The basis of Numis’ risk rating is that the UK equity market is considered average risk for a UK based investor. Trusts are classified into one of six categories depending on their risk characteristics relative to a broad index of the UK equity market. It should be noted that all trusts carry a degree of risk, and “Below Average” trusts may still fall in value and you may not get back the amount originally invested.
The key quantitative measure used to assess risk is volatility of returns, using historic net asset value (NAV) performance over 1 and 3 years. In this instance volatility measures how much a trust’s NAV fluctuates over time in relation to the UK equity market. The higher a volatility figure, the more the NAV has fluctuated (both up and down) against this index over time. The starting point for classifying trusts is a comparison of volatility against the UK equity market using a series of bands, illustrated in the table below:
Risk classifications – Initial Quantitative screen
|Category||Volatility Relative to UK equity market|
|Slightly Below Average||70-80|
|Slightly Above Average||120-140|
(Source: Numis, July 2017)
Numis focus on NAV rather than price as they believe changes in a trust’s discount*, though relevant for shareholders, can provide a misleading picture of the likely future risk. For instance, a trust’s discount* may widen because of selling by a major holder, but there is no reason to expect this event to happen again. In addition, the volatility of smaller, illiquid** stocks is often vastly understated due to infrequent trading. As a result, Numis focuses on the risk at the portfolio level, as measured by the NAV.
In addition to the quantitative analysis, Numis also assesses a number of qualitative factors before determining a trust’s risk rating. Issues that may cause Numis to modify a trust’s rating include:
Portfolio concentration by stock or industry sector
Changes in mandate, investment style, gearing policy or capital structure
Type of asset class e.g. volatility tends to be understated in smaller companies due to illiquidity of the underlying investments, while private equity trusts only publish NAV on a periodic basis. Numis typically assigns a higher risk to less liquid underlying assets.
Please note that risk categorisations are indicative and based principally on historic data and should not be solely relied upon when making investment decisions.
* Shares of investment trusts can trade at higher (premium) or lower (discount) value than the assets in the underlying portfolio.
** Liquidity describes how easy or difficult it is to buy a company’s shares. Companies shares could be described as illiquid when there are a small number of shares in issue or if they are not regularly traded.