Objectives of the Club’s investment strategy are (not necessarily in priority order):-
a. To Make Money through investment
a.1 to beat the FTSE 100…….
a.2 whilst sensibly protecting against significant losses……
a.3 yet having opportunity to speculate and make significant gains
b. To Learn
b.1 about a variety of sectors (e.g. IT, Transport, Construction, etc.)
b.2 about a variety of investment products (e.g. Shares, Warrants, Bonds, Options, etc.)
b.3 about a variety of markets (e.g. FTSE, Aim, Ofex, Overseas, etc.)
c. To Have Fun
c.1 being a member of the Club
c.2 at Club meetings
c.3 especially where this also aids learning (e.g. fantasy portfolio) or can make money (e.g. entering competitions)
Overall target is to beat the FTSE 100 on a year-on-year basis.
Investments should not be purchased without an expectation of a future sale.
There is no pre-determined wind-up date for the Club.
Investment decisions are to be based on different types of analysis such that the Club’s overall portfolio is comprised of three sub-portfolios; each sub-portfolio having a different strategy, different objectives and different analytical approach. The detailed approach to be used in each of the three sub-portfolios is set out later in this document but can be summarised as follows:-
· Sub-portfolio 1 : Speculative Investment Portfolio
· Analysis based on identification of speculative selections that could make quick and/or very significant returns on investment and/or assist in the Club’s education
· Sub-portfolio 2 : Fundamental Investment Portfolio
· Analysis based on examination of company fundamentals, appreciation of business area and recognition of growth opportunities or intrinsic value
· Sub-portfolio 3 : Mechanical Investment Portfolio
· Analysis based on unemotional, mechanical application of clearly defined selection criteria to identify investments that are sound and relatively defensive yet which are still capable of capital growth and provision of income
· Technical analysis can be used as an aid to prioritising between candidates for purchase should multiple candidate investments be considered and it not be possible/appropriate to purchase all candidates at once.
The primary investment vehicle for the Club shall be shares in common stock as tradable on the FTSE market but no investment vehicle available through the Club’s broker is specifically excluded.
Trading should be such that holding periods are expected to be longer than 2 months (i.e. short term “day trading” is not within the Strategy of the Club)
The Club’s overall portfolio should be managed to be within the following thresholds:
· Composition by sub-portfolio
· 0-25% in Speculative portfolio (calculated as cost of holdings / Club asset value)
· 25-50% in Fundamental portfolio (calculated as value of holdings / Club asset value)
· 40-70% in Mechanical portfolio (calculated as value of holdings / Club asset value)
· 0-25% in cash (excluding cash that is considered part of the Mechanical sub-portfolio)
· Composition by Sector
·
At least 75% of total net
assets should be in common
· No more than 40% of invested assets should be in any one sector, where the sector is determined from www.digitallook.com, other reliable source, or as agreed otherwise by a majority of club members
· No more than 20% of invested assets should be in any one stock
Approximately £300 or 1% of net asset value (whichever lower) should be allocated annually to cover furthering learning (e.g. magazines, software, data feeds, seminars, etc.)
Approximately £300 or 1% of net asset value (whichever lower) should be allocated annually to cover “fun” (e.g. internal prizes for competitions, Club meals, etc.)
Trading amounts should be such that dealing costs in any one trade (buy or sell) are less than 3%.
Should there be a rights issue for one of the companies held then there should be a vote by the Club to decide whether or not to take up the offer. Default position is not to take up the offer.
In order to provide the opportunity for a return on the Club’s cash balance, the cash should be managed as follows:-
· Up to two tradable funds (such as Investment Trusts) and one tradable debt (such as a Government bond) to be considered as temporary investment vehicles
· Specific temporary investment vehicles for consideration to be proposed via Buy Proposals with key selection criteria being low capital risk and probability of an overall return higher than placing cash on deposit
· No more than 10% of total club net assets to be assigned to any single temporary investment vehicle
· Between 5% and 10% of total club net assets to be held as uninvested cash
· Decisions on when funds should be transferred to/from temporary investment vehicles, and how much should be transferred, to be made by majority agreement of club members
· Trading amounts for the temporary investment vehicles to be such that transaction charges for “round trip” (i.e. buy and sell) are no more than 2%
Risks are controlled primarily by diversification of the investments across the sub-portfolios as per the compositions defined in section 5 above.
