Everlake Guide to Investing in Ireland

Introduction

Investing is a very personal decision. Some of us are very comfortable talking about money and investing. For others the world of equities and bonds is very distant from our everyday lives. It is something that we hear in the business news and often that news is portrayed as being bad for investors and this makes us anxious. It can be difficult to know what to do.

In this guide we set out the key issues that we believe you need to consider in putting an Investment Plan in place. The key to a successful investment experience is to have clearly thought through what is important to you and what you want to achieve, and then document it as your plan.

We normally recommend that you undertake a full financial planning process (focusing on protecting your family, paying down debt, planning for retirement and tax and estate planning) before putting in place your Investment Plan. Full consideration of your financial needs and goals can have major implications for your investment planning. For further details on our Financial Planning services see our guide.

Before designing an Investment Plan for you, we recommend that you complete a full analysis and review of your existing and likely future circumstances. You may be a professional, a senior executive, or participate in a family business, or you may be internationally mobile with interests outside Ireland.

Whatever your circumstances you will have unique challenges and opportunities. Over the years you will have entered-into financial arrangements for what were probably good reasons at the time. With the passage of time and change in your circumstances and the tax and regulatory environment your existing portfolio of assets may not be optimal now.

There may be opportunities to restructure your personal or business assets to avail of favourable tax reliefs. We will always take the time necessary to review your existing circumstances and make specific recommendations in respect of your existing assets and liabilities. As fee-based advisers, we conduct this analysis free from the conflict of interest associated with an adviser who is only remunerated if they sell you a new product.

As we look to the future you may wish to consider new issues such as life and legacy planning. You may have children progressing through education or starting their career. We always take to time to consider the best way of deploying your assets with legacy planning in mind. We can facilitate a range of planning structures including loans, partnerships, trusts and corporate structures that may assist you to support your family as they progress through life

Finally, bear in mind that, relative to other countries, the Irish tax and investment landscape is relatively complex. Books and websites in, for example, the USA and UK don’t necessarily translate well for an Irish Investor.

We will help you to understand these issues and to articulate them by working through each of the steps you need to consider as laid out in this guide. Only when we have worked through and documented your preferences and understood your values and motivations for investing will we move to implementation.

Once your Investment Plan has been put in place it is important to keep it under regular review. Many things can change over the course a year. Your personal circumstances, other external circumstances

such as tax and regulatory issues or the performance of the markets may all impact on your plan.

Rather than look to an arbitrary external market index such as the S&P 500, we use your financial plan as a personal benchmark against which to assess if you are on track with your objectives.

We monitor and update your plan as necessary on an ongoing basis to give you the best chance of achieving all that is important to you.

We hope that you find this guide useful. Please contact us if you want to discuss any aspect in greater detail or if we can assist you with your financial planning or investment needs.

Our Approach To Working With You

Before embarking on your Investment Plan we will review the following with you:

1. Assess your current assets and liabilities. This involves listing all your assets and loans by reference to valuation, ownership structure, domicile (where they are physically) and tax status. Key assets and liabilities will typically include:

• Private Residence

• Private Motors

• Cash Savings

• Family Business

• Restricted Stock

• Investment Properties

• Investment Funds

• Equities

• Bonds

• Pension(s)

• Mortgages & personal loans

• Life Assurance & Protection Policies

We will assess these assets to understand the allocation between different asset classes and to establish the overall risk profile of your assets. This will be an important consideration when we move on to consider the asset allocation under your investment plan.

2. Discuss recommendations for optimisation. There may be opportunities to restructure your current portfolio that make sense before you embark on designing your investment plan. Typical opportunities might include:

• Realising certain capital gains and losses which may be offset against each other.

• Taking advantage of tax planning opportunities such as pension contributions

• Reducing debt

• Consolidation of investment assets to simplify administration or for Estate Planning

3. Consider planning opportunities. As you focus on the future there may be a range of solutions that you could put in place. Some examples include:

• Wills & Powers of Attorney

o Appropriate provision for foreign assets

• Legacy Planning

o Structured Loans

o Family Partnerships

• Business Succession

o Maximising Entrepreneurial Relief for all family members

o Ensuring shares are structured to avail of Retirement Relief

o Passing on a participation in the business to children and family members in a tax efficient way

o Key-person insurance

Developing Your Investment Plan

Once all the topics arising from the review above are completed, we can move on to consideration of how to make best use of your investable assets. Our investing process centres around six steps:

1. Assess your investment goals and personal values. The investment plan process begins during a Discovery Meeting with a discussion of your financial values and goals, as well as your key relationships, existing assets, other professional advisers, preferred process, and important interests.

2. Set long-term investment objectives. Taking into account the long-term nature of successful investing, we help you set objectives for your portfolio that are appropriate for your willingness, ability and need to take risk, and the investment horizon(s) you identify.

3. Optimise Tax Structures. The tax treatment of your investments will be dependent upon their legal form. For example, pension assets are not taxable within a pension structure but are potentially taxable on withdrawal (often at a lower marginal rate).

Investment assets may be subject to either Exit Tax at a flat rate of 41% on income and gains with no reliefs or exemptions (most funds) or general tax principles of income and capital gains tax (certain forms of securities).

4. Plan your asset allocation. Asset allocation, the mix of investments in your portfolio between lower risk defensive assets such as cash and bonds and riskier growth assets such as Equities and Real Estate is generally accepted by academics objectively studying the subject as more important than either trying to time when to buy or sell (market timing) and trying to pick winning securities (stock picking) collectively known as active management.

During the asset allocation process, we set out how much of your portfolio to invest in each of the different investment types, or asset classes, including stocks, bonds and real estate in order to meet the expected return you need to achieve your investing objectives

5. Select your investment approach. With an asset allocation in place, we now turn our attention to how you might best achieve a successful investment experience. Unlike many of our competitors, we don’t believe that there is a “magic sauce” which can do this but rather that two key investing principles should guide how you approach investing: the importance of diversification and the benefit of staying invested in the markets.

6. Build your portfolio. Building on the first five steps, we construct a portfolio which is customised and best suited to your needs, goals, time horizon, risk capacity and significantly your personal values about investment considerations such as taxation, cost and sustainable investing considerations

The building blocks in our client’s portfolios are generally best in class global investment funds from leading managers such as Vanguard, Blackrock and Dimensional Fund advisers who collectively manage over $16 Trillion as at the end of June 2022.

1. Assess Your Investment Goals and Personal Values

Long-term investment success means different things to different people. The best investment plan for you depends on your specific circumstances and objectives. That is why we begin the investment planning process with a discussion during our Discovery Meeting of your values, goals, relationships, assets, advisers, preferred process and interests.

Your investment plan is only one part of your overall financial plan. You may wish to consider your wider financial goals and objectives as you put your investment plan in place.

While everyone’s situation is unique, certain factors matter in creating any investment plan. These factors include the purpose of the investment, its size, the sources and planned uses of the funds, and the amount of uncertainty you are comfortable having. By thinking clearly about your goals and circumstances, you build the foundation of an investment plan that best matches your needs and the realities of the financial markets.

We always seek to ensure that your values are reflected as fully as possible in the financial planning and investment approach that we recommend.

For example, we ask you to articulate your interest in Sustainable Investing, the umbrella term for investing that explicitly considers ESG factors (Environmental, Social and Governance), that aims to achieve a sustainability outcome and/or reflect a particular set of values or beliefs.

But what does Sustainable Investment really mean? Is it for you or are you more interested in Social Impact investing and Philanthropy? And, if it is, how do you go about choosing socially responsible and/or sustainable investments?

