OUR APPROACH TO INVESTMENT RISK MADE FOR YOU

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1 OUR APPROACH TO INVESTMENT RISK MADE FOR YOU 1

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3 UNDERSTANDING YOU At Charles Stanley we have a different approach to investment services. We first and foremost consider how much risk you are able to take in order to identify the most rewarding investment opportunities with the aim of satisfying your own personal investment objectives. A RISK DRIVEN APPROACH TO UNDERSTANDING YOUR NEEDS We believe that a keen and deep understanding of your investment needs and aspirations provides a solid foundation for a long and successful relationship. This starts with an introduction to one of our investment managers, who will listen to what you have to say, ask questions and assemble a comprehensive picture of where you are and where you want to be. He or she will also assess and form an opinion of the level of risk that you are able to bear, based upon the information provided. This is time well invested, ensuring you benefit from a high quality and bespoke service that delivers the right risk/reward balance for you. Traditionally, a conversation about investment needs has focused on return aspirations and has been followed by cautionary observations about the risks entailed. At Charles Stanley we believe this should be reversed in favour of a more protective approach and will agree with you an appropriate capacity for loss of capital and income. Our dedicated investment managers will seek to understand your personal risk tolerances and build realistic returns expectations from this framework, in the context of what we see financial markets poised to offer in the years ahead. 3

4 MANAGING RISK Clients are typically concerned with four types of risk: Outcome Risk - the portfolio of investments might fail to deliver the expected returns over the appropriate horizon Drawdown Risk - returns are volatile, and an interim period of weakness coincides with an unexpected need to sell investments Inflation Risk - while long term returns appear satisfactory, the purchasing power of the portfolio is eroded by inflation Liquidity Risk - access to the portfolio s investments is prevented by problems with the investment s issuer, failures in the financial system and/or governmental/regulatory action The basis for our approach to the prudent management of these risks includes: Risk cannot be eliminated. Without assuming risk on behalf of clients we are unlikely to generate satisfactory returns We will seek to mitigate risks unless they are expected to contribute positively to returns, or if they are unavoidable TYPES OF RISK Outcome Risk In managing Outcome Risk, we consider both the likelihood that the portfolio might fail to deliver the expected returns over the appropriate horizon, and the scale at which it might happen. The likelihood is mitigated by our focus on anticipating broad market trends. We manage this risk by striving to maintain robust investment processes, with extensive investment research, all executed by talented and motivated investment managers. The scale of the outcome is managed by assessing the volatility of the portfolio. For example, if the investment horizon is ten years, we estimate how much the value of the portfolio is likely to rise or fall across that period by considering rolling periods of past market performance. While it is unlikely that the next ten years will look like the average of all previous such periods, it does provide a good marker and we also consider how this has changed. If the expected volatility is too high, the portfolio can then be balanced with less risky investments. We also remain vigilant regarding the possibility of extreme outcomes, sometimes termed black swan events. By their very nature, these risks are difficult to identify. Quantitative analysis provides risk measures which are objective and statistically robust, however these must be interpreted with experience and judgement rather than applied blindly 4

5 The old adage about not placing all your eggs in one basket really does apply in risk management. We can monitor concentration risk to ensure that we have enough individual holdings to avoid the overall return being dominated by the outcomes of just a few. Ideally, we will achieve both adequate and effective diversification by combining not only more than a handful of investments but also holdings that in the past have not tended to move closely together. Getting this right requires sophisticated analytical software, but it needs to be employed by experienced staff with the right mix of rigour, curiosity and healthy scepticism. Drawdown Risk The same volatility and concentration risk tools used to manage Outcome Risk can also be used to manage Drawdown Risk. For example, in case you need unanticipated access to funds, or are simply uncomfortable with significant temporary gyrations, the tools can help manage the structure of the portfolio. The relationship between risk and return is important here. A portfolio constrained by Drawdown Risk will be likely to return less than an equivalent for which this does not matter. Inflation Risk Responsible, active, modern day central banking has greatly reduced investors concerns over Inflation Risk. However, with the recent use of unconventional monetary policy there is no room for complacency. In addition to monitoring carefully the outlook for inflation in the major economies we consider which categories of investment seem likely to survive or even prosper amidst rising inflation, and which are particularly vulnerable. While there can be trade-offs between managing Outcome Risk and Inflation Risk, investments that protect against the latter are frequently less promising in terms of more immediate returns. Measuring risk solely in terms of volatility might lead an investor to assume that a cash deposit was risk-free. However, since inflation of 5% will halve purchasing power over 14 years, we see cash as providing only a short-term role in portfolios. Liquidity Risk We recognise that some clients may have concerns that it might become expensive or difficult to sell investments and recover cash. This can happen in relatively normal market conditions if there is little active turnover in the stocks concerned, or if market makers withdraw. It also applies to collective vehicles where redemption opportunities may become infrequent or disadvantageous in more volatile market conditions. We seek to manage this risk by prudent selection of individual holdings. Systemic risks are of greater concern. These can take the form of dysfunctional markets and/or regulatory intervention to freeze investments. We again seek to manage these risks through careful selection of individual investments and collective vehicles, with careful consideration to the means of exit when appropriate. 5

