Methods of Analysis
General
Security analysis methods are primarily fundamental analysis.
The main sources of information include meetings with company management
(and its annual reports / prospectus), sell-side brokers / strategists' reports etc.
International and Global Growth Equity investment strategy
The portfolio management team employs several different analytical methods,
including fundamental analysis, charting, technical analysis and cyclical analysis.
Please see the investment strategy descriptions below for more information.
Investment Strategies
General
IHKL’s investment style generally has a strong focus on bottom-up stock
selection where they can add the most value. Major components to risk
management are shown as follows:
• Portfolio managers construct portfolios based on the performance objectives,
benchmark and pre-determined risk budget of the specific mandate. Risk
budget is expressed as a target min-max level of tracking error. If a portfolio’s
ex-ante tracking error is outside the target range, we need to understand the
reasons and if appropriate, take action to rectify.
• The risk and performance team under regional Head of Risk & Performance
is responsible for risk analytics and performance attribution analyses. They
provide regular reporting and monitoring of portfolio risk and performance
using Barra, FactSet and proprietary systems (RiskExplorer).
Investment Strategy: Greater China investment strategy
For the Greater China equity strategy, the team focuses on bottom-up stock
selection where they believe they are able to add the most value. The team
members adopt a transparent and disciplined investment process, which is
summarised in the diagram below.
For illustrative purposes only.
Distilling the universe
The team looks at the Chinese equities universe and has a ‘selective list’, which
is a list of around 250-300 of the most competitive Greater China enterprises
within their investable universe. The list is derived based on our selective
approach, with selection criteria including: transparency and communication
(corporate access), corporate culture (management style/mentality), strategy
(business model, competitive product/service), financial disciplines and capital
structure, risk management, governance, ownership, environmental and social
issues.
Investment ideas are not bounded by the selective list, but rather, the list is
dynamic and will increase over time, with research and insights from the team.
Stocks included in the selective list are closely monitored. These stocks are
researched by the team to determine their fair values for the purpose to provide
guidance to add or trim.
Focus research analysis – through detailed fundamental analysis
The investment team conducts proprietary company research via company visits,
SWOT analysis, multi-factor score sheet, earnings & valuation analysis, financial
models including P&L, balance sheet and cash flow analysis. Investment thesis
are documented in the Stock Research Discussion Notes (“SDRN”) and
discussed in the team meetings to uncover biases, develop conviction and
confirm attractiveness of the investment idea.
The team’s proprietary stock analysis focuses on quantitative factors such as
growth prospects and profitability, valuation parameters, as well as qualitative
factors such as quality and sustainability of growth, management quality, in
particular, the team conducts fundamental analysis based on the three main
criteria as illustrated below.
For illustrative purposes only. The information presented represents how the portfolio management team
generally applies their investment process under normal market conditions. Subject to change, without
further notice.
Company research is conducted via company visits, financial analysis and
evaluation of a number of factors. In 2018, the Invesco Equity Investment Team in
Asia research professionals conducted more than 2,200 company meetings. In
addition, they also leverage on sell-side research to supplement their own in the
stock research process.
Through company visits, the team evaluates management integrity and capability.
Through detailed analysis, the team looks at the business model that includes
value chain analysis, industry food chain analysis and product analysis. The
team checks growth assumptions and conduct financial analysis to ensure the
quality of financial data.
Detailed research and analysis is summarised and documented in the SDRNs
and discussed in weekly meetings. By encouraging discussions and expressions
of different views, and incorporating the best ideas from the highly experienced
Invesco Equity Investment Team in Asia with different perspectives, the Greater
China equity portfolios can benefit from the team’s collective knowledge and
insight. However, it is ultimately the decision of the lead portfolio manager, Mike
Shiao, as to whether a stock is included in the equity portfolio.
Fair value
Fair value refers to the ‘true value’ that the team believes a company deserves
over a 3 to 5 year time horizon. This is different from the consensus’ or sell-side
target price which tends to overshoot or undershoot amid short-term momentum
and liquidity. Fair values are determined by the team to provide guidance to add
or trim, based on a multiple of parameters and valuation methods, including P/BV,
PER, EV/EBITDA, ROE, PEG, P/FCF, discount to NAV, Yield, sum-of-the-parts,
etc. The team does not believe one valuation methodology works across all
sectors or the entire earnings cycle.
