introduction to investing - infinity

How to become a successful investor

INTRODUCTIONTO

INVESTING

CONTENTS3 About Infinity About Bestinvest

4 Introduction What makes markets move? Regular saving How can we tell if shares are cheap?

5 Understanding the risks

6 How can you measure risk?

7 Importance of asset allocation Regular rebalancing

8 The world is your oyster Fashion and style

9 The benefits of collective funds Active versus passive

10 Selecting fund managers

11 Bonds

12 Investing in property

13 Alternatives

14 Important information

INTRODUCTION TO

INVESTING

CONTENTS3 About Infinity About Bestinvest

4 Introduction What makes markets move? Regular saving How can we tell if shares are cheap?

5 Understanding the risks

6 How can you measure risk?

7 Importance of asset allocation Regular rebalancing

8 The world is your oyster Fashion and style

9 The benefits of collective funds Active versus passive

10 Selecting fund managers

11 Bonds

12 Investing in property

13 Alternatives

14 Important information

About BestinvestFounded in 1986, Bestinvest has grown to become a leading private client investment adviser, looking after over £4 billion of assets for more than 50,000 clients. We offer a range of investment services all of which are underpinned by rigorous research aimed at identifying those fund managers we believe will deliver long-term outperformance. Bestinvest has won numerous awardsincluding UK Wealth Manager of the Year 2011 as voted by readers of theFinancial Times and Investors Chronicle.We have also been voted Best Discretionary Manager 2011 by Money Marketing and Investment Adviser of the Year 2012 at the Professional Adviser Awards.Headquartered in Mayfair, London,Bestinvest has 14 regional offices with200 staff. The company is one of thefastest-growing investment advisoryfirms and is proud to support the NSPCC.

About InfinityInfinity Financial Solutions is a leading provider of expat financial services across Asia with offices in Malaysia, Hong Kong, China, Cambodia and Vietnam. It is our fundamental belief that financial planning makes life better and we are dedicated to providing exceptional service to both our individual and corporate clients.

The combination of carefully tailored financial planning and a wide range of options is at the heart of what makes Infinity different from other financial advisers. We’re completely independent, so the advice we give is impartial and unbiased.

We’re here to protect, build and maximise your wealth for the future security of you and your family. But most of all, we want to help you achieve your hopes and objectives, whatever they may be. The possibilities are endless.

BEST XXX XXX XXXXXX XXXX WINNERBESTINVESTBEST WEALTH MANAGER FOR INVESTMENTS BEST XXX XXX XXXXXX XXXX

WINNERBESTINVESTUK WEALTH MANAGER OF THE YEAR

2011Best Discretionary

Adviser

2012Investment Adviser

of the Year

3INTRODUCTION TO INVESTING

What makes markets move?The value of most investments fluctuates in a largely unpredictable manner. This is always disconcerting for investors and can be expensive if it leads to a knee jerk reaction to sell when values are depressed. The first point to make is that markets already discount what is currently known and expected. You’ll often see the shares of a company fall after it has delivered strong growth in profits, simply because the market had been anticipating even more. Likewise, the declaration of huge losses can, sometimes, represent a buying opportunity as all of the bad news is already discounted.

So how can we predict when shares, or any other investment, will go up and down? The simple answer is that this is impossible with any consistency, especially in the case of large companies whose shares are researched intensively on a continuous basis by investment banks, stockbrokers and fund managers. The economic cycle has some impact on overall market prices but not in a way that lends itself to reliable forecasts. You might think that over the long term it must make sense to invest in those coun-tries that will achieve the highest rates of

economic growth but intriguingly there is no evidence that this works, even if you are clever enough to identify the fastest growers accurately (economists are very poor at doing this). Indeed, some academic research suggests that the opposite may be true and you will actually make more money by backing the slow-growth economies.1

Regular savingOne way in which you can use market movements to your advantage is by making regular contributions to your investments so that you buy when the markets have down periods as well as during the up periods. This allows you to benefit from a phenomenon called “Pound Cost Averaging” which means that you smooth out some of the risks of getting the timing wrong and your money works harder when values are depressed. Setting up a regular investment scheme is a good discipline, which results in you keeping on investing through the ups and downs and reduces the chances that you will get carried away by the prevailing sentiment.

