In this article, Ronan Kearney Responsible for Fund Structure and Governance on the Verbatim Investment Committee, examines some of the investment assumptions many professional fund managers and advisers take for granted. He raises the questions: Are these investment assumptions justified? Or are there potentially alternative approaches to asset allocation and portfolio construction that could better serve the financial community?
The first question any adviser or investor alike should ask their investment manager is: Which FTSE 100 do you use for your analysis, and why? In taking a closer look at the FTSE 100 it often comes as a surprise to investors, and even to professional advisers, that there is more than one version of the FTSE 100. But should it really be a shock? After all, the FTSE 100 is a manufactured index, owned and licensed by a corporate entity, and product variation is to be expected.
The original FTSE100 was launched in 1984, with a base value of 1000, and it originally offered access to companies that generated the majority of their revenues in the UK. Because the stock market was relatively small at that time, it made sense to structure the index using the key characteristic of Market Capitalisation. That is to say, if you had invested £100 it would have been allocated according to the relative value of the companies in the index. A larger company would have more than £1 invested and a smaller company would potentially have as little as £0.10 invested.
In terms of performance, this was initially a very successful model, but over time two disadvantages have arisen from Market Capitalisation. The first is that the FTSE has increasingly become dominated by global multi-nationals that generate the majority of their revenues outside the UK (over 70% at the current time). This makes share price performance subject to changes in exchange rates as well as business performance, arguably adding to the volatility of the index. In addition, three sectors have come to dominate the FTSE in valuation terms, namely Energy, Financials and Pharmaceuticals. Investors therefore have to contend with less diversification and greater exposure to exchange rate risk, both of which add to the risk of their portfolio.
In taking a closer look at the FTSE 100 it often comes as a surprise to investors, and even to professional advisers, that there is more than one version of the FTSE 100.
In order to counter some of these aspects, other variants of the FTSE 100 have been published by the FTSE group that focus on alternative investment factors to market cap. In 2011, the first Equal Weight variant was published on a quarterly rebalanced basis, and in 2014 an additional Equal Weight variant was published on a semi-annual rebalanced basis. In 2017 a Minimum Variance version was also launched.
These additional indices comprise an attempt by FTSE to capture the new investment theory that has driven much institutional thought over the last 15 years, growing to $1,9 trillion in 2018. This is the concept, first published by Ross in 1976, that identified that factors other than size or Market Cap (for example, earnings growth), would drive a company's growth. This seems obvious to many, but is something that is often missed if you invest in a Market-Cap weighted index, that allocates your money based solely on company size.
For this reason, the Verbatim Multi-Index fund range utilises factor based investment strategies to identify and allocate to the key drivers of performance, and incorporates them into a UK Equity benchmark. Hundreds of equity factors have been identified in academic research. At Verbatim, we have set the following criteria for a factor to be eligible as part of our portfolios:
- Commonly identified: The factor has been shown to deliver attractive risk and return characteristics in a number of academic studies
- Supported by a logical economic rationale or a behavioural bias: There must be an explanation as to why the factor produces a return premium or reduces risk over the long term.
- Persistent: The factor must persist across time periods and across regions / markets.
With this in mind, we have identified the following key factors for inclusion in the Verbatim portfolios: Value, Quality and Low Volatility.
- Value: Aims to capture excess returns from stocks that have low prices relative to their fundamental value.
- Quality: Defined by low debt, stable earnings, consistent asset growth, and strong corporate governance.
- Low Volatility: Portfolios of low-volatility stocks can have higher risk-adjusted returns than portfolios with high-volatility stocks
The Verbatim Multi-Index fund range consists of four established multi-index, risk-managed portfolios.
To find out more about Verbatim visit www.verbatimassetmanagement.co.uk or contact us on 0808 12 40 007.
The value of investments and any income from them can go down as well as up and is not guaranteed. Your clients could get back less than they originally invested. Past performance is not a guide to future performance. The portfolios’ investments are subject to normal fluctuations and other risks inherent when investing in securities. Verbatim Asset Management has taken due care and attention in preparing this document, which is solely for the use of professional advisers. Verbatim cannot be held responsible for any inaccuracies arising out of information detailed within and will not accept liability for any loss arising out of or in connection with its use. This article is for information only and should not be deemed as advice.