A Swallow Financial Planning Explanation of How to Invest for the Best Returns

1. An Explanation Of
How To Invest For The Best Returns
16/01/2013 Investment Presentation 1/18

2. Within this presentation we will Explain:
• Why we believe clients should invest in asset backed investments if they want the best long term returns.
• Why some asset classes tend to outperform others.
• Why we believe it is essential to diversify your investments.
• Why risk and return are always related and why we believe it is imperative to keep within your comfort zone.
• We will show that “risk” reduces over time and we will explain why we prefer passive funds.
16/01/2013 Investment Presentation 2/18

3. Preamble
Throughout these notes we have tried wherever possible to use 20 years of data, starting in November 1992 and
finishing in November 2012.
In November 1992:
• Inflation was standing at 3.02%
• Bank base rate was at 6.88%
• The FTSE 100 was at 2,759
In November 2012:
• Inflation is at 2.98%
• Bank base rate is at 0.5%
• The FTSE 100 is at 5,867
Back in 1992 if you used 10 year GILTS to generate £10,000 of income you would need (ignoring costs) £120,192. To
achieve the same income using 10 year GILT yields in November 2012 you would need £502,513. This is equivalent to
an annualised growth rate of 7.41%. Had the FTSE 100 grown by the same sum it would now be at 11,500.
(Bank of England, FTSE and Wren Research statistics).
16/01/2013 Investment Presentation 3/18

4. Why Invest in Assets Rather Than Cash?
Over the longer term assets tend to perform better than cash or inflation:
Asset Growth November 1992 to November 2012
900%
800%
FTSE 100
700%
International Equities
Total Growth
600%
Emerging Markets
500%
Property
400%
Global Bonds
300%
Cash
200%
RPI
100%
0%
Year
16/01/2013 Investment Presentation 4/18

5. Are Some Asset Classes More Volatile (Risky) Than Others?
Standard Deviation Chart November 1992 - November 2012
12%
10%
FTSE 100
Annualised Return
UK Small
8%
International Equities
6% Emerging Markets
Property
4%
Global Bonds
Cash
2%
0%
0% 5% 10% 15% 20% 25% 30% 35%
Annualised Standard Deviation
So UK Small has an average return above 10% but in any one year this varies between
-13.2% and + 33.6%. Cash averages at 4.4% but in any one year this varies between 2.2% and 6.6%.
16/01/2013 Investment Presentation 5/18

6. Asset Classes Tend to Outperform At Different Times
Empirical evidence has shown that if you combine asset classes the end result is greater than that of the composite parts. By
choosing uncorrelated assets you can achieve reasonable returns in most markets as when some assets are going
down, others normally rise.
12/1992 to 11/2012
A correlation of 1.0 indicates a perfect association, a correlation of 0 indicates no relation & a correlation of -1.0 is a perfect
disassociation
16/01/2013 Investment Presentation 6/18

7. Different Asset Classes For Different Risks
At Swallow Financial Planning we categorise clients into one of 7 risk categories. These are based on your FinaMetrica score
(1 to 100). If you want to know how we do this, please refer to our Risk Profile notes.
Investment Investor FIXED/ CASH PROPERTY EQUITIES TOTAL
option Type
UK Intl UK Intl UK International
Core Value Small Main Emerging
Markets Markets
1 Wary 90.00% 10.00% - 100.00%
2 Cautious 60.00% 15.00% 10.00% 5.00% 10.00% - 100.00%
3 Prudent 30.00% 20.00% 15.00% 5.00% 15.00% 5.00% 10.00% 100.00%
4 Balanced 15.00% 10.00% 15.00% 10.00% 15.00% 5.00% 5.00% 20.00% 5.00% 100.00%
5 Adventurous 5.00% 5.00% 15.00% 5.00% 20.00% 10.00% 5.00% 27.50% 7.50% 100.00%
6 Speculative - - 10.00% 5.00% 23.00% 10.00% 10.00% 27.00% 15.00% 100.00%
7 High Risk - 10.00% 20.00% 20.00% 30.00% 20.00% 100.00%
So the most cautious investor (i.e. with a FinaMetrica score of less than 20) is the wary one. On the other hand, the high risk
investor (with a score of 90 +) is “Gung Ho”. holding the most volatile assets.
16/01/2013 Investment Presentation 7/18

