The Four Stage Investment Process
Stage 1 – Strategic Asset Allocation
The first stage is the implementation of the Strategic Asset Allocation (the SAA). This is the percentage of equities held for the three main objective-based portfolios, Protect, Enjoy, and Grow. A personalised blend of some, or all, of these portfolios is considered by your adviser in order to meet your investment objectives, risk tolerance and your capacity for loss.
Each of the three main portfolios has a different SAA:
This portfolio is permitted to hold between 10-25% in equities. In addition to equities, it will invest in assets or investment strategies which carry relatively low downside risk as well as produce returns that are expected to exceed inflation over a medium- and longer-term investment horizon.
This portfolio is permitted to hold between 47-66% equities. In addition to equities, it will invest in assets or investment strategies which carry relatively low downside risk as well as produce returns that are expected to exceed inflation over a medium- and longer-term investment horizon.
This portfolio is permitted to hold between 86-100% equities. In addition to equities, it will invest in assets or investment strategies which carry relatively low downside risk as well as produce returns that are expected to exceed inflation over a medium- and longer-term investment horizon.
Stage 2 – Tactical Asset Allocation
The next stage is to add a Tactical Asset Allocation (the TAA) overlay to the portfolios. The TAA is more fluid and revolves around the SAA, permitting the Investment Committee and the portfolio managers to adopt greater or less equity risk across the economic and market cycle, whilst always remaining within the parameters laid down by the SAA. Subject to the conclusions of any given Investment Committee meeting, the models may be rebalanced as appropriate.
Stage 3 – Investment Selection
Our portfolio managers use a rigorous selection criterion to identify funds to use in the portfolios. We blend qualitative and quantitative inputs within our selection methodology, focussing on our “4 Ps” approach: Performance, Process, Potential, and Pedigree.
We all know that past performance is not a guide to the future, but it is a starting point.
When we consider performance, the relevance really comes into play when we consider the next three areas.
We all know that experience is the result of making, and learning from, poor decisions. Therefore, we are always looking for the managers who already have proven experience rather than those that will build their experience with our money. Depth of resource is another factor that we consider alongside experience, but this doesn’t distract us from smaller boutique fund managers whose specialisations can give them unmatched insight into their chosen fields.
Our experience shows that investors who have a set process for investing, can replicate good results. Where a process is used, investment decisions are not reliant on the presence or whims of the person buying or selling. A good process is often one that is regimented but not overly restrictive, permitting the fund management team some license to express themselves within the parameters of good discipline. A consistent approach can usually deliver consistent results.
Therefore, we always look for investment managers or funds that have a strong, replicable process.
Investing in what has done well is fine, but what is more important, is investing in what will do well in the future, which is where potential comes into play. Using market data and a macro-outlook we attempt to ascertain where the market has been, and more importantly, where it is going, and then source funds we believe are best placed to capture future trends and themes.
When considering these funds, we are looking at asset types and investments which are ‘undervalued’ when compared to the rest of the market. These are the types of investment that can increase by much more than the competition
Stage 4 – Ongoing Review
Monitoring the investment performance of each individual fund within the model portfolios is formally observed by the Investment Committee on a quarterly basis, with a full reassessment of the 4 P’s to ensure the rationale for holding any fund is still applicable. Additionally, less formal reviews take place on a daily and weekly basis to ensure any matters arising are dealt with in a timely manner, and we will reassess any fund against stage three anytime it is required.
Our investment philosophy uses objective led investing by looking at the three main things people want to do with their investments:
People who want to protect their capital with small returns over the long term
People who want to find a balance between protection and growth
People who want to grow their investments over the long term
We enable investors to combine these objectives into our blended portfolios to help them achieve their overall goals with their investments.
In addition to equities, it will invest in assets or investment strategies which carry relatively low downside risk as well as returns that, as part of the overall portfolio, are expected to exceed inflation over a medium- and longer-term investment horizon.
Seeks to provide long term capital growth. The fund will endeavour to achieve its objective whilst displaying lower volatility than global equity markets.
