Investor Resources

As a client of Sparrows Capital, you will be benefitting from an approach rooted in evidence-based research.

We are committed to applying techniques derived from robust academic studies for the benefit of our clients and would like you to have a clear understanding of the principles that we stand by.

Investor Education

Our investment philosophy reflects the objective lessons of over a century of investment history, applied systematically and unemotionally.

Analysis of the data reveals five key findings:

• return is a function of risk

• certain risks attract a persistent premium

• stock picking and market timing seldom add value

• costs matter

• it is critical to remain invested across the full cycle.

These findings dictate our investment style, which can be summarised as:

Evidence Based

Strategic

Risk Based

Factor Based

Cost Efficient

In this educational section you will find an explanation of each of these styles and their relevance to portfolio construction. We also provide access to learning resources in the form of Academic Papers, Sparrows Capital White Papers and Recommended Books. Please do get in touch if you would like to discuss any of this in more detail.

Evidence Based Investing

EBI is effectively the real-world manifestation of Modern Portfolio Theory, an investment approach envisioned by Nobel Economic prize-winners. Investing often relies on a deeply embedded set of assumptions. In many instances this accepted wisdom is not supported by objective analysis. We have access to market data covering 100 years of investment history, and a wealth of robust academic studies. Important lessons and conclusions can be derived from these studies and applied to investment processes. These insights can help identify and avoid the pitfalls which often erode portfolio performance.

Long run market performance

Portfolio performance is primarily a function of Strategic Asset Allocation, and more specifically the extent to which the investor chooses to be invested in equities, as opposed to fixed income or cash. The SAA is responsible for up to 94% of portfolio returns, and is the most important element of the investment process.

 

See: Does Asset Allocation Policy Explain 40, 90 or 100 Percent of Performance? Roger G. Ibbotson and Paul D. Kaplan, Financial Analyst Journal

Strategic Investing

The evidence shows that Alpha is elusive, that very few asset managers possess the requisite skills to generate added value through stock picking or market timing, and that those managers that do add value tend to do so over a limited period of time (and tend to absorb the lion’s share of that value in fees).

Strategic investing eschews the concept of active management, at least in relation to the core liquid portfolio, and focuses on delivering the market return (beta) corresponding to a given risk profile across the full market cycle. The approach uses highly efficient ETFs and Index Funds to deliver market returns with minimal friction. The portfolio is regularly rebalanced back to its original risk allocation, but there is no subjective attempt to anticipate market moves via tactical overlays.

Delivering the market return

Strategic Investing involves harvesting market returns (beta) across the cycle as efficiently as possible. There is no attempt to time markets or to pick stocks. This objective approach avoids many of the behavioural biases which so often erode portfolio performance.

 

 

 

Risk Based Investing

It is estimated that an investor’s strategic asset allocation explains some 94% of portfolio returns. This means that the allocation of risk across asset classes and across geographies is quite simply the most important decision in the investment process.

Risk based investing focuses on the individual investor’s risk tolerance and financial capacity to assess the appropriate level of portfolio risk. Importantly, risk is never dialled up in order to meet an investment objective; if the appropriate risk allocation is not capable of meeting the desired outcome, then either the objective must be reassessed, or the invested amount must be increased through additional savings or transfer.

Risk is the primary driver of returns

Long-run return is a function of risk, but risk is associated with volatility. Calibration of a strategic asset allocation to the investor’s risk profile is critical: too little risk and the portfolio will disappoint over the long term; too much risk and the investor will succumb to psychological pressures during market swings, eroding long term performance.

Factor Based Investing

Certain identifiable risk factors are rewarded with a persistent risk premium by the market. These risk premia have been recognised by academic research for many decades. Rewarded risk factors include:

  • Size
  • Value
  • Low Volatility
  • Momentum

 

Incorporating strategic exposure to specific risk factors or to combinations of risk factors can enhance a portfolio’s expected risk-adjusted returns across the cycle.

A selective approach to market beta

The market has historically awarded a persistent risk / return premium  to certain risk categories. A factor-based approach favours these categories with a view to improving portfolio performance across the cycle relative to traditional index benchmarks.

Cost Efficient Investing

The costs of investing can be substantial, and comprise investment management charges, fund charges, custody and transaction costs. A major benefit of strategic investing is its use of ultra low cost investment vehicles, including ETFs and Index Funds.