Our Consultative client process is designed to uncover your true intent about your money. If aligning your investment strategy and values about society and the environment are important to you, then we offer portfolios that will help you to meet this specific investment objective. However, in this guide we are not going to try to convince you that any one investment strategy or approach is better or worse than any other. As Financial Planners, it is our belief that the only perspective that really matters is this; the way in which you invest your money should reflect your personal and deeply felt values and beliefs.

Details of the full Investment Spectrum is included in Appendix 1.

2. Set Your Long-Term Investment Objectives

Most investors know they should focus on the long-term. This often gives rise to the question “How long is long term?” The answer for many investors is surprising your long-term horizon should be as far into the future as possible and therefore, ideally, inter-generational

One of the many surprising facts about investing is that having a long horizon is a powerful advantage. You want your horizon to be as long as possible, because as an investor, time is your ally.

For many investors, the most important long-term goal is to make work optional in order to be able to do what they want. But many investors also have intermediate-term goals funding college educations for their children, buying holiday homes or even founding charitable foundations are three examples. Investors may also have goals that reach far into the future for example, they may wish to leave legacies to their children, grandchildren and even great-grandchildren.

Regardless of the time horizon of your goals, the simple fact remains that the more time you have, the more likely you are to succeed as an investor. Why? There are two reasons. The first is the miracle of compound interest, and the second is the phenomenon of reversion to the mean

The Miracle of Compound Interest

Compound interest operates on a very simple principle. When you put money aside to earn returns, and then reinvest those returns, you have both your original investment and the returns working for you. The longer you allow this process to continue, the greater your accumulation will likely be. Imagine putting €1 million into an investment that consistently earns 8 percent every year. The table below shows how the compounding process works.1

At 8 percent, your investment would grow to more than 4½ times its original size in 20 years. To see the effect of compounding, notice that you would earn €1,158,925 in returns in the first ten years, but even more in the second ten years - €2,502,032.

While many people are familiar with the concept of compound returns, they may not be so strongly aware that time actually also helps reduce investment risk, especially in a diversified portfolio of stocks. It is natural to worry that if you invest in the stock market today, it may go down tomorrow. But if you have a long investment horizon, tomorrow is just one of the thousands of market days during which you will be investing. Over long periods of time, many of the ups and downs in the market are cancelled out, leaving you with the broad market trend return.

1 Figures are for illustrative purposes only and are not a guarantee of future performance. Figures do not reflect the effect of fees or taxes.

Stocks For The Long Run

The following graph shows how the range of annualized outcomes for the U.S. Stock market as measured by the S&P 500 narrows as your time horizon becomes longer. It shows results based on the performance of Standard & Poor’s 50 Index from 1926 to 2018 2 Although the average annual return has remained relatively constant at around 10% pa, the market has produced a wide range of outcomes around this average. An investor holding stocks for just one calendar year could have had returns ranging from a positive 162.88% percent to a negative -67.57 percent. An investor with a tenyear horizon could have experienced annualized returns ranging from a high of 21.43 percent to a low of -4.95 percent

However, investors who were invested for 20 years, had all 20-year time periods with positive returns.

Standard & Poor’s 500 Index Overlapping Returns Annualized

Annual: 1926–2018

We thus see the importance of simply investing for the long term, regardless of when you buy. This is true because an investment plan’s success cannot be fully realized until the underlying portfolio has gone through the various economic and market cycles that will be experienced over a long period, such as ten years.

What Do We Mean By Investment Risk?

In simple terms, risk is the possibility of something bad happening.

Before putting in place a long-term investment plan it is critically important to understand the risks associated with investing. Investment risk can be considered in several different ways. There is the risk of the permanent loss of capital either through an investment collapsing in value with no possibility of recovery, like Anglo Irish Bank, or the constant grinding erosion of value over time from inflation.

2 U.S. large capitalized stock performance calculations are based on annual performance of the Standard and Poor’s 500 Index, an unmanaged index intended to represent the performance of a diversified portfolio of large cap U.S. stocks.

This is different to volatility. Volatility is when the value of your portfolio fluctuates from day to day and is analogous to turbulence on a flight, it makes us feel uneasy, but it won’t cause a crash.

It is crucial that you consider all the dimensions of risk.

These include:

• Your attitude to investment risk or risk tolerance this is very personal to you and may influence your response to market fluctuations or volatility

• Risk capacity: Your ability to suffer losses without materially impacting your ability to do the things that are important to you. This is more of an objective assessment and in planning terms is the most important consideration

• Risk avoidance: Do you even need to take investment risk? Maybe paying off debts or arranging insurance could be a better strategy

• Your tolerance for tracking error: your ability to have your portfolio look different from popular market indices. This relates back to the idea that the best portfolio for you might not look like anyone you know

• Your rate of return objective. This is the return your portfolio needs to achieve on average and meet the objectives set out in your plan. It isn’t the “best return possible at all costs” it’s the return you need to meet your goals.

We will take time to explore your capacity for risk. See Appendix 2 Risk Considerations for further details.

Behavioural Biases

Another concept to consider is the field of behavioural finance which attempts to identify the systematic errors and biases which recur predictably in certain circumstances, offering a framework for understanding when and how people make mistakes.

Often, our emotions prevent us from holding an optimum portfolio that will allow us to achieve the returns we need since we have certain in-built biases which prevent us from objectively constructing our portfolios. We suffer from overconfidence in our abilities as investors. We suffer from regret about decisions made in the past. We extrapolate random patterns into the future. We suffer from hindsight bias (past events now seem obvious) and we are loss averse so that we emotionally weight the benefit of gains less than the hurt of losses.

From an investment perspective, an important aspect of avoiding such biases is first to become aware of them. Thus, by avoiding behavioural biases investors can more readily reach impartial decisions based on available data and logical processes. This requires understanding one’s behavioural biases, resisting the tendency to engage in such behaviours, and developing and following objectively prudent investment strategies. See Appendix 6 Behavioural Finance for more on this

3. Optimise Tax Structures

Because investors spend after tax returns, before we determine your preferred asset allocation, we will consider the best way to implement that allocation by reference to the legal structures available and the tax treatment of the various investment instruments. The tax implications of the various options are as follows:

1. Pensions

Pensions are one of the most valuable planning options available to investors in Ireland. Tax relief is available on contributions against earned income and all income and gains within the pension are exempt from Irish Tax. When the funds are drawn down, they will be subject to income tax but often at a lower marginal rate than when working.

This offers an opportunity to grow assets tax efficiently and free from the tax complexities of personally held assets. Currently up to €2million can be accumulated tax efficiently per investor in an Irish Pension. In practice this may only be possible through certain company structures as the annual contribution payable by an individual is subject to restricted limits.

2. Equities & Bonds (Directly Held)

Marketable securities (typically equities and bonds) are subject to normal income tax and CGT rules. Dividends and interest are subject to income tax, PRSI etc and capital gains are subject to CGT. This allows for a certain amount of flexibility as to when you realise gains are losses. This allows you to match gains and losses in a particular tax period. Losses can also be carried forward to offset against future gains. CGT can also be offset against CAT on certain gifts.

3. Investment Funds (Directly Held)

Investment funds come in various legal form. Most funds available to investors in Ireland will be constituted as a UCITS fund3. These funds and similar offshore funds are subject to an Exit Tax regime. The tax treatment of directly held marketable securities and Investment Funds is explored further in Appendix 3 Tax Considerations

4. Family Partnership

A Family Partnership is an effective Estate Planning option as the income and gains will generally be assessable against adult children rather than their parents effectively passing on growth to the next generation. In the case of minor children who are partners Income Tax will be payable by the parents, but CGT will be payable by the children directly.