How can we tell if shares are cheap?If we can’t predict the timing of market cycles, can we work out if markets are cheap or expensive? This would be very useful because there is plenty of evidence that suggests you make much more money if you buy when shares are cheap.

The standard measure for valuing shares is the Price/Earnings ratio (P/E) which is the multiple of the market value of a company to its underlying profits after tax. If the P/E is 15 then in effect the company is valued at 15 years of current earnings. In broad historical terms if the P/E on the overall market is over 20 then shares are likely to be expensive and if less than 10 they are probably cheap. However, nothing is that simple with investing. Company profits change all the time and there can be periods when they are very depressed, or very high compared to ‘‘normal’’ levels. One way of accounting for this is to calculate the P/E on the basis of the average profits over a period of 10 years and this is called Cyclically Adjusted P/E (or ‘CAPE’).

1Triumph of the Optimists by Dimson, Marsh & Staunton

In this guide we try to give you a few pointers on how to be a successful investor. For most of us the future performance of our investments will have a huge impact on our standard of living later in life.

Understanding how to get the best results is vital and unless you are willing to let someone else make all the decisions for you this means you need to be familiar with the basics. Investing is a strange world where the usual rules don’t seem

to apply. If the price of a car or television falls we probably feel more tempted to buy it.

With investments the opposite happens – private investors often buy just when caution is needed after a steep rise and sell heavily when markets slide downwards. This stems from a tendency to follow the crowd and seek safety in numbers when we are uncertain or feel limited in our knowledge. It is also difficult to ever know for sure if markets are cheap or expensive; there will always be compelling arguments both ways.

4 INTRODUCTION TO INVESTING

Understanding the risksIt’s a fundamental law of investment that you have to take more risk in order to have the potential for higher returns. However, it’s important to understand that taking extra risk certainly does not guarantee higher returns (if it did then it wouldn’t be risky!). The following chart gives an impression of how the potential for higher returns increases as you take more risk – but so does the potential for losses.

It stands to reason that risks must be greater when investments are highly priced than when they are cheap. So you should reduce the amount of risk when markets are high but unfortunately many investors do exactly the opposite and pile in. After a period of strong market rises it’s easy to believe that the good times will roll on forever and that nothing can ever go wrong. Likewise, when markets become very cheap there will appear to be no prospect of them ever recovering. It takes courage to invest at this point but history suggests that it will eventually be well rewarded.

After you have invested it’s quite possible that prices could fall so that you would have a loss if you sold immediately. This is

always depressing but don’t feel any guilt about it.

As we said earlier, no one can predict the timing of market cycles with any consistency and what really matters is the return you make over the period when you need to cash in the investment. If you are still in that period of your life when you will be investing more money then you can cheer yourself up with the thought that your next purchases will be made at even better valuations.

Maximum and minimum annual returns 1991-2011

%

-40

-30

-20

-10

0

10

20

30

40

Equities75% cash, 25% equities

50% cash, 50% equities

25% cash, 75% equities

Cash

Source: Lipper for Investment Management

5INTRODUCTION TO INVESTINGAll investments carry risks. Please see Important Information on page 14 for detailed information.

How can you measure risk?Since risk is such a fundamental part of the investment world, can we measure it accurately? ‘No’ is unfortunately the answer because we can’t predict the future. We do know that the main determinant of risk in most portfolios is the amount invested in equities (also known as shares) as these fluctuate more than most other types of investment but even this statement needs a caveat. One of the biggest risks facing long-term investors is inflation. A portfolio

consisting wholly of government bonds may have little investment risk (although in these uncertain times that’s less true than in the past) but it will be very susceptible to any increase in inflation, so it’s not really low risk at all.