This balance will be monitored on a monthly basis as part of each Club meeting.
If the thresholds defined above are breached then the Club should discuss how and when to rebalance the portfolio within the overall objectives.
How the three sub-portfolios and the shares within those portfolios are monitored will be defined in the Strategy of the appropriate sub-portfolio later in this document.
An investment can only be purchased for the Club if it clearly satisfies the Entry Strategy for one or other of the three sub-portfolios (see later in this document).
An investment will be sold by the Club if it clearly satisfies the Exit Strategy for the sub-portfolio that the investment belongs to (see later in this document).
Where Exit criteria are defined and subsequently met, they provide a mandate to sell with no further discussion being necessary.
The Club will review the Investment Strategy at least annually.
Objectives of the Strategy for the Mechanical Sub-portfolio are (not necessarily in priority order):-
a) to achieve an average annual rate of return on investment across the portfolio that beat the FTSE 100
b) to provide a reasonable level of “safety” so that the risks of significant losses within the portfolio are small
c) to have a selection mechanism that is explicit, unambiguous, clearly understood and repeatable
d) to provide a means of regular (though not necessarily frequent) share trading so that the Club’s overall portfolio maintains interest
e) to have a mix of “value” investments and “growth” investments
Overall target is to beat the FTSE 100 on a year-on-year basis.
Investments will be purchased with clearly defined exit criteria that will typically result in the share being sold after 1 year – see section 10.8 below.
Analysis based on unemotional, mechanical application of clearly defined selection criteria based on company fundamentals in order to identify investments that are sound and defensive yet which are still capable of capital growth and provision of income.
Technical analysis can be used as an aid to prioritising between candidates for purchase should multiple candidate investments be considered and it not be possible/appropriate to purchase all candidates at once – see section 10.7 below.
The investment vehicle for the Mechanical sub-portfolio shall be shares in common stock as tradable on the FTSE market.
The sub-portfolio should be managed to comprise 12 holdings each purchased 1 month apart and each held for approximately 1 year (see section 10.8 below). When the portfolio is “full” this will mean that every month will typically involve the sale of an existing holding and the purchase of a replacement.
The Mechanical sub-portfolio should be managed such that each holding represents approximately the same proportion of the sub-portfolio’s value. That is, the sub-portfolio should be balanced in terms of relative weightings of holdings.
Trading amounts will vary depending on the total value of the sub-portfolio so there will occasionally be a cash-balance associated with this sub-portfolio. This mechanical cash needs to be clearly distinguishable from the overall cash of the Club.
The most appropriate method for maintaining some form of balance across holdings will be in setting the cost of purchase of each holding by following the steps below.
1. Complete the sale of any holdings that satisfy the exit criteria this month
2. Calculate the total value of the sub-portfolio after completion of any sales
3. Calculate the optimal cost of next purchase as being one twelfth of the sub-portfolio’s value (as the aim is to have twelve holdings within this sub-portfolio)
4. Calculate the available cash by dividing the mechanical portfolio’s cash balance by the number of ‘gaps’ in the portfolio (i.e. 12 – current number of holdings)
5. Purchase the number of shares that would make the cost equal to the optimal value (from step 3 above) or the available cash (from step 4 above) whichever is the lower
All dividends paid from mechanically selected holdings should be incorporated into the mechanical sub-portfolio’s own cash balance.
Trading amounts should be such that dealing costs in any one trade (buy or sell) are less than 3%.
Should there be a takeover bid for one of the companies held in the mechanical portfolio then there should be a vote held by the Club to decide whether to sell or to hold. Should the decision be taken (or the takeover force the action) to sell the shares, then the resulting cash should simply be added to the mechanical portfolio’s cash. A replacement stock should be selected at the next Club meeting.