Seeks to provide long term capital growth. The fund will endeavour to achieve its objective whilst displaying similar volatility to global equity markets.
Strategic Asset Allocation
The first stage of the investment process is the implementation of the Strategic Asset Allocation (SAA). This is decided by the Investment Committee and reflects the long-term objectives of the portfolios.
Each of the base three portfolios has a different Strategic Asset Allocation:
This portfolio is permitted to hold between 10-25% in equities. In addition to equities, it will invest in assets or investment strategies which carry relatively low downside risk as well as returns that, as part of the overall portfolio, are expected to exceed inflation over a medium- and longer-term investment horizon.
This portfolio is permitted to hold between 47-66% in equities. In addition to equities, it will invest in assets or investment strategies which carry relatively low downside risk as well as returns that, as part of the overall portfolio, are expected to exceed inflation over a medium- and longer-term investment horizon.
This portfolio is permitted to hold between 86-100% in equities. In addition to equities, it will invest in assets or investment strategies which carry relatively low downside risk as well as returns that, as part of the overall portfolio, are expected to exceed inflation over a medium- and longer-term investment horizon.
The Strategic Asset Allocation is the same for all Trust DFM portfolio ranges.
Tactical Asset Allocation
The next stage in the investment process is the Tactical Asset Allocation (TAA) overlay. The TAA is more fluid and revolves around the SAA, permitting the Investment Committee and the portfolio managers to adopt greater or less equity risk at certain points in the economic and market cycles.
These market views are supported by use of Tyndall Compass which analyses equity market valuations to give a positive, neutral, or negative sentiment depending on the market valuations today versus historic valuations. Tyndall Compass also analyses sector valuations to give them a sentiment view which the Investment Committee can use to view thematic investments.
These market sentiments are used to determine the allocation weightings to each region for each of the portfolios, with the Investment Committee given the decision on whether to carry an over, neutral or under-weight allocation in each market.
The fund selection stage uses the Four P’s principles:
Observing the past performance, after charges, of a fund against its benchmark over a selection of short, medium and longer-term time frames often highlights funds that have robust and repeatable processes that deliver outcomes that add value.
Consistent, rather than unpredictable performance, often shows the quality of the fund management team despite understanding that past performance does not indicate future returns.
Understanding how a fund manager ends up with the portfolio that they have, and to ascertain if it is both successful and repeatable.
A good process is one that is regimented but not overly restrictive, permitting the fund management team some license to express themselves within the parameters of good discipline.
To ensure models are progressive and not solely backward looking, Trust DFM uses inputs from Tyndall Compass to ascertain where the market has been and where it is going. They then source funds which are best placed to capture future trends and themes.
Looking at the fund management team and their experience gives a view on their approach to environmental, social and governance factors, how the team is renumerated and their passion regarding their area of expertise.
Each portfolio range has a buy list for each of the different markets and as appropriate, underlying thematic sectors. The funds on the buy list go through the same fund selection process and are regularly reviewed to determine whether any material changes have taken place within the 4 P’s, which may make an alternative fund more appropriate for the portfolios than the existing fund.
Funds on the buy list may not currently feature in the portfolios, but allow for a fund to be ready and available should the Investment Committee decide that a fund substitution is appropriate.
Monitoring the portfolio performance and the performance of each constituent fund is formally observed by the Investment Committee on a quarterly basis. Less formal reviews are done on a daily and weekly basis to ensure matters are looked at and dealt with in a timely manner.
The Investment Committee meets three times a quarter to address in detail:
The Asset Allocation meeting is where the Investment Committee will consider the current market and economic climate and with input from Tyndall Compass, implement the new Tactical Asset Allocation for the next quarter.
The Investment Committee uses this meeting to assess the current funds that the portfolios are invested in and review their performance and volatility. The Committee also uses this meeting to review funds which are being added to the buy list.
