CASTLE TRUST STRATEGIC ASSET ALLOCATION REPORT · 2015-11-23 · Castle Trust Strategic Asset...

© Distribution Technology Ltd

CASTLE TRUST

STRATEGIC ASSET

ALLOCATION REPORT

March 2012

Castle Trust Strategic Asset Allocation Report ii

Copyright

© Distribution Technology Ltd 2012 onwards. All rights reserved.

The opinions expressed in this report are those formed by Distribution Technology and do not

represent investment advice or a recommendation to buy or sell units or shares in a particular fund or

portfolio. A significant part of this report and its results are dependent on information supplied by third

parties and specifically information supplied by the manager of the funds analysed. The information

does not indicate a promise, forecast or illustration of future volatility or returns.

Distribution Technology is not liable for the data in respect of direct or consequential loss attaching to

the use of or reliance upon this information. Distribution Technology does not warrant or claim that the

information in this document or any associated form is compliant with obligations governing the

provision of advice or the promotion of products as defined by the Financial Services Act.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form

or any means, electronic or mechanical, including photocopying and recording for any purpose other

than the purchaser’s personal use without the written permission of Distribution Technology.

This publication may not be reproduced in full or in part without the express written permission of

Distribution Technology. Its findings may only be shared, along with all caveats and assumptions with

professional investment advisers.

Sources of information

Castle Trust; Halifax; IPD; Rimes Technologies Corporation; iBoxx; Office of National Statistics and

Bank of England

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other intellectual property rights covering subject matter in this document. The furnishing of this

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holders.

Document name Castle Trust Strategic Asset Allocation Report

Version Final

Document reference CT Final

Issue date 13/03/2012

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Castle Trust Strategic Asset Allocation Report iii

Contents Executive summary ................................................................................................................................ iv

1. Introduction ...................................................................................................................................... 1

2. Product descriptions ........................................................................................................................ 3

2.1. Growth HouSAs....................................................................................................................... 3

2.2. Income HouSAs ...................................................................................................................... 3

2.3. Report scope and General Product risks ................................................................................ 4

3. DT Risk Methodology....................................................................................................................... 5

3.1. Investor Objectives .................................................................................................................. 5

3.2. DT fund risk profiling framework ............................................................................................. 5

3.3. DT strategic asset allocation framework ................................................................................. 5

4. Results ............................................................................................................................................. 7

4.1. Returns and volatilities ............................................................................................................ 7

4.2. Risk and Return Matrix ............................................................................................................ 8

4.3. Correlations ............................................................................................................................. 9

4.4. Asset allocations ................................................................................................................... 10

Appendix A: Investment assumptions ................................................................................................... 16

Appendix B: Data .................................................................................................................................. 18

Appendix C: Volatility boundaries ......................................................................................................... 20

Appendix D: Total Expense Ratio ......................................................................................................... 21

Castle Trust Strategic Asset Allocation Report iv

Executive summary

This report sets out the results of Distribution Technology’s analysis of the benefits of including UK

residential property as an asset class within the asset classes used on the Distribution Technology

Dynamic Planner Platform. The report also investigates the benefits of including allocations to the

Castle Trust HouSAs.

Aims

Castle Trust contracted Distribution Technology Ltd (DT) to create model asset allocations which

include explicit exposure to the retail housing market within the risk levels used on the Distribution

Technology Dynamic Planner® platform.

Availability of such a set of portfolios would allow Castle Trust to engage in conversations with IFA

firms and retail investment product providers about providing risk rated solutions with exposure to the

housing market. Castle Trust investment products could, alongside exposure to other asset classes in

the diversified allocations put together by DT, form part of the strategic asset allocations used on the

Platform.

Approach

This report reviews unmodified exposure to the UK housing market using the Halifax House Price

Index as a proxy for house price performance. The Castle Trust HouSA investments are linked to this

index.

The Halifax House Price Index is a price only index. To simulate total returns from the housing

market, the index was adjusted to allow for a fixed yield of 2.5% per annum. This makes the index

more comparable to the total return indices used on the Distribution Technology Platform to generate

planning assumptions for other asset classes.