5. Corporate Structures

Marketable Securities and Investment Funds held within corporate structures are generally subject to an onerous tax treatment and should be avoided or minimised.

3 UCITS – Undertakings for Collective Investment Transferable Securities. This refers to a regulatory framework that allows for the sale of cross-Europe mutual funds.

6. Charitable giving and philanthropy

Finally, there may be some tax advantages associated with making gifts to Charities

4. Plan Your Asset Allocation

Once we have worked with you to determine your time horizon, ability to take investment risk and satisfied you with a feasible rate-of-return objective that will meet your goals, we can begin the task of building your investment portfolio. The first step in this process is asset allocation.

The Importance Of Asset Allocation

Asset allocation is the process of deciding how much of your portfolio to invest in each of the different investment types, or asset classes equities, bonds and short-term investments as well as “real assets” such as real estate or commodities (See Appendix 5 Modern Portfolio Theory)

To investigate how important asset allocation really is, three leading investment experts (Brinson, Hood and Beeblower) performed a comprehensive statistical study to measure the importance of various factors in determining a portfolio’s performance. They studied the results of 91 major corporate pension plans over a ten-year period which included both good and bad markets. Their conclusion was that, on average, 94 percent of the variability in returns could be explained by the plans’ long-term asset class policy (see chart below). The remainder was attributable to individual security selection (4 percent) and market timing (2 percent).4 However, even though security selection and market timing explained 6 percent of the variability of returns, the overall contribution to performance was negative. The average plan lost 0.66 per year from market timing decisions and another 0.36 percent from security selection.

The authors conclude: “Because of its relative importance, investment policy should be addressed carefully andsystematically byinvestors.”

Determinants of Investment Portfolio Performance

4 Gary P. Brinson, L. Randolph Hood and Gilbert L. Beebower, “Determinants of Portfolio Performance,” Financial Analysts Journal, July/August 1986.

Asset Classes (Equities vs. Fixed Income)

The main asset classes are outlined in Appendix 4 Asset Classes. The most basic asset allocation choice is between equities and fixed-income investments (also known as bonds). Equities represent participation in the long-term growth of companies and of the economy as a whole, while fixedincome investments (bonds) represent fixed obligations of governments and corporations. It seems natural, then, that equities should offer superior long-term growth potential, while fixed-income investments offer more stability. The choice of allocation between equities and fixed income is a clear example of the basic investment trade-off between risk and return.

In exploring asset classes, we begin with the historical performance of investment categories. This is not to say that the past guarantees future performance; however, it does indicate reasonable relationships between various asset classes. By referring to the graph below, you can see that historically, equities have far outperformed fixed-income securities. For example, one dollar invested in equities (as represented by the S&P 500 Index) at the beginning of 1926 would have been worth $7,025 (assuming reinvestment of dividends) by the end of 2018, while an investment in small company stocks would have been worth $68,312. An investment of $1 in small-value stocks would have grown to a staggering $128,193.

By contrast, fixed-income investments, and cash, have trouble even keeping pace with inflation. That same dollar invested in 5-year U.S. government notes would have been worth $98.47. If invested in 30-day U.S. Treasury Bills, this dollar would have been worth $21.17. Simply to maintain purchasing power (to stay even with inflation) an investor over this period would have required an increase in value to $14.04.5

5 Roger G. Ibbotson and Rex Sinquefield, Stocks, Bonds, Bills, and Inflation. Dow Jones Irwin, Homewood, IL. 1986. Updated annually by Ibbotson Associates via Morningstar

Source Dimensional Fund Advisers

5. Select Your Investment Approach

As noted previously, the most important factor determining your investment outcome will be your asset allocation. Once you have determined your asset allocation, the next step is to consider your investment approach.

Most of the money around the world is managed by Wealth Managers and Investment Managers who subscribe to an “active management” approach. Their glossy brochures will focus on the ways in which they will help their clients to “beat the market”.

An investor could have beaten the S&P 500 between 1926 and 2018 which averaged 9.88%pa simply by taking a “Value investing” approach like that taken by Warren Buffet which averaged 11.09% pa. Or by investing in riskier smaller companies 11.96% pa or by investing in both small and value companies which over this period averaged 13.12% pa.

Growth of $1 between 1926 and 2018

Cash (one month Treasury Bills)

Source: Dimensional Fund Advisers

Whilst the research indicates that these dimensions of the stock market represent reliable sources of investment risk in global capital markets there is still no guarantee that investors who follow these strategies will profit from them. That is, after all, the nature of risk.

Unlike many, if not most, of our competitors, we don’t believe that most investment professionals possess sufficient skill to consistently beat the market after costs. Equally, whilst it is relatively easy to identify people who may have beaten the market over a particular period, it is difficult to distinguish between luck and genuine skill and we don’t know of any reliable way of identifying those who might beat the market in advance.

“The idea that any single individual without extra information or extra market power can beat the market is extraordinarily unlikely. Yet the market is full of people who think they can do it and full of other people who believe them….Why do people believe they can do the impossible? And why do other people believethem?” - Daniel H Kahnemann, 2002 Nobel Laureate in Economics.

Instead, we prefer to take an evidence-based approach derived from academic research to identify reliable sources of risk in global capital markets.

This body of work is known as Modern Portfolio Theory (see Appendix 5) and two key investing principles that should guide how you approach investing are:

• the importance of diversification and,

• the benefit of staying invested in the markets

Diversify Globally

One reason why many investors are reluctant to invest much in the stock market is that they know many stories of companies and stocks that have suddenly fallen on hard times. Some investors imagine an investment in the stock market to be like that when a stock has gone very high, it may be just the time that it is about to fall sharply. The mistake they make when they think this way is that they forget that while a single stock may rise or fall dramatically, the movements of the overall market are relatively much more subdued. As an example, see the performance of Bank of Ireland compared to the MSCI World Index below:

Graph of Bank of Ireland compared to the MSCI World Index Feb 1987 to Dec 2011

MSCI data copyright MSCI 2010, all rights reserved. Bank of Ireland Source Bloomberg

Modern Portfolio Theory provides the reason. It explains that two effects govern the movements of every stock market and stock-specific events. It is primarily the stock-specific events that cause individual stocks to move up or down wildly relative to the overall market. (Appendix 5).

You may think that your best protection against stock-specific risk is to have portfolio managers that know all the companies in your portfolio well. The trouble is, the events that cause the most damage to stocks usually come as a complete surprise. A company may have a sudden product liability problem, or the chairman may die or come under a cloud. On the upside, the company may make a surprise new product announcement, or land a major contract. These events are often unanticipated, and so they cause price movements that not even the best portfolio managers can predict

In fact, Modern Portfolio Theory tells us that if the market can anticipate an event, then the effect of the event is already reflected in the stock’s current price to such an extent that no further profit from knowledge of the event should be possible.

If it is surprising that portfolio managers cannot anticipate a stock’s movement, then how can an investor protect a portfolio against them? The answer is simply through diversification. The stockspecific movements of individual stocks may not be predictable, but when considered over a diversified portfolio, they tend to cancel one another out.

Modern Portfolio Theory tells us that we can build diversified portfolios to greatly reduce stockspecific risk, but that market events, which affect all stocks, are not diversifiable. That is, even a diversified portfolio of stocks is subject to the overall movements of the market. Fortunately, the theory predicts that the market rewards us for taking this risk by giving us generous long-term growth potential. The asset allocation decision is where we decide how aggressively to pursue this long-term growth.