This meeting is for the Investment Committee to evaluate the performance of the portfolios from the last quarter and review whether the decisions that had been made have benefitted the portfolios.
Changes can be made to the portfolios at any time at the discretion of the Investment Committee. Any changes issued by the Investment Committee are sent to the operations team for implementation. The operations team have discretion to implement these changes in the most effective way on each platform that the portfolios are active on, unless the instruction from the Investment Committee specifically instructs the method of implementation.
Rebalancing is at the discretion of the Investment Committee, however, there are some differences in how platforms allow changes to be implemented. Where a platform requires a rebalance to implement any change instructions, the operations team has discretion to rebalance on that platform to implement that change.
Where a full rebalance is required, the Investment Committee will send a request detailing which portfolios are to be rebalanced across all platforms.
The Investment Committee decides and implements the most appropriate portfolio benchmark(s). The current benchmarks for the portfolios are the Personal Investment Management & Financial Advice (PIMFA) Equity Risk benchmarks:
PIMFA Equity Risk 1
PIMFA Equity Risk 3
PIMFA Equity Risk 5
The benchmarks were chosen due to their alignment to the current Strategic Asset Allocation equity allocations. The benchmarks being used are regularly reviewed by the Investment Committee to ensure their continued suitability.
The Investment Committee relies largely on proprietary research including but not limited to fund manager meetings and engagement on a regular basis. Tyndall Compass operates as the framework for the asset allocation and Investment Committee discussions which is classified as paid for research.
Guide to Sustainable Investing at Trust DFM
What makes a sustainable investment?
A sustainable investment is defined under the EU Sustainable Finance Disclosure Regulation (SFDR) as one that either promotes Environmental, Social and Governance (ESG) characteristics (Article 8, “Light Green”), or, one that contributes to an environmental and/or social objective, and which does no significant harm to any other social or environmental objective (Article 9, “Dark Green”).
What that means in practice is that properly sustainable investments generally avoid harm and seek to improve outcomes either for the environment or for society.
Some of the funds that we select go even further. They aim to encourage companies (through the vote that comes with owning shares) to improve on their impact on the environment and drive forward change.
How does that differ from a typical investment?
Exposure to sustainable themes
No company is 100% sustainable and a portfolio of companies is even less so. But the best sustainable funds separate out their exposure to sustainable themes so that we can identify exactly which theme our money is allocated to. A typical theme would be improving the efficiency of energy use or delivering a circular materials economy. But there are many more, and the best funds have an exposure to multiple themes.
Technology driving change
Technology has the power to dramatically change processes for the better. We need to design waste out of our economy and reuse more of what we already have.
As technology companies are vital to our goals of decarbonising and increasing the circular economy, a typical sustainable fund will have a higher exposure to technology than a standard fund. Technology company shares can be volatile in price. That means volatility in sustainable investing comes with the territory.
The damage wreaked by releasing carbon into the atmosphere means that we require fund managers to have a fossil fuel exclusion policy or commit to not investing in fossil fuels. Whilst there is much debate about encouraging oil and gas companies to make the transition to renewable energy, we have chosen to avoid them altogether. Other harmful products, such as tobacco or armaments are also excluded.
In equity funds, these exclusions mean we are not able to invest in up to 40% of any equity index, but for a bond fund to be truly sustainable that number is much higher. They must exclude up to 90% of the index, which means there are times when we will perform very differently from the typical benchmarks, such as the FTSE 100.
This difference will seem very extreme when oil and gas companies, or tobacco and weapons manufacturers are doing well. We will never participate in this and have to sit on our hands whilst it happens. The market activity during the first half of 2022 is a prime example of this key differentiation.
The best way to influence company behaviour and drive change is to use the vote that comes with being a shareholder. Your portfolios will typically be at the top end of the equity range so that we can harness that vote. Bond markets are less convincingly sustainable due to the large amount of private company debt and exposure to government bonds. This adds up to a preference for equities in the portfolios.
While equities carry greater risk than bonds, they also carry greater potential for reward. They can provide the opportunity to have our voices heard at the very top of the corporate ladder, resulting in a bigger impact overall.