The report investigates the level of allocation that can be made to the HouSA investments, taking into

account the design of the investments. Throughout the analysis asset allocations to all other asset

classes are maintained at the Distribution Technology standard asset weightings. If the optimisation

was run in an unconstrained manner the full exposure to property would have been invested in

residential property.

The investment assumptions used in this report are based on investment returns in excess of inflation

(i.e. real returns). This is the standard practice on the Dynamic Planner Platform.

Estimates of correlations and the volatility of investment returns for all asset classes are derived from

historical index data. The index used for each asset class is the nominated representative index for

that asset class.

The expected return assumptions used on the Dynamic Planner platform are forward looking

estimates of real returns for each asset class. In addition to analysis of historical index data, the

Distribution Technology Platform also uses the following market indicators to estimate expected

returns:

• Yields on UK Gilts; conventional and index-linked,

• UK corporate bond yields,

• Yields on global bonds,

Castle Trust Strategic Asset Allocation Report v

• Equity earnings and dividend yields.

Distribution Technology applies qualitative and quantitative constraints to portfolio optimisations to

arrive at the standard Platform asset allocations. The constraints are designed to produce more

diversified portfolios that meet best industry practice on consumer risk profiling and match client

expectations.

Main findings

Introducing UK residential property as an asset class increases the level of diversification that can be

achieved for portfolios from DT profile 2 to DT profile 7.

Investment returns from the housing market show:

• low correlation to fixed income and equity market returns, and

• modest correlation to returns from commercial property.

• The risk and return profile of residential property compares favourably to the profiles of other

asset classes.

• The residential property asset class delivers similar returns to the commercial property asset

class with less volatility risk.

Including the residential property asset class expands the portfolio efficient frontier (i.e. a greater

return can be achieved for any given level of risk or put another way a lower level of risk can be

achieved for a given level of return).

When residential property is added to a portfolio, the optimiser would allocate the full property

exposure to it. Allocating the full property weighting for each Distribution Technology strategic asset

allocation to residential property generates the same expected return at a lower level of risk.

If efficiency is the only consideration, then allocating all of the standard property weighting to

residential property provides the most optimal results. An equal split of the standard property

weightings between residential and commercial property provides additional diversification without a

significant loss in efficiency. It is left to individual adviser firms to decide on an appropriate split.

Table 1 shows the maximum allocations to UK residential property that are consistent with the DT

standard asset allocations.

Castle Trust Strategic Asset Allocation Report vi

Table 1: Allocation to residential property

Risk Level Maximum Allocation to UK Residential

Property

1 0%

2 10%

3 13%

4 14%

5 13%

6 8%

7 2%

8 0%

9 0%

10 0%

Castle Trust Strategic Asset Allocation Report 1

1. Introduction

This report was commissioned by the Castle Trust Group of Companies (Castle Trust). Castle Trust

has contracted Distribution Technology Ltd (DT) to create a set of risk graded model asset allocations

which include exposure to the retail housing market within the risk profiles used on the Distribution

Technology Dynamic Planner® platform.

The strategic asset allocations set out in this report are the standard allocations used on the DT

platform adjusted to include exposure to residential property. Within each risk profile, the weighting to

residential property has been limited to a maximum of the standard allocation to UK commercial

property. The resulting allocations are not replacements of the standard asset allocations on the

platform but they serve as alternatives for those advisers that wish to use residential property in their

recommended portfolios.

Castle Trust intend to use the outputs from this report to support discussions with Independent

Financial Adviser (IFA) firms and retail investment product providers about providing investment

solutions with profiles that are calibrated to the risk categories on the DT platform. The asset

allocations set out in this report include diversified exposure to a range of asset classes. Castle Trust

investment products would need to be offered as part of a diversified portfolio to meet the

expectations of investors and their advisers.

DT provides this analysis on the understanding that investors will access Castle Trust investments

through a regulated advice process. The recommendation on whether or not to include these products

in an investor’s portfolio and the amount to include should be made by advisers with the necessary

FSA permission to give advice on investments. DT accepts no liability in respect of any advice given

to investors relating to any investment strategy or the purchase of any specific products.