Team discussions
There are various communication channels among team members to facilitate
effective collaboration as follows:
Weekly Tuesday
− Regional funds review (bi-weekly)
Wednesday
− Regional in-depth stock discussion (2 stocks)
Friday − Hong Kong / China coverage list review (weekly)
− Regional coverage list review (bi-weekly)
Monthly discussions
− Market performance recap
− Major economic issues review
Semi-Annual discussions
− Macro outlook discussion
Mike Shiao is primarily responsible for portfolio construction based on the
investment objectives, risk parameters, investment guidelines and restrictions.
The team holds higher weightings/active stock weightings where they have high
conviction, taking into consideration the teams’ derived fair value, expected
investment return, as well as its risk and liquidity.
Buy discipline
Companies with:
• Sustainable industry leadership and competitive advantages, trading at a
discount to fair value;
• Transparency and communication;
• Good corporate culture;
• Competitive business models/ product/ service;
• Financial disciplines and solid capital structure
Sell discipline
Companies which are:
• At risk of earnings multiple contraction;
• Unable to sustain or have lost clear leadership or competitive advantages
in market share, technology, scale etc. or have lost potential to become
leaders in industry
The team also looks to sell companies which they have lost confidence in the
company management.
Investment Strategy: Pacific growth equities investment strategy (Asia Pacific ex
Japan portion only)
The Pacific growth equities investment strategy adopts a similar transparent and
disciplined investment process with regard to bottom-up stock selection. It also
incorporates country analysis process to determine allocation across regional
markets through a quarterly investment meeting to focus on domestic economic
cycle positioning and how it relates to corporate earnings – e.g. analysis of
monetary / interest rate trends and forecasting liquidity developments.
Investment Strategy: China-India investment strategy
Investment Philosophy & Approach
Our goal is to take advantage of market inefficiencies through a bottom-up
stock selection process
• Selective approach:
- Focus on companies with sustainable leadership & competitive
advantages
• Original ideas:
- Act before consensus is formed
- Look for under-researched ideas
• Valuation focus:
- Utilize a disciplined fundamental analysis driven process
• Long-term investment horizon:
- Focus on both dividend income & capital appreciation
- Identify companies that can deliver steady and above average earnings
over business cycles
Investment Process
For illustrative purposes only
Top-Down and Asset Allocation Process
Top-Down
Investment Process Overview
An iterative process with focus on bottom-up stock selection
For illustrative purposes only.
Detailed Fundamental Analysis
Based on three main criteria
For illustrative purposes only. The information presented represents how the portfolio management team
generally applies their investment process under normal market conditions. Subject to change, without
further notice.
Risk Management
Quality control through diligent oversight
For illustrative purposes only
Investment Strategy: International and Global Growth Equity investment strategy
International Companies: A long-term strategy that seeks exposure to high-
quality international companies of all market capitalizations, across both
developed and emerging markets. Risks associated with this strategy include:
depositary receipts, derivatives, emerging markets securities, foreign securities,
geographic focus, growth investing, investing in the European Union,
management, market, preferred securities, and small- and mid-capitalization
companies risks.
Investment Strategy: India equity investment strategy
The Invesco India Equity strategy follows Invesco Equity Investment Team in
Asia’s investment process which focuses primarily on bottom-up stock selection.
The team adopts a transparent and disciplined process, which is summarised in
the following chart:
For illustrative purposes only.
Distilling the universe
The flowchart below summarises how the team narrows the research focus and
generates investment ideas for Indian equity portfolios:
For illustrative purposes only. The information represents how the portfolio management team applies their
investment processes under normal market conditions.
1 Under normal market conditions.
The first step of the stock selection process is to distil the investment universe,
using a market cap screening based on a minimum market cap of US$400 million.
This narrows the stock universe to ~330 stocks. A proprietary FVMC screening that
looks for four key parameters namely Franchise value, Valuation, Management, and
Cash Generation Capability -- along with other broad research and quantitative criteria
are then used to arrive at a Monitor List of 100-120 names.
The team defines each of the four FVMC screen parameters with attributes as follows –
For illustrative purposes only.
Proprietary earnings model
By conducting further fundamental research, qualitative analysis and focusing on
companies which have ‘quality growth’ attributes, the team narrows down the
Monitor List to a Focus List of approximately 50-60 stocks. Focus List stocks are
ideas that the team considers as investment candidates. The team performs
comprehensive fundamental analysis on Focus List stocks, with each stock
having a proprietary earnings model to determine its fair value.