Medium sized bias
Solutions to the challenges ahead are often found in nimble, innovative companies which tend to be smaller than those which dominate the top global indices, such as the FTSE 100 in the UK or the S&P 500 in the US.
There is a great deal of research which shows that medium and smaller sized companies do well over the long term, but they can be more volatile at times of stress. Stressors could include rising interest rates or poor liquidity, such as when an economy is heading into a recession.
This bias towards medium and smaller sized companies means that the portfolios will be more volatile than a standard portfolio. Therefore, it is more likely you’ll to see a lot of variation in performance in the short term. This does not detract from the potential to deliver good returns over the long term.
Sensitivity to interest rates
Most sustainable companies themselves are no more sensitive to interest rates than standard companies. In fact, with smaller carbon footprints they have fewer buildings and factories to finance so may even be slightly better off. However, their growth potential lies in future demand for climate change and other solutions as we transition to a net zero economy. That is a multi-decade process. Whilst some ambitious net zero targets go out to 2030, the vast majority are out to 2050.
Sustainable companies which are focussed on environmental solutions have a huge demand profile, but because it is often strongest in the future, the shares of these companies are extremely sensitive to the interest rate used to forecast their future value. At times of interest rate change or uncertainty this can create significant volatility as markets anticipate the moves. Once the moves have happened, investors start to focus on the growth rates once more. But for a short while this can lead to sustainable investments doing badly compared with standard investments.
A typical standard fund will have what is known as a “home bias”. That means that a substantial percentage of investments will be in the home market. Climate change knows no geographical boundaries and the next solution is as likely to come from Mumbai as it is to come from Manchester. European companies are at the forefront of climate change solutions thanks to a tough regulatory environment set by the EU. Sustainable portfolios tend to be global and have more in Europe and less in the UK than a typical fund.
All this adds up to a strong long-term outlook as sustainable funds invest in companies which are providing future solutions and driving change. But it means that there will be times when performance is hit by some, or all, of the above stressors and funds will experience elevated levels of volatility and possibly lower than average performance during those periods. For any investor in sustainable investments, it’s important to understand these vital differences.
We hope you have enjoyed our guide to sustainable investing at Trust DFM and if you have any more questions before you make your decision about whether to invest in the Sustainability range, please get in touch with your adviser and we will be delighted to answer them.
ESG Investing and The Attenborough Scale®
You may have come across the term ‘greenwashing’ in the news or articles relating to ESG investments. Greenwashing is the process by which people design products to look ‘green’ or ‘sustainable’ when they are really doing nothing different to what they have done before. Effectively using the term ESG as a smoke screen for a lack of action when it comes to investments that protect rather than harm the planet.
The financial services sector can act as a force for good in this area, where institutions large and small can use their business decisions, their innovation and their voice, to encourage positive change. But when firms undermine the confidence of the public in this way, it leads them to question the integrity of all the great work that is really being done. To help prevent this in the future, the Financial Conduct Authority (FCA) issued an open warning in July 2021 to investment management firms on ‘greenwashing’, and they are also developing a clear set of guidelines for ESG investing in the coming months and years.
But we don’t want to wait to start making an impact, and so we’ve sought out our own guidelines and identified the principles that we want to uphold when we’re investing, with a view to improving what we can in the world and society around us. We’ve identified the European Union (EU) financial regulation known as the Sustainable Finance Disclosure Regulation (SFDR), Articles 8 and 9, as the measurement of what ESG will mean to us. in addition, the work of the widely respected broadcaster, biologist, natural historian and author David Attenborough and the innovative economist Kate Raworth will provide our guiding principles.
SFDR Article 8
For an investment to qualify as an Article 8 investment it must go past ESG, to become what you might think of as ESG Plus! It focuses on minimum standards of governance and promoting positive environmental and social characteristics.
This is reasonably easy to achieve and many funds that you can buy meet this Article 8 level, simply because it is based more on lower levels of accountability.