6 UNDERSTANDING YOUR NEEDS We offer investment flexibility by providing portfolios across Income, Growth and Balanced objectives intertwined with a specific risk profile. Based on the principles described in this booklet, an investment manager will meet with you to understand your requirements and agree a framework for the establishment and, where you are an Advisory Managed or Discretionary Managed client, the active management of your investment portfolio. There are a number of important tools that are used to support these conversations, and to limit the scope for ambiguity or misunderstanding. Risk is at the heart of these conversations. In order to make calculations straightforward, the investment industry often uses volatility as its preferred measure of risk. This is based on the degree of historic variation of an investment s returns and how these correlate with those of other investments in the portfolio. These characteristics may not persist, but provide a good estimate basis for looking at possible future portfolio volatility. At Charles Stanley we have based our broad risk categories on volatility scores that correspond to possible future investment risks and returns as indicated in this booklet. It is important to emphasise that volatility and its relationship with return vary through time. The conversation would also establish any need for regular income to be generated by the portfolio and withdrawn for expenditure. In the absence of such needs, the investment approach would focus on growth, or more specifically, growing the capital value of the portfolio. A balanced approach would incorporate both a need for income and a desire to grow capital. These objectives are termed Income, Growth and Balanced. Should you express no preference, Balanced is the default option. 6

7 Although the asset allocation for a given risk appetite will not vary significantly across these objectives, the specific securities and collective vehicles selected will be materially dependent on them. There are twelve different combinations of risks and objectives, one of which should meet your personal requirements. The indicative benchmarks used to facilitate the assessment of investment performance will also be tailored to these combinations. Reaching the appropriate combination, however, does not immediately lead to a standardised Charles Stanley portfolio; rather, it provides a foundation for your investment manager to begin to build your bespoke portfolio. It also provides an anchor to ensure that house views are adequately reflected. This maintains a consistent client experience across our teams and branches in an intellectually coherent way. Ensuring that these preferences remain current is central to the relationships we have with our clients and a key foundation for the delivery of long term satisfactory performance. It is important to note that the volatility measures represent only one element of the overall management of your portfolio and require interpretation by experienced investment managers. Volatility Volatility is an industry standard method of measuring risk. It looks at the degree that monthly returns over a period of time vary from the mean (or average) return for that period. This is an indicator of unpredictability of returns. It is expressed as a percentage value, which is the standard deviation of returns, usually on an annualised basis. Associated with this value is a degree of confidence, typically 95%. In this case, one would expect the return of an investment to be within the range defined as the mean return plus or minus twice the volatility, 95% of the time over 12 monthly periods. So, if a portfolio has a mean 12 month return of 8% and a volatility of 10%, the expected range of returns would be -12% to +28%, 95% of the time. However, the remaining 5% of the time, the returns can be significantly outside that range. Technical Note We use a system that calculates volatility as the standard deviation of an investment s monthly returns over eight years. At a portfolio level, the correlation between your investments returns is taken into account and your manager can see the risk contribution of each holding (for example, BP and Shell may rise together because of oil price movements). The system weights more recent returns more highly than older movements to reflect medium term trends in risk (i.e. the 2007 data will begin to drop out of the calculations over 2015 and 2008/9 data is less important than 2013/14 data). 7

8 FOUR GROUPS OF RISK APPETITE Portfolio characteristics Typical expected Investment horizon Lower risk Implies an aversion to anything other than modest capital losses, and a portfolio will be invested primarily in non-equity securities. Equity exposure will be derived mainly from collective investment vehicles that help achieve diversification in a cost-effective way. Overall risk would be deemed relatively low. 1 year or more Medium low risk Implies a still significant investment in non-equity securities but greater exposure to the more volatile asset classes that can deliver higher returns. Overall risk would be deemed moderately low. 5 years or more Medium high risk Implies a greater appetite for more volatile asset classes, while possibly retaining exposure to non-equity investments. A broader range of equity markets and sectors is likely to be used. Overall risk would be deemed moderately high. 10 years or more Higher risk Implies a capacity for more significant portfolio volatility, in search of higher investment returns. Significant exposure to riskier asset classes would be utilised. Overall risk would be deemed higher than average. 10 years or more 8 Charts/graphs show returns on a total returns basis. Past performance is not necessarily a guide to the future and the price of shares, and the income derived from them, may fall as well as rise and the amount realised may be less than the original sum invested. These simulations are based on a number of working assumptions that may not be possible in actual investment management