The key take home for investors is that you should expect some investments within your portfolio to be going down from time to time and some to be going up. If all of the investments in your portfolio are all going up at the same time, you cannot possibly be diversified. We like to use the analogy of a shop selling both sunglasses and umbrellas. It doesn’t matter that on rainy days’ people don’t want to buy sunglasses and vice versa.

Stay Invested

Investors often ask when is the right time to invest? For a long-term investor, the answer is today. There is no short-term investment opinion behind that statement. No one can predict the movements of the market for the next month or year.6 Just as with unanticipated events, if portfolio managers could somehow predict the future movement of the market, then prices in the market would already reflect that knowledge, and so it would be impossible to profit from it.

Even though there is always a danger that the market will go down tomorrow, today is the right day to start investing. The next chart shows why. A large proportion of the long-term gain in investment in the stock market comes from sharp upward bursts. Just missing a few of the best days would have resulted in dramatically lower returns than staying invested throughout the period. Smart investors stay invested for the long term.

Source Dimensional Fund Advisers

6. Build Your Portfolio

For most people, building a truly diversified portfolio is difficult. Imagine that you wanted to build a diversified portfolio of 10,000 stocks worldwide. It is simply not cost effective for an individual investor to attempt to achieve this.

Equally, the lowest price investment funds available to institutional investors are beyond the reach of most individual investors.

Even if you have enough money to build a diversified portfolio, you may not have enough time. Choosing 10,000 stocks that you can buy with confidence is difficult enough. Once you had bought the stocks, you would still have a lot of work ahead of you. You would receive masses of information on many companies, and you would have to review your portfolio regularly to decide whether it still suits your objectives. It would be a lot of work to even calculate the performance of your portfolio and decide whether it was good or bad.

An easier way to implement a diversified portfolio is through investment funds used by large financial institutions rather than retail investment products. By buying an institutional asset class fund, in a single transaction you invest in a broad diversified portfolio in a specific asset class. These institutional asset class funds combine your investment with those of other investors to build up a pool of money large enough to buy a diversified portfolio. The portfolio manager’s full-time job is making sure that the securities in the portfolio continue to be suitable for the fund’s investment objective.

Asset Classes

Brief details of the main asset classes are included in Appendix 4. Our client’s portfolios are almost exclusively designed to incorporate the asset classes below

Cash

• Bank Deposits and State Savings

Bonds

• We generally favour Global Bonds Funds of high credit and short-term with currency risk hedged to Euros

Equities

• Developed Equities (e.g USA, Europe and the Far East)

• Emerging Market Equities (e.g . China, India etc)

Other Assets

• Global Real Estate Investment Trusts (REITs)

• Infrastructure funds focused on sustainable investing and renewable energy projects

Note that we do not advocate investing directly in residential or commercial property for our client’s investment portfolios. Being a landlord is a full-time job and there are easier, more flexible, and less

risky ways of investing in Real Estate.

Our Strategic Portfolio Management Process

The financial goals and values you shared with us at our Discovery Meeting have become the basis for your investment plan, as well as our Strategic Portfolio Management Process. This is not a one-time event, however. The Strategic Portfolio Management Process that we use is constantly ongoing to ensure that we are on track to achieve those goals and values. It is vital in managing the investment component of your overall investment plan. The process has four distinct parts, as illustrated below.

Gap Analysis

Current Situation

Financial Values and Goals

Asset Allocation

Investment Objectives

Risk Tolerance

Asset Class Selection

Rebalancing and Reporting Progress

Fine-Tuning of Portfolio Performance Report

Portfolio Activity

Gap Analysis

Manager Selection

Cost Effectiveness

Tax Efficiency

This is an ongoing evaluation of your current situation. We reassess where you are now, where you want to go, and consider any actions or changes that may be necessary to maximize the probability of achieving all that is important to you.

Asset Allocation

As we have discussed, we use Modern Portfolio Theory (Appendix 5) to determine that your account has the proper asset class selection to meet your financial goals. Change is one thing of which we are certain, and because proper asset allocation is so important, we periodically review each asset class to determine if it is still appropriate to your overall plan.

Attempting to chart a way through this complexity is difficult enough even for seasoned Professionals and ensuring that we can devote sufficient time to working with you to achieve all that is important to you is always our primary objective.

However, managing investment portfolios in Ireland is challenging for several reasons including the relative complexity of the tax rules, the lack of the “plumbing” necessary to facilitate our investment approach, and the time taken to manually trade investment portfolios with a client signature required for even the most mundane administrative matter. For further details of tax considerations see

Appendix 3 Tax Considerations.

Where suitable, we therefore delegate some of the investment portfolio management work to our investment partners Conexim supported by PortfolioMetrix Asset Management. Conexim provides a discretionary investment management service, but we are also able to provide an advisory service for those clients looking for a bespoke investment solution subject to minimum investment amounts

Manager Selection

The decision to retain or terminate an investment manager cannot be made by a formula. Also, extraordinary events do occur that may interfere with the investment manager's ability to prudently manage investment assets.

We generally recommend funds instead of individual securities due to their inherent diversification benefits. We usually advocate passively managed (e.g., "index") funds rather than actively managed funds.

Principally due to their lower fees, passively managed funds' long-term performance must exceed that of most actively managed funds investing in similar securities before tax For more information, see Nobel-prize winner William Sharpe's excellent brief article on the subject, "The Arithmetic of Active Management"

Note that past performance isn't one of our criteria. That is because, contrary to conventional wisdom, there is very little correlation between past performance and future performance. This has been proven statistically with a high degree of confidence in several academic studies.

In general, picking investment funds on the basis of their past performance is likely to be little better (or, more likely, a little worse) than picking funds at random. There is a better way. That's why we use the above criteria: they have been shown to have a correlation with future performance (i.e., they have been shown to be good predictors of long-term performance).

“All the time and effort that people devote to picking the right fund, the hot hand, the great manager, haveinmostcases led to no advantage.” - Peter Lynch, Magellan Fund and Fidelity Investments (1977 to 1990).

Reporting Progress

During our Regular Progress updates, we will ask you about any specific events in your life that may call for a change in your portfolio. These events might include, for example, the birth of a child or grandchild, the death of a parent or a change in your marital status. When changes in your situation indicate that changes and rebalancing in your portfolio are warranted, we make these as needed.

We will also report on how your portfolio has performed and if it needs to be adjusted or rebalanced to align with your required asset allocation

Rebalancing

The benefits of portfolio re-balancing derive from controlling risk and not from an increase in the expected returns. The proposition that rebalancing can increase the expected return of a portfolio is dubious. One thing is certain: rebalancing entails costs and possibly taxes and costs reduce expected rates of return.

For rebalancing to increase expected returns over time, asset prices would have to be consistently mean reverting and clients would need to be able to accurately time their rebalancing decisions. We do not recommend a market timing strategy or attempts to drive a “tactical” asset allocation strategy through a rebalancing strategy.

As we have seen, a portfolio’s asset allocation determines the portfolio’s risk and return characteristics.

Over time, as different asset classes produce different returns, the portfolio’s asset allocation changes.

To recapture the portfolio’s original risk and return characteristics, the portfolio must be rebalanced to its original asset allocation.

Our Investment Solutions

We povide a wide range of investment solutions which are designed to accommodate your values, your risk appetite and your tax status. Our solutions are summarised in the tables below:

Taxable Accounts

Non-Taxable Accounts (Pensions/ARFs/Charities etc)

Appendix 1: The Investment Spectrum

Individual investors typically have a range of motivations and objectives when deploying their funds. These include financial, personal and social considerations.