The analysis provided in this report should not be construed as marketing, promotion or

recommendation of the Castle Trust products or any specific product. The report is addressed to

Castle Trust with the understanding that Castle Trust can share findings with suitably qualified

advisers. The report, or any of its contents, is not addressed directly to retail consumers. DT is happy

for Castle Trust to reproduce this report in whole or in part for the benefit of qualified advisers.

The analysis in this report has been based on data and information provided by Castle Trust and

other third parties as set out in Appendix B: Data. It has been assumed by DT to be correct as of the

date of this report.

The performance of the HouSA products is assumed to be in line with the descriptions set out in

section 2. No view is taken on the ability of Castle Trust to deliver performance in line with these

descriptions.

We have split the analysis into two phases:

• The initial phase looks at unmodified exposure to the housing market using the Halifax House

Price Index (HHPI) with an assumed yield of 2.5% as a proxy for house price performance,

• The second phase looks at the HouSAs offered by Castle Trust, in particular the gearing built

into the design of HouSAs.


Castle Trust has applied to the UK Financial Services Authority (FSA) for permission to undertake

regulated financial activities in the UK. At the time of writing this report, the authorisation had not yet

been granted by the FSA and there is therefore no financial or operational track record of Castle Trust

to review.

Once authorisation has been granted, we understand that the products will be made available directly

from Castle Trust and also through ISAs and SIPPs.


2. Product descriptions

The product descriptions set out in this section are based on information provided by Castle Trust.

Castle Trust offers two types of fixed term HouSAs:

• Growth HouSA This product will offer an Investor exposure to the potential growth or decline

of the HHPI over the life of the product (with the potential for enhanced upside or reduced

downside participation).

• Income HouSA The Income HouSA will track the HHPI directly, offering 100% upside and

downside exposure to the HHPI plus an interest return on the initial investment amount of

between 2% to 3% depending on the investment term.

Both the Growth HouSA (which is a holding of shares in Castle Trust PCC, a Jersey protected cell

company) and the Income HouSA (which is a holding of debt securities issued by Castle Trust Income

HouSA plc, a Jersey company) are securities which will be listed on a recognised stock exchange, the

Channel Islands Stock Exchange.

Halifax publishes several versions of the HHPI; HouSAs are linked to the “All Houses, All Buyers,

Non-Seasonally Adjusted” monthly index. Further details on the products and rates are set out below.

2.1. Growth HouSAs

The Growth HouSAs earn multiples of the return on the HHPI. Growth HouSAs are fixed term

investments available for 3, 5 and 10 years term. If the HHPI increases over the term of an

investment, the investor receives the initial investment plus a return on the principal equal to the

increase in the HHPI multiplied by the Upside Ratio. If the index falls, investors get back their initial

investment less a return equal to the fall in the HHPI multiplied by the Downside Ratio. The following

table sets out the Upside and Downside Ratios for each investment term.

Table 2: Growth HouSA investment returns

Maturity Upside ratio Downside ratio

3 years 125% 75%

5 years 150% 50%

10 years 170% 30%

2.2. Income HouSAs

Income HouSAs are fixed term loan notes with a maturity value linked to the rise or fall in the HHPI

and an income yield that depends on the length of investment term. The loan notes are available for

terms of 3, 5 and 10 years.


The following table sets out the income yield on Income HouSAs by term.

Table 3: Income HouSA investment returns

Maturity Income yield

3 years 2.0%

5 years 2.5%

10 years 3.0%

2.3. Report scope and general product risks

This report focuses on passive investment in residential property as represented by the HHPI and the

profile of exposure gained through the HouSA investments. As such, the report only focuses on

matters of interest to potential investors in the HouSA investments. It makes no comment on the other

elements of the proposition and their contingent risks.