This has commonly become known as ‘Light Green’.
SFDR Article 9
Article 9 is where real change happens. It is not about what you are going to do, or aspire to do, but what you are actually doing. Sustainable investing is an objective for Article 9 funds and investments must be assessed against the “do no significant harm principle.” The principle is defined as ensuring that activities make a substantial contribution to climate change improvement or mitigation and do not cause harm in other environmental areas. This type of investing has come to be called ‘Dark Green’.
No company is 100% sustainable, indeed it is difficult to achieve sustainability in business. No fund can be fully sustainable either but, by considering these issues, fund managers of Article 9 funds are required to take these issues into account thereby helping to drive change. And we as investors can hold them to account for their decisions.
Attenborough and Raworth
In his book ‘A Life on our Planet’ David Attenborough says:
“In a sustainable world…our banks and pension funds would only invest in sustainable businesses’
He believes that there needs to be focus on five separate areas to make a real difference:
- Control of population growth
- The use of renewable energy
- Focusing on re-wilding the planet
- Reducing and reversing deforestation
- Moving to a plant-based diet
- This seems straight forward in practice, but how do we implement these things when developing your investment portfolio?
Fortunately, someone has already done a great deal of detailed work for us, and this is discussed in part three of Attenborough’s book.
Kate Raworth is an economist at Oxford University’s Environmental Change Institute who has designed a structure that promotes and supports Attenborough’s five principles. The structure is called Doughnut Economics and she can be seen presenting it at TED. You can watch that presentation by going to this link:
In Raworth’s work and in her excellent book ‘Doughnut Economics: seven ways to think like a 21st century economist’ she covers nine areas that we need to focus on to support everyone in the global society and protect the planet that we all rely on to exist.
Copyright © Kate Raworth 2017
In this simple diagram you can see the nine areas of focus, with the inner green circle representing the minimum level that supports society and the outer green circle being the maximum level that protects the planet.
The objective is to focus on these nine areas and invest in a way to meet the Article 9 (Dark Green) requirements. Not all the areas are possible to invest in, but if we can achieve just some of this it will have a real impact on the world.
In building a range of sustainable portfolios we focus on Dark Green investments. Going forward, we will only add investments that are Light Green (Article 8) if there is no credible Dark Green alternative.
The result of this is that we will, by default, be investing in many funds that do not have much of a track record, simply because many of these companies and businesses did not exist five, or even three years ago. So, when it comes to our “4 Ps” approach, we know that there will be very few investments that can give a similar level of “pedigree” to those we would use within our Core range, but we must accept this for the time being to meet our sustainability goals. Of course, over time, the pedigree of these types of investments will build, so we know this is only a short-term compromise.
When we say that the past is not necessarily a guide to the future; in this instance it is no guide to the future. We believe that investing in this way will, over a five-year period outperform ‘standard’ investments. However, there is no documentation to prove this.
There is no promise that we can make to you. There is no historic information to go on. When investing in this Dark Green way, you are investing because the protection of the planet is one of your key investment objectives. This may or may not produce better results. Only time will tell.
The Attenborough Scale®
If you want to invest in portfolios that have sustainability (as defined by the SFDR) at their core, then our Trust DFM Sustainability range could be the right choice for you. You may not be ready to invest 100% into this range right now, perhaps because of your own circumstances, or perhaps because of the short track record of the type of investments that we’re using. So we’ve introduced a way to make the transition to the ‘Dark Green’ investment style easier.
Investing anything from 10% to 100% of your assets is possible, the choice is yours, and we call this style of mixing the standard and sustainability range of investments, ‘The Attenborough Scale®.’
You decide how far up the scale you want to go, and we combine the portfolios for you so that they represent a level of engagement with ethical investing that feels right for you, and still meets your investment objectives and appropriate levels of risk and volatility.
The investments will still be actively managed day to day. The only difference is the actual investments that are used, which may perform very differently because of their sustainable characteristics.