The team engages with company management to understand their business
models and conducts company visits if necessary to form the fundamental and
qualitative part of the analysis. In 2018, the Invesco Equity Investment Team in
Asia research professionals conducted more than 2,200 company meetings. Within
which, over 400 company interactions are dedicated to Indian companies. These
include on-site company visits in India, corporate management travelling to Hong
Kong, various sell-side conferences, and conference calls with corporate
management. On a quarterly basis, the team engages with corporate
management via conference calls to review on the earnings results for all the
holdings within the portfolio as well as select stocks on the Focus List. Together
with various financial attributes, the team construct their own proprietary model.
During this process, the team also takes input from independent experts, sell-
side research, as well as the Invesco Asset Management (India) Private Ltd in
Mumbai.
Fair value
The team derives the ‘fair value’ from the proprietary model which serves as
guidance to buy/trim/sell. The team will consider acquiring the stocks if they are
trading below their fair value estimates. When stocks are trading at or above the
fair values, the team revisits the fundamentals again to affirm whether the
underlying assumptions are intact.
Fair value estimates are updated and revised regularly, based on changes in
underlying assumptions and/or fundamentals.
The determination of fair value of each stock is mainly based on the three
fundamental analysis of the following:
•
Visibility of earnings growth
•
Cashflow projections
•
Allocation of capital and return ratios
Focused research and analysis
The team conducts proprietary company research by identifying ‘Quality’
business franchises which have superior business models and can deliver steady
and above average earnings growth over business cycles. What defines ‘Quality’
companies is strong management, solid brand recognition adaptability to change,
dominant revenue market share, consistent above average earnings growth and
sustainable operating margins, to name a few. The key is to select companies
with sustainable industry leadership and competitive advantages.
The investment team uses quantitative analysis via proprietary earning models
while also giving significant weight to qualitative factors. The team’s proprietary
stock analysis focuses on various factors such as growth prospects and
profitability, valuation parameters, quality and sustainability of growth, and
management quality. In particular, the team conducts fundamental analysis
based on the three main criteria as illustrated below:
Portfolio ConstructionDetermine Fair Value For illustrative purposes only.
Management/Franchise Value Business landscape
Business and earnings model
Balance sheet
Core competencies
Qualitative analysis
ESG considerations
Earnings Growth Earnings growth momentum
Sustainability and quality of earnings
Growth in market share
Growth derived organically, new
projects or through an asset injection
Valuation P/E (prospective), P/B, PCF
Premium or discount to NAV
EV/EBITDA, Yield, ROE
Relative to historic, sector,
market
Liquidity & Risk Days to get in/out
Total turnover
Risk assessment
Facilitates asset allocation
Investment
Universe
Focus List
Detailed Fundamental AnalysisPortfolio
Construction
Risk
Management
Companies within the Focus List are divided into different sector groups amongst
“Growth,” ”Cyclical” and “Financials”, for which different valuation metrics are
used to help determine fair value, in addition to the three fundamental analysis
mentioned above.
Portfolio construction
Shekhar Sambhshivan is responsible for portfolio construction based on
investment objectives, risk parameters, investment guidelines and restrictions.
The portfolio aims to have between 35-45 stocks under normal market conditions.
Active stock weighting is a function of the conviction level, expected return based
on target prices, as well as risk and liquidity considerations. The team may have
sector preferences at times, but generally sector allocation is a by-product of
stock selection. Risk control is an integral part of portfolio construction at an
aggregate portfolio level.
Investment Strategy: Asia ex-Japan equities investment strategy
The investment team believes that there are pockets of inefficiencies in the Asian
equity markets, resulting in frequent mispricing of stocks due to over/under-
reaction to new information. The team seeks to systematically take advantage of
market inefficiencies through identifying changes in fundamentals by strictly
adhering to a disciplined investment process focusing on earnings and valuation
of each company. The team also believes that local knowledge is important. By
having an experienced team conducting proprietary on the ground research and
capturing the best ideas, the team gains an information advantage and an
opportunity to achieve favorable returns.