9 Historic performance FTSE WMA reference indices Percentage return (per annum) Percentage return (per annum) Percentage return (per annum) Percentage return (per annum) 50% 40% 30% 20% 10% 0% -10% -20% -30% % 40% 30% 20% 10% 0% -10% -20% -30% % 40% 30% 20% 10% 0% -10% -20% -30% % 40% 30% 20% 10% 0% -10% -20% -30% FTSE WMA Conservative index Portfolio Value FTSE WMA Income index Portfolio Value FTSE WMA Balanced index Portfolio Value FTSE WMA Global Growth index Portfolio Value situations, nor do the figures take into account our charges. The FTSE WMA Conservative and Global Growth indices started in July 2011; for the purposes of the illustrations above, a synthetic return series prior to that date has been constructed using the asset allocation at that date and the historic performance prior to that date of the underlying constituent indices. Cash Cash Cash Cash

10 INVESTMENT PERFORMANCE The key measure of investment performance is the degree to which returns meet or exceed expected returns, in the context of the risks assumed. MEASURING AND ASSESSING INVESTMENT PERFORMANCE For our Advisory Managed and Discretionary Managed clients, while portfolios are managed with a particular or longer-term horizon in mind, regular client updates are provided and the investment manager has access to daily performance data. The key measure of investment performance is the degree to which returns meet or exceed expected returns, in the context of the risks assumed. Expected return is the forecast return of an investment, given its historical performance; it is important to note that this is not a guarantee of future performance. A broader assessment can also be made in the context of market opportunities. Publicly available indices provide a measure of the returns delivered by stock and bond markets. Other indices, such as those compiled by the FTSE in conjunction with Wealth Management Association (WMA), also suggest the type of returns earned by a portfolio with a blend of assets, more representative of UK private client portfolios. We consider these indices as indicative and helpful in providing context to your portfolio returns. It is important to understand that your investment manager is not focusing on replicating the composition (by asset class or geographic region) or outperforming these particular indices, but rather focuses on the agreed objectives. Indices with comparable volatility to your portfolio play a useful role in supporting a conversation about the portfolio outcomes over the relevant time horizons. 10

11 Indexing We do not necessarily seek to track an index explicitly so although we have the information, you may not hear your manager talking about how your portfolio differs from the index ; this is sometimes referred to as Tracking Error or Active Money. We do not believe in holding a position in the portfolio just because it is in the index or too risky not to. Investments should be held to generate returns and diversify risks. Index funds remove one sort of risk, the risk of underperforming an index, but do little to reduce the total risk of investing in a specific market. The way we might use an index (or tracker ) fund would be consciously to take on that risk, for example to implement a view cheaply and rapidly on a whole asset class, such as an overseas market. THE ROLE OF INCOME Investment returns can be delivered in the form of income or capital appreciation. While fixed interest securities offer predictable income and value of capital on maturity (assuming no default), equity investments offer less predictable dividend streams but the prospect of capital appreciation, which can be realised as capital gains. Equities vary in the opportunities they offer for both income and capital appreciation across industries, size and maturity of companies, balance sheet strength and management quality. A portfolio can be structured to provide different mixes of expected income and capital appreciation. While portfolio construction can be an imprecise science, it is very important to give proper consideration to such preferences, as selling investments to provide income can be inefficient and expensive and the two categories can carry different tax treatment. 11

12 SATISFYING YOUR INVESTMENT OBJECTIVES At Charles Stanley our goal is to deliver investment returns that meet or exceed expected returns, so we set about that task with the associated risks very much at front of mind. We cannot avoid taking risks on your behalf because they fuel the very returns we seek, but we can and do strive to manage those risks diligently. We use an experienced and analytical understanding of risk to construct the framework for client portfolios that suitably reflect their appetites and expectations. This understanding is expressed in portfolios across the firm, which are organised using a combination of risk and income preferences. 12

13 FURTHER INFORMATION This information does not constitute advice or a personal recommendation or take into account the particular investment objectives, financial situations or needs of individuals. The value of investments may fall as well as rise and you may not receive back the amount you originally invested. If you would like to know more about any of the services mentioned in this booklet, you may also be interested in referring to one of our other brochures, listed below: Our Investment Process Investment Services Please ask your usual contact at Charles Stanley, who will be happy to provide you with a copy. Alternatively you can request copies from madeforyou@charles-stanley.co.uk or download them from our website, 13

14 CONTACT DETAILS For more information, please contact us: LONDON HEAD OFFICE Charles Stanley & Co. Limited 25 Luke Street, London, EC2A 4AR (Switchboard) (New client enquiries) OUR OFFICES Bath Beverley Birmingham Bournemouth Cambridge Cardiff Cirencester Dorchester Eastbourne Edinburgh Exeter Guildford Ipswich Isle of Wight Leeds Leicester Liverpool London (Head Office) Manchester Newbury Norwich Oxford Plymouth Reading Southampton Southend-on-Sea Tunbridge Wells Wimborne 14

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16 30.23 May 2015 Charles Stanley & Co. Limited is registered in England No Registered Office: 25 Luke Street, London EC2A 4AR T DX BROADGATE-1 Authorised and regulated by the Financial Conduct Authority. Member of the London Stock Exchange. 16 Charles Stanley & Co. Limited

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