A Bit of Background

We are Investors and we manage portfolios for Private Clients, Family Offices and Institutions. Our Investors have been managing portfolios for decades, for institutions and individuals on behalf of investment managers in Asia, North America and Australia. The Principals of First Degree have spent their entire professional careers in investment management and it is both our profession and our passion

We formed First Degree Global Asset Management in 2011 because we had firm ideas about what an investment manager should be and the relationship that it should have with its clients. Much of the good and bad of this came from our experiences working for other investment managers. Our goal is to take the best of what we have learned, address the things that have challenged us over our careers and to develop a business that we can be proud of

We own First Degree, and its success or failure is our own

Our industry has not covered itself in glory in recent times, and that is a tragedy because the services the industry offers are those that its clients need. Much of the reason for this is structural, rather than because of a lack of talent or integrity from the people who work in it

We have worked with many fine investment professionals over the years who have been completely committed to achieving results for their firm's clients. But until the industry organises itself to reflect the nature of the obligations that it owes to its clients, the bad will continue to be intermingled with the good

We are not completely altruistic in our aims, we want to be commercially successful. But we believe that the best chance of achieving that success in the long run is by doing things the right way, even if it means we sacrifice some short-term opportunities that are not in line with our thinking

We have built, and will continue to build, a business that will only succeed if our Clients succeed. As an independent investment manager, the challenge can be daunting at times, particularly when we talk with investors in parts of the world where the independent managers are scarce. But, ultimately, we know that we have the right people, the right culture and the right way to do business and we believe in what we are doing. We are delighted that so many Clients and Advisors have bought into our thinking and joined us in our first few years. We intend always to honour the trust that they have placed in us



    The Principals of First Degree left their employment with leading investment managers to form First Degree. In part, we did that out of frustration with the challenges that large investment managers now face in delivering services to their clients in a way that is consistent with the duties that it owes to those clients


    Most public investment managers are today (often relatively small) parts of what are often described by the media as financial supermarkets. In addition to investment management, many of these financial supermarkets provide banking, investment banking, corporate finance, securities trading, treasury services, custody and principal trading services to the same market


    The last decade has demonstrated the challenges that can arise when all of these activities co-exist under one roof. Most of these activities - other than investment management - are principal businesses: the firm provides a product or service to a client and charges a fee: the firm's responsibility is to ensure that the product or service is consistent with how it is sold to the client and that is about it. The firm generally does not owe a duty to the client to ensure that the product or service is appropriate for it, the relationship is generally one of buyer and seller

    In contrast, investment management is a fiduciary business: an investment manager has a duty of trust to its client, requiring it to act in the client's interests and to put the client's interests ahead of its own. Over hundreds of years, courts all around the world have held that a fiduciary duty is the highest standard of care at law and the fiduciary should not put itself in a position where there is any conflict with the duties that it owes to its clients

    The principal rationale for the creation of the financial supermarkets is that they are able to offer a broad pallet of products and services to a single client. The financial supermarket might, for example, advise a corporate client on its merger and acquisition strategy, manage its liquidity needs, provide credit facilities, act as the company's stock broker, raise capital for it and manage its pension fund. Executives of the financial supermarket are appointed with the specific responsibility of cross-selling the firm's services or, in industry parlance, gaining a greater share of the client's wallet

    In the non-fiduciary businesses described, this is fair enough. The law treats the financial supermarket and the client as independent of each other, with the underlying principle being caveat emptor, or buyer beware

    For a fiduciary business like investment management, it is a process fraught with difficulties. The duty of trust that an investment manager owes to its clients should be the only factor that drives the investment manager's choice of broker, or foreign exchange provider, or hedging counterparty or custodian for its client, and it should not be influenced by internal cross selling targets, even if these are dressed up as independent services protected by so-called Chinese Walls