Neglect"Dogs"
Earnings
Disappoint
Estimates Lowered
Estimates PlateauEstimate RevisionsEarnings Surprise
Positive Estimate
Revisions
Core Holding
Momentum Buyers
EPS MomentumHIGHLOWConsensus confirmationInvest in companies with sustainable industry leadership and competitive advantages at below fair value The strategy’s investment style is ”sustainable value investment”. The team focuses
on acquiring companies with sustainable leadership position and competitive
advantages at a discount to their fair value, based on the following approaches:
Selective approach
Focus on companies with sustainable leadership and competitive advantages
Favour companies with superior creativity and efficiencies
Original ideas
Act before consensus is formed
Look for under-researched ideas
Valuation focus
Utilise a disciplined fundamental analysis driven process
Evaluate fair value versus target price
Long-term investment horizon
Focus on both dividend income and capital appreciation
Willing to ride through short term earning cycles
Investment Process The team focuses primarily on bottom-up stock fundamentals where they can add
the most value. Although the team creates value primarily through bottom-up stock
selection, the team combines bottom up fundamental analysis and top down
analysis to derive the decision to invest in any particular stock. Top down country
allocation, plays a secondary role for the strategy. It is primarily the result of where
we see structural opportunities in the different markets in Asia and the decision is
crossed checked via a proprietary country allocation process that has been in place
for over 10 years.
Top down country allocation
Please see below our country allocation process:
StrategicFocusCountry AllocationStock Selection China, India, being
key markets/drivers in
Asia ex Japan
Country allocation not
seen as major alpha
source
Cross checked via
semi-annual strategy
meetings where in
depth analysis are
conducted
Stock selection is
done by Greater
China, India, South
Korea and ASEAN
specialists
The strategy has a strategic focus in China and India; the two largest economies in
the region by far where the team believes have the most investment opportunities.
The strategic focus is held unless the team sees better opportunities in other
markets.
The strategy normally reviews country allocation, taking reference of the proprietary
country allocation output and the one and a half day strategy discussion meetings
which occur on a semi-annual basis. The process combines quantitative inputs and
qualitative discussions on Asia ex Japan countries in considering various
fundamental (e.g. EPS growth, valuation factors, GDP growth, inflation, money
supply, trade and current account, political and technical factors) and momentum
(e.g. rate of change of EPS, FX rate, policy outlook and market conditions) factors.
The details are discussed and debated amongst all the team members during the
strategy discussion meetings. Output of the asset allocation discussion is a set of
country allocation decisions, in terms of over/underweight direction relative to MSCI
Asia ex Japan Index and serves as reference to cross check implementation of the
Strategy.
The team sees country allocation as its secondary alpha source. The excess return
breakdown from attribution has shown that security selection has accounted for
majority of the value added, whilst strategic focus in China and India has also
contributed.
Bottom-up stock selection
The team adopts a transparent and disciplined bottom-up stock selection process,
which is summarised in the diagram below.
* Risk management is embedded at every stage of the investment proc ess
Portfolio ConstructionBalances risk and return
Distilling the UniverseIdentifies attractive
investment opportunities
for further investigation
Review & MaintenanceControls quality through
oversight
Ensures product integrity
Focused Research and AnalysisConfirms attractiveness of
investment ideas
Captures deeper
understanding
Develops c onviction
Selective
List
Detailed
Fundamental
Analysis
Portfolio
Construction
Risk *
Management
Investme nt
Universe
Investment universe
The investment universe will include generally companies within substantial
exposure in Asia. This totals approximately 14,000 listed companies (as of
December 2018), containing a very large majority listed in Asia ex Japan equity
markets and select Asian companies listed as well as American Depositary
Receipts. After the team has applied its filter of securities with a market capitalisation
of USD 400 million, there are approximately 3,700 companies that remain. This
represents a wider stock coverage as compared to the reference index, MSCI AC
Asia ex Japan, thereby allowing the team to invest in holdings which are not in the
reference index should they see attractive stock opportunities.
Selective list
The team has in-depth experience in various local markets; the breadth and depth of
the proprietary company research performed throughout the years, allows the team
to arrive at a ‘selective list’ of above 500 stocks. Investment ideas are not bounded
by the selective list. The list is dynamic and will continue to increase over time to
include more interesting ideas.
Ideas generation
Sources of stock ideas are from various different sources. This includes ideas
coming from meetings of companies/companies in the entire value chain,
economists, regulators, government officials, leverages from sell-side, conferences
that the team attend, new rising stars within the industries, to name a few. In
particular, there is a dedicated time for the analysts to present and discuss
specifically on new stock ideas every second Friday, on top of the other regular
meetings where stocks are discussed.
We have in the recent years increased our coverage on China domestic A shares,
and is ahead of the MSCI’s inclusion of China A shares in the indices, in terms of
research coverage. Most of our strategies including the strategy have exposure in
quality China A shares companies.