Compounded costs can erode a substantial part of your portfolio’s long term returns. Across your whole investment portfolio you need to have a clear picture what you are paying for and how the added value compensates for the additional costs.

Strategic investing involves low-cost instruments, and produces very low turnover rates, and focuses on delivering market returns as efficiently as possible.

Costs Matter

Management, custody, vehicle and transaction costs and fees are often intransparent, complex and substantial. It is critical to ensure that fees are appropriate for the service being provided, and that they are justified by the value added. The graph illustrates the effect of different fee levels on portfolio performance over a 7 year timeframe, underlining the outperformance hurdle required by active strategies just to cover their charges.

Diversification

By allocating across the entire liquid universe and by using broad market ETFs and index funds, Strategic investing delivers the benefits of multi-layered diversification.

Diversification is the closest thing to a free lunch an investor can find in the financial markets. Diversification allows reduction portfolio risk without sacrificing long term expected return.

There are a few dimensions to diversification, notably:

  • Asset classes
  • Geographies
  • Securities
  • Factors

 

Strategic investing also provides you with the benefit of strategy diversification and  access to uncorrelated investment approaches.

Eliminate idiosyncratic risk

Diversification acts to distill the risks down to the targeted systemic market risk, without reducing expected portfolio returns. This improves the portfolio expected risk / reward profile (expressed as the Sharpe Ratio).

FAQ

Why are traditionally “active” funds using traditionally “passive” products like ETFs?

A genuinely passive investment approach involves an objective, rules based approach to markets, the building blocks for which are passive ETFs and Index Funds. At the same time many active market participants adopt a hybrid approach, and express active macro views using efficient passive instruments. In doing so, these participants are foregoing one potential source of alpha, stock selection, and are focusing their effort on extracting outperformance (alpha) through market timing. This style relies on subjective decisions and manager skill, and is therefore not a passive approach, although it is often presented and marketed as such.

What is the role of tactical asset allocation?

Tactical asset allocation is another euphemism for a strategy which attempts to extract outperformance (alpha) through market timing, by identifying asset classes which are overbought (or oversold) and decreasing (or increasing) portfolio exposure to such asset classes. Empirical studies demonstrate that the vast majority of managers consistently fail to add value through tactical allocation, and indeed tend to destroy value through such decisions. A genuine passive strategy does not involve tactical allocation.

With over 1,500 ETFs listed in Europe alone, how does an investor know which one to choose?

The passive universe contains not only ETFs but also index funds. Portfolio construction should begin with a high level risk allocation process focussed on the investor. This should then be expressed as a benchmark in the form of a granular set of indices representing the relevant investable universe. The ETFs tracking the benchmark indices must then be screened for methodology, tracking error, liquidity, costs, tax efficiency, structure and counterparty risk.

Why pay a manager to select index funds and ETFs? Can’t anyone do it?

If the intention is to select a single product, then an investor can indeed self-select on the basis of product sponsor and cost. But single products tend to focus on large cap companies in major market, and they fail to address the full investable universe, the full market. This approach also  forgoes the benefit of applying factor tilts to the portfolio (see below). Employing an adviser also improves discipline, facilitates consistent rebalancing, reduces an investor’s behavioural bias and reduces the tendency to make ill-timed subjective decisions.

Should all of your portfolio be in ETFs and passively managed?

We advocate a core / satellite approach, with the core portfolio invested passively with a view to harvesting market returns (beta) as efficiently as possible. This can be complemented by a number of specialist satellite products / strategies intended to capture alpha or to access other risk premia (examples might be private equity or real estate holdings). It is important that the investor fully understand why and how each satellite strategy will add value, and that their performance is rigorously reassessed on a regular basis.

How do you know when you should rebalance?

The primary purpose of rebalancing is to ensure consistency of portfolio risk. As with all aspects of a passive strategy, rebalancing must be carried out objectively in accordance with pre-defined rules. Much work has been done to identify optimal rebalancing frequencies, thresholds and timing, but ultimately the most important component of a rebalancing process is discipline.

What is factor investing?

Academic studies have revealed that certain sub-sections of the market have persistently experienced higher returns than the broader market. Factor investing tilts the portfolio, again using a rules-based approach, towards these rewarded risk factors. The resulting strategy remains focused on harvesting market returns (beta), but the components of the market are weighted toward persistently rewarded factors (selective beta).

How do you diversify?