Many academics and professionals use volatility as a measure of risk. This is a statistical term that measures how much an individual investment or a portfolio of investments fluctuates in value. This is a useful concept but it is not guaranteed to

be a reliable predictor of the future as it is a backwards looking measure that has an unfortunate tendency to understate risk at critical moments in time, such as in the summer of 2007. So it needs to be treated with caution. However, it can help to show how your portfolio compares with others and with benchmarks such as the FTSE 100 index. At Bestinvest we regularly review the volatility of client portfolios to help monitor risk.


Importance of asset allocationOnce you start to accumulate a number of investments the chances are that these will be of different types. Some will be equities, some bonds, perhaps some property and also some of the more esoteric assets such as commodities (eg gold and oil), hedge funds and private equity. This mix is called asset allocation and academic research suggests that it is responsible for 90% of the differences in investment returns2. So it’s worth putting in some effort to get this right.

As we said earlier, most investments fluctuate in value. However, they don’t all fluctuate in the same way. There will be times when equities are rising while bonds and property are falling. Good asset allocation uses this lack of correlation between asset classes to achieve a higher return for a given level of volatility.

Regular rebalancingRebalancing means bringing your investment portfolio back to its original asset allocation. It may have become out of kilter because, over time, some investments can grow faster than others. It’s useful to rebalance regularly (annually is about right) and, in effect, it makes you sell equities when they are overvalued and buy them when they are cheap.

0

20

40

60

80

100

120

140

160

Sept 02 Sept 04 Sept 08 Sept 10 Sept 12

Diversified portfolios can lower risk whilst still achieving attractive returns

Bonds (FTSE A British Govt All Stocks TR)

Source: EPFR, Credit Suisse research

Portfolio (60% Equities, 30% Bonds, 10% Property)

Property (IPD UK All Property Monthly TR)

Equities (FTSE All-Share TR)

% INCREASE


2Source: Brinson, Hood & Beebower (1986); Ibbotson & Kaplan (2000)

The world is your oysterUK stock exchange listed companies represent around 10% of global stock markets, so it simply doesn’t make sense to restrict your choice of investments to the UK market alone. These days it’s easy to invest internationally – there are thousands of funds available covering most of the overseas markets. Where should these fit in to your portfolio? Everyone expects the Asian economies to achieve higher growth than the West for the foreseeable future but as we discussed earlier this probably has no bearing on the performance of their stock markets and, in any case, economists are not very good at forecasting growth.

Generally it makes sense to invest as widely as possible – this will deliver some diversification benefits and also allow exposure to the full range of investment opportunities.

Fashion and styleThere are many different ways of investing successfully. Some people try to find shares that have fallen out of favour and the market appears to have undervalued their prospects. A few years ago WM Morrison was a good example of this when it seemed to be struggling after acquiring Safeway. Others prefer to invest in companies that are growing fast. Even though these shares often appear expensive they could still be very profitable for investors if the growth continues. Companies such as Amazon and Google would be good examples of this. There is not a ‘right’ or ‘wrong’ approach here, although history suggests that ‘‘value’’ investors, who focus on picking companies that have been ignored by the wider market in the belief their value will eventually be recognised, have the odds more on their side. Legendary investor Warren Buffet is the most well-known

adherent of value investing. What you will see are periods when a particular style seems to be doing very well while others will be out of favour. It’s tempting then to switch away from the managers who are doing badly and jump on the bandwagon but this is unlikely to be a successful approach compared to investing with a mix of managers who pursue different strategies.


The benefits of collective fundsUnless you have a personal interest in shares and are prepared to allocate a large amount of your time to researching and monitoring them, it will usually make sense to invest via a collective vehicle (or fund) where your money is pooled together with others and invested on your behalf in a number of individual investments. Popular types of funds include OEICs (open-ended investment companies), unit trusts, Investment Trusts or Exchange Traded Funds (ETFs). Each of these will provide you with exposure to a diversified portfolio.

