Guide to Investment Risk

This guide has been produced by Jesmond Mizzi Financial Advisors Ltd to provide both knowledgeable and less experienced investors with additional information to help them decide on their investment strategy. Its purpose is to help you to understand the risks and potential returns associated with stock market investment. It is not intended to be a comprehensive guide to risk and if you are in any doubt as to the suitability of any strategy or transaction, you should consult your investment advisor. This guide should be read in conjunction with the agreements governing our relationship and our terms of business. The information contained in this guide is correct at the time of preparation, is included for illustrative purposes only and does not form the basis of an investment recommendation.

You must be aware that any investment involves a degree of risk and that some investments are riskier than others. Prices can fall as well as rise and there is a risk that you may lose some or all the money that you have invested. Past performance is no guarantee of future performance. The income which you receive from your investments can fluctuate and is not guaranteed. However, risk can be managed by creating a well diversified portfolio. There are many different financial products available, each carrying their own level of risk. Some of the most common instruments and the risks attached to them are outlined below.

Guaranteed Products

There are various insurance-backed and institutionally-backed products on the market, which offer “guaranteed” returns of capital or part-capital or capital and growth. These are only as safe as the company that has guaranteed them.

High quality sovereign bonds

High quality sovereign bonds, commonly known as Sovereign Bonds, are issued by highly rated developed country governments. Such countries have little chance of default of their financial obligations. With fixed interest sovereign bonds, supply and demand for the stock, current and likely interest and inflation rates cause the price of the stock to move during its lifetime. This can produce periods of volatility and loss of capital which is not normally associated with such bonds during their lifetime. However, the government promises to repurchase or redeem the stock at a guaranteed price on a set date (or between set dates) which means that the final redemption value of your investment is pre-determined. The secondary market for such bonds is a massive market and thus liquidity – the ability to buy and sell – is not an issue.

Corporate Bonds (“bonds”)

Other fixed interest securities, are widely available. The characteristics of price movement, predetermined redemption and liquidity can be similar to high quality sovereign bonds. However, the price is also dependent on the credit worthiness of the borrower. Borrowers vary widely from large corporations to relatively small companies and thus, depending on which you select, the risk can also vary widely. There is a greater risk that the issuer will not repay in full when investing in corporate bonds, although it should not be forgotten that a surprising number of governments have, in the past, also defaulted. Thus, certain bonds are likely to be far more volatile and less liquid than sovereign debt. Some bonds are credit rated by renowned agencies; where available, this is a useful guide to assessing the risk associated with individual bonds. Bonds rated BBB or better by Standard and Poor’s are considered to be of investment grade, whilst bonds falling below this standard are not. Inexperienced or lower risk investors should only consider bonds with an A rating or better.

Collective Investments (“funds”)

Collective investments, such as open ended collective investment companies (OEICs), unit trusts (open ended) and investment trusts (closed ended) (collectively known as “funds”), pool your investment with that of other investors. This is then managed by a fund manager in a portfolio which may include, amongst other asset classes, cash, stocks, shares (both domestic and overseas), property, precious metals and/or derivatives in order to achieve the fund’s objectives. The number of asset classes and investments within an asset class held by the fund helps to spread risk. The investor also benefits from having the fund’s investments constantly monitored by the fund manager and economies of scale mean that a collective investment can be a cost efficient way to buy and sell shares or other asset classes.

The liquidity of closed ended funds is generally driven by the fund’s size and underlying asset class. The same considerations as outlined below (under the section Shares) apply. Open ended funds should not suffer from liquidity problems unless the underlying assets held become illiquid and a large number of holders wish to sell their holdings. In addition, you should also be aware that open ended funds have fixed dealing days, which can be daily, weekly, monthly or longer if it is a specialist fund. Depending on frequency of dealing, both buying and selling may be delayed accordingly.

Some funds employ gearing. This means that they borrow a sum of money against the collateral of the shareholders’ equity and invest that sum alongside shareholders’ equity. The risk profile of funds employing gearing is higher than those which do not employ gearing and will increase according to the level of gearing employed. You should be aware that where an investment employs gearing, it may be subject to sudden and large falls in value. In addition, movements in the price of the fund are more volatile than the movement in the price of the underlying investments and there is a risk that you may lose all the money you have invested.

Holders of ordinary shares are the last to be paid in the event of a company becoming insolvent. However, ordinary shareholders also have the potential for good returns provided the company does well and is perceived to be continuing to do well. Please note that the value of shares and the income from them can go down as well as up. This means that it is advisable to hold shares in a number of diverse companies, rather than be too dependent on one particular company or industry sector. A spread across different economies is also advisable. Overdependence on one company’s shares is unwise. Trying to predict the future performance of the stock market and individual shares is very difficult and nothing is guaranteed. Liquidity is an important risk factor when investing in individual equities. Liquidity is generally driven by the capitalisation of the company and current market conditions can change on a day to day basis; this can often restrict the trading in particularly illiquid mid and small market capitalisation equities. Shares can go from being very liquid to illiquid in a very short period of time.

Exchange Traded Funds (ETFs)

Similar to a fund, an exchange traded fund or ETF, is a portfolio of bonds, shares or a mix of both, which tracks an underlying index. The latter could be an index which tracks the performance of the largest companies by market capitalisation or the most valuable companies in a specific sector, among others. ETFs are not usually actively managed and unlike actively managed funds they do not aim to beat their benchmark.