Risks are controlled by combination of the Entry Criteria (see section 10.7 below) and the balancing of the holdings as described in section 10.5 above.
An investment can only be purchased for the Mechanical sub-portfolio if it clearly satisfies the Entry Criteria set out in the Appendices to this document. Appendix A sets out the mechanical entry criteria for “value” based investments and Appendix B sets out the criteria for “growth” based investments.
The selection criteria used will alternate each month between value and growth criteria.
The appropriate mechanical criteria should be applied to identify candidate stocks prior to each Club meeting with a view to the Club meeting ratifying the selection, and the purchase being made at the earliest opportunity following the meeting.
In the event of no suitable share being mechanically selected in a particular month, then the criteria should be re-run the next month and purchases made as appropriate. If this re-run still does not identify a suitable candidate, then a formal review of the mechanical Entry Criteria must be conducted at the next Club meeting.
On purchasing shares, a ‘target price’ will be set as 150% of purchase price. A trailing stop loss threshold of 15% of purchase price will also be set in pence for the holding. An investment will be sold from the Mechanical sub-portfolio when it has been held for 12 months UNLESS it has passed through the target price within the 12 month period but not yet fallen back by its predefined trailing stop loss pence amount. In this latter situation, the stock will be held until the trailing stop loss is breached. If a share is bought after a particular monthly meeting, then the above exit criteria will be applied at the corresponding monthly meeting of the following year.
It is possible that a holding may be due to be sold yet may also have been selected via the Entry Strategy. If this is the case then, to save on trading costs, the stock should be held for an additional year. The downside of this approach is that the opportunity for re-balancing the sub-portfolio is lost (see section 10.5 above). It will be acceptable to purchase additional shares or sell part of the holding for balancing purposes only if the dealing costs associated with any such trade are less than 3% of the total cost of the trade.
It is possible that a holding is subject to a takeover and that this may create an unplanned “vacancy” within the portfolio. Any holding in this situation should be considered held (i.e. not a vacancy) whilst it is still shown as a holding in the Treasurer’s monthly valuation report.
Objectives of the Strategy for the Fundamental Sub-portfolio are (not necessarily in priority order):-
a) To achieve an average annual rate of return on investment across the portfolio that beats the FTSE 100
b) To protect against significant losses and to increase market knowledge by contributing to the Club’s overall diversification across sectors
Overall target is to beat FTSE 100 on a year-on-year basis.
Investments should be purchased with an expectation of holding beyond 12 months.
No specific, single approach to identifying candidates for the Fundamental sub-portfolio is suggested but a formal buy proposal must be completed and it must be possible to explain what provoked the initial interest in the candidate.
The primary investment vehicle for the Fundamental sub-portfolio shall be shares in common stock as tradable on the FTSE market.
Trading should be such that holding periods are expected to be longer than 12 months.
The Fundamental/Active sub-portfolio should be managed to the following targets:
·
At least 80% of investments
should be in common
· No more than 50% of investments should be in any one sector
· No more than 30% of investments should be in any one stock
Trading amounts should be between 10% and 15% of the Club’s non-mechanical asset value and be such that dealing costs in any one trade are less than 3%.
There will be a “champion” for each holding within the Fundamental sub-portfolio and that champion will be required to submit a monthly report prior to each Club meeting with a recommendation on action to be taken (typically SELL or HOLD) for that holding.
In exceptional circumstances (e.g. if the value of a holding has crashed to make it not worth selling) the Club may decide that it is unnecessary for the champion to continue to produce the report. The report should be re-instated when the Club agrees that it is appropriate to do so.
The balance of investments as defined in section 11.5 above will be monitored on a monthly basis as part of each Club meeting. If the thresholds defined are breached then the Club should discuss how and when to rebalance the portfolio.
It is possible that one of the investments within the sub-portfolio grows to become the dominant member. In this situation, it may be acceptable to breach the thresholds particular to this sub-portfolio provided that the overall thresholds as set out in section 5 above are still met. Should re-balancing be necessary then this will typically be achieved by selling some or all of the dominant investment.