    We believe in the adage that a man cannot serve two masters. Either one acts for its clients or it acts for itself. To accept the former responsibility within an environment that rewards the latter, is not a recipe for unbiased behaviour, as events have shown



    Some of these problems have come from dishonest advisors chasing sales commissions, but many of them have come from advisors who lack even a basic understanding of markets and investment management practice. To put this into context, in Australia it takes a minimum of four years to satisfy the entry requirements for most professions. Trades require a minimum three year apprenticeship. Even to become a personal trainer requires a three month course. But a person can complete the qualification courses to call themselves a financial advisor in just seven days, without any other backup qualifications. This is patently absurd


    Investment management is a profession that is based upon science, often complex science. Many Nobel Prizes have been won for work on the science of investing. Markets do not move randomly, at least over the long run, there is much structure to them. Short-term pricing anomalies arise from time to time, but over the long run, the underlying dynamics are the dominant forces on markets. Working with those dynamics to construct portfolios in a risk-adjusted way requires a deep understanding of markets and investment management processes (and not inconsiderable patience and judgment), all of which call for years of study and experience, not a half-day course in a hotel ballroom on How I Made My First Zillion Dollars Trading Currencies at Age 9


    At First Degree, we reject the minimum regulatory standards as manifestly inadequate. All of our investors are degree-qualified in a relevant discipline, with further post-graduate qualifications in a finance discipline. They have a minimum twenty years of genuine investing experience (not just picking a few funds that someone else manages), and they have managed portfolios across asset classes and geographies, being wholly-accountable for the performance of those portfolios


    We believe strongly in managing money according to a defined investment process that is research-underpinned and tested constantly. We believe in the science of investing


    In short, the very minimum that we require of our investors are the qualifications and experience that would be required to be admitted as a practitioner of any other leading profession

    Investment management is a profession, not a part-time hobby or something one does in their spare hours away from the family business

    We have found the entry criteria necessary to qualify to invest another person's life savings as ridiculously low in almost every jurisdiction. Indeed, we believe that most governments and regulators designate minimum entry standards by reference to the people who are already in the industry, rather than by reference to the people who should be in the industry. This is most evident in the retail space - generally the area where the investors are the least informed and therefore in most need of qualified advisors and investment managers

    If the industry wants the respect that other professions attract, then it needs to admit only those who have qualifications and experience commensurate with the responsibilities that we take on. Accountancy, for example, requires the completion of a university degree (four years, generally) and then a further professional year under the supervision of an experienced practitioner. Engineering generally has a five year university degree entry point, as does dentistry, medicine and so on

    The consequences of letting unqualified, even if well-meaning, "advisors" loose on ordinary investors has almost always been calamitous. In Australia, for example, there has been an almost constant stream of stories of late of unsophisticated investors being sold inappropriate, high risk strategies, of investors of modest means being put into highly leveraged products secured against their family homes and of products with no investment merit whatsoever being sold for the sole purpose of producing tax deductions, deductions that often later prove illusory



    This is obvious area where the industry has been let down by its regulators and by itself. The duty of an advisor or manager to its client is absolute - you cannot be a bit of a fiduciary to your client, if one owes a duty to one's client, then that duty is above everything else under ordinary fiduciary principles. If an advisor does not owe a duty his client, then what is he doing calling himself the client's advisor? We might be in a very small minority that holds that view, but we are adamant that there is no other valid construction of the advisor/client relationship


    And what about the use of relatively insignificant? The guidelines state a commission is insignificant if it is insignificant relative to the advisor's total revenue. So you could have an enormously successful adviser who sells products influenced by outrageous commissions if he only does it occasionally? Making three biased investments out of fifty in a year might be insignificant to the advisor, but we are sure that it will not be insignificant to the clients concerned


    Enacting nonsensical legislation to ratify existing poor market practices rather than setting the standard at what it should be encourages the behaviours that go to the very heart of why there is such a lack of respect for our industry


    At First Degree, our staff own the business - there is no other party that has any ownership interest in the firm that could influence what we do for our Clients.