Active versus passiveDo you want to select an actively managed fund that employs a manager to try and beat the market by picking stocks or sectors they believe will perform best, or a passive vehicle that should deliver you with index returns before costs? Opinions vary on the merits of each.

What is indisputable is that many active managers do not manage to beat their benchmarks over long periods of time and this is even more difficult in the most highly researched areas such as large-cap US equities. If you are going to invest in actively managed funds then it is important to be super selective.

Passive investment will provide performance that is similar to the index or market as a whole – though these funds will slightly underperform because they also have charges. Some index funds are much too expensive in our view. If you decide to use ETFs (passive vehicles listed on stock exchanges) then be careful about those that use derivatives rather than actually buying the underlying shares. These are called synthetic ETFs and carry an additional risk of a default by the provider of the derivatives – usually an investment bank.


Selecting fund managersIf you go down the active route you must be very selective as the difference between the best and worst performance can be dramatic: only best of breed managers can justify the higher costs versus passives. Fund manager selection is a highly complex matter. The most obvious approach might appear to be to choose those funds that have performed best in the past from a comparison table but there is overwhelming evidence that this approach does not work. That’s mainly because it’s hard to separate out luck from skill. If you held a contest to find the best person at tossing a coin 10 times to get an outcome of heads and

attracted 1,000 people, the chances are that one person would achieve 10 heads. If he or she was a fund manager they would be judged a genius and be winning awards. Consistency of performance over long time periods is an important factor when selecting an actively managed fund but it takes many, many years for the luck element to diminish.

Therefore most analysis of fund managers focuses more on qualitative factors, such as trying to assess how they make decisions and what gives them an edge over the rest of the market. Bestinvest has been assessing fund managers for more than 20 years and has developed a number of proprietary techniques to help

pick the sheep from the goats. Overall this has helped our clients to perform better than most but please be aware that successful investment is about playing percentages. There are no certainties and there will always be periods when even the very best managers struggle to make money.

Some fund managers have very distinctive styles. Some may have a history of doing relatively well when markets are falling, others have the opposite characteristic. When putting funds together in a portfolio it’s usually a good idea to have a mixture of styles, otherwise you will have to endure poor performance during some market conditions.


BondsBonds are essentially “IOU” notes allowing governments and companies to borrow for relatively long periods of time during which they will pay interest (known as the ‘‘coupon’’) to the bond-holders. Bonds should form a part of most portfolios as a means of diversifying the risk from equities. The most straightfor-ward bonds are fixed interest gilts issued by Governments. These offer a predefined rate of return over a fixed life which can range from a few months to many decades. The longer the duration, the high-er the yield (in most market conditions) but with the higher yield comes much more volatility in capital value.

You can also invest in a type of bond known as index-linked bonds, which offer protection from inflation. This is a very attractive feature and as a result these bonds are valued very highly.

Bonds are also issued by companies (‘‘corporate bonds’’) and various other bodies. These bonds tend to be of a shorter duration than most gilts and their behaviour is influenced by the market’s perception of the riskiness of the borrower and interest rates generally. The bonds issued by companies with the strongest financial health and a high credit rating are known as investment grade. High yield bonds, which used to sometimes be referred to in the US as ‘‘junk bonds’’, are

those issued by companies that are not considered to be investment grade and these tend to behave more like equities. It’s usual to access these types of bonds through a fund. This will provide the ben-efit of professional management to make the selections and will diversify the risk from any defaults. A default is the risk that the company will miss a payment, or not be able to fully pay back the loan at the end.


Investing in propertyCommercial property – such as office blocks, shopping centres and warehouses – has a number of attractions for investors: long leases with high quality tenants should provide good security for rental income and over the long term commercial property should protect against inflation. On the downside it is very illiquid, hard to value accurately and transaction charges for buying and selling buildings are very high (at least 6%). This means that all of the vehicles used for investing in property have some serious downsides.

Real Estate Investment Trusts (REITs) are companies listed on the stock market that invest in property. The price of their shares therefore fluctuates on a daily basis. This means that they perform most of the time in a similar way to other shares, reflecting the ebbs and flows of investor sentiment. However, in the long run they should reflect the performance of the underlying property portfolio.

