Guide to Risk and Investment - Novia

www.canaccord.com/uk Guide to Risk and Investment - Novia This document is important. Its purpose is to help with understanding investment in financial markets, the associated risks and the potential returns. It is intended to provide information to enable you to decide whether or not investment in the Stock Market is appropriate for you and, if so, understanding which investment objective would be the most suitable. Having provided this Guide, it will be assumed that you have sufficient knowledge to make an informed decision, regardless of whether or not you have any previous experience of investing in stock markets. You should not proceed unless you believe that you have sufficient information and knowledge about investing in equities, bonds or any other type of investment. Please consult with your financial adviser if you feel unsure about anything contained within this Guide, or investment in general. On entering into the Investment Management Agreement we will act in the belief that, regardless of your level of professional or academic education, having this information you have sufficient knowledge to make an informed decision. Similarly, it will be assumed that no professional experience of investing exists unless we are told otherwise. This document aims to provide an explanation of how we interpret, classify and approach investment risk. It also provides information on the main asset types, and explains how the investment risk will be managed within a portfolio, given the stated attitude to risk. This Guide is not intended to be all encompassing. If there are any doubts as to the suitability of either investing in the stockmarket or strategy, you should consult your Financial Advisor. This Guide should be read in conjunction with our terms of business. Further information on investments and their associated risks together with a Glossary of basic investment terms can be found via the Financial Conduct Authority s website www.fca.org.uk. Things to consider before investing: How much can I afford to invest? For how long can I be without the money to be invested? What do you want your investment to provide - capital growth, income or both? How much risk and what sort of risk am I prepared to take? What are the tax implications - what taxes will I pay and can they be minimised? The information contained in this Guide is correct at the time of going to print, is for illustration purposes only and does not form the basis of an investment recommendation. Risk When deciding whether to invest, it is key to ask how comfortable you would be facing a loss in order to have the opportunity to make long-term gains? Risk is a very personal thing - what may be a small amount of risk to one person may be a big risk to another. A separate assessment of your attitude to risk should be undertaken by your Financial Advisor. The important thing to remember is that with investments, even if your investment goes down, you will have only actually realised a loss if you sell it at that time. If you are going to invest, you need to be prepared to take some risk and to be prepared to see some fall in the value of your investment from time to time. Living with risk Risk can never be eliminated but it is possible to manage it, by diversification - spreading your risk. Different investments behave in different ways and are subject to different risks. Putting your money in a range of different investments helps reduce the loss, should one of them fall. However, as mentioned, risk can never be completely eliminated and events such as the terrorist attacks in 2001 affect all asset classes. It is also important to remember that risk and reward generally go hand in hand. The higher the potential reward you aim for, the more risk you have to take. If you are not prepared to lose any of your money under any circumstances then you have to accept a lower level of return and should not invest in the Stock Market. Managing Risk We will consider the overall portfolio risk and objective rather than the risk and objective of each individual constituent, when managing your portfolio. Currency Risk You should also be aware of currency risk. Currencies - e.g. sterling, euro, dollars, yen - move in relation to one another. If you are putting your money into investments which are either listed in another country, or their principal 1

activities are based in another country, then their value will move up and down with currency changes as well as normal price movements. Whilst your investments will not be placed in any currency other than Sterling, you should be aware that currency fluctuations can affect the investments within the funds within your portfolio and could affect you. Inflation Risk Although we usually talk about the risk of losing money, there are other risks to think about. One is inflation risk. Inflation means that you will need more money in the future to buy the same things as now. When investing, the impact of inflation is therefore, an important consideration. Liquidity In financial markets, liquidity refers to the ease of dealing in a security - whether shares, bonds, options, warrants or some other instrument. Another way of looking at it is - how easily can the investment be bought and sold without significantly moving the price? Whilst we will not buy direct investments for you, and therefore you will not be directly affected by this problem, the Funds that you invest in, could be and it could affect their ability to liquidate their assets and therefore fulfil a redemption order. Funds that invest in large companies, with hundreds of millions of shares in issue and high numbers of shares changing hands every day, have good liquidity. Therefore, where you have Funds that invest in these areas, they should not have any trouble fulfilling their management activities. In contrast, with Funds that invest in small companies, with few shares or asset classes that are less readily traded (such as property for example) then you may find that the Fund in question finds it difficult to liquidate these assets on demand and at times are unable to fulfil redemption orders immediately. Funds Unit Trusts and Open Ended Investment Companies (OEICs) are examples of funds; which are where all of your money will be invested. In a fund, investors pool their money which is then invested in one or more asset classes by a fund manager. They are open ended which means that there is, potentially, no limit on the size the fund can