Stocks included in the selective list are closely monitored to identify attractive
investment candidates. These stocks are researched by the team to determine their
fair values for the purpose to provide guidance on entry and exit levels. Fair values
are determined based on a multiple of valuation methods, including P/BV, PER,
EV/EBITDA, ROE, PEG, P/FCF, discount to NAV, Yield, sum-of-the-parts, etc. We
do not believe one valuation methodology works across all sectors or the entire
earnings cycle.
In general, the team looks for Asian companies that will benefit from secular growth
drivers. Specifically, we rely on our proprietary research to identify companies with
sustainable leadership and competitive advantages. We favour companies with
superior creativity, solid cash flow and high operating efficiency.
Focus Research Analysis-through detailed fundamental analysis
With the investment team’s focus mainly on bottom-up stock selection, there is a strong
emphasis on proprietary company research through detailed fundamental analysis. The
majority of the team’s research is conducted internally and this is made possible via the
well-resourced research platform/analysts team. Strong emphasis is in place, starting
from the recruitment process, to ensure that all members adhere to the team’s
investment philosophy and approach. Members of the team have strong credentials,
well experienced, with key professionals working together for a long time.
The key challenge is to seek opportunities where the earnings or improvement in
fundamentals are not fully reflected in the valuation of that stock. The team conducts
proprietary company research via company visits, SWOT analysis, multi-factor score
sheet, earnings and valuation analysis, financial models including P&L, balance sheet
and cash flow analysis. Investment thesis are documented in Stock Research
Discussion Notes (‘SDRN’) and discussed in the Wednesday meetings to uncover
biases, develop conviction and confirm attractiveness of the investment idea.
In 2018, the team conducted more than 2,200 company meetings. Through company
visits, the team gathered insights on management integrity and capability. Through
detailed analysis, the team examined the business model that includes value chain
analysis, industry food chain analysis and product analysis. The team also cross-checks
growth assumptions and conducts financial analysis to ensure the quality of financial
data. In addition to proprietary research, the team also leverages the best sell-side
research. Sources of external research materials include brokers’ research,
conferences, magazines/newspaper articles, and various meetings etc.
The team’s proprietary stock analysis focuses on quantitative factors such as growth
prospects and profitability, valuation parameters, as well as qualitative factors such as
quality and sustainability of growth, management quality, in particular, the team
conducts fundamental analysis based on three main criteria as illustrated below:
For illustrative purposes only. The information presented represents how the portfolio management team generally applies their investment
process under normal market conditions. Subject to change, w ithout further notice.
Liquidity Days to get in/out
Total turnover
Portfolio ConstructionDetermine Fair ValueValuation P/E (prospective), P/B, PCF, PFCF
Premium or Discount to NAV
DDM, EV/EBITDA, Yield, ROE
Relative to historic, sector, market
Management/ Franchise Value Determination Management capability/ track record
Clear Ownership (private enterprises
vs. SOE)
Competitive Advantages/ leadership
in industry
– Financial Strength
– Technology, Scale, Brand, Sales
network
Earnings Growth EPS Growth, sustainable growth
rate in next 2–3 years
– Growth in Market Share
– Origin of Growth (Organic , new
project, asset injec tion)
Earnings visibility
Detailed research and analysis is summarised and documented in the SDRNs and
discussed in the Wednesday meetings. By encouraging the discussions and
expressions of different views, and incorporating the best ideas from our highly
experienced Asia ex Japan team with different perspectives, the portfolios can benefit
from the team’s collective knowledge and insight. During these Wednesday meetings
the team challenges the investment thesis. However, it is ultimately the decision of the
lead portfolio manager, as to whether a stock is included in the portfolio.
Fair value The team has strong valuation discipline and believes that the adherence to the
investment process and in particular valuation discipline is key to the delivering of
excess alpha. One of the key aspects within the fundamental researches is to come up
with the ‘fair value’ of companies that we closely monitored.
Fair value refers to the ‘true value’ that the team believes a company deserves over a
three-year to five-year time horizon. This is different from the consensus’ or sell-side
target price which tends to overshoot or undershoot amid short-term momentum and
liquidity. Fair values are determined by the team to provide guidance to add or trim,
based on a multiple of parameters and valuation methods, including P/BV, PER,
EV/EBITDA, ROE, PEG, P/FCF, discount to NAV, yield, sum-of-the-parts, etc. The team
does not believe one valuation methodology works across all sectors or the entire
earnings cycle.