Modern portfolio theory relies on a multi-asset class approach to ensure multi-layered diversification. We advocate liquid, global, multi-asset portfolios comprising ETFs and index funds which, in turn, ensure maximum diversification within each investment layer.

If everyone is rushing into passive investing, what is the future for asset management and hedge funds?

The emergence of highly efficient passive investments is forcing active managers to up their game substantially. Managers with low active share (including closet indexers) will be competitively forced to lower fees and increase efficiency; we are already seeing related merger activity as this industry looks to consolidate and achieve economies of scale and scope. Smaller active managers will be forced to increase active share and focus on genuine consistent alpha production in order to justify fees and remain viable. We expect the industry to be smaller and more competitive in the future.

Is passive investing a fad in a rising market? What happens when markets fall?

Passive investing has been practiced since the 1970s and has stood the test of the global financial crisis. By definition, an investment designed to replicate the market return will efficiently track markets downwards as well as upwards, but the important question is whether this outcome will be better or worse than that of a managed investment in the same conditions. Our analysis shows that managers succumb to the same behavioural biases which are known to damage the performance of individual investors in turbulent markets, and that attempts to protect a portfolio from volatility tend to significantly destroy value across the cycle.

Latest Posts

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Sparrows is an independently owned investment firm which provides management services to substantial professional clients across the world. As stated elsewhere on this site, our overriding objective is to protect and increase the real wealth of our clients by investing using liquid and diversified ETF and Tracker funds, in order to capture market returns across all asset classes, irrespective of geographic location.

Consistent with that objective and aim, our principal strategy is to invest in funds which are managed by other investment managers (who may have committed to the Code).

Consequently we may, consistent with the level of risk, decide to exit an investment where we disagree with the manager’s strategy and reinvest elsewhere rather than committing to spend a long period trying to change the manager’s strategy.

Therefore, while we support the general objectives behind the Code, we do not consider that it is appropriate for us to commit to the Code.

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Pillar 3 Disclosures

Background

These are the Pillar 3 disclosures made by Sparrows Capital Limited (“Sparrows”) in accordance with the UK Financial Conduct Authority’s (“FCA”) Prudential Sourcebook for Banks, Building Societies and Investment Firms (“BIPRU”).

The European Union Capital Requirements Directive (“CRD”) created a regulatory capital framework consisting of three ‘pillars’ namely:

  • Pillar 1 – sets out the minimum capital requirements that firms are required to meet;
  • Pillar 2 – requires firms to take a view on whether additional capital should be held against capital risks not covered by Pillar 1; and
  • Pillar 3 – requires firms to publish certain details of its risks, capital and risk management process.

Disclosure policy

The rules in BIPRU 11 provide that Sparrows may omit one or more of the required disclosures if it believes that the information is immaterial. Materiality is based on the criteria that the omission or misstatement of material information would be likely to change or influence the assessment or decision of a user relying on that information for the purposes of making economic decisions. Where Sparrows considers a disclosure to be immaterial, this will be stated in the relevant section.

Sparrows is also permitted to omit one or more of the required disclosures where it believes that the information is regarded as proprietary or confidential. Proprietary information is that which, if it were shared, would undermine Sparrows’ competitive position. Information is considered to be confidential where there are obligations binding Sparrows to confidentiality with its clients and counterparties.

Where Sparrows has omitted information for any of the above reasons, a statement explaining this will be provided in the relevant section.

Unless stated as otherwise, all figures contained in this disclosure are based on Sparrows’ audited annual reports for the year ending 31 December 2016.

Frequency

These Pillar 3 disclosures will be reviewed on an annual basis as a minimum. The disclosures will be published as soon as is practical following the finalisation of Sparrows’ Internal Capital Adequacy Assessment Process (“ICAAP”) and its annual accounts.

Verification

The information contained in these disclosures has not been audited by Sparrows’ external auditors and does not constitute any form of financial statement.

Publication

Sparrows’ Pillar 3 disclosures are published on its website.

Scope and application of CRD requirements

These disclosures are made in respect of Sparrows, a BIPRU firm authorised and regulated by the FCA, providing  financial advice and discretionary investment management services.

Risk management objectives and policies

Sparrows’ risk management policy reflects the FCA requirement that it must manage a number of different categories of risk. These include: liquidity; credit; interest rate; market; and operational risks.