When considering the suitability of investment in the HouSA product it would be important that

advisers consider, among other factors and risks:

• that the investor may have a significant level of exposure to residential property through their

main residence, buy-to-let properties and holiday homes,

• that the investor understands and is comfortable with the possibility of losing money on their

investment, in terms of the risks inherent in investing in the residential housing market,

• the investor’s need for access to funds over the term of the investment, as the investments

are for fixed terms and there are no guarantees on amounts payable on early redemption,

• the investor’s need for income.

• Halifax may change the index construction methodology or discontinue the index altogether,

which would have consequences for investment outcomes and management of the HouSA

products (the HouSA terms and conditions cover this contingency).

• Any counterparty risk that may arise from the structure of the HouSA investment vehicle.

• The investor’s investment objectives; their nature and term.

The above factors are not exhaustive and other factors may need to be considered when assessing

suitability.

AKG Actuaries and Consultants Ltd. (AKG) conducted a corporate due diligence and financial

strength assessment on Castle Trust. AKG’s conclusions were that Castle Trust Capital plc was an

appropriately qualified provider of investment products with a clear strategy on delivering the

payments promised on the HouSA investments. AKG also concluded that Castle Trust appeared

more than adequately capitalised for the business they intend to undertake, and the risk framework

and philosophy was well regarded by AKG.

Note that the fixed term nature of the products will also constrain the ability of portfolio managers and

IFAs to rebalance client portfolios.


3. DT Risk Methodology

3.1. Investor Objectives

It is generally agreed that one of the key tasks for an investor is to determine how much investment

risk to take on. This decision will depend on an investor’s willingness and capacity to take on risk,

which in turn depends on psychological, financial and other factors. The investor will want to

maximise the reward for taking on this risk through the selection of optimal weights to each asset

category included in the investment portfolio.

3.2. DT fund risk profiling framework

The main objective of the DT risk profiles and the strategic asset allocations is to provide IFAs and

their clients with a meaningful measure of the long-term risk of investment strategies and a

mechanism for selecting portfolios suitable for investor risk appetites.

This report discusses both the effect of including residential property on strategic asset allocations

and comments on the risk profile of investing through the strategies used for the HouSA products.

The risk profile assigned to a portfolio by DT is a classification of the long-term strategic asset

allocation adopted for the portfolio. The measure of risk associated with each portfolio is mainly based

on the portfolio’s estimated volatility. In this instance we are discussing only a component that will go

to make up an overall portfolio (i.e. the inclusion of the HouSA products in diversified portfolios).

Investment in the housing market through HouSAs is assumed to be directly linked to the HHPI.

The actual riskiness of a portfolio or specific exposure to an asset class over the long term will

depend on, among other things, the level of flexibility in the mandate and how far the portfolio

deviates from the strategic position and for how long. Within an asset class, the actual holdings of the

portfolio may be more concentrated than the representative index for that asset class, which may

increase the riskiness of that portfolio.

3.3. DT strategic asset allocation framework

The DT methodology for constructing strategic asset allocations takes into account the expected

return and volatility of each asset class as well as the extent to which the movements in asset class

returns are correlated with one another and uses this information to create an “efficient frontier”. This

efficient frontier provides a guide to the range of asset allocations which are likely to provide the

highest level of future returns for a given level of estimated volatility or risk.

However, in addition to the risk of variability of portfolio values and returns, IFAs should also consider

each client’s individual circumstances and investment objectives.

For the purposes of constructing the efficient frontier, estimating return distributions and rating funds,

we have split the investment universe into the following asset classes:

• Cash

• UK Gilts

• UK Index-Linked Gilts

• UK Corporate Bonds


• International Bonds

• UK Equities

• European Equities

• North American Equities

• Japanese Equities

• Pacific (ex. Japan) Equities

• Emerging Market Equities

• UK Commercial Property

• Commodities

• Hedge Funds

• UK Residential Property

We derived the assumptions used to create the efficient frontier from historical and market data as at

the end of the second and third financial quarters of 2011. The historical data used is that of a

representative index for each asset class. The indices used for each asset class, along with the

inception date for each index, are set out in Appendix B: Data


4. Results

A summary of DT’s approach to setting the investment planning assumptions set out in this section

can be found in Appendix A: Investment assumptions. Full details of the DT parameter estimation

approach can be found in DT quarterly estimation reports.