Team discussions In addition to the daily open discussions and the Wednesday SDRN discussions as
noted above, the team also meets every Tuesday and Friday to update research and
recommendations, discuss industry trends and developments, update company results
and developments, discuss company visits, and review fair values. Focus of the
Tuesday and Friday meetings will be on regional Asia ex Japan equities, and Chinese &
Hong Kong equities respectively. On alternative Fridays, there will be an additional
presentation and discussion of new stock ideas, where the team will present, discuss
and debate on the new stock and investment ideas.
Weekly Tuesday
− Regional funds review
Wednesday
− Regional in-depth stock discussion (2 stocks)
Friday
− Hong Kong/China coverage list review (weekly)
− Regional coverage list review (bi-weekly)
− New stock and investment ideas discussion (bi-weekly)
Monthly discussions
− Market performance recap
− Major economic issues review
Semi-Annual discussions
− Macro outlook discussion
Portfolio Construction Lead managers are assigned to each strategy. The lead manager will be responsible for
portfolio construction based on the investment objectives, risk parameters, investment
guidelines and restrictions.
Our portfolio construction process for is shown below:
Portfolio ConstructionPortfolioIdea generation via team meetings“Selective list” Bottom-up fundamentals
Assess sustainable value
Not benchmark focused
Higher weighting for conviction positions
Bottom-up stock selectionWeekly meetings
-Stock Research Discussion Notes (SDRN) review
-Regional funds review
-Regional in-depth stock discussion
-HK/China coverage list review
-Regional coverage list review
-New stock ideas discussion
C onsumer
Discretionary
& Staples
FinancialsEnergy, Raw Material
Internet
Software
Media
Industrial,
Telecom,
Utilities
Healthcare
There are normally around 50-70 stocks in our Asia ex Japan equities portfolio. The
team holds higher weightings/active stock weightings where there is high conviction,
taking into consideration the expected investment return of a stock based on its fair
value, as well as its risk and liquidity. There is no market cap bias, albeit liquidity
conditions are monitored when sizing positions.
While the team may have market/sector preference, but market/sector weightings are
generally a by-product of stock selection. We keep part of the position as our core
holding unless the fundamentals of the company are worsening for a prolonged period
of time. In taking active positions, we are not constrained by the benchmark and take
active bets.
When constructing the portfolio, the team has the following control measures to ensure
the portfolio is sufficiently diversified:
Top down: maximum double or half weighted in “key” markets
Bottom-up control measures:
- Maximum 10% in single stock holding
- Single stock active weight normally within a 2% to 4% range
- Prefer companies with market cap over USD 400 million
- Maximum 10% cash
Buy and Sell discipline
Buy discipline Qualitatively speaking, the team seeks companies that have strong competitive
advantages, sustainable business models and quality management. With regard to
quantitative assessments, the team uses proprietary models to determine whether
companies are able to achieve stable to improving earnings growth, as well as having
sound balance sheets, along with share prices below the team’s estimated fair value.
Sell discipline The team will seek to sell companies which they believe are at risk of earnings multiple
contractions, or in which they have a loss of confidence in the company management.
The team will also sell companies that they believe are unable to sustain the
competitive advantages (in market share, technology, scale, etc.) or companies that
have a loss of clear leadership in those aspects.
Risk management
Managing risk is an integral part of Invesco’s investment culture, and risk management
is imbedded in every stage of the investment process. There are three major
components to the team’s risk management, as shown below:
Source: Invesco. For illustrative purposes only.
In the risk budgeting process, performance targets and risk limits at the portfolio level
are agreed between the clients, CIO and the portfolio managers.
The CIO (Asia ex Japan), together with the Head of Investments, and the Risk Team,
review the performance and risk profile of the portfolio on a regular basis. They review
the level as well as the breakdown of tracking error relative to the portfolio’s investment
objectives and risk tolerance levels to determine whether we are comfortable with the
current risk profile. Sector and stock exposures relative to benchmark are monitored.
We also review portfolio characteristics (e.g. P/B, ROE relative to benchmark, turnover,
and market cap breakdown) as well as risk adjusted performance.
Risk of Loss
All investment programs have certain risks that are borne by the investor. Our
investment approach constantly keeps the risk of loss in mind. Investors face the
following investment risks:
• Market Risk: The price of a security, bond, or mutual fund may drop in
reaction to tangible and intangible events and conditions. This type of risk is
caused by external factors independent of a security’s particular underlying
circumstances. For example, political, economic and social conditions,
investor sentiment, general economic and market conditions, regional or
global instability, currency and interest rate fluctuations may trigger market
events.