Many investors are committed to family businesses or property investments. In family businesses the financial and personal objectives may be closely aligned. Typically, investments in family businesses come with a significant personal time commitment either at a management or board level. Similarly, private equity investments, depending on the nature of the investment, may come with a personal time commitment in support of management. In these cases, the objectives are often not purely financial. Individuals are generally focused on achieving a commercial objective which includes both delivering on the vison or mission of the business and delivering a satisfactory financial return. Where investors have significant residential and property portfolios these investment may come with significant personal and social responsibilities. For many family businesses and property owners working with their local community is also an important dimension of their activities. In all the financial, personal and social are closely linked.

When investing in the public markets personal commitment is less important. In this case the investment spectrum spans the range of opportunity from investing where financial returns are the priority to Investing where social outcomes are the goal. Each of the various investment approaches has a particular attitude to risk and return and to its approach to Environmental, Social and Governance (ESG) considerations. There are potentially significant trade-offs between the various options.

One is in relation to risk and return where investors must consider the range of choices spanning from seeking to:

• Achieve optimum balance between risk and return

• Balance financial returns with social outcomes

• Focus on social outcomes with financial returns secondary

• Focus solely on social outcomes

A second is in relation to ESG considerations and this can be broken down further into:

• ESG not considered usually described as an Agnostic or Conventional approach)

• ESG factors considered as they impact the investment i.e. an Input Approach usually described as Stewardship & ESG Integration.

• ESG factors considered as they impact society - this is an Outcome or Consequences approach usually described as Sustainability Approach & Exclusions.

• Maximising social outcomes (Philanthropy)

Which approach is appropriate for you will be influenced by your personal circumstances and preferences and your stage in your investment journey:

• If you are seeking to build your savings and investments, then your focus may be on optimising financial returns and an Agnostic or Input approach may be appropriate.

• If you have sufficient funds for your requirements, you may wish to take a more balanced approach to social and financial objectives and an Outcome approach might suit.

• If your assets are concentrated in a family business or property you may wish to balance your existing personal and social commitments with a balanced approach.

• Where your funds are surplus to your personal requirements and you are planning to pass on your assets to the next generation you may wish to consider the Consequences approach. This can be a useful way to educate and engage your children around the opportunities and responsibilities that come with managing your wealth.

• Philanthropy can be incorporated into each approach if appropriate.

The various options are summarised in the graphic below:

In relation to risk and return, both Agnostic and ESG Integration are designed to achieve an optimum balance between risk and return. They put financial return first without consideration of environmental or social outcomes. In this context ESG factors are taken into account when trying to assess the risk adjusted returns of a company. To the extent that they do not impact on risk and return they can be ignored. This is sometimes referred to as the “Input” approach.

Sustainability Focus & Exclusions, Impact and Philanthropy on the other hand consider financial return only after ESG factors have been taken into account and the investors’ social objectives have been satisfied. In this context ESG factors are considered for their impact on the environment or society. The ESG factors may have a positive or negative impact. Negative ESG impacts considered as “externalities” i.e. costs associated with the company’s activities but currently borne by society. In these approaches the investor seeks to avoid investment with negative externalities arising from ESG factors and invest in companies with positive ESG attributes. This is what most people consider as ‘green” or “ethical” or “sustainable “investing.

We refer to all forms of investing that adopt the Input, Outcome or Consequences approach as Sustainable Investing. Most investors have minimal knowledge of the actual companies in which their funds are invested. However, when presented with a viable alternative many investors would choose to invest differently. In our experience investors are becoming increasingly conscious of the social and environmental impact of all economic activity. These investors want to see their values reflected in the companies in which they invest.

We endeavour to align your values with your investment portfolio. The right approach for you will depend on both your financial and social and environmental goals. We will explain the trade-offs between financial risk and return and ESG factors for your portfolio.

The difference between the various forms of both Conventional and Sustainable investing is explored below.

Conventional (Agnostic) Investing

Conventional or agnostic investing is focuses on maximising financial returns.

Market Portfolio

Investing in the market portfolio is often referred to as an “agnostic” or passive approach to investing. You are investing in all available assets in proportion to their market capitalisation. This is regarded as an “efficient” approach to investing. It is based on the proposition that the collective wisdom of all investors is captured in the prevailing market prices and in the absence of superior knowledge it is extremely difficult to out-guess the market.

Factor Portfolio

Under “Modern Portfolio Theory” in Appendix 5 we discuss a number of priced economic risk “factors” which have been discovered by researchers to have different risk and reward profiles to that of the market. Factor investing involves tilting your portfolio away from the market to increase exposure to

one or more of these factors. This is a way to customise your investments to your risk and reward preference or employment circumstances.

For example, if you work for a Large US Tech Company you might wish to retain stock options in your employer. To improve diversification of your overall wealth you might wish to increase your exposure to smaller cyclical companies in your pension, rather than buying a passive market portfolio which could include a large position in your employer’s company. This would be a good reason to arrange a stand-alone PRSA for Additional Voluntary Contributions (AVCs) rather than saving in the main scheme.

Sustainable Investing

Historically, a multitude of terms have been used to describe investing that incorporates social, environmental, and ethical considerations along with pure financial considerations. Everlake incorporates the business of Ethical Financial which was established in 1997 with the objective of offering socially responsible investment solutions. We are committed to our Ethical heritage. In the meantime, terminology has evolved.

We now use the term Sustainable Investing as our preferred term for investing that:

• Focuses on long-term returns through consideration of pertinent ESG risks & opportunities

• Achieves sustainability outcomes (for example investing in renewable energy)

• Reflects a particular set of values or beliefs

While there are many forms of Sustainable Investing, we think it is useful to categorise them into three general categories: Stewardship & ESG Integration, Sustainability Focus and Exclusions and Impact Investing

Stewardship & ESG Integration

“Stewardship is the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society” 9

ESG refers to the Environmental, Social and Governance characteristics of a company or business. The facets of the business contribute to the risks and opportunities it is exposed to now and in the future. ESG integration is “The systematic and explicit inclusion of material ESG factors into investment analysis andinvestment decisions”.10

ESG Integration does not prohibit any specific investments as long as material ESG risks are identified and taken into account as part of the investment decision.

Sustainability Focus and Exclusions.

“Investment approaches that select and include investments on the basis of their fulfilling certain sustainability criteria and/or delivering on specific and measurable sustainability outcomes). Investmentsarechosenonthebasisoftheireconomicactivities(whattheyproduce/whatservicesthey deliver) andontheirbusiness conduct (howthey deliver their products andservices).”11

Exclusions (also referred to as negative screening) is the predominant approach of many ethical funds. There are many different types of exclusion including:

• Ethical/values-based/religious (e.g., alcohol, firearms, tobacco)

• Norms-based (e.g., companies involved in human rights violations / corruption)

• Poor sustainability (e.g., oil companies)

• ESG assessment (e.g., worst rated ESG companies)

Impact Investing

Impact investing represents “Investingmadewiththeintentiontogeneratepositive,measurablesocial and environmental impact alongside a financial return.”12 Impact investments intentionally contribute to social and environmental solutions. This differentiates

9 According to the Financial Reporting Council in the UK Stewardship Code 2020.

10 As defined by UN PRI.

11 Adapted by IA from Global Sustainable Investment Alliance (GSIA) definitions.

12 Global Impact Investing Network (GIIN)

them from other strategies such as ESG integration, stewardship and exclusions. Often one of the positive impacts sought will be one of the UN’s Sustainable Development Goals.