ETFs trade like equities on a stock exchange and similar to most other financial assets, their value fluctuates over time. ETFs tend to offer diversification benefits at a lower cost compared to actively managed funds, given the fact that ETFs do not aim to beat their benchmark and hence involves very limited human intervention.

Important note:

Investment on the stock market typically produces greater returns over the longer term than keeping money in a bank. We normally recommend stock market investment on a medium to long term basis with a minimum investment period of at least 5 years. In the short term, investors should be aware that markets, bonds, funds, shares and securities generally can be subject to major movements and volatility due to a variety of economic, political, fiscal and other (often emotional) factors.

Deciding on your investment aims/objectives

Having decided that you are prepared to expose some of your money to the risks involved in stock market investment, you need to consider the level of risk that you are prepared to take. This will largely be based on the type and level of return you want from your portfolio. Please note that the return may take the form of an increase or a decrease in the capital value of your portfolio and/or the income received from it, over a period. As a first stage and after understanding your knowledge and experience and your current financial situation, you must decide:

What level of income do you require (both now and in the longer term)?
What level of capital growth are you expecting?
What level of risk are you prepared to take to achieve the returns you want?
How would you feel if the value of your portfolio fell by, say 10%, 20% or more?
What is your investment time horizon (short / medium / long term)?
Which risk return profile are you comfortable with?

Deciding on the level of risk you are prepared to take

Typically, the higher your expectations are for the returns from your portfolio, the higher the degree of risk to achieve those objectives. Risk can mean different things to different people and can take different forms.

Stock market risk

Investing in types of securities traded on stock markets will mean that the value of the securities and/or the income received from them may go down as well as up and you may not get back all the money you have invested. There are five main reasons why this might happen:

The actual and perceived financial standing and trading of the company concerned may change.
All securities are subject to the laws of supply and demand and are capable of significant price movement. Such movements could be a reflection of e.g. company size, economic or political news, company or sector specific news, and quantity and frequency of shares being traded (liquidity);
The stock market itself is capable of large movements due to economic, political, fiscal and other (often emotional) factors;
Fixed interest securities (including high quality sovereign debt) are subject to the same factors mentioned above and their values are mostly affected by actual or expected changes in levels of interest and inflation rates. The shares of one company may be acquired by another company, or the company in which you have invested may make a bid for another company. This could have a dramatic effect on share prices.

Assessing the relative risk of any of these factors is highly subjective and in the same way as market conditions, can change over time in response to specific events or revised economic forecasts. It is impossible to lay down precise guidelines for the measurement or potential impact of risk on your investments.

Risk can be managed by creating a well diversified portfolio and by the use of collective investment schemes. Diversification within a market and/or across a number of geographical areas also helps lower exposure to specific economic, political and fiscal factors.

Categorising risk for your own portfolio

To obtain a clear understanding of the level of risk you are willing to accept for your portfolio as a whole, we recommend that you consider the three definitions shown below as a broad guide. They are commonly used risk levels amongst our client base. The definitions include the types of investment instruments that might be held in the portfolio.

Lower risk portfolio:

The spread and types of investment will result in lower overall volatility and therefore lower risk. The portfolio should include a proportion of highly rated bonds, since these securities are not particularly volatile and have lower default probability. Generally, at least 50% would be invested in securities of this type. The portfolio may also contain mainstream funds. Any minor allocation to shares or equities bought for the portfolio would normally be shares of global leading companies.

Medium risk portfolio:

The portfolio will contain some exposure to high quality sovereign bonds and corporate bonds with a higher than normal weighting if there is an income requirement. Shares in the portfolio will generally be large and mid-cap international companies. A modest percentage of the portfolio might also be invested in the shares of smaller companies. Funds may also be used to give a limited exposure to precious metals, property or emerging markets . Some of the funds may employ gearing.

Higher risk portfolio:

The portfolio could include any securities, in any proportion, from worldwide stock markets (but not options or other derivative products, unless specifically agreed). It could also include aggressively geared products. Generally, you will be willing to accept higher risk in anticipation of higher returns.

A note on tax

The tax treatment of income and/or capital gains from your investments and the availability and value of tax reliefs will depend on the nature of the investments, the tax laws in your country of residence and your individual circumstances. Jesmond Mizzi Financial Advisors Limited are not tax advisors or tax experts and we therefore have not endeavoured to cover the subject of taxation in this guide. If you have any questions or doubts about your tax position, you should seek professional tax advice. It is your responsibility to obtain independent advice where appropriate and to correctly discharge your tax liabilities wherever they fall due.

NOTE FOR ADVISORY NON-MANAGED CLIENTS:

JESMOND MIZZI FINANCIAL ADVISORS LIMITED WILL NOT BE RESPONSIBLE FOR MANAGING YOUR PORTFOLIO, THE STRATEGY AND MIX OF YOUR PORTFOLIO AND THE PROPORTION INVESTED IN ANY INVESTMENT OR TYPE OF INVESTMENT WILL BE YOUR RESPONSIBILITY.

NOTE FOR MANAGED ADVISORY AND MANAGED DISCRETIONARY CLIENTS:

RISK AND PERFORMANCE WILL BE CONSIDERED ON THE BASIS OF THE PORTFOLIO AS A WHOLE AND NOT AT AN INDIVIDUAL STOCK LEVEL

Version: March 2023