/ Investment Process A Guide

/ Investment Process A Guide / Contents / Introduction / Risk Profiling / Asset Allocation / Asset Selection / Reporting / More Information / External Consultants

/ Introduction Assessing the level of investment risk that a client is willing and able take - and the suitability of that investment - is core any recommendation an Adviser makes. This document focuses on the Novia investment process and planning ols and the level of risk that a client is willing take when making an investment. It does not consider the ability that a client has make an investment which will be influenced by The extent of the financial assets and liabilities that a client may have The client s capacity for loss, that is, the ability for the client absorb falls in the value of their investment and still meet their liabilities. Any outstanding debts. Before recommending an investment the Adviser should consider whether the client would be better off repaying any outstanding debt. The level of risk that clients are willing take will generally be secondary their ability take that risk. / Investment Process Novia have used the best in cutting edge technology alongside academic rigour and investment experience, both internal and external, create the planning ols and portfolio construction process which sits at the heart of Novia. This process ensures Advisers can effectively and efficiently match an investment portfolio the risk and reward objectives of their clients. Novia offers Advisers full flexibility in the investment process. Using our quick and easy online technology Advisers can simply choose individual investments from our broad range populate a portfolio for a client and benefit from all the convenience and reporting functionality available. Alternatively, Novia enables an Adviser complete the full investment process from start finish through the service risk profiling, asset allocation, asset selection and finally reporting using our integrated online ols. The full investment process available through Novia and the steps involved are outlined in the rest of this guide. This investment process follows four standard steps which enable Advisers create and communicate a portfolio that is optimised meet the objectives and risk profile of a client. 1. Risk Profiling 2. Asset Allocation 3. Asset Selection 4. Reporting Our investment portfolio process uses fully integrated ols seamlessly construct a portfolio using these steps via the Novia platform.

/ Risk Assessment Assessing an individual s attitude risk forms an integral part of the suitability process undertaken by Advisers. This is based upon an Adviser s assessment of two elements which affect an individual s approach investment: 1. Capacity for risk 2. Appetite for risk An Adviser will typically look at capacity for risk as part of their overall client assessment through gathering client information and assessing facrs outside any proposed investment such as: Other assets and sources of income Liabilities they may face Timing and future plans Appetite for risk can be assessed using methods such as risk profiling ols. Novia provides a risk profiling ol as part of investment process explained in this document. We provide a questionnaire that delivers an appetite for risk score for each client based on the answers they provide. Whilst this is an important guide it must be used as part of an Advisers overall risk assessment process and in conjunction with their exploration of a client s capacity for risk. Risk Scoring Risk scoring is an integral part of the portfolio construction process. Clients are assigned a risk score from 1 10 following completion of an online questionnaire and scoring module or as selected by the client/adviser themselves based on their understanding of that client s investment profile. The risk score is essentially a measure of an invesrs appetite for risk in their portfolio. This is then matched the theoretical volatility (guided by independent research and reviewed regularly) of a potential portfolio and is used as a means of selecting a particular optimal long term investment strategy within the Novia investment ols. Questions asked The risk profile questionnaire uses three types of questions in order determine the risk score: 1. Understand a client s investment objectives 2. Obtain a client s view on investment risk 3. Assess a client s attitude risk These questions obtain factual details about client time frames for the investment (ie time before assets will be drawn on and over what period they will be spent), amount invest, income details etc. These questions aim find out how much risk the client is willing take on. These questions look find out how the client would react good, or more importantly, bad outcomes in the investment portfolio and what mitigating actions would be available.

