City Trading Post

CTP’s objective in managing your money is to boost value by optimizing performance through strategic asset allocation, portfolio construction, ongoing management, and regular review.

So what if the extra performance costs you a bit more!? Do you really care if your advisers and fund managers are rewarded for making you money!? Far too many people, lead by advisers and managers hiding behind pathetic performance track records, focus on cost rather than performance. Obviously cost competitiveness is important, but focusing on cost to the exclusion of all else usually proves to be false economy. “Look after the pennies and the pounds will look after themselves”… Tosh and twaddle! Look after the pounds! Focus on the pounds!

At CTP we aim to help you drive this extra performance out of your pension funds and other investments. We’ve put a huge amount of time, effort, resource, technology, and expertise (the majority of financial advisers are unqualified in this area, and won’t pay for the technology required to do the job properly) into building an asset allocation model, and fund selection and portfolio construction processes. Over the last few years we’ve helped our clients achieve growth on their investments that they’ve never experienced before. One of our clients recently said

“The fund selections that you made for me (8 months ago) are excellent, thanks. The value of my (funds) has grown from £76k at the start of the year to £110k now with only £10k of extra contributions…”

The bottom line is this: Driving more performance out of an investment is a far more economical means of increasing value than just putting more money in or trying to cut costs. Here’s how we do it.

The failure of the financial services industry (except us) to adequately look after your money

The difference in performance levels between an average portfolio of investments and a well structured, diversified and managed portfolio can be many, many percentage points. At CTP we frequently come across cases where people have significant sums of money languishing in half forgotten pension funds or other investment vehicles. These funds are suffering from neglect. More often than not they are invested in one-size-fits-all funds that might be cheap, but certainly do not perform. This reflects badly on advisers and managers who use the cheapness of the funds they are recommending to divert attention away from the performance that they are not delivering.

Sadly, far too many managers of your money - whether we’re talking about your advisers and administrators or the underlying fund managers into whose hands your advisers and administrators have put your money – fail to perform by any measure. Some of the reasons for this are:

•    Advisers and managers rely on their big brand names: A large employer, or worse a lazy adviser, may put your money with one of the ‘big names’ into one or more of their ‘big funds’, just because they have the brand name and it’s an easy option. Investors generally do put faith in a brand they know and trust – or their employer or adviser does on their behalf. Brand may inadvertently become a more important factor in the manager selection process than performance

•    Advisers and managers often put too much emphasis on charges and fees, and will look for cheaper funds and structures regardless of performance. However, it is very easy to demonstrate that investors who put their money into actively managed, diversified portfolios of funds usually end up with significantly more value, regardless of the impact of higher charges and fees

•    It’s difficult to stay at the top of the performance tables. Continuous monitoring is required to keep track of how the various funds and fund managers are doing. Most advisers do not regularly review their clients’ portfolios (because they don’t know how, and they earn their commission upfront and don’t care after that). This is like pointing a car in the general direction of the destination at the start of the journey, and then not bothering to steer

•    Investors are often very undemanding! Investors seem reluctant to switch advisers or fund managers, in spite of the fact that their funds are neglected and lack of performance is detracting from the potential value of the investments. It’s your money. Take charge! At the very least, a portfolio of investments should be reviewed and rebalanced if necessary to account for changes in fund performance, risk characteristics, over and underweight positions, changes in macroeconomic factors, and changes in personal circumstances which may impact on financial targets and risk tolerances. Think about that old preserved pension scheme languishing in some unknown fund administered by your three-jobs-ago ex-employer. Have they rebalanced your portfolio for you recently

•    Buying high, selling low: Er, yes, it should be the other way around, if you want to make any money. However, investors often pile into funds that have recently performed well simply because they have recently performed well – managers advertise and market on the back of strong performance, and lazy advisers take the easy option of placing their clients’ funds there, without looking under the bonnet to determine whether it was achieved through luck or at great risk, or trying to ascertain if that performance is sustainable on an ongoing basis. No one wants to back a lame duck – but the long term winning strategy is to back the tortoise, not the hare.

All of this represents a general mass failure of the financial services industry to service its customers. The essential conclusion of this is that bad advisers and managers should be fired immediately, and professional advisers and managers appointed to run your money, extract greater performance from your investments, and make a positive proactive contribution to building your wealth.

The alternative

We will help you to put your funds to work in a well structured, diversified and actively managed portfolio of funds in tax efficient investment vehicles. Our model portfolio is constructed on the basis of thorough analytical research and back testing using institutional caliber software and tools. Even if it costs more, which is usually does, the extra cost can be easily and quickly overcome by the potentially superior performance that can be achieved.

Asset allocation

This is the most important stage of the process. The asset allocation of a portfolio of investments has more impact on the long term performance than individual fund or stock selection (in fact, it has been calculated that as much as 92% of performance can be attributed to asset allocation alone). It is also the stage at which diversification can have most benefit, as different asset classes are usually less correlated with each other than individual funds within a sector or asset class are. The main asset classes that we consider are -

•    Equities
•    Commodities
•    Fixed interest
•    Property
•    Cash

The main application of our core portfolio is for pension funds or other tax efficient investment vehicles such as ISAs and offshore bonds. These are almost invariably only a relatively small part of a client’s overall balance sheet, which usually includes separate items of property and cash. It is also a simple fact that the majority of CTP’s clients are in the 30 to 45 age bracket, and therefore they are in the accumulation phase of their financial lives rather than the income drawdown phase; the implication is that capital growth is more important to them than income generation and capital preservation. Therefore, for our purposes and unless specified by a client according to their particular requirements or preferences, we do not include cash or property or fixed interest in our core portfolio. We focus on equities and commodities for growth, inflation proofing, and diversification. And as time horizons are generally long, and the portfolios that we are constructing are a relatively small part of the overall picture, there is a bias toward overseas investment in actively managed growth funds.