Philanthropy

Many people are motivated by the desire to promote the welfare of others, expressed especially by the generous donation of time and money to good causes. This can be facilitated by means of ongoing support or as part of a legacy.

Appendix 2: Risk Considerations

Your Attitude to Investment Risk

While we can do a great deal to mitigate risk, we cannot eliminate it. In any investment plan, it is important to understand both the types and the amount of risk you are taking and to be sure that you are comfortable with these. This understanding will greatly increase your ability to adhere to your long-term investment plan and increase your chances of achieving your financial goals.

The right level of risk for you depends on both your personal preferences and your situation. We break the risk equation into the following parts:

Risk tolerance: Your response to market fluctuations

Over the course of your investment life, the value of your portfolio will rise and fall. While we would always rather see our portfolio value rise, a prudent investor knows that any investment will have some periods in which the value will fall. Equity and commodity markets can be very volatile, and investors must expect that there will be regular periods of rising prices and regular periods of falling prices.

Your risk tolerance describes your level of comfort in waiting through the downturns. If the risk you take is within your risk tolerance, then you will be able to maintain your investment strategy through both strong markets and weak ones, giving you the best chance of investment success.

Risk capacity: Your vulnerability to suffering losses

Designing an appropriate investment strategy requires understanding and weighing factors that can be in conflict. Your tolerance for risk may be high, but as a prudent investor, you should consider your ability to withstand financial losses. Because market downturns are unpredictable, you need to assess the real economic harm you might face if your portfolio seriously declined in value. If your portfolio failed to provide the returns you had planned for, would you need to adjust your goals?

Risk avoidance: Your need to take investment risk

Most investors would not choose to take more risk than is necessary. While this is a simple statement, investors often fail to build this concept into their investment planning. Your need to take risk is directly tied to your rate-of-return objective.

If you need your portfolio to grow more quickly over your time horizon, you will want a higher rate of return. An increase in your rate-of-return objective, however, will generally mean taking more risk. If your return objective is higher than your risk tolerance (willingness to take risk) or your risk aversion (your vulnerability to losses), then you must adjust one or more of these parameters. This could mean, for example, retiring later and possibly subjecting yourself to the discomfort of greater risk or increasing the amount that you save.

On the other hand, if your rate-of-return objective can be lowered because your assets can support your goals with less growth, then your need to take risk is reduced and your portfolio should be allocated accordingly. As your portfolio grows over time, your need to take risk should be reassessed and your investment strategy adjusted accordingly.

Your tolerance for tracking error: ability to have a different portfolio to popular indices

Many investors are more comfortable when they know they are doing as well, or as poorly, as most other investors. A portfolio that tracks the returns of a popular index such as the ISEQ can provide that comfort, despite the fact that it may not provide the risk management or higher returns that may be available from an effectively diversified portfolio.

Tracking error is the amount by which the performance of a portfolio differs from that of familiar market indices. You should understand your personal tolerance for the tracking error that can result from a portfolio that purposely diversifies away from popular indices in order to decrease volatility and increase expected returns.

Bear in mind that tracking error can be present over lengthy periods. If, for example, your portfolio is weighted heavily toward smaller companies and value asset classes because of the higher expected return over time, it will often look quite different from say the S&P 500 or FTSE 100 indices, which are composed primarily of large growth stocks. The difference can be either positive or negative and may be present over many years.

Your Rate-of-Return Objective

Every investment choice you make involves a trade-off between risk and expected return. In general, a portfolio of safer investments will have less growth potential than a riskier one. To increase the rateof-return objective, you will typically have to take more risk. Thus, your rate-of-return objective must match the realistic opportunities that you have, given your time horizon and ability to take risk. If your rate-of-return objective is higher than your time horizon and risk attitude permit, then you must adjust one of the three parameters.

All other things being equal, you would most likely prefer to have a higher return. In particular, if two portfolios were equally risky, but one made a higher rate-of-return objective feasible, then you would choose the more rewarding portfolio. One way to construct a rate-of-return objective is to find the portfolio that offers the highest possible rate-of-return objective for your time horizon and risk attitude. In the language of the academic study of investments, this is an efficient portfolio.

Over a long investment horizon, a modest increase in your rate of return can make a significant difference in the amount you accumulate. The table below shows the sum to which an initial investment of €1 million will grow over 10 and 20 years at rates of return ranging from 2 percent to 10 percent.13

One way in which investors can increase their rate of return is by keeping costs and taxes down.

Appendix 3: Tax Considerations

In desiging your investment portfolio, it is important to consider both Irish and International tax impacts. Within Ireland Investment Returns are subject to different tax regimes depending on the form of the investment. As a retail investor you generally have the option of investing in investment funds or directly in securities

• Investment Funds – means collective investment funds of any type including, Irish Unit Linked Funds, Unit Trusts, Open Ended Investment Companies (OEICs), SICAVs, UCITS or Exchange Traded Funds which are liable to exit tax at a rate of 41% (Tax year 2022).

• Securities – means listed shares, certain non-EU ETFs or certain UK Investment Trusts (which are listed companies) or any instrument (exchange traded or otherwise) that is not taxed as a fund.

Taxation of Investment Funds (Exit Tax)

Investment funds are subject to an Exit Tax of 41% (2022). This is applicable on dividends arising from the fund or on the sale or redemption of units / shares in the fund. It also applies to the increase in value of the fund after each eight year holding period.

Some of the disadvantages of this tax are

• Losses on one fund cannot be offset against gains on a different fund

• Investors pay a flat rate of tax with no allowances or reliefs and with no reference to their personal marginal rates of income tax.

• Losses on shares, property or other assets cannot be offset against gains on funds and vice versa

• A notional tax charge is applied every 8 years on notional gains whether these are realised or not

• Exit tax will apply on death

Taxation of Securities (Income Tax and Capital Gains Tax)

Taxed under general tax principles, income is subject to Income Tax at your marginal rate (plus PRSI and USC) and growth at Capital Gains Tax 33% (Tax year 2022)

Taxation implications for investors

Marginalratetaxpayers

For taxpayers with income in excess of the standard rate band i.e. those whose income is sufficient to push them into the marginal rate of income tax of 40%, then any additional dividend income from securities will be taxed at the following marginal rates of tax:

Aged 70+ with income below €60,000

For older married taxpayers the annual income tax exemption is €36,000pa and the maximum rate of USC is 2% with no liability to PRSI:

€36,000)

Standardratetaxpayers

For taxpayers with income at or below the standard rate band, i.e. those whose income is insufficient to push them into the marginal rate of income tax of 40%, then any additional dividend income from securities will be taxed at the following marginal rates of tax:

Charge (Assuming income in excess of €21,296)

14 55% if self-employed with income in excess of €100,000 per year.

15 Note a tax credit is given for Dividend Withholding Tax payable in say, the USA of 15%, making this calculation more complex in practice

16 Individuals 70 years or over whose aggregate income for the year is €60,000 or less, will only pay USC at a maximum rate of 2%. ‘Aggregate’ income for USC purposes does not include payments from the Department of Social Protection.

17 USC income up to €70,044 ignoring rate bands

International Tax Considerations

If you in invest in a international security you may be subject to the following foreign taxes:

WithholdingTax

Interest or dividends on a foreign security may be subject to withholding tax by the tax authorities where the security is issued. This withholding tax may or may not be recoverable against Irish tax. This is dependent on whether Ireland has a tax treaty with the relevant jurisdiction and what are the terms of the tax treaty.