To calculate the risk score, each question s possible answer is assigned a score between 0 and 100. In very broad terms, this score indicates how far up the risk scale a client is prepared go, based on this question alone. Each question also has an 'importance weighting', as some questions are more indicative of the clients likely attitude risk and/or generally more accepted as a proxy for investment risk. The overall risk score for the risk profile questionnaire is the sum of the weighted scores for all the questions. This overall risk score is then mapped on a risk scale of 1-10 in such a way that approximately 10% of possible scores are mapped a risk score of 1 or 2, 10% are mapped risk score of 9 or 10 and 80% are mapped a risk score of between 3 and 8, following the normal distribution curve. Investment risk in the Novia portfolio management ols is matched against volatility of the assets being bought as the benchmark. There are other ways measure investment risk eg, probability of achieving certain target returns, possible losses in portfolio value over a specified time horizon, so called Value at Risk (VaR) and many others. However, under certain assumptions all these different ways measure investment risk can be ultimately mapped on the volatility of the portfolio of assets in a consistent way. In order use the risk profile score with the other Novia ols, in particular the Asset Allocation ol, the risk score of 1-10 is translated annual return volatility. Risk score mapping annual return volatility The basic mapping approach is such that a risk score of 1 would be mainly invested in Cash, a risk score of 3 will be based on an all Fixed Interest/Property portfolio and a risk score of 10 will be based on an all equity portfolio. Intermediate scores will have volatility that is distributed evenly (in broad terms) between the pivotal risk scores of 1, 3 and 10. Please see the table for a set of recent indicative figures below (for the current, up date figures please contact your Regional Sales Manager or Client Services Executive who can provide you with the latest review). Example, indicative figures see latest Review Document for up date details Risk Score Mid Point Volatility 1 2 3 4 5 6 7 8 9 10 1.95% 3.90% 6.00% 7.70% 9.40% 11.10% 12.80% 14.60% 16.30% 17.75% Range up 2.93% 2.93% 4.95% 4.95% 6.85% 6.85% 8.55% 8.55% 10.25% 10.25% 11.95% 11.95% 13.70% 13.70% 15.45% 15.45% 17.03% more than 17.03% Expected Return * (Net Funds) Expected Return * (Gross Funds) 2.08% 3.01% 3.73% 4.25% 4.78% 5.25% 5.70% 6.18% 6.55% 6.78% 2.64% 3.68% 4.37% 4.85% 5.21% 5.55% 5.88% 6.24% 6.56% 6.80% *The expected returns were reduced by the effect of taxation and expenses within the funds. They vary with the optimal asset allocations at each risk level and are likely change at every review, unlike the mid-point volatilities which are likely remain unchanged.

Expected Returns gross versus net As shown above, in some optimised portfolios, expected returns may be higher in asset allocations optimised for net product wrappers rather than gross. Whilst this may seem counterintuitive, gross efficient portfolios may have lower expected returns than net ones (for a given risk level) as the optimiser produces different asset allocations for a given risk level for net and gross product wrappers. This is due the fact that the optimisation takes place after adjustments for tax and hence asset classes will have different attractions in net and gross wrappers. In the gross wrappers fixed interest and/or property will probably have larger proportions than in a net wrapper, where the likely proxy will be equities. As fixed interest and property have lower returns than equities, the asset allocations for net wrappers can produce higher return than for gross wrapper. If you specify an asset allocation, it will always be true that gross wrapper return will be always greater or equal the net wrapper return. Attitude Risk Risk Level Typical proportion in risky assets* Likely range of returns 1 less then 5% -1.25% 6.75% 2 10% -4.00% 12.00% 3 20% -7.25% 17.50% 4 35% -9.75% 22.00% 5 50% -12.50% 26.50% 6 60% -15.00% 31.25% 7 75% -17.50% 36.00% 8 90% -20.25% 41.50% 9 100% -22.50% 46.75% 10 100% -24.50% 51.25% Volatility range (return variability) Annual potential loss Monthly potential loss up 2.93% - 301-353 2.93% 4.95% - 1,379-769 4.95% 6.85% - 2,719-1,231 6.85% 8.55% - 3,811-1,604 8.55% 10.25% 10.25% 11.95% 11.95% 13.70% 13.70% 15.45% 15.45% 17.03% more than 17.03% - 4,929-1,980-6,033-2,353-7,111-2,724-8,219-3,113-9,252-3,478-10,123-3,789 Definitions Example potential annual loss Example potential monthly loss Risky assets 1 in 20 chance of losing this amount on 50,000 investment in a year 1 in 20 chance of losing this amount on 50,000 investment in a month Property, UK Equities and Global Equities Typical proportion in risky assets* Excluding the minimum held in the Cash Facility Likely range of returns The returns are 95% certain be in this range, i.e. there is 1 in 40 chance of being below this range and 1 in 40 chance above.

Range of returns in graphical form 60% 50% 40% 30% 20% 10% 6.1% 11.2% 16.7% 21.2% 26.0% 30.8% 35.8% 41.4% 46.6% 51.2% 0% -10% -20% -30% -1.7% -4.6% -7.8% -10.4% -12.9% -15.3% -17.8% -20.2% -22.6% -24.6% Risk 1 Risk 2 Risk 3 Risk 4 Risk 5 Risk 6 Risk 7 Risk 8 Risk 9 Risk 10 / Asset Allocation Asset allocation is the division of an investment portfolio between different asset classes. In its broadest definition asset allocation defines the relative exposure of a portfolio asset classes, such as Cash, Equities, Fixed Interest and Property. Modern Portfolio Theory maintains that asset allocation is critical efficient and effective investment strategy, accounting for up 90% or even 95% of a portfolio s return. The principle is that the invesr should aim achieve an asset allocation that will offer the optimal potential return for a given level of risk. The range of such asset allocations is expressed statistically as the efficient return. The Novia Investment Process uses assumptions about asset class returns, volatilities and correlations that are long term in nature ie, they do not necessarily change every time there is a change in the short term outlook. In a similar vein, the volatility assumptions are only going change if there is a significant departure from the long term norm and the correlations may be changed only as part of an annual review. These assumptions and the optimal asset allocations provided are reviewed quarterly by experienced consultants in association with Capital Economics and other sources of research. Novia s Asset Allocar ol uses the volatility range applied each risk score and assumptions about asset classes give an optimal asset allocation for a client s risk profile.