Commodities are, by definition, an ‘international’ asset class, whereas equities are usually specific to a region. Investing outside one’s home territory creates relative risks through currency exposure and asset price volatility. A useful metaphor is standing in a carriage on a train and witnessing the apparent stability of your carriage relative to the next carriage along, which appears to buck and jump around at every bump in the track. Investing internationally allows for a much greater degree of diversification within a portfolio – diversifying into other areas, as well as diversifying away from an over-concentration of investment in your own region, which is a risk in itself – as well as creating the opportunity to benefit from higher growth areas of the world. Therefore, we break the equities element of the asset allocation into -

•    Local
•    International
•    Emerging

‘Local’ ultimately refers to the country where it is envisaged that the investment will eventually be encashed and spent; the UK for most of our clients. The majority of our clients have plenty (if not too much) exposure to the UK via their main homes and employer pension schemes.
We exclude UK equities from our core portfolio to enhance overall client balance sheet diversification. We break down the international element into the following sub-regions -

•    North America (i.e. USA)
•    Europe
•    Asia

And we break down the emerging markets into

•    Global
•    Latin America
•    New Europe
•    China

Let us consider a typical client example: A 40 year old male planning for retirement at age 55. Even if he has a fairly conservative attitude to risk, he has a long time horizon, so he can afford to take some more risk; the higher trend growth rate of a diversified portfolio of actively managed and individually risky funds should overcome the increased volatility over the longer term. We would recommend the following portfolio -

•    30% commodities
•    70% equities

Within the equities allocation, the regional allocation is as follows

•    20% Europe
•    20% Asia ex Japan
•    10% China
•    20% other emerging markets

Note that the US and Japan are missing from the regional allocation. This is based on our firm view currently that the US is in decline, and Japan has some major structural problems that it is struggling to deal with. We are aware that excluding two of the world’s greatest economies goes against the grain as far as diversification is concerned – but if we strongly believe that this is truly the case, why would we back these regions with your money?! We may well bring a US and/or Japanese allocation back into the portfolio when we believe they’ve reached a turning point, but that time is not now.

Fund selection and portfolio construction

The next stage is actual fund selection and portfolio construction. It is important to have access to as large a universe of funds as possible, and a flexible trading platform to operate from so that portfolio adjustments and fund switches can be implemented quickly and efficiently when required. For that reason, CTP works extensively with Skandia and Selestia, because they have the largest range of funds and access to the most third party specialist fund managers of any wrapper providers in the market, as well as offering technologically superior trading platforms. Within the available fund universe we select funds within each sector according to the following criteria -

•    Minimum 3 years track record
•    Top quartile performance for last 3 years (and 5 years, if required to narrow field)
•    Top quartile ‘information ratio’ relative to sector benchmark for last 3 years

The reason we require a minimum 3 year track record is that we want to have sufficient data to make credible comparisons between different funds within a sector. A newly established fund is not necessarily inferior – in fact, some brand new funds offer some very interesting and, in our opinion, potentially very rewarding strategies. However, that is just our opinion, and unless a client specifically wants to make such an investment alongside their core portfolio, we restrict our selection of core funds to ones where there is track record and data available to rank funds relative to their peers.

We require consistent top quartile performance. We acknowledge that past performance should not be used as a guide to the future, unless it is considered in the context of other factors. We use past performance simply to narrow the field – we rule out the funds that have done badly, and we take no further interest in those funds. Then, focusing on the remaining funds, we look at the ‘information ratio’ (IR).

There are many statistical measures of risk adjusted performance, and it is our view that this is the best one for our particular purposes. The IR measures the performance over benchmark relative to risk over benchmark; in plain English, that means we are separating out fund manager performance from underlying market performance, and considering the level of risk that was taken to produce that performance. For example, we’re not interested in the fund manager who made a fortune, but took disproportionately high levels of risk to achieve it; we’re much happier with the consistent ‘tortoise’ fund manager who takes some risk and delivers regular, proportionate outperformance against his benchmark.

So, while we’re using performance statistics to narrow the field, we’re looking at risk relative performance to make the final selection. Using this methodology, we have selected the following funds within the various sectors to come up with our core portfolio -

•    15%    Merrill Lynch Gold & General
•    15%    JPM Natural Resources
•    20%    Baring Europe Select
•    20%    Fidelity South East Asia
•    5%    Gartmore China Opportunities
•    5%    Invesco Perpetual HK & China
•    10%    Axa Framlington Emerging Markets
•    5%    Invesco Perpetual Latin America
•    5%    JPM New Europe

This is how our portfolio has performed versus the FTSE All Share over the last few years –

Click here to view the portfolio vs benchmark chart

Not bad! Of course it’s easy for us to pick a portfolio now that looks good on a historic basis – but as many of you know reading this newsletter, this portfolio contains funds that we have been recommending for several years. However, in the interests of fair play, we will only start keeping score from now. Each quarter we’ll publish our portfolio performance in the newsletter, and also explain any portfolio adjustments. We invite your views and comments on our approach – many of you are financial services professionals yourselves, so what do you think?

We will assume a £1,000 per month regular contribution starting on 28th April 2008 and keep track from there.

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