4.1. Returns and volatilities

The returns and volatilities used to build strategic asset allocations were estimated from a

combination of historical data and market data. The return and volatility adopted for each asset class

is set out in Table 4.

Table 4: Return and Volatility

Assets Expected Nominal

Returns

Expected Real

Returns Volatility

Cash 2.6% 0.1% 1.5%

UK Corporate Bonds 3.8% 1.3% 7.6%

UK Index Linked Gilts 2.6% 0.1% 7.2%

International Bonds 3.0% 0.5% 8.2%

UK Gilts 3.0% 0.5% 7.0%

UK Equity 7.6% 5.0% 19.5%

Europe ex UK Equity 7.2% 4.6% 20.0%

North American Equity 7.4% 4.8% 21.0%

Japanese Equity 6.6% 4.0% 23.0%

Pacific ex Japan Equity 8.3% 5.7% 24.0%

Emerging Markets Equity 8.8% 6.2% 27.8%

UK Commercial Property 5.0% 2.4% 14.0%

Commodities 5.8% 3.3% 23.0%

Hedge Funds 4.1% 1.6% 11.0%

HHPI (Price Only) 2.5% 0.0% 9.5%

HHPI plus 2.5% yield 5.0% 2.4% 9.5%

5 year Income HouSA1 4.6% 2.0% 8.9%

5 year Growth HouSA2 4.3% 1.8% 11.0%

1

Based on simulated internal rates of return (over a 5 year holding period). 2 Based on average of annualised simulated returns (over a 5 year holding period).


4.2. Risk and Return Matrix

Figure 1 shows the location of each asset class on a risk and return chart.

Figure 1: Matrix of individual asset classes return and volatility

In addition to the risk and return profile of each asset class, optimal strategic allocations also take into

account the correlations between the asset class returns.

UK Cash (GBP)

UK Corporate Bonds

UK Index Linked Bonds

International Bonds UK Gilts

UK Equity

Europe Ex UK Equity North American Equity

Japanese Equity

Pacific Ex Japan Equities

Emerging Market Equities

UK Commercial Property

Commodites

Hedge Funds

HHPI + 2.5% Yield

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0%

Exp

ecte

d R

eal R

etu

rn

Volatility


4.3. Correlations

Table 5 shows the correlation matrix used by DT to generate strategic asset allocations.

Table 5: Correlation Matrix for all the asset classes used in analysis

Risk Level UK Cash

(GBP)

UK Corporate

Bonds

UK Index

Linked Bonds

International

Bonds UK Gilts UK Equity

Europe Ex UK

Equity

North

American

Equity

Japanese

Equity

Pacific Ex

Japan Equities

Emerging

Market

Equities

UK

Commercial

Property

UK Residential

Property

UK Cash

(GBP) 1.00 0.18 0.16 0.25 0.30 0.11 0.16 0.15 0.07 0.03 0.06 0.15 0.06

UK Corporate

Bonds 1.00 0.56 0.25 0.59 0.29 0.26 0.16 0.17 0.23 0.18 0.19 0.01

UK Index

Linked Bonds 1.00 0.36 0.61 0.27 0.24 0.21 0.15 0.26 0.18 0.03 -0.12

International

Bonds 1.00 0.59 0.12 0.23 0.31 0.32 0.19 0.15 -0.28 -0.22

UK Gilts 1.00 -0.13 -0.03 -0.05 -0.01 -0.06 -0.10 -0.16 -0.22

UK Equity 1.00 0.57 0.54 0.32 0.70 0.62 0.12 -0.01

Europe Ex UK

Equity 1.00 0.68 0.49 0.69 0.68 0.13 0.01

North

American

Equity

1.00 0.41 0.71 0.71 0.10 -0.02

Japanese

Equity 1.00 0.48 0.49 0.06 0.06

Pacific Ex

Japan Equities 1.00 0.82 0.10 0.02

Emerging

Market

Equities

1.00 0.12 0.03

UK

Commercial

Property

1.00 0.40

UK Residential

Property 1.00


4.4. Asset allocations

In all scenarios shown in this section, asset allocations to residential property have been limited to a

maximum of the DT standard weightings to UK property for each risk profile. The standard DT

allocations to UK property only include commercial property.

