantly that these funds have yield and not income targets. Meaning that whilst, in any given year, they may meet their yield target, the absolute level of income received can vary.

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Risk Targeted Funds - A look at the market

A significant growth area among multi asset funds over the last few years has been a group of solutions often referred to as risk targeted funds. Inflows of assets into risk targeted funds over the last five years has been substantial and the market is now estimated at over £35bn with around 250 different funds to choose from.

The definition of a risk targeted fund can vary but generally refers to any fund which targets a defined level of risk as its primary objective. This contrasts with traditional funds which generally have return as the principal focus. Risk targeted and risk profiled funds are often confused and wrongly thought of as being one and the same. Any fund can be risk profiled but not every fund will be risk targeted. A risk profiled funds is designated to fit within a particular risk profile based on current portfolio and performance characteristics which may change over time whereas a risk targeted fund is specifically designed to expose investors to a predefined level of risk, which is often directly aligned to a risk profile.

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The similarities between Marathon runners and Fund Managers

With the London Marathon only days away, people across the country will be adding an extra bowl of pasta to their dinners in order to get the energy needed for the big race. The many attributes that these runners require in order to take on the mammoth task of running 26 miles and 385 yards are also required by fund managers across the city in order to deliver the required outcomes for their investors.

The point that all marathon runners fear is the dreaded 'wall', where sudden fatigue and loss of energy hits the body making any movement let alone running difficult. Many runners aren't able to deal with this pain and give up, while others fight through the pain and make it to the finish line. Similarly no fund manager is immune from difficult periods, however unlike other mangers, which have fallen by the way side, the fund managers mentioned in this article have survived their 'wall' and bounced back stronger.

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Square Mile: four funds to meet investor expectations

The FCA has castigated the asset management industry for promoting closet-trackers as actively managed funds. Elsewhere, it shames companies offering investment vehicles which do not deliver the outcomes to investors that their marketing literature promises.

Against this backdrop, investors could be forgiven for shying away from investment funds altogether. However, Square Mile Investment Consulting and Research stresses that there are examples of best-of-breed practice and highlights four funds which do not reference benchmarks, preferring to construct portfolios to meet specific investor objectives.

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Rerunning the Widow Maker

There have been a number of investment opportunities that have stood out over the last twenty years but few, at the time, seemed as compelling as shorting Japanese Government Bonds (JGBs) once yields slipped below 2% eighteen years ago. Fortunately I did not have the wherewithal to do much about this, so I escaped devastating losses as yields halved, halved and halved again. Anecdotally, this was a popular trade for the more sophisticated types in the hedge fund world. Eventually, the trade rather darkly earned the moniker 'the widow maker'. Following the financial crisis, JGB yields have continued to spiral lower until, almost with a resigned inevitably, the 10 year note finally sunk into negative territory in February. This article covers some thoughts as to whether gilts are investable for retail clients on current yields or whether buyers should be institutionalised (in either sense of the word).

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Evaluating Open-Ended Passive Funds

In theory, selecting passive funds for investment should be quite straightforward. This is certainly true when compared to the work required to identify suitable active funds but still challenges remain. The range of options for passive investment has broadened enormously over recent years as the ETF industry has developed and if systematic smart beta options are included, the options become boggling. During the summer, Square Mile initiated a ratings coverage of passive funds. This article highlights some of the issues that we came across in analysing passives and how we set about overcoming some of these difficulties.

Firstly, we restricted ourselves to mainstream open ended vehicles. There are well over 1,000 listed ETFs available to investors with many following a smart beta approach. However, there are questions as to whether smart beta approaches should be considered passive or active management. For instance, value indices can be defined by a price to book, price to earnings, price to cash flow or through a combination of these factors. Since a subjective judgement is required to identify the most appropriate metric I believe that smart beta approaches require a due diligence approach more in keeping with active funds and were excluded from our review of passive funds.

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