8. Combining Assets Creates Better Returns With Reduced Volatility
High Risk Portfolio v Asset Class November 1992 to November 2012
700%
600%
500% High Risk
Total Growth
FTSE 100
400%
UK Value
UK Small
300%
International Equities
200% Emerging Markets
100%
0%
Year
The High Risk portfolio contains the other asset classes but has beaten all but UK Value and UK Small
whilst generating far less volatile returns (total return over 20 years: 466%)
16/01/2013 Investment Presentation 8/18

9. Combining Assets Creates Better Returns With Reduced Volatility
Prudent Portfolio v Asset Class November 1992 to November 2012
900%
800%
700%
Prudent
600%
Total Growth
Global Bonds
500% Property
400% FTSE 100
UK Value
300%
International Equities
200%
100%
0%
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Year
Again the Prudent portfolio contains the other asset classes but has beaten all but Property and UK Value
whilst generating far less volatile returns. (total return over 20 years: 340%)
16/01/2013 Investment Presentation 9/18

10. Different Asset Classes Reduce Risk
Risk, in investment terms, is usually different from what a lay person considers as risk. Most lay people consider a risk as the
risk of losing the physical value of their money. In investment terms is not the physical risk to the initial capital value, but
rather it is the risk the investment will perform better or worse than expected. This is also called the standard deviation to the
norm. If we look at the returns for the above asset classes over 20 years we have a table as follows:
As you can see, the use of a mixture of assets overall generates better returns at lower risk than does an equivalent asset
class.
16/01/2013 Investment Presentation 10/18

11. Better returns mean higher volatility
Highest and Lowest returns, Swallow Portfolios November 1992 to November 2012
50.00%
45.00%
40.00%
35.00%
30.00%
25.00%
20.00%
15.00% Highest
Return
10.00%
5.00% Lowest
-
( 5.00%) Average
( 10.00%)
( 15.00%)
( 20.00%)
( 25.00%)
( 30.00%)
( 35.00%)
( 40.00%)
Wary
High Risk
Cautious
Balanced
Prudent
Adventurous
Speculative
Portfolio
Wary has an average return of 4.8% with a best return of 8.6% and a worst return of 0.9%, whereas Speculative has an
average return of 10.2% however its best return was 36% and it’s worst return in a year was -35%. If you don’t like the
risk, choose a lower long term return.
16/01/2013 Investment Presentation 11/18

12. The Longer The Term The More Certain The Return
If you look at the best and worst returns from a selection of our recommended portfolios you see the following:
Best / Worst Returns
Annual: 12/1992 - 11/2012; Default Currency: GBP
Wary Prudent Balanced High Risk
If you don’t need your money for 10+ years you can affird to take more risk knowing the return is more likely to be as
expected.
16/01/2013 Investment Presentation 12/18

13. Passive Funds Will Generate Better Returns
We explain our approach to investments in “Our Approach to Investment Management” notes. In brief, we believe investment
returns in the future will (on average) reflect the inflation rate. If Inflation is low then an average passive fund with charges of
1% is bound to out perform an average managed fund with charges of 2.5%.
Active Versus Passive Investment: The Effect of Charges
£30,000
£25,000
No charges
Value
£20,000 Passive
Active
£15,000
£10,000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
Years
£10,000 at a gross annual return of 5% over 20 years will grow to £26,500 with no charges, £21,911 in a passive fund or
£16,386 in an active fund meaning the active fund has to grow by 30% better than the index just to keep pace with it.
16/01/2013 Investment Presentation 13/18