Table 6 sets out the standard DT property weightings for each risk profile on the DT platform.

Table 6: Standard DT asset allocation to UK Commercial property for each risk level

Risk Level UK Commercial Property

1 0%

2 10%

3 13%

4 14%

5 13%

6 8%

7 2%

8 0%

9 0%

10 0%


The following chart shows efficient frontiers for risk profiles 2 to 7 on the following basis:

• The standard DT strategic asset allocations (with no allocation to UK residential property),

• An equal apportionment of the DT standard property allocation between UK commercial

property and UK residential property (based on HHPI plus 2.5% yield),

• The standard DT strategic asset allocations with UK commercial property replaced by UK

residential property (based on HHPI plus 2.5% yield),

• If the data was run in an unconstrained manner the full exposure to property would have been

made to residential property within the standard DT property allocation.

Figure 2: Efficient frontiers for HHPI plus 2.5% and IPD

Figure 2 shows that allocating the full standard weighting to residential property (based on HHPI plus

2.5% yield) increases the efficiency of the DT strategic asset allocations. The figure also shows that,

although not as efficient, an equal split of the DT property weighting between residential property and

commercial property produces results fairly close to the efficient frontier.

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

2.6% 5.2% 7.8% 10.4% 13.0% 15.6% 18.2%

Exp

ecte

d R

etu

rn

Volatility

100% in IPD 50% in HHPI plus 2.5% yield and 50% in IPD 100% in HHPI plus 2.5% yield



• The standard DT strategic asset allocations (with no allocation to residential property),


property and 5 year Growth HouSA,

• The standard DT strategic asset allocations with commercial property replaced by 5 year

Growth HouSA,


made to residential property within the standard DT property allocation..

Figure 3: Efficient frontiers for 5 year Growth HouSA and IPD

Figure 3 shows a similar pattern to the results in Figure 2. The increase in efficiency is less

pronounced when the 5 year growth HouSA is used in place of residential property.

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

2.6% 5.2% 7.8% 10.4% 13.0% 15.6% 18.2%

Exp

ecte

d R

etu

rn

Volatility

100% in IPD 50% in Growth HouSA and 50% in IPD 100% in Growth HouSA



• The standard DT strategic asset allocations (with no allocation to residential property),


property and 5 year Income HouSA,

• The standard DT strategic asset allocations with commercial property replaced by 5 year

Income HouSA,


made to residential property within the standard DT property allocation.

Figure 4: Efficient frontiers for 5 year Income HouSA and IPD

The results for the 5 year income HouSA show a similar pattern to those for the Growth HouSA and

HHPI plus 2.5%.

Because of problems with liquidity, some firms that use the Platform either use substitutes for

property or adjust the allocation to suit their clients. For this reason we are not making a prescriptive

recommendation on the split that should be adopted.

The efficient frontiers shown above and the investment assumptions used in the analysis do not take

into account expenses or tax. For information, Appendix D: Total Expense Ratio shows the Total

Expense Ratios (TERs) used on the DT Platform for each asset class.

For illustration, Table 7 sets out the full DT strategic asset allocations based on the standard

weightings to property but with the optimised weightings between residential and commercial

property.

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

2.6% 5.2% 7.8% 10.4% 13.0% 15.6% 18.2%

Exp

ecte

d R

etu

rn

Volatility

100% in IPD 50% in Income HouSA and 50% in IPD 100% in Income HouSA


DT would like to emphasise that the asset allocations set out in this report are intended as a guide.

Individual advisers and adviser firms may choose to use different allocations. The actual allocations

chosen should, among other things, be based on a full suitability assessment that takes into account

all the client’s circumstances.


