Prospectus, extract Practice document Page 6 of 40
Larch Europe Value Tilt Fund Class A, accumulating · a UCITS factor fund · made up for this lesson
Investment policy The fund holds shares across the whole European market.1 It compares its return with a European share index.
The tilt It holds more of “value” companies, cheap compared with their accounts, and less of expensive ones.2
The weights follow the written rule in this prospectus, not the manager’s view.3
Other funds in this range Sister funds follow the same kind of rule for momentum, quality and low volatility.4
Charges Ongoing charges sit above the house’s plain index fund and below its active funds.5
Risks The tilt can lag the market for several years.6
This paper is made up for Red Start Education and describes no real fund. Past performance does not predict future returns.
Line 1 · The whole market
Index-like at its base “The fund holds shares across the whole European market.”
The fund holds a whole market, like an index fund. What makes it a factor fund is a lean towards one trait, by a fixed rule.
It lets the manager Own the whole European market It never may Bet the fund on a handful of companies Read it slowly A fund that holds the market but leans towards cheap companies by a fixed rule is an index fund with a value tilt.
Check it yourself Look at your own fund’s top ten holdings: are they the market’s biggest companies?
Line 2 · The tilt
What a factor is “It holds more of “value” companies, cheap compared with their accounts, and less of expensive ones.”
A factor is a trait shared by many companies that has, over long periods, gone with different returns. In 1992 and 1993 Eugene Fama and Kenneth French showed that small companies and “value” companies, cheap compared with their accounts, had earned more than the market alone explained.
It lets the manager Hold more of cheap companies than the index does It never may Drop the tilt after a bad year for value Read it slowly Cheap here means cheap compared with the company’s own accounts, not a low share price.
Check it yourself Find the trait your own fund leans on, if any, in its name or its prospectus.
Source: Fama & French, Journal of Finance (1992); Journal of Financial Economics (1993)
Line 3 · The written rule
A rule, not a view “The weights follow the written rule in this prospectus, not the manager’s view.”
Factor funds, sometimes called smart beta, hold a whole market but tilt towards one trait, by a written rule rather than a manager’s view. The rule is in the prospectus, so you can see what you are getting.
It lets the manager Follow its rule, even when it feels wrong It never may Swap the rule for a hunch Read it slowly A rule you can read is also a rule you can test on real prices.
Check it yourself Find the rule in your own fund’s prospectus: what does it measure?
Line 4 · The other traits
Momentum, quality and calm “Sister funds follow the same kind of rule for momentum, quality and low volatility.”
Shares that have risen most over the past year have tended to keep rising for a while, and the weakest to keep lagging (Narasimhan Jegadeesh and Sheridan Titman, 1993; Mark Carhart added it to the standard model in 1997). Profitable, steady companies have done better than their risk suggested (Robert Novy-Marx, 2013). So, oddly, have calmer shares compared with jumpy ones (Andrea Frazzini and Lasse Pedersen, 2014).
It lets the manager Lean on momentum, quality or low volatility, each by its own rule It never may Mix in a trait its rule does not name Read it slowly A fund that says it buys “quality” or “low volatility” is leaning on these findings.
Check it yourself When a fund’s name has one of these words, find the rule behind the word.
Source: Jegadeesh & Titman, Journal of Finance (1993); Carhart, Journal of Finance (1997); Novy-Marx, Journal of Financial Economics (2013); Frazzini & Pedersen, Journal of Financial Economics (2014)
Line 5 · What it costs
Between an index fund and an active one “Ongoing charges sit above the house’s plain index fund and below its active funds.”
Factor funds’ costs usually sit between an index fund and an active fund. The rule costs a little more than the plain market.
It lets the manager Charge more than a plain index fund It never may Leave its costs out of its KID Read it slowly The tilt has to earn its extra cost before it earns you anything.
Check it yourself Set your own fund’s ongoing charge beside a plain index fund on the same market.
Line 6 · Where it bends
A bet on a pattern continuing “The tilt can lag the market for several years.”
A factor can lag for years, long enough for most people to give up. And once a pattern is published, money chases it: a 2016 study of 97 such findings found their returns were on average 58% lower after publication. A tilt is a bet on a pattern continuing, not a free extra.
It lets the manager Lag the market for years and still follow its rule It never may Promise the pattern will go on Read it slowly The years a tilt lags are the years people leave it. Published edges tend to shrink.
Check it yourself Look at your own fund’s worst stretch against its index, not only its best.
Source: McLean & Pontiff, Journal of Finance (2016)