grow to - new units / shares are created as required to accommodate new investors money. The price of each unit / share in a fund is based upon the value of the assets held divided by the number of units / shares that are in issue. The main benefits of funds are: Professional expertise - an investment expert will seek investments for you, monitor those investments closely and judge when, within the funds mandate to buy or sell them. Diversification - even with small amounts to invest, your money is spread across a wide range of investments. This will reduce the impact on your total investment if an underlying company performs badly. Reduced dealing costs - buying a range of different investments directly, means that dealing costs could be significant. By pooling your money, you make savings because of economies of scale. Less administration - the fund manager handles the buying, selling and collecting of dividends and income. Choice - there are several thousand funds available, investing in the majority of all the various industrial sectors and geographic regions. Funds can either be actively or passively managed. Active fund managers research the market and select assets to buy and sell, aiming to provide a good comparative return for investors. Passive funds (also known as Trackers ) simply aim to track the market in which they are invested. For example, a FTSE100 tracker would aim to replicate the movement of the FTSE100. They might do this by buying the right proportion of all the shares in the index. For technical reasons the return is rarely identical to the index, mainly because management charges are deducted. Trackers tend to have lower charges than actively managed funds. This is because managers of actively managed funds are paid to outperform a benchmark or generate a steadier return for investors, rather than tracking an index. Of course the fund manager could make the wrong decisions and underperform. This should not be the case with trackers, but they are not necessarily less risky than actively managed funds invested in the same asset class. Asset Classes Funds that will be purchased for you will invest in four main asset classes: equities, fixed interest, alternatives (e.g. commodities, hedge funds, property) and cash. A brief summery of the characteristics of these underlying investments follows: Equities (Shares) The value of equities can go up and down and they can be at times quite volatile. However, risk and reward tend to go hand in hand. In the long run the hope is that these investments would provide better overall returns than the other asset classes (but this is not guaranteed). If you are investing in shares you should expect the value of your investment to go down as well as up, and you should be comfortable with this. Holding shares is high risk - if you have put all your money into one company and that company becomes insolvent then you will probably lose most, if not all, of your money. In the short term, shares will go up and down in value and this can occasionally be very significant. By using funds, you spread your risk amongst a number of different companies, industries and countries and therefore reduce the likelihood of losing all or most of your money. However, it is important to stress 2

that even with these investments, some volatility should be expected and you need to be looking to the long term when investing in equities at least 5 years, but preferably longer. Fixed Interest (Bonds) We will only invest in Bonds via funds. A Fixed Interest investment or Bond is a loan to a company, government or local authority. Generally, interest is paid to you as the lender and the amount of the loan repaid at the end of the term. This type of investment can be known as: Loan stocks Debt securities Gilts (UK government loans) Sovereigns (government loans) Corporate bonds (loans to companies) The main benefit of these investments is that you normally get a regular stable income. They are not designed primarily to provide capital growth, however capital gains or losses can be made. Bond prices fluctuate although their interest, which is fixed, should remain the same. This may be for a number of reasons, Including supply and demand, but also they tend to move in the opposite direction to Interest rates, (e.g. when Interest rates rise their prices fall) and when the perceived risk attached to them changes. In general, bonds have a nominal value. This is the sum that will be returned to investors when the bond matures at the end of its term. Most bonds have a nominal value of 100 however the price quoted for a bond may be more or less than 100. There are several reasons for this. For example: A bond is issued with a fixed interest rate (coupon) of 5%. Prevailing interest rates then fall well below 5%. 5% then will look like a competitive yield and the market price of the bond will tend to rise. The reverse is also true. If interest rates rise, the fixed rate of a particular bond might become less attractive and its price could fall below 100. If a company is not performing as well as when its Bonds were issued, ratings agencies may decide to increase the risk rating associated with the company s debt. If this happens then the market price of the Bond might fall. On the other hand, if the risk associated with the company s debt is lowered, this may lead to a price rise. There are also Bonds where the redemption value and the interest paid are linked to changes in an index. These are called Index Linked Bonds. In addition, some Bonds pay interest that is calculated by reference to a variable factor, such as the Base Rate set by the Bank of England. These are frequently called Floating Rate Notes (FRNs). Investment in Bonds is generally considered to be less risky than investment in shares. However, there is a risk that the company behind the issue cannot pay the interest due or cannot repay your loan at the end of the term. These risks do not generally apply to gilts or sovereign debt - a government is expected always to pay in full - though there have been instances of certain countries having been unable or unwilling to repay. Bonds issued by governments will usually pay a comparatively lower rate of interest, as a result of the perception that they are less risky. Companies have different credit ratings and a company with a high credit rating is regarded as a safer investment than a company with a lower credit rating. Companies with a lower credit rating will have to offer a higher rate of interest on