  1. Liquidity risk

Sparrows manages all cash and borrowing requirements to maximise potential interest income whilst ensuring it has sufficient liquid resources to meet the continued operating needs of its business. This is supported by a robust budgeting and forecasting process which has the full involvement of the senior management team.

  1. Credit risk

The main credit risk for Sparrows relates to income from fees, the risk being that a client does not pay amounts due for services provided by Sparrows.  Quarterly management fees are charged to clients based on a percentage of the client’s assets under management.  Concentration risk is defined as the risk of loss of income through external changes having a disproportionate impact on overall income due to a reliance on revenue from certain sectoral, geographic areas and/or businesses.  Credit risk concentrations include:

  • significant exposure to an individual client or group of clients; and
  • credit exposures to clients in the same economic sector or geographic region.

A significant proportion of Sparrows’ income is received from clients that are part of the same group as Sparrows’ major shareholders.  This ongoing interest in the activities of Sparrows by the group mitigates the risk of the group jeopardising Sparrows’ income flow.

Sparrows is exposed to country risk as a number of clients are based in a non-European Economic Area country.  As these clients are all high net worth or ultra-high net worth long-term investors with spare capital invested in globally diversified liquid financial instruments, the risk of being unable to meet unforeseen financial needs and payment of Sparrows’ fees is low.

Based on the analysis of concentration risk, the risk of non-payment of fees has been assessed as minimal.

  1. Interest rate risk

Sparrows has no exposure to interest rate risk.

  1. Market risk

The main market risk for Sparrows relates to falls in value of assets under management following a market downturn, which would lead to lower management fees. To mitigate its market risk, Sparrows regularly analyses various different economic scenarios to model the impact of economic downturns on its financial position.

 

  1. Operational risk

Operational risk is defined as the potential risk of financial loss or impairment to reputation resulting from inadequate or failed internal processes and systems, from the actions of people or from external events.

Major sources of operational risk include: outsourcing of operations, IT security, internal and external fraud, implementation of strategic change and regulatory non-compliance.

Sparrows operates a robust risk management process which is regularly reviewed and updated by the Board. The Board formally reviews all significant risk issues annually as part of the ICAAP.

All senior members of staff bear responsibility for internal controls and the management of business risk as part of their accountability to the Board.  All staff are responsible for identifying the risks surrounding their work, implementing controls over those risks and reporting areas of concern to their senior member of staff.

  1. Other risks

Sparrows operates a simple business model. Accordingly, many of the specific risks identified by the FCA do not apply.

Capital resources

Pillar 1 requirement

In accordance with the FCA rule GENPRU 2.1.45R (calculation of variable capital requirement for a BIPRU firm), Sparrows’ capital requirement has been determined as being its fixed overhead requirement and not the sum of its credit risk capital requirement and its market risk capital requirement.

The Pillar 1 capital requirement for Sparrows was £261,000 as at December 2016.

Pillar 2 requirement

Sparrows’ overall approach to assessing the adequacy of its internal capital is set out in its ICAAP report. The ICAAP involves separate consideration of risks to Sparrows’ capital, combined with stress testing using scenario analysis. The level of capital required to cover risks is a function of impact and probability. Sparrows assesses impact by modelling the changes in its income and expenses caused by various potential risks over a 1-year time horizon. Probability is assessed subjectively. In addition, Sparrows has reviewed the outputs of its risk reviews to quantify any risks identified. This has identified a number of key business risks, which (having reviewed the guidance in BIPRU 2.2.61-65) Sparrows has classified against the risk categories outlined in FCA rule GENPRU 1.2.30R.

Sparrows Pillar 2 capital requirement, which is its own assessment of the minimum amount of capital that it believe is adequate against the risks identified, has been assessed as greater than its Pillar 1 requirement.

There is a considerable surplus of reserves above the capital resource requirement deemed necessary to cover the risks identified.

Regulatory capital

The main features of Sparrows’ capital resources for regulatory purposes, as at 31 December 2016 are as follows:

 

Capital item: £000s
Tier 1 capital (called up share capital, share premium account, profit and loss account, externally verified interim net profits) 804
Total of Tier 2 and Tier 3 capital (broadly long and short term subordinated loans)  –
Deductions from Tier 1 and Tier 2 capital  –
Total capital resources, net of deductions 804

 

 

Sparrows holds regulatory capital in accordance with the CRD. All such capital is classified as Tier 1 capital and is therefore of the highest quality.