14. Managed Funds Do Not Beat The Index
Sector Total Number of Funds producing above average returns for:
Funds
31st December 3 consecutive years 5 consecutive years
2007
Funds % Funds %
UK All Companies 346 38 10.98% 13 3.76%
UK Corporate Bond 121 15 12.40% 5 4.13%
North America 90 10 11.11% 1 1.11%
Europe (x UK ) 110 14 12.73% 3 2.73%
Pacific (x Japan ) 75 13 17.33% 2 2.67%
Japan 63 3 4.76% 0 -
(Source: Lipper Hindsight growth total return, default tax rate, in £ to 31/12/2007)
This schedule indicates the percentages of funds over 5 years which generate above average performances. With less than 5% of
managed funds achieving a consistent return better than average, why take the risk?
16/01/2013 Investment Presentation 14/18

15. Do Not Time The Market!
FTSE 100 UK Value UK Small International Equities Emerging Markets Property Global Bonds Cash
The Graham and Campbell study of 237 market timing newsletters showed that less than 25% of the “experts” predicted the
right outcome once, let alone consistently. If we cannot get the asset timing right, we believe clients should remain invested
in their optimum asset classes.
16/01/2013 Investment Presentation 15/18

16. Summary
Within this presentation we have tried to show in graphical form why we believe clients should have a diverse range of
investments set up according to how much they are prepared to see the capital value of their investments fluctuate in the short
term. We have also tried to explain why you should choose different sectors of the market which may well perform better than
others over the longer term. Finally we have touched on our reasons for using passive rather than active fund managers.
So looking forward, what might the circumstances we find ourselves in now suggest that the next 20 years might bring? Well
firstly fixed interest rate investments can only go one way. If the underlying interest rates now are effectively 0%, then the yield
over the next 20 years can only go up (as most institutions and individuals will not want to pay people to hold your money it
seems unlikely that interest rates will go significantly into the negative!). If yields go up, the capital value of fixed interest
securities (i.e. Government gilts and corporate bonds) will fall.
One could also argue that the long term outlook for commercial property is also somewhat subdued. If interest rates do rise
then there will be some narrowing of the very wide risk margins we see now (typically yield to value are in the region 8% to
10% at present) but eventually the capital values will fall. Against this, however, there is the influence of new build costs to
consider so there is always an element of inflation proofing over the longer term.
The value of an equity is the value of its dividends over the life of the share, so if the outlook for certain markets is uncertain
(i.e. the gradual lowering of western standards of living in comparison with those in developing countries) then one needs to be
circumspect over where one invests on a macro level at least.
But no one know what is going to happen! One thing we can be certain of is that if you want your investments to keep up with
and hopefully beat inflation you will have to accept risk.
Andrew Swallow January 2013.
16/01/2013 Investment Presentation 16/18

17. Disclosure and Fund Information
The graphs and schedules within this presentation would not have been possible without access to the Dimensional Fund Advisors Ltd back tested
database of funds. The funds we have used were somewhat restricted due to the desire to show 20 years performance (many indices are only 5 to 10
years old). The specific indices we have used are:
Citigroup World Government Bond Index 1-30+ Years (hedged)
Dimensional Global Short-Dated Bond Index (gross of fees, hedged in )
Dimensional Small Cap Index
Dimensional Value Index
FTSE 100 Index
FTSE All-Share Index
MSCI Emerging Markets Index (gross div.)
MSCI World ex UK Index (gross div.)
S&P Global Property Index (gross div.)
S&P Global REIT Index (gross div.)
One-Month Treasury Bills
Retail Price Index
In addition we have used Bank of England data concerning interest rates and related issues. Wherever possible we have included dividend income in
the returns so as to compare all investments on a like for like basis.
•We have taken no account of charges (except in our comments re active fund managers) although clearly charges have a major effect on long term
performance.
•We have taken no account of taxation within our figures. At present in the UK capital gains tax is at a maximum of 28% and income tax is at a
maximum of 62%. This makes a colossal difference to the end return on your investments.
•Performance data shown represents past performance. Past performance is no guarantee of future results and current performance may be higher or
lower than the performance shown.
And finally, whilst we have tried our best to ensure that we have presented you with an accurate and well reasoned presentation any advice we give to
clients must be client specific and not of a generalised nature. E.&.O.E.
16/01/2013 Investment Presentation 17/18