EstateTaxes

On death international securities may be subject to estate taxes in the jurisdiction where the securities are issued. In a similar way to withholding tax the estate tax may or may not be recoverable against Irish tax. This is dependent on whether Ireland has a tax treaty with the relevant jurisdiction and what are the terms of the tax treaty

Comparison of Exit Tax and General Tax Principles

Exit Tax and CGT Portfolios

For illustrative purposes only. Assuming the investor is aged 70+ with income under €60,000pa and either has capital gains tax losses or doesn’t realise the gain during their lifetime.

Appendix 4: Asset Classes

The investible universe is divided into different asset classes. The principal asset classes are Cash, Bonds, Equities and Real Assets. Each asset class is described below:

Cash

The assets management industry’s definition of “Cash” is generally broader than many realise. As well as bank deposits, the asset class generally includes short-term debt securities such as short-term government debt, commercial paper, repurchase agreements, certificates of deposit and bills of exchange (collectively: “money market instruments”).

Bonds

Often referred to as Fixed Income, bonds are tradeable forms of loans to governments, companies, or other organisations. Bonds provide the borrower (issuer) with external funds to finance investment or expenditure. It is a debt security, under which the issuer owes the holders (creditors) a debt and, depending on the terms of the bond, is obliged to pay them interest (the coupon) and usually to repay the principal at a later date, termed the maturity. Interest is usually payable at fixed intervals (semiannual and annual being the most common). Bonds are usually used in lower and mid-risk portfolios as they exhibit lower volatility. In most cases it is crucial to hedge the currency risk on foreign bond holdings so as not to accidentally increase the low volatility profile they are selected for.

Equities

Equities generally refer to holdings of shares or stock of publicly listed companies. Equities are held in anticipation of income from dividends and capital gains, as stock prices rise. The name comes from the accounting context “shareholders’ equity” (the value of the companies’ assets after all debts are paid off). As the asset classes are most frequently organised into geographical areas and are considered the ‘growth’ assets of most portfolios. The growth comes at the cost of higher volatility than cash or bonds.

Other Assets

There are other asset classes that offer the potential for further diversification from the asset classes listed above. These include Global Property generally in the form of Real Estate Investment Trusts (REITS), Infrastructure and Commodities.

Unlike our competitors we don’t recommend Private Equity (even with the tax break of an EIS), Hedge Funds, Absolute Return Funds, Crypto currencies, precious metals, or commodity funds., structured products also known as “tracker bonds”, loan notes or any form of financial engineering which seeks to package up a product to sell something to investors in order to earn a commission.

Appendix 5: Modern Portfolio Theory

Modern portfolio theory is based on the Nobel Prize winning work of financial economists and has been developed from decades of empirical research. This approach, commonly referred to as “asset class investing”, is common within the institutional market but is rarely offered to private clients.

So, what are the differences, and why is it that asset class investing is superior and why is it not often offered to private clients?

The key difference is that the traditional stockbroker will attempt to add value by the selection and trading of stocks, while asset class investing relies upon the allocation of the portfolio to various asset classes to deliver returns.

The rationale for asset class investing is simple: capital markets work and diversification between asset classes increases return and reduces risk. Over the long run, markets reward investors with positive returns for taking risks and providing capital. If they did not, the capitalist system would have collapsed long ago. Market prices reflect the knowledge and expectations of all investors. Decades of academic research has shown that traditional managers are unable to outperform the markets by anything more that we would expect by chance. Investment experts usually summarize this evidence as a body of knowledge called “modern portfolio theory”.

The foundation of Modern Portfolio Theory was a 1952 paper, “Portfolio Selection” by Dr Harry Markowitz in which he established a theory explaining the best way for an investor to choose a portfolio. Modern Portfolio Theory is of such fundamental importance in investing that the economists that formulated the theory received the Nobel Prize in Economic Science in 1990.

Modern Portfolio Theory

has four basic premises:

1) Investors are inherently loss averse. Investors are generally more concerned with loss than they are with reward.

2) Securities markets are competitive and drawn to a long run state of equilibrium. This means that investors should assume that the price of any publicly traded security reflects the views and opinions of all market participants and is therefore probably a “fair price”.18

3) The focus of attention should be shifted away from individual securities analysis to consideration of a portfolio as a whole, predicated on the explicit risk/reward parameters and on the total portfolio objectives. The efficient allocation of capital in a portfolio to specific asset classes is far more important than selecting the individual investments.

4) For every risk level, there is an optimal combination of asset classes that will maximise returns. Portfolio diversification is not so much a function of how many individual stocks or bonds are involved, as it is of the relationship of each asset to each other asset.

18 Security prices are an “unbiased predictor” in the sense that the next move in price is just as likely to be up as it is to be down.

Following on from the foundation established by Markowitz Modern Portfolio Theory has developed into a robust body of knowledge. Subsequent work by Gene Fama and Ken French examined different characteristics of equity portfolios to determine what factors drive risk and return.

It is clear from their work that all equity portfolios are not the same. Equity portfolios can be constructed to reflect different risk & return characteristics. These characteristics are associated with a range of different investment “factors”. The main factors we consider in constructing a portfolio are size and value & growth factors.

Value & Growth

Equities or equity portfolios can be categorised as “Value” or “Growth”. Growth stocks tend to have relatively high score on metrics such as Long-term projected earnings growth, Historical earnings growth, Sales growth, Cash flow growth and Book value growth. Typically, a lot of the well-known technology stocks such as Apple will satisfy these criteria. Because of their “growth” characteristics they tend to be relatively highly valued.

Value stocks on the other hand tend to be those stocks which have a relatively low score on a range of metrics like Price-to-projected earnings, Price-to-book, Price-to-sales, Price-to-cash flow and Dividend yield. These are often more cyclical or out-of-favour businesses which from time to time will change as the fortunes of different industries such as banking, utilities or oil companies ebb and flow. However, just because they might be seen as cheaper than the market in general, does not mean that the price can’t go even lower.

Value and Growth stocks historically have a different risk & return profile. Over long-time scales Value stocks have outperformed. However there have also been sustained periods of underperformance

Size

Stocks can be categorised by size. The global names that we are all familiar with are generally largecap stocks. These will typically comprise a large proportion of the global stock market. The next tier are mid-cap stocks, and the smallest stocks are referred to as small-cap stocks. For example, in the US the top 250 stocks represent 70% of the US stock market, the next 750 stocks represent the next 20% of the market. All remaining stocks just represent 10% of the market. Each tier of stocks has a different risk & return profile. There is evidence that a portfolio of small stocks has a higher return over the longer term. This is associated with higher volatility in the shorter term.

Other Factors

In addition to size, Value and Growth there are several other factors to consider in constructing a portfolio. These factors include Quality, Momentum and Volatility.

Style Box

Style boxes are a mutual fund classification scheme created by the financial analytics firm Morningstar, which are designed to visually represent the investment characteristics of stocks and mutual funds.

Style boxes provide a graphical representation of investing categories for both fixed-income and equity investments. A style box is a valuable tool for investors to use when determining asset allocation. There are slightly different style boxes used for equity and fixed-income investments.

It is possible to graphically illustrate your portfolio positioning on a Style Box 19like that illustrated below. This is a matrix with Size on the vertical axis and Value & Growth on the horizontal axis. The style box below shows several indicative portfolios.