their Bonds than companies with a higher credit rating, simply to attract investors and to compensate for the higher risk. Bonds can be bought and sold in the market (like shares) and their price can vary from day to day. A rise or fall in the market price of a Bond does not affect what you would get back if you hold the Bond until it matures. In general you will only get back the nominal value of the Bond in addition to having received the appropriate interest payments. Property Property is not considered a liquid market and it may take some time to realise an investment in a property fund, should you need to sell. This has meant that in time of crisis, that some property funds have found it difficult to realise their assets when their investors are making redemption requests. Therefore, whilst property has in the long run been a good investment, it also goes through periods when the risk has increased in respect of this asset. Therefore, whilst we may construct a portfolio which has an element of property within it, you should be aware that property prices can go down as well as up and liquidity can affect these areas and therefore there is a risk attached to being invested in this asset class. With a property investment you are often looking to receive rent from a tenant - whether this is a private person, or a company - and also capital growth as the value of the property increases. Unlike investment in shares, Bonds and cash, investing directly in property means that your money is tied up. It can be difficult to realise your investment quickly as you will need to sell the property. The commercial property market is different to the residential property market in terms of what causes the price to change. Commercial properties are let out to businesses and tend to be on long leases, often 25 years. As a result, the value of the property will often increase as a result of the length of the remaining lease and the perception of the financial strength of the company paying the rent. If there is a long lease and a financially strong company paying the rent, then the owner of the property has a reasonably safe long-term rental income. Property prices can, and do, go down as well as up. Also, there is the risk of not having a tenant to pay the rent. If investing in property directly then there are other risks, including for example, the risk of interest rate rises if you are borrowing to buy, the risk of problems with tenants and the risk of needing costly repairs. 3

Commodities Split into so called hard commodities such as Copper, Gold and Oil and soft commodities (coffee, cocoa, wheat etc), they are mostly traded via futures contracts. As such they offer returns via changes in capital value rather than income. They have their own characteristics and agricultural commodities can obviously be affected by the likes of weather and seasonal conditions. As they are traded via derivatives, which are essentially geared investments, they can be volatile and high risk. However, we will only invest in this asset class via funds, which should provide a level of diversification to control these risks. Hedge Funds Hedge Funds are a wide group of collective schemes, which employ a varied number of strategies, which can be complex and therefore by their nature opaque. Strategies can include, amongst others, those which target mispricings between markets and in special situations (arbitrage), and those which employ derivatives (futures and options) to exploit downside movements in markets. Additionally, some employ so called black box systems, which mechanically trade markets via set mathematical formulae, whilst others have a hands-on approach. Due to the geared instruments they frequently employ, their underlying investments can be extremely volatile and potential risks large, if not properly controlled. Also due to the complex nature of their trades and the markets that they sometimes deal in, liquidity can vary, meaning that at times, investors have not been able to withdraw money. We may use these in a relatively small proportion in portfolios, usually to hedge against unfavourable market movements, meaning that any exposure to this class of alternatives should be modest. Furthermore, exposure may be via funds which in themselves invest in a collection of hedge funds to diversify risks further. For obvious reasons we do not intend to invest in funds that may not be able to guarantee liquidity. Cash Although viewed as an asset it is not generally used as a longterm investment. However, you should be aware that it may be used from a strategic point of view in the portfolio at differing levels, reflecting the amount of opportunities available in other asset classes. Investment Trusts These will not be bought directly but may be held within a fund purchased for you. These are companies that, in general, can invest in one or more of the four asset classes and in this they are similar to funds. However, unlike funds, they are closed ended i.e. only have a set number of shares available. Because of this, supply and demand has an impact on the value of each share. This means that shares will usually be bought or sold at either a premium or discount to the value of the underlying assets the trust has invested in (Net Asset Value or NAV). Because they are in effect companies, investment trusts are also able to borrow money to invest. This is known as gearing. Gearing improves an investment trusts performance when its underlying investments are increasing in value but will magnify losses if the underlying investments fall in value. Not all investment trusts are geared. Because of the impact of supply and demand and the possibility of gearing, investment trusts can be more volatile and therefore more risky than funds (assuming the same underlying investments). Futures and Traded Options Whilst these instruments can be used as speculation, they are more commonly used as hedging tools to reduce risk on portfolios. Therefore, whilst these will not be bought directly within your portfolio, you should be aware that they could be used within certain funds to reduce the risk. However, because they are geared investments in which gains and losses can be magnified there is risk attached to them. It is likely however, that in the funds purchased for you that these will be used in a modest way, for hedging purposes. Portfolio Structure / Objective You will need to decide, in consultation with your financial adviser, what you want your investments to achieve - capital growth, an income (or fixed distribution), or a balance between the two. Within these main objectives there are seven portfolio structures offered and, as a general guide and for indicative purposes only, there follows a brief explanation of what strategy will be used to achieve each of these main objectives. A Growth Oriented Objective The main aim is to achieve capital growth over the medium to long-term, which may include, depending upon your tolerance for risk, a high proportion invested into UK and international equities, via pooled investments. In anticipation of higher returns, such a high exposure to equities has a commensurately greater risk. A portfolio may contain some exposure to bond funds, along with a core exposure to UK large capitalised equities, through funds. A portfolio may also have an exposure to Funds invested in mid or smaller capitalised equities, as well as international equities and other asset classes. Strategic allocations may be made to specialist situations, such as commodities, emerging markets etc, again via Funds. There are three portfolio structures available within this objective, with differing levels of risk: the standard Growth Portfolio, which would have a significant exposure to equity investments, the Cash Plus Portfolio with a lower level of equity content and a higher proportion of alternative strategies and other asset classes to produce a lower risk and an Aggressive Growth Portfolio, which has a higher risk and, potentially, a 100% commitment to equity investments via Funds and in particular is likely to have a greater exposure to more volatile situations, such as smaller companies, and hence have above average risk. 4

An Income Oriented Objective The main aim is to provide an above average income yield from the invested capital with the potential for income growth. The underlying portfolio can be structured in part equity/part fixed interest portfolio. As the name suggests, this portfolio may maintain a significant level of fixed interest investments along with UK and overseas equities using funds, depending upon risk profile. Normally the equity portion will be gained via Funds investing in highly liquid large capitalised UK equities. Although there may be some modest exposure to medium and small company funds. Some exposure to international equity markets and other asset classes, again via funds, may be used to provide diversification but this is likely to be only modest as they have a comparatively low dividend yield. There are two strategies where their primary objective is income production: the income portfolio, with a significant portion in higher yielding equities and fixed interest and the Fixed Interest Portfolio, which, as the name suggests, is mainly fixed interest, but with some absolute and alternative strategies also, to provide lower volatility and lower risk. Income oriented portfolios are generally perceived as lower risk and whilst volatility is likely to be lower, fixed interest investments should not be viewed as without risk see previous comments on fixed interest investments. Significant movements in interest rates can have significant effects on capital values and this should be appreciated before any investment is made into this type of asset class. A Balanced Objective The main aim is to achieve a balance between growth in the capital value of your investments and the generation of income over the medium to long-term. It would be anticipated that the portfolio would contain an exposure to bonds, as well as a core exposure to UK large capitalised equities, via funds. The portfolio may also have exposure to funds investing in mid or smaller capitalised equities. Diversification may be provided by investing in international equity funds as well as strategic allocations made to specialist situations such as commodities, emerging markets etc. We have two portfolio offerings to meet this objective with differing levels of risk: a Balanced Portfolio and a Cautious Balanced Portfolio. It would be anticipated that the level of equity content for a Balanced Portfolio would be between that of a part equity/part fixed interest portfolio and a Growth Portfolio, whilst the Cautious Balanced Portfolio would maintain a lower equity level than the Balanced Portfolio, thus, its level of risk would be expected to be lower. Due to the lower levels of equity exposure and potentially lower levels of risk, a Balanced objective would be more suitable for a cautious investor who has no income requirement. Tax For UK individuals and Trusts, dividends and interest received are subject to Income Tax. Gains made in excess of the Capital Gains Tax Allowance will be subject to Capital Gains Tax. For other entities and individuals not resident in the UK, other taxes and / or rules may apply. Investments in Individual Savings Accounts (ISA) are not subject to higher rate Income Tax or Capital Gains Tax. Canaccord Genuity Wealth Management is neither a tax advisor nor expert in this field and we, therefore, have not endeavoured to cover the subject of taxation in this Guide in any more detail. If you have any questions or doubts about your specific tax position, professional advice should be sought. It is your responsibility to obtain independent advice where appropriate and to discharge your tax liabilities correctly wherever they fall due. Whilst it is important to emphasise that your Financial Advisor will choose the portfolio most suited to your individual needs and circumstances, there will be a number of common things that will benefit most objectives. This Guide has been constructed to help you understand the risks and potential returns associated with financial markets and should be used as part of the decision making process when deciding on the investment strategy for a portfolio. If you need any further information, you should seek advice from your financial adviser. Importantly, should your attitude to risk change, please advise your financial adviser so that they may inform us. Please remember that any investment involves a degree of risk and some investments are more risky than others. Past performance is no guarantee of future performance. When investing in financial markets there is a risk that the income return and the capital value, may fall as well as rise. Canaccord Genuity Wealth Limited is authorised and regulated by the Financial Conduct Authority. Registered office: 88 Wood Street, London. EC2V 7QR. Registered in England & Wales no.3739694. MAY 2013 NF0003 5