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Academic Papers, Behavioural Finance,
March 8, 2018 - Mark
Barberis, N. and Thaler, R., 2003, “A Survey of Behavioral Finance,” Handbook of the Economics of Finance, Chapter 18, pp 1051-1121.
Behavioral finance argues that some financial phenomena can plausibly be understood
using models in which some agents are not fully rational. The field has two building
blocks: limits to arbitrage, which argues that it can be difficult for rational traders to
undo the dislocations caused by less rational traders; and psychology, which catalogues
the kinds of deviations from full rationality we might expect to see. The paper discusses
these two topics, and then presents a number of behavioural finance applications: to the
aggregate stock market, to the cross-section of average returns, to individual trading
behavior, and to corporate finance. The authors close by assessing progress in the field and
speculating about its future course.
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United Kingdom’s Stewardship Code. The Stewardship Code (the “Code”) was developed from the Walker Review on Corporate Governance in the UK and aims to enhance the quality of engagement between investors (and investment managers) and UK listed companies. Although the Code is voluntary, the Financial Conduct Authority requires Sparrows to include on this website a disclosure about its commitment to the Code or, where it does not so commit, its alternative strategy.
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.
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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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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:
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 2017.
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.
The information contained in these disclosures has not been audited by Sparrows’ external auditors and does not constitute any form of financial statement.
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.
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.
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:
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.
Sparrows has no exposure to interest rate 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.
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.
Sparrows operates a simple business model. Accordingly, many of the specific risks identified by the FCA do not apply.
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 £260,000 as at 31 December 2017.
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.
The main features of Sparrows’ capital resources for regulatory purposes, as at 31 December 2017 are as follows:
|Tier 1 capital (called up share capital, share premium account, profit and loss account, externally verified interim net profits)||909|
|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||909
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:
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.
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