Some property funds have an open-ended structure so the price is always loosely linked to the underlying asset value. However, it can oscillate by more than 6% from day to day simply depending on whether there are net buyers or sellers of the fund. To provide liquidity for any sellers the fund has to hold a reasonable level of cash, which acts as a drag on long-term returns. At times this cash proportion can rise sharply owing to the delays involved in completing new purchases.


Alternatives – hedge funds, private equity and commoditiesOver the last two decades the asset allocation of many professionally managed portfolios has widened beyond equities, bonds and property to include more esoteric strategies. Bestinvest has been at the forefront of this approach since it offers the prospect of potentially higher returns for a given level of risk but only on a highly selective basis.

The term hedge fund now covers such a wide range of investment strategies that it is virtually meaningless. However, for the purposes of this document we will take it to mean funds that employ a much wider range of trading strategies, designed to achieve positive returns when markets fall as well as when they rise. These are often called Absolute Return funds. Many

of these were extremely successful in the past but in more recent years the picture is much more mixed: during the 2008 credit crisis, the average hedge fund lost 19%. Not only have hedge funds overall failed to deliver very attractive returns, they also now seem to be quite closely correlated to other markets.

Private equity refers to investments in companies that are privately owned and whose shares are not publicly traded on stock exchanges. This can encompass quite large firms, which are backed by private equity finance as well as venture capital which generally targets smaller, younger businesses. As these types of investments are illiquid, it is normal for private equity firms to become involved in the development of the businesses, usually through representation on the Boards.

Commodities is another broad asset class that really includes a number of underlying physical substances with very different characteristics, such as precious metals, minerals, base materials and agricultural crops. Gold is primarily seen as a hedge against the debasement of paper currencies. Oil and industrial metals are mainly sensitive to changes to supply and economic activity, while soft commodities such as wheat and orange juice are influenced by climate. However, the common characteristic among them is that they provide no underlying income return, indeed there is generally a cost attached to ownership (for example storage or insurance etc). So all of the return needs to be generated by increases in value as there is no income.


Important informationPlease remember the value of all investments can go up as well as down. This introduction to investing does not constitute personal advice and if you are in any doubt as to the suitability of an investment please contact one of our advisers. All investments carry risks but we would point out the following:

FundsDifferent investments carry varying levels of risk depending on the geographical region and industry sector to which they are exposed. You should make yourself aware of these specific risks prior to investing The value of all investments and the income from them can go down as well as up, and you can get back less than you originally invested. Past performance or any yields quoted should not be considered reliable indicators of future returns.

BondsBonds issued by major governments and companies are generally considered more stable than those issued by emerging markets or smaller corporate issuers; in the event of an issuer experiencing financial difficulty, there may be a risk to some or all of the capital invested.

Absolute return fundsInvestors should be aware that Absolute Return funds do not guarantee a positive return and you could get back less than you invested, as with any other investment. Additionally, the underlying assets of these funds generally use complex hedging techniques through the use of derivative products, which can carry additional risks which may not be immediately apparent.

CommoditiesFunds which invest in specific sectors may carry more risk than those spread across a number of different sectors. In particular, gold, technology and other focused funds can suffer as the underlying stocks can be more volatile and less liquid.

Property fundsThe property market can be illiquid; consequently, there can be times when investors will be unable to sell their holdings. Property valuations are subjective and a matter of judgement.

Specialist funds Due to their nature, specialist funds can be subject to specific sector risks. Investors should ensure they read all relevant information in order to understand the nature of such investments and the specific risks involved.


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Bestinvest (Brokers) Limited (Reg. No. 2830297) and Bestinvest (Consultants) Limited (Reg. No. 1550116) are both registered in England and are authorised and regulated by the Financial Services Authority. Registered office: 6 Chesterfield Gardens, Mayfair, London W1J 5BQ. 201212-2723

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