• Inflation Risk: When any type of inflation is present, a dollar today will not buy
as much as a dollar next year, because purchasing power is eroding at the
rate of inflation.
• Currency Risk: Overseas investments are subject to fluctuations in the value
of the dollar against the currency of the investment’s originating country. This
is also referred to as exchange rate risk. If a client account buys a security
denominated in a foreign currency, during the time that the client account
owns that security, for the purposes of calculating the NAV of that client
account, the value of the security is converted into U.S. dollars on a daily
basis. Fluctuations in the value of the U.S. dollar relative to the foreign
currency impact the NAV of the client account. If the value of the U.S. dollar
has increased relative to the foreign currency, the return on the foreign
security may be reduced, eliminated or made negative. The opposite can also
occur; that is, a client account holding a security denominated in a foreign
currency may benefit from an increase in the value of the foreign currency
relative to the U.S. dollar. Some portfolio managers choose or are required to
mitigate this risk by using derivatives to hedge the impact of foreign currency
fluctuations. However, these derivative transactions may not be fully effective.
Some foreign governments may restrict currency exchange. If we cannot
exchange the currencies in which a client account is invested, the client
account will be less liquid.
• Business Risk: These risks are associated with a particular industry or a
particular company within an industry. For example, oil-drilling companies
depend on finding oil and then refining it, a lengthy process, before they can
generate a profit. They carry a higher risk of profitability than an electric
company, which generates its income from a steady stream of customers who
buy electricity no matter what the economic environment is like.
• Liquidity Risk: Liquidity is the ability to readily convert an investment into
cash. Generally, assets are more liquid if many traders are interested in a
standardized product. For example, Treasury Bills are highly liquid, while real
estate properties are not.
• Financial Risk: Excessive borrowing to finance a business’ operations
increases the risk of profitability, because the company must meet the terms
of its obligations in good and bad times. During periods of financial stress,
the inability to meet loan obligations may result in bankruptcy and/or a
declining market value.
• Developing/Emerging Markets Securities Risk: The prices of securities issued
by foreign companies and governments located in developing/emerging
markets countries may be impacted by certain factors more than those in
countries with mature economies, such as greater political, tax, economic,
foreign exchange, liquidity and regulatory risk. For example,
developing/emerging markets countries may experience higher rates of
inflation or sharply devalue their currencies against the U.S. dollar, thereby
causing the value of investments issued by the government or companies
located in those countries to decline. Governments in developing/emerging
markets countries may be relatively less stable. The introduction of capital
controls, withholding taxes, nationalization of private assets, expropriation,
social unrest, or war may result in adverse volatility in the prices of securities
or currencies. Other factors may include additional transaction costs, delays
in settlement procedures, and lack of timely information.
• Cash/Cash Equivalents Risk: Holding cash or cash equivalents may
negatively affect performance. To the extent the client account holds cash or
cash equivalents rather than securities in which it primarily invests or uses to
manage risk, the client account may not achieve its investment objectives and
may underperform.
• Convertible Securities Risk: The client account may own convertible
securities. The values of convertible securities in which the client account
may invest may be affected by market interest rates. The values of
convertible securities also may be affected by the risk of actual issuer default
on interest or principal payments and the value of the underlying stock.
Additionally, an issuer may retain the right to buy back its convertible
securities at a time and price unfavorable to the client account.
• Depositary Receipts Risk: Depositary receipts involve many of the same risks
as those associated with direct investment in foreign securities. In addition,
the underlying issuers of certain depositary receipts, particularly unsponsored
or unregistered depositary receipts, are under no obligation to distribute
shareholder communications to the holders of such receipts or to pass
through to them any voting rights with respect to the deposited securities.
• Derivatives Risk: The value of a derivative instrument depends largely on
(and is derived from) the value of an underlying security, currency, commodity,
interest rate, index or other asset (each referred to as an underlying asset). In
addition to risks relating to the underlying assets, the use of derivatives may
include other, possibly greater, risks, including counterparty, leverage and
liquidity risks. Counterparty risk is the risk that the counterparty to the
derivative contract will default on its obligation to pay the client account the
amount owed or otherwise perform under the derivative contract. Derivatives
create leverage risk because they do not require payment up front equal to
the economic exposure created by owning the derivative. As a result, an
adverse change in the value of the underlying asset could result in the client
account sustaining a loss that is substantially greater than the amount
invested in the derivative, which may make the client account's returns more
volatile and increase the risk of loss. Derivative instruments may also be less
liquid than more traditional investments and the client account may be unable
to sell or close out its derivative positions at a desirable time or price. This risk
may be more acute under adverse market conditions, during which the Client
account may be most in need of liquidating its derivative positions.