Table 7: Asset allocation across different risk levels

Risk Level UK Cash

(GBP)

UK

Corporate

Bonds

UK Index

Linked

Bonds

International

Bonds UK Gilts UK Equity

Europe Ex

UK Equity

North

American

Equity

Japanese

Equity

Pacific Ex

Japan

Equities

Emerging

Market

Equities

UK

Commercial

Property

UK

Residential

Property

1 100% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0% 0%

2 44% 5% 0% 7% 25% 5% 2% 2% 0% 0% 0% 0% 10%

3 5% 22% 0% 15% 23% 15% 3% 4% 0% 0% 0% 0% 13%

4 5% 30% 0% 2% 6% 22% 8% 10% 3% 0% 0% 0% 14%

5 5% 22% 0% 0% 0% 28% 9% 10% 5% 3% 5% 0% 13%

6 0% 16% 0% 0% 0% 39% 10% 10% 5% 5% 7% 0% 8%

7 0% 8% 0% 0% 0% 45% 10% 10% 5% 10% 10% 0% 2%

8 0% 0% 0% 0% 0% 40% 7% 5% 5% 20% 23% 0% 0%

9 0% 0% 0% 0% 0% 17% 5% 5% 0% 35% 38% 0% 0%

10 0% 0% 0% 0% 0% 5% 0% 0% 0% 40% 55% 0% 0%


Appendix A: Investment assumptions

This appendix sets out the method used to generate the planning assumptions used on the DT

platform and the additional assumptions required for residential property.

The correlations and volatilities used on the DT platform are derived mainly from historical index data

for a representative index for each asset class.

The IPD index used for UK commercial property is a valuation based index. To overcome some of the

problems from estimating volatility from valuation indices, DT apply de-smoothing techniques to the

index series before calculating volatility.

Full details of methodology for de-smoothing property returns can be found in Booth and Marcato3.

Details of the index used for each asset class are set out in Appendix B.

The annualised volatility of real returns on the HHPI since inception in 1983 has been 4.6% based on

monthly index data. However, because of serial correlation in the returns from the index, this estimate

is not suitable for analysing returns over long holding periods. The index history is not long enough to

calculate volatility based on five year holding periods as there are not enough non-overlapping 5 year

periods to produce a statistically credible result. We therefore based our estimate of the volatility of

real returns on analysis of annual index data. The volatility assumption adopted for this analysis is

9.5%.

The forward looking estimates of returns for equities, UK commercial property and corporate bonds

take into account the current levels of the following market indicators:

• Yields on UK Gilts; conventional and index-linked,

• UK corporate bond yields,

• Yields on global bonds,

• Equity earnings and dividend yields.

The relative historical returns between asset classes are also reviewed within the process for setting

assumptions. Generally, these values are highly dependent on the historical period chosen for

analysis and therefore more emphasis is placed on the current market indicators.

HHPI has been assumed to grow in line with inflation.

The expected returns on fixed income asset classes are set with reference to the yield on the

representative index for each asset class. The spreads on corporate and international bonds are

adjusted to allow for defaults and downgrades (i.e. the return expected to be realised on these asset

classes is less than the current yield). Dimson4 et al in their study of 101 years of investment returns

found that about half the “promised” yield differential on corporate bonds fails to materialise because

of defaults, downgrades, and early calls, and the balance represents the achieved risk premium.

3 “The measurement and modelling of commercial real estate performance”, P. M. Booth and G. Marcato,

Presented to the Institute of Actuaries, 22 September 2003. 4 “Triumph of the Optimists: 101 Years of Global Investment Returns”, Elroy Dimson, Paul Marsh and Mike

Staunton, Princeton University Press, 14 Jan 2002.


Full details of the DT estimation methodology can be found in DT quarterly estimation update reports,

which are available on request.


Appendix B: Data

The data on HouSA investments was provided by Castle Trust. The data included:

• Castle Trust product brochures,

• HouSA presentation materials, and

• Information gathered during meetings and discussions with Castle Trust.