Asset Risk/Return/Correlation assumptions For the technically minded and as an example, the main asset class assumptions used in the Novia ols at a recent review are shown below. For the current, up date figures please contact your Regional Sales Manager or Client Services Executive who can provide you with the latest Review Document. Risk & Return Return % p.a. Volatility* % p.a. Cash 2.25 2.00 UK Fixed Interest 5.00 5.75 International Fixed Interest 5.15 6.75 Property 5.75 16.00 UK Equity 8.25 20.50 International Equity 8.25 19.50 Please note the example figures here are provided by an independent consultant actuary and are reviewed quarterly. Please ask Novia for the latest, up date figures. * Volatility here refers measure of the extent of price changes over a specified time period. It is defined as the standard deviation of the continuously compounded returns and sometimes referred as 'hisrical volatility'. Correlations Cash UK Fixed Interest International Fixed Interest Property UK Equities International Equities Cash 1.00 0.18 0.10-0.10 0.15 0.11 UK Fixed Interest 0.18 1.00 0.54 0.20 0.50 0.40 International Fixed Interest 0.10 0.54 1.00 0.20 0.40 0.50 Property -0.10 0.20 0.20 1.00 0.29 0.09 UK Equity 0.15 0.50 0.40 0.29 1.00 0.81 International Equity 0.11 0.40 0.50 0.09 0.81 1.00 International Equity Using the Novia ols, International Equity can be split in different regions of the world Europe excluding UK, North America, Japan, Pacific excluding Japan and Global Emerging Markets. At an Adviser s discretion this can be split according GDP, market capitalisation, consensus or it can be split either equally or specific a clients requirements. Non-optimised assets Novia also enables the use of alternative assets, which cannot be optimised, through the platforms investment process. These may include Structured Products for example. This ensures that an Adviser and client s choice is not limited standard, daily dealt authorised funds but embraces the full breadth of investments available. Advisers can select the proportion of the portfolio be held in non-optimised investments through the asset selection ols and these will be displayed in full for reporting purposes.

This ensures clients and Advisers have access a breadth of investments through a platform that was previously unthinkable and ensures the convenience and efficiency of investing in this manner applies all assets. / Asset Selection Once the asset allocation has been provided, Novia s investment ols allow Advisers populate the different asset classes from one of the broadest ranges of investments in the industry. Novia offers a full range of investment options across all the major asset classes see attached appendix. We make available authorised funds such as unit trusts and OEICs alongside offshore and institutional funds, shares, ETFs, hedge funds and structured products and a range of cash offerings. Investment Tools All investments available through the platform are classified within one of the asset classes used in the asset allocations provided. Our integrated portfolio construction ols allow Advisers select investments for each category as appropriate and therefore build a portfolio reflecting the optimal asset allocation for the client s risk profile. For example, these ols include: Asset Selecr quickly and easily enables Advisers view, filter and search the universe of assets available through Novia and then select chosen assets efficiently populate a portfolio. Fund Charting allowing Advisers research assets by accessing a comprehensive range of performance charts and benchmarking indices. Model Portfolio Evaluar enables Advisers evaluate a client s portfolio against model portfolios created by either Adviser or Discretionary Fund Manager and check the efficiency of the constructed portfolios against the market. Offers Advisers the ability demonstrate a portfolio s risk against annualised return, risk against return over a range of timeframes and print/pdf any material created. Asset Selection Options There are a number of different options available Advisers and their clients when selecting assets construct a portfolio. This can be either through the Adviser selecting assets for that particular client, through the use of model portfolios for a number of clients or by utilising the expertise of a Discretionary Fund Manager outsource asset selection. Adviser Asset Selection Using this route an Adviser uses the Asset Selecr build a portfolio from Novia s range of available investments for a client. This can then reflect the client s risk profile and asset allocation and any client specific requirements. Model Portfolios Advisers can construct a range of model portfolios reflect a number of risk profiles, for example 1 10. These portfolios can then be used for a number of clients depending on their individual risk profile. These model portfolios can be amended and all clients switched aumatically so that their investments match their Adviser s choice at all times, delivering significant efficiency benefits.