As you can see from the matrix most market portfolios are up and to the right reflecting the fact that the global stock indices are dominated by the large growth companies. This is true for both a conventional global market index and global ESG indices. Global equity impact portfolios tend to be in the mid-cap blend bucket although there are a wide range of options. It is also possible to construct a portfolio with a small-cap value tilt if your preference is for a portfolio with higher risk and return characteristics.

19 Style BoxTM is methodology developed by MorningstarTM to illustrate portfolios and investment funds by reference to their size and value, and growth characteristics.

Appendix 6: Behavioural Finance

Modern portfolio theory and behavioural finance represent differing schools of thought that attempt to explain investor behaviour. Perhaps the easiest way to think about their arguments and positions is to think of modern portfolio theory as how the financial markets would work in the ideal world, and to think of behavioural finance as how financial markets work in the real world. Having a solid understanding of both theory and reality can help you make better investment decisions.

Behavioural finance20 is the study of psychological influences on investors and financial markets. It uses psychology and economics to explore why people sometimes make emotional rather than logical decisions and why their behaviour does not follow the predictions of accepted economic models.

It looks for answers to questions such as why even experienced investors buy too late and sell too soon, or why someone doesn’t use their savings account to help with paying off massive credit card debt. It even studies anomalies such as the small but measurable advantage companies have in the market if their stock ticker abbreviations come first in the alphabet, or the effect of the weather on market values.

Often, our emotions prevent us from holding an optimum portfolio that will allow us to achieve the returns we need since we have certain in-built biases which prevent us from objectively constructing our portfolios. We suffer from overconfidence in our abilities as investors. We suffer from regret about decisions made in the past. We extrapolate random patterns into the future. We suffer from hindsight bias (past events now seem obvious) and we are loss averse so that we emotionally weight the benefit of gains less than the hurt of losses.

Behavioural finance attempts to identify the systematic errors and biases which recur predictably in certain circumstances, offering a framework for understanding when and how people make mistakes. There are two types of human behaviour that factor heavily in behavioural economics: heuristics and biases.

Heuristics are mental shortcuts we use to decide something quickly or not at all. Investors and financial professionals often use heuristics when analysing investment decisions. Heuristics are often based on assumptions or rules of thumb that often but not always, hold true.

20 Behavioural finance originated from the work of psychologists Daniel Kahneman and Amos Tversky and economist Robert J. Shiller in the 1970s-1980s. They applied the pervasive, deep-seeded, subconscious biases and heuristics to the way that people make financial decisions. At about the same time, finance researchers began to propose that the efficient market hypothesis, a popular theory that the stock market moves in rational, predictable ways, doesn’t always hold up under scrutiny. In reality, the markets are full of inefficiencies due to investors' flawed thinking about prices and risk. In the past decade, behavioural finance has been embraced in the academic and financial communities as a subfield of behavioural economics influenced by economic psychology. By showing how, when, and why behaviour deviates from rational expectations, behavioural finance provides a blueprint to help everyone make better, more rational decisions when it comes to their finances.

An example of a common heuristic is to assume that past investment performance indicates future returns. Although that seems to make sense on the surface, it doesn’t take into account changes in the economy, or how fully valued a stock has become. An investor might assume that because an emerging markets equity mutual fund has posted positive returns for the past five years, a sensible decision would be to maintain or increase the position in the fund. However, it is possible that the mutual fund has undergone a turnover in management, or oil prices have risen which affects shipping costs to these markets, for example. A mental shortcut in investment analysis can have an adverse effect on a portfolio.

When economic and financial heuristics lead to inaccurate judgments and beliefs, the result is cognitive biases.

The most common cognitive biases include:

• Self-attribution bias: Believing that good investment outcomes are the result of skill, and undesirable results are caused by bad luck.

• Confirmation bias: Paying close attention to information that confirms a finance or investment belief and ignoring any information that contradicts it.

• Representative bias: Believing that two things or events are more closely correlated than they really are.

• Framing bias: Reacting to a particular finance opportunity based on how it is presented.

• Anchoring bias: Letting the first price or number encountered unduly influence your opinion.

• Loss aversion: Trying to avoid a loss more than on recognizing investment gains, so that desirable investment or finance opportunities are missed.

These biases and the heuristics that helped create them can affect investor behaviour, market and trading psychology, cognitive errors, and emotional reasoning.

From an investment perspective, an important aspect of avoiding such biases is first to become aware of them. Thus, by avoiding behavioural biases investors can more readily reach impartial decisions based on available data and logical processes. This requires understanding one’s behavioural biases, resisting the tendency to engage in such behaviours, and developing and following objectively prudent investment strategies.

As investors our primary concerns are often a direct result of uncertainty about the future. We worry about the news and wonder how it might affect our investments. But we have no control over these concerns, so they make us feel uneasy. So, where should investors concentrate their efforts in order to maximise the areas where we have some control over the outcome? The simple answer is to focus on your personal goals and values rather than react to the noise from the markets.

This means identifying your personal goals and objectives, your values, and your willingness and your capacity to bear losses. Only then can we help you to determine an appropriate asset allocation strategy which should be monitored against strict tolerances and rebalanced when required. This will help guard against our behavioural biases - experienced and seasoned investors have learned that success often comes from reining in their emotions and overcoming their biases, so they often avoid making the same mistakes as many new investors. These include:

• Investor Behaviour: Overconfidence, excessive optimism, self-attribution bias, framing bias, and loss aversion often lead investors astray. All of these factors lead to irrational rather than well-considered investments.

• Trading Psychology: Trading psychology refers to the mental state and emotions of a trader that determines the success or failure of a trade. Assumption heuristics, such as making a decision based on one positive result, anchoring bias, loss aversion, and confirmation bias can yield less than desirable investment or financial outcomes.

• Market Psychology: Human economic and financial heuristics and biases affect economic markets, the odd mix of collective and independent decisions of millions of people, acting for themselves and on behalf of funds or companies. As a result, many markets are not successful for many years. Understanding what causes the anomalies in valuations of individual securities and the stock market can result in better market performance.

• Cognitive Errors: Sub-optimal financial decision-making is the result of cognitive errors, many of which are made because of heuristics and anchoring, self-attribution, and framing biases. Exploring neuroscience discoveries and the implications for financial decision-making under uncertainty can result in sounder strategies for client debiasing and financial management.

• Emotional Reasoning: Many investors believe that their heuristics and biases are examples of sound, scientific reasoning and therefore should be used for investment decisions. They are surprised to learn that they are emotional, not logical.

Disclaimer

This document has been prepared for educational and information purposes only and does not represent a specific recommendation for an individual to follow.

Taxation

References to Taxation have been obtained from sources which we believe to be reliable

and are based on our understanding of Irish Tax legislation at the time of writing. We cannot guarantee its accuracy or completeness. The rates and bases of taxation may change in the future. We recommend that you obtain specific tax advice for your own personal situation. We will refer you to a suitably qualified tax consultant on request.

Investments

As with any investment strategy, there is potential for profit as well as the possibility of loss. Past experience is not necessarily a guide to future performance. The value of investments may fall or rise against investors’ interests.

Any person acting on the information contained in this document does so at their own risk. Recommendations in this document may not be suitable for all investors. Individual circumstances should be considered before a decision to invest is taken.

Income levels from investments may fluctuate. Changes in exchange rates may have an adverse effect on the value of, or income from, investments denominated in foreign currencies. We do not guarantee any minimum level of investment performance or the success of any portfolio or investment strategy. All investments involve risk and investment recommendations will not always be profitable.

Warning: the value of your investment may do down as well as up. This service may be affected by change in currency exchange rates. Past performance is not a reliable guide to future performance.

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