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Advisers will need to take a view on:
The firm’s track record delivering the
target level of returns
The firm’s track record achieving BPR
(we would suggest anything less than
100% success would be a serious cause
for concern)
the firm’s investment strategy and
chosen underlying assets (we would
recommend a sense check that the
target return is proportional to the
return that the underlying assets might
yield in the open market)
Related to above, are they using
gearing to generate the return (and what
that does to the risk /return “profile”?)
These assessments are much more
objective and advisers can set their
own decision making criteria (ours are
suggested above) for inclusion in their
potential product set.
Advisers will also need to look at the
targeted level of performance. Bearing
in mind that they are supposed to be
low risk investments, the manager
has to take out fees and charges and
underlying companies (non AIM) have to
pay corporation tax, does the targeted
level of returns look achievable given
the nature and sector of the investment
without exposure to more risk?
LEVEL OF DIVERSIFICATION
AND LEVEL OF CONTROL
Managers attempt to reduce investment
risk with two broad strategies. They
either diversify so that their portfolio
has the capacity to absorb losses -
losses that may be offset by gains
elsewhere - or they concentrate on a
few qualifying businesses where they
exercise a high degree of control. As
a (very general) rule the first strategy
applies to products based on investing
on AIM and the second to products
based on unquoted investments. Both
strategies still rely upon skilful security
selection of course.
For a diversified portfolio, advisers
should “look through” to the underlying
holdings to verify that it is a genuinely
diversified portfolio. A look at the
investment mandate and review of the
portfolio construction criteria will also
be instructive - what is the maximum
percentage of the portfolio that can be
invested in any one firm, the maximum
percentage holding of a single company
that is allowed, maximum exposure to
a particular sector, minimum number
of holdings, maximum / minimum held
in cash, etc. - the manager should be
sticking to their own mandate and
running a sufficiently diverse portfolio.
We would suggest that a sufficient level
of diversification would be a portfolio
of between 10 and 30 holdings across
at least three of four sectors, but
advisers will need to come to their own
view based on their perception of the
investment risks.
We included a section on the statistical
research into small company investing
in our EIS 2014 Industry report,
available for download from the
Intelligent Partnership website
.
Another issue is that as the managers’
investment criteria are quite specific
based on the need for capital
preservation and BPR qualification,
the final size of their investment
universe may prohibit the levels of
diversification advisers are used to in
more mainstream investment funds.
Advisers will need to take a view on:
The level of diversification in the
current portfolio
The level of diversification required
by the investment mandate (and is the
mandate being followed)
The diversification at both sector and
stock level
What they believe is a sufficient level
of diversification, given their view of the
investment risks.
Deciding what the right levels of
diversification are, and how these
interact with the investment risks is
a subjective judgement that advisers
have to make. Again, we would suggest
recording the thought process that led
advisers to their final view on this. Once
the criteria are set, screening products
against them is a simple, objective
exercise.
Where managers employ the opposite
strategy and concentrate investment,
advisers need to assess if they
a)
have
sufficient influence and control over the
underlying assets to ensure that they
retain their BPR qualifying status and
b)
the management team has sufficient
skill and experience to ensure the
assets perform as expected.
Often the managers will own, or
part own, the underlying investee
companies. This can present conflicts
of interest, as what is good for the
company may not be good for investors,
so advisers need to satisfy themselves
that robust policies exist to manage any
conflicts of interest, but obviously this
arrangement guarantees the highest
levels of control over the underlying
investments. Advisers must also assure
themselves that the investee companies
are commercially trading with a view
to making a profit and not being used
solely to manufacture tax reliefs.
Advisers must take a view on:
The level of control exercised on the
underlying investee companies
If that control hinders or enhances
the company’s chances of commercial
success
That the underlying companies are
genuine trading businesses
Once again assessing the level of control
and how much that mitigates both
investment risk and the risk of loss of
BPR status will be more subjective than
objective.
INVESTMENT RISKS,
RISK MITIGATIONS AND
ONGOING MONITORING
Advisers will need to draw their
own conclusions about the level of
investment risk inherent in a particular
product. For AIM portfolios assessing
this will be somewhat easier as all of
“When selecting a BPR investment, there is often a balance to strike between the targeted return and the
ability to access capital quickly if needed. Understanding the client’s desired balance between accessibility
and return, and selecting an investment that can deliver it, is crucial”
Andrew Sherlock, Oxford Capital