 

Remuneration Code Disclosures

Sparrows is subject to the BIPRU Remuneration Code. This section provides further information on Sparrows’ remuneration policy.

BIPRU Remuneration Code Staff

Sparrows has identified, and maintains a record of, BIPRU Remuneration Code staff (“Code staff”), i.e. staff to whom the BIPRU Remuneration Code applies. This includes senior management and members of staff whose actions may have a material impact on Sparrows’ risk profile. All of Sparrows’ Code staff fall into the “senior management” category of Code staff (rather than the “risk taker” category) for the purposes of the BIPRU Remuneration Code.

Decision Making / Remuneration Committee

Sparrows does not have a Remuneration Committee. The Board is responsible for Sparrows’ remuneration policy including:

  • Determining the framework and policy for remuneration and ensuring it does not encourage undue risk taking.
  • Agreeing any major changes in remuneration structures.
  • Reviewing the terms and conditions of any new incentive schemes and in particular, considering the appropriate targets for any performance related remuneration schemes.
  • Considering and recommending the remuneration policy for senior staff taking into account the appropriate mix of salary, discretionary bonus and share based remuneration.

In determining remuneration arrangements, the Board will give due regard to best practice and any relevant legal or regulatory requirements including the BIPRU Remuneration Code.

Link between pay & performance

Competitive salaries form the basis of Sparrows’ remuneration package. There is no variable pay element.

Quantitative information on remuneration

The FCA rules require certain firms to disclose aggregate information on remuneration in respect of its BIPRU Remuneration Code staff broken down by business area, senior management and other Code staff, including “risk takers”.

Sparrows has only one business area – investment management & advice.

Sparrows has 3 Directors but no “risk takers”. Director remuneration is agreed formally at Board meetings. The link between performance and pay is inevitable in a small firm, but Sparrows’ risk adverse strategy and robust risk management systems mitigate any risks.

Privacy Policy

At Sparrows Capital we are committed to safeguarding and preserving the privacy of our visitors. This Privacy Policy explains what happens to any personal data that you provide to us, or that we collect from you whilst you visit our site.

We do update this Policy from time to time so please do review this Policy regularly.

Information We Collect

In running and maintaining our website we may collect and process the following data about you:

  1. Information about your use of our site including details of your visits such as pages viewed and the resources that you access. Such information includes traffic data, location data and other communication data.
  2. Information provided voluntarily by you. For example, when you register for information or make a purchase.
  3. Information that you provide when you communicate with us by any means.

Use of Cookies

Cookies provide information regarding the computer used by a visitor. We may use cookies where appropriate to gather information about your computer in order to assist us in improving our website.

We may gather information about your general internet use by using the cookies. Where used, these cookies are downloaded to your computer and stored on the computer’s hard drive. Such information will not identify you personally. It is statistical data. This statistical data does not identify any personal details whatsoever.

You can adjust the settings on your computer to decline any cookies if you wish. This can easily be done by activating the reject cookies setting on your computer.

Use of Your Information

We use the information that we collect from you to provide our services to you. In addition to this we may use the information to provide information to you that you request from us relating to our services and to inform you of any changes to our website or services.

Storing Your Personal Data

In operating our website it may become necessary to transfer data that we collect from you to locations outside of the European Union for processing and storing. By providing your personal data to us, you agree to this transfer, storing or processing. We do our upmost to ensure that all reasonable steps are taken to make sure that your data is treated and stored securely.

Unfortunately the sending of information via the internet is not totally secure and on occasion such information can be intercepted. We cannot guarantee the security of data that you choose to send us electronically. Sending such information is entirely at your own risk.

Disclosing Your Information

We will not disclose your personal information to any other party other than in accordance with this Privacy Policy and in the circumstances detailed below:

  1. In the event that we sell any or all of our business to a buyer.
  2. Where we are legally required by law to disclose your personal information.
  3. To further fraud protection and reduce the risk of fraud.

Third Party Links

On occasion we include links to third parties on this website. Where we provide a link it does not mean that we endorse or approve that site’s policy towards visitor privacy. You should review their privacy policy before sending them any personal data.

Access to Information

In accordance with the Data Protection Act 1998 you have the right to access any information that we hold relating to you. Please note that we reserve the right to charge a fee of £10 to cover costs incurred by us in providing you with the information.

Contacting Us

Please do not hesitate to contact us regarding any matter relating to this Privacy Policy at info@sparrowscapital.com.