Derivatives may also be harder to value, less tax efficient and subject to
changing government regulation that could impact the Client account's ability
to use certain derivatives or their cost. Also, derivatives used for hedging or to
gain or limit exposure to a particular market segment may not provide the
expected benefits, particularly during adverse market conditions.
• Equity risk: Companies issue equities, or stocks, to help finance their
operations and future growth. A company's operating results, financial
strength, competitive position and prospects for future growth will have the
most influence on its stock price over the long term. In addition, the economic
environment in which the company operates will also impact stock prices.
When the economy is expanding, the outlook for many companies will be
positive and the value of their stocks should rise. The opposite is also true. In
the short term, investor sentiment can have a significant impact on stock
prices as investors necessarily evaluate the uncertainty of a company's future
value. The value of a client account is affected by changes in the prices of the
stocks it holds. The risks and potential rewards are usually greater for small
companies, newly public companies and companies in emerging markets.
Investments that are convertible into equity may also be subject to interest
rate risk.
• Foreign Securities Risk: The dollar value of a client account's foreign
investments may be affected by changes in the exchange rates between the
dollar and the currencies in which those investments are traded. The value of
the client account's foreign investments may be adversely affected by political
and social instability in their home countries, by changes in economic or
taxation policies in those countries, or by the difficulty in enforcing obligations
in those countries. Foreign companies generally may be subject to less
stringent regulations than U.S. companies, including financial reporting
requirements and auditing and accounting controls. As a result, there
generally is less publicly available information about foreign companies than
about U.S. companies. Trading in many foreign securities may be less liquid
and more volatile than U.S. securities due to the size of the market or other
factors.
• Geographic Focus Risk: The client account may from time to time invest a
substantial amount of its assets in securities of issuers located in a single
country or a limited number of countries. Adverse economic, political or social
conditions in those countries may therefore have a significant negative impact
on the client account's investment performance.
• Growth Investing Risk: Growth stocks tend to be more expensive relative to
the issuing company's earnings or assets compared with other types of stock.
As a result, they tend to be more sensitive to changes in, or investors'
expectations of, the issuing company's earnings and can be more volatile.
• Investing in the European Union Risk: Investments in certain countries in the
European Union are susceptible to high economic risks associated with high
levels of debt, such as investments in sovereign debt of Greece, Italy and
Spain. Separately, the European Union faces issues involving its membership,
structure, procedures and policies. The exit of one or more member states
from the European Union would place its currency and banking system in
jeopardy. Efforts of the member states to further unify their economic and
monetary policies may increase the potential for the downward movement of
one member state's market to cause a similar effect on other member states'
markets.
• Management Risk: The investment techniques and risk analysis used by
some client account's portfolio managers may not produce the desired results.
• Non-Diversification Risk: The client account may be non-diversified, meaning
it can invest a greater portion of its assets in the obligations or securities of a
small number of issuers or any single issuer than a diversified client account
can. To the extent that a large percentage of the client account's assets may
be invested in a limited number of issuers, a change in the value of the
issuers' securities could affect the value of the client account more than would
occur in a diversified client account.
• Preferred Securities Risk: Preferred securities may include provisions that
permit the issuer, in its discretion, to defer or omit distributions for a certain
period of time. If the client account owns a security that is deferring or
omitting its distributions, the client account may be required to report the
distribution on its tax returns, even though it may not have received this
income. Further, preferred securities may lose substantial value due to the
omission or deferment of dividend payments. Preferred securities may be less
liquid than many other securities, such as common stocks, and generally offer
no voting rights with respect to the issuer. Preferred securities also may be
subordinated to bonds or other debt instruments in an issuer’s capital
structure, subjecting them to a greater risk of non-payment than more senior
securities. In addition, in certain circumstances, an issuer of preferred
securities may redeem the securities prior to a specified date, and this may
negatively impact the return of the security.
• Small- and Mid-Capitalization Risks: Stocks of small- and mid-sized
companies tend to be more vulnerable to adverse developments and may
have little or no operating history or track record of success, and limited
product lines, markets, management and financial resources. The securities
of small- and mid-sized companies may be more volatile due to less market
interest and less publicly available information about the issuer. They also
may be illiquid or restricted as to resale, or may trade less frequently and in
smaller volumes, all of which may cause difficulty when establishing or
closing a position at a desirable price.
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