Discretionary Fund Managers Novia also enables the use of Discretionary Fund Managers and provides the technological functionality and support ensure such third party expertise can be utilised through the platform. This allows Advisers and clients access a Discretionary Fund Manager s model portfolios or appoint a dedicated investment manager manage a specific portfolio on a bespoke basis. / Reporting Novia offers Advisers access a full suite of reporting resources ensuring they can offer their clients full information regarding their investments and the process leading the construction of their portfolio. This also ensures Advisers can meet all disclosure requirements. Client Report A range of client reports, suited each product wrapper, but offering Advisers the flexibility white label and tailor their client s specific requirements is available. These reports can provide clients with information regarding the use of the Novia service, the investment process, details of investments selected and the costs involved. Portfolio Scan Portfolio Scan allows an Adviser evaluate a client s portfolio in full and look through the investments selected fully understand the underlying assets and asset classes they are invested in. Portfolio Performance Review Portfolio Performance Review looks at a client s portfolio over time and, taking in account any additional investments or any withdrawals, gives a complete picture of performance over a given period. This provides a meaningful evaluation of how a portfolio has performed for a client removing the artificial impacts of movements of money in or out of the product wrapper. / Further Information Further information is available from your Regional Sales Manager or Client Services Executive if you are unsure about any aspect of the Novia investment process please contact us. Contact details and more information are available at our website www.novia-financial.co.uk

/ External Consultants Peter Ludvik, Investment and Actuarial Consultant Former Head of Asset Allocation at Watson Wyatt The assumptions used and optimal asset allocation review is provided by our Investment and Actuarial Consultant, Peter Ludvik. Peter graduated from Edinburgh University with a 1st Class Honours Degree in Mathematics and then spent 3 years on postgraduate research in the University of York. He qualified as a Fellow of the Faculty of Actuaries in 1979. Before joining Watson Wyatt as a partner in February 1995 he worked for Noble Lowndes & Partners (now part of Mercer) for 15 years in the areas of pensions, computer systems and investment, and before that for Guardian Royal Exchange for 5 years. Peter ok early retirement from Watson Wyatt in 2005. Since then he continues work as a consultant leading investment platform providers in the areas of Investment Planning Tools for individuals. In Watson Wyatt, Peter was Head of Asset Allocation and was responsible for asset liability modelling (ALM) and strategic asset allocation advice major UK and international clients. He has written several papers and was a regular speaker at investment conferences on ALM, benchmarking, risk budgeting, ETFs and indexation issues. In his professional role, Peter served on the Council of the Faculty of Actuaries and was a past Chairman of the Investment Committee of the Institute and Faculty of Actuaries and the Institute and Faculty of Actuaries Steering Committee for Certificates in Derivatives. He was also a member of the FTSE Policy Group and a member of the INQUIRE Council. Peter has always been involved in cutting edge projects, from the early pioneering work in the 1970s of using microcomputers in life office actuarial calculations sophisticated schastic investment modelling of assets and liabilities. His major projects included: ALM and strategic asset allocation advice multi-billion corporate pension funds ALM of the Nuclear Decommissioning Fund at the privatisation of British Energy modelling the run-off of the non-life liabilities of Names, or Underwriters, at Lloyd's of London as part of the launch of the Equitas re-insurance company in September 1996 development of bespoke schastic ALM systems. His current projects include the development of ALM ols, using computers, for private invesrs and Advisers. Capital Economics Novia and it s consultants use Capital Economics as their primary source of research inform judgements around asset allocation and the assumptions used. This research is also used during the quarterly reviews. Capital Economics is one of the leading independent macro-economic research consultancies in the world, providing research on the US, Europe, Asia and the UK, and on the property secr. Founded in 1999, they have gained an enviable reputation for original and insightful research and have built up a wide and distinguished client base. Offices in London and Toron produce

publications for world-wide distribution and offer clients access economists during working hours in both Europe and North America. Over 600 institutions across the globe, ranging from some of the world s largest banks boutique property invesrs, subscribe these publication packages. They include fund managers, insurance companies, pension funds, investment banks, hedge funds, sckbrokers, retailers, house builders, property developers, construction companies, building societies and specialist lenders. Roger Bootle is the Managing Direcr of Capital Economics and is one of the City of London s best known economists, having worked in or around the financial markets since 1978. As well as being Managing Direcr of Capital Economics, he is also Economic Adviser Deloitte a Specialist Adviser the House of Commons Treasury Committee and an Honorary Fellow of the Institute of Actuaries. He was formerly Group Chief Economist at HSBC and, before the change of government, he was appointed one of the Chancellor s panel of economic forecasters, the socalled Wise Men. He studied Economics at Oxford, and began his career in the academic world as a lecturer in Economics at St Anne s College, Oxford. This document is intended provide information for professional advisers only and is not intended for onward transmission clients. Novia does not provide advice - advisers must seek their own compliance/legal advice before relying on the information provided in this document.