Information on the HHPI index and the Halifax Index Methodology was sourced from Halifax5. Halifax

makes the following statement about the HHPI index:

“The Halifax House Price Index is prepared from information that we believe is collated with care, but

we do not make any statement as to its accuracy or completeness. We reserve the right to vary our

methodology and to edit or discontinue/withdraw this, or any other report. Any use of this report for an

individual's own or third party commercial purposes is done entirely at the risk of the person making

such use and solely the responsibility of the person or persons making such reliance.© Bank of

Scotland plc all rights reserved 2012.”

The terms and conditions for the HouSA investments include the following provisions covering

changes to the HHPI.

“There is no commitment from Halifax (or anyone who takes over their business) to continue to

publish the HHPI in its current form, it is possible that the HHPI may change significantly, or even stop

being published, in the future. If the HHPI changed in a way which would make it unrealistic for Castle

Trust to continue to use it to work out the value of a HouSA, they will use a suitable alternative house

price index or combination of indices.”

Table 8 sets out the indices used for each asset class.

5 Please see http://www.lloydsbankinggroup.com/media1/economic_insight/halifax_house_price_index_page.asp

for more details on index.

http://www.lloydsbankinggroup.com/media1/economic_insight/halifax_house_price_index_page.asp


Table 8: Indices used for each asset class

Asset Classes Index Inception date

Cash Bank of England, Monthly Average of UK banks'

base rates Jan 1978

UK Corporate Bonds iBoxx £ Corporate Total Return Index Dec 1997

UK Index Linked Gilts Barclays Capital UK Government Inflation-Linked

Bond Index May 1981

International Bonds Merrill Lynch Global Broad Market Total Return

Index Dec 1996

UK Gilts iBoxx £ Gilts Total Return Index Dec 1997

UK Equity MSCI UK Total Return Index Dec 1969

Europe ex UK Equity MSCI Europe (ex UK) Total Return Index Dec 1969

North American Equity MSCI North America Total Return Index Dec 1969

Japanese Equity MSCI Japan MSCI Total Return Index Dec 1969

Pacific ex Japan Equity MSCI Pacific (ex Japan) Total Return Index Dec 1969

Emerging Markets Equity MSCI Emerging Markets Total Return Index Dec 1987

UK Commercial Property IPD UK Monthly Property Total Return Index Dec 1986

Commodities S&P GSCI Total Return Index Jan 1970

Hedge Fund HFRI Fund Weighted Composite Index Dec 1989

UK Residential Property Halifax House Price Index (Price Only) Jan 1983

Inflation Retail Price Index (RPI) June 1948


Appendix C: Volatility boundaries

Table 9 sets out the lower and upper volatility boundary for each risk level on the platform.

Table 9: Volatility boundary for each risk level

Risk Profile Lower Boundary Upper Boundary

1 0.0% 2.6%

2 2.6% 5.2%

3 5.2% 7.8%

4 7.8% 10.4%

5 10.4% 13.0%

6 13.0% 15.6%

7 15.6% 18.2%

8 18.2% 20.8%

9 20.8% 23.4%

10 23.4% 26.0%


Appendix D: Total Expense Ratio

Table 10 sets out the current total expenses ratios in use on the DT platform. In addition a 0% TER

for residential property is used, as no charges will apply to the products under review. The expense

ratios are calculated using data provided by Lipper, a Thomson Reuters Company.

Table 10: Total Expense Ratio for each asset class

Asset Classes Total Expense Ratio currently in production

Cash 0.5%

UK Corporate Bonds 1.1%

UK Index Linked Gilts 0.5%

International Bonds 1.3%

UK Gilts 0.6%

UK Equity 1.6%

Europe ex UK Equity 1.7%

North American Equity 1.6%

Japanese Equity 1.7%

Pacific ex Japan Equity 1.7%

Emerging Markets Equity 1.8%

UK Commercial Property 1.6%

HouSA Investments 0.0%

UK Residential Property N/A

CASTLE TRUST STRATEGIC ASSET ALLOCATION REPORT · 2015-11-23 · Castle Trust Strategic Asset...

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