An investment can only be purchased for the Fundamental sub-portfolio if it satisfies all the following criteria:-
a) a Buy Proposal Form has been completed
b) Exit Criteria for the holding have been clearly defined (e.g. based on target price, stop-loss, timeframe, etc.). These Exit Criteria provide the mandate to sell when the conditions are met but, can be reviewed/revised by discussion at Club meetings prior to the conditions being met.
An investment will be sold from the Fundamental sub-portfolio when one of the following conditions have been met:-
a) The Exit Criteria current at the time for the investment have been met
b) The champion for the share recommends that the investment be sold and the Club agrees at a Club meeting
Objectives of the Strategy for the Speculative Sub-portfolio are (not necessarily in priority order):-
a) to achieve an average annual rate of return on investment across the sub-portfolio that beats the FTSE 100
b) to allow the Club to make speculative or high-risk investments without risking significant funds
c) to allow introduction to investment products that are unfamiliar to the Club (e.g. warrants, options, etc.)
d) to allow introduction to markets that are unfamiliar to the Club (e.g. Aim, Ofex, overseas, etc.)
Overall target is to achieve an annual rate of return at least as good as the FTSE 100 on a year-on-year basis.
Investments should be purchased with an expectation of sale within 12 months.
No specific, single approach to identifying candidates for the Speculative sub-portfolio is suggested but it must be possible to explain how any particular candidate has been identified and why it is considered suitable for inclusion in this sub-portfolio.
The primary investment vehicle for the Speculative sub-portfolio shall be shares in common stock as tradable on the FTSE market but no investment vehicle available through the Club’s broker is specifically excluded.
Trading should be such that holding periods are expected to be longer than 2 months (i.e. short term “day trading” is not within the Strategy of the Club) but shorter than 12 months.
The Speculative sub-portfolio should be managed to the following targets:
·
At least 50% of investments by value
should be in common
Trading amounts should be such that dealing costs in any one trade (buy or sell) are less than 3% but that the maximum trade should be between 5% and 7.5% of the Club’s non-mechanical asset value.
One of the key objectives on the Speculative sub-portfolio is to allow the Club to take risks. The control of risk within this sub-portfolio is relatively unimportant. The Club’s overall exposure to risk is controlled by management of the level of funds within each of the sub-portfolios as set out in section 6 above. However, should a holding within the Speculative sub-portfolio double in value since purchase, a “champion” should be appointed in a manner similar to the Fundamental sub-portfolio (see section 11.6 above) and that champion will be required to submit a monthly report prior to each Club meeting with a recommendation on action to be taken (typically SELL or HOLD) for that holding.
The balance of investments as defined in section 12.5 above will be monitored on a monthly basis as part of each Club meeting. If the thresholds defined above are breached then the Club should discuss how and when to rebalance the portfolio.
As this sub-portfolio is inherently risky, it is possible that one of the investments within the sub-portfolio grows to become the dominant member. In this situation, it may be acceptable to breach the thresholds particular to this sub-portfolio provided that the overall thresholds as set out in section 5 above are still met. Should re-balancing be necessary then this will typically be achieved by selling some or all of the dominant investment.
An investment can only be purchased for the Speculative sub-portfolio if it satisfies all the following criteria:-
a) a Buy Proposal Form has been completed
b) exit criteria for the investment are clearly defined
and at least one of the following criteria :-
c) there is a clear possibility of achieving 100% return on investment within 1 year of purchase
d) the investment is in a product or market that is unfamiliar to the Club
An investment will be sold from the Speculative sub-portfolio when one of the following conditions have been met:-
a) The Exit Criteria current at the time for the investment have been met
b) The champion for the share (see 12.6 above) recommends that the investment be sold and the Club agrees at a Club meeting
The default Exit Criteria for investments purchased for this sub-portfolio are that one of the following conditions have been met:-
i. the value of the investment has doubled since purchase and a trailing stop-loss of 15% from high has been breached (For example: this condition would be satisfied by an investment that was purchased at 100p and which subsequently rose to 200p before falling back to 170p, at which point it would be sold).
ii. the value of the investment has fallen to below 50% of the value at the time of purchase
iii. the Club agrees to sell the holding at a Club meeting
Appendix A: “Value” Selection Criteria for the Mechanical Portfolio
To select a “Value” candidate for the Mechanical Portfolio, the following process should be followed:-
Step 1: Data Source
In order for the selection mechanism to be repeatable, consistent and
unambiguous, the same source of data must be used; the data source for the Club
shall be the Club’s own Stock Screener program (RSICSS.EXE)
Step 2: Screening the Data
Apply the following ‘filters’ to the market data
|
Measure / Indicator / Ratio |
Condition |
Comment |
|
Market Capitalisation |
>0.04 of AllShare Market Cap |
To ensure that higher risk, small or micro-cap companies are excluded. The precise setting of the threshold is “index-linked” to the FTSE All Share to maintain an appropriate effect of this filter. |
|
Price to Book |
<2.5 |
To provide a level of safety based on underlying tangible assets of company. Ratio calculated as Market Capitalisation divided by Net Tangible Assets |
|
Price to Sales |
<1.5 |
To select stocks that are potentially undervalued. Ratio calculated as Market Capitalisation divided by last 12 months Turnover |
|
Forecast Normalised EPS Growth |
>5% |
To select stocks that are expected to grow. Measure calculated as % year on year difference between Normalised EPS for the current year and each year in the available consensus broker forecasts |
|
Forecast EPS Growth over 2 years |
>15% |
To select stocks that are expected to grow more significantly across the next 2 years. Measure calculated using combined % year on year difference between Normalised EPS for the current year and each year in the available consensus broker forecasts |
|
Current Dividend Cover |
>1. 5 |
To ensure that the company is retaining some profits and not just maintaining dividend for market sentiment. Measure calculated as Normalised EPS for the current year divided by dividend paid over last 12 months. |
|
Forecast Dividend Cover |
>1. 5 |
To ensure that the company’s dividend strategy is consistent. Measure calculated as consensus forecast for Normalised EPS for the next year divided by consensus forecast dividend to be paid over next 12 months. |
|
Return on Capital Employed (ROCE) |
>0% |
To select stocks that are potentially making good use of shareholder funds. |
|
PE Ratio relative to market average |
<0.85 |
To select stocks that are potentially undervalued. Measure calculated as current PE of the stock divided by the average PE of the FTSE AllShare (using normalised earnings) |
|
Current Dividend Yield relative to market average |
>1.2 |
To ensure a level of income from the portfolio. Measure should be calculated as current dividend yield (dividend paid over last 12 months divided by current share price ) divided by the average current dividend of the FTSE AllShare |
|
Forecast Dividend Yield relative to market average |
>1.2 |
To protect against selection of companies that have high current dividend purely because share price has slumped – maintains expectation of future income from the portfolio. Measure should be calculated as consensus dividend (forecast of dividend to be paid over next 12 months divided by current share price) divided by the average current dividend of the FTSE AllShare |
|
Gearing |
<75% |
To protect against selecting companies that have a high level of borrowing. |
Step 3: Ranking the Candidates
Should more than one candidate satisfy all the conditions
defined above then the candidates will be ranked so that those that ‘most
exceed’ the conditions are given priority over those candidates than ‘only
just’ satisfy them. To determine this
ranking, the following rules must be applied
Step 3.1: Each selection filter needs to be allocated a ‘weighting’ (of between 0 to 10) so that those that are considered more important for a candidate to exceed contribute more to the ranking process than those that are less important. As each Club member may have a different view as to how important each filter is, the weightings to be used must be a combined ‘average’ weighting based on each Club member’s suggested weightings as provided in the table below:-
|
|
Adrian T |
Chris |
Dave |
Kit |
Simon |
Richard |
|
Average |
|
Market Cap |
0 |
0 |
3 |
0 |
1 |
3 |
|
1.17 |
|
Price to Book |
7 |
3 |
8 |
7 |
6 |
7 |
|
6.33 |