    We do not have a related broker, dealer, currency desk or custodian to refer client business to. We have no commercial incentive to use any counterparty for a Client other than the based upon our assessment of what the counterparty can do for our Client. We have no commercial, agency, representative, brokerage, commission, incentive or any other arrangements whereby we will accept any compensation whatsoever for anything that we do for our Clients. We do not accept so-called soft dollars to cover any of our costs from any broker, trader, banker or counterparty.


    The only thing that impacts us commercially are the fees that our Clients pay us, and those depend upon us doing a good job for our Clients and keeping them as our Clients over the long-run


    We feel completely comfortable calling ourselves independent

    The term independent has come to mean different things in the financial services world to different people


    For example, under the Financial Advisers Act of Singapore an advisor may call himself independent - with all of the connotations for impartiality and lack of bias that that term brings - if it does not receive any commission or other benefit from a product provider which may create product bias. The guidelines for the use of the term say that the term "independent" should only be used by financial advisors who can clearly demonstrate that they do not have commercial or financial links with product providers which are capable of influencing their recommendation or these are relatively insignificant


    Wow! Note the absence of a fullstop after both uses of term provider. Receiving commissions and benefits from a product provider while sitting in front of a client calling oneself the client's advisor is allowed, the only restriction being on the use of the label independent and only then when it can be established that those commissions could be considered to influence the recommendations of the advisor


    How does this possibly square with the fiduciary duty that we discussed above that an advisor owes to its client? What is the advisor doing taking any remuneration at all from third parties for things that he recommends to his client? How can the advisor not be influenced by the commission paid by the product provider? If commissions did not in reality influence the recommendations of the advisor, why does the product provider pay the commissions at all?



    As a result, the trust that we ask our Clients to place in us is significant and we feel that the arrangements that we have with our Clients should reflect that.


    If a Client feels that that relationship of trust has broken down, the Client is completely free to take its affairs elsewhere, without penalty and without any other restrictions


    We therefore do not lock any of our Clients into fixed term contracts. We do not ask them for a multi-year commitment to us. We charge no exit penalties or levy disguised entry commissions if a Client wants to take his business elsewhere. In the direct portfolios that we manage for our Clients, each portfolio is registered in the Client's own name (or nominee) with an external custodian, broker or bank and to terminate our mandate our Client has only to notify its counterparty that our authority has been withdrawn


    If we cannot keep our Clients' trust, we do not deserve to keep their business

    A relationship between a Client and its advisor must be one of trust. Our Clients entrust us with their financial futures, and the responsibility that comes with that is great indeed

    The services that we offer to our Clients are intangible, they are not something that can be handled to test them out, they cannot be examined physically to detemine if they are of the standard that we say they are: and whether or not they deliver will only be known at some future point, perhaps years down the road


    These are the facts upon which we discuss expected returns, and the volatility of those returns, with our Clients


    However, we also speak with investors who tell us that they have been lead to expect from other managers or advisors returns of 15% per annum or more from these very same investments. Some of these other projections come from managers who clearly do not understand markets, or who seem willing to make wild projections to win business. Either way, that approach is setting the investor up for disaster. Either the investor is going to be disappointed by his investment when markets ultimately produce what markets are inevitably going to produce, or the manager has to throttle up the risk profile of the investor's portfolio so significantly that the volatility of those returns is going to be way beyond what most investors can accept


    To achieve a return 50% greater than the market return does not mean adding 50% to the investor's risk profile, it means increasing his risk profile by three or four times, as risk increases exponentially, rather than incrementally


    In rough terms, managing a portfolio to an expected return of the market plus 50% (and you would be looking at the market plus 100% to get to the 15% long-term return projection) means that instead of the investor having a mild negative year about one in every five years, he is probably looking at the negative year being down 40% to 50%, rather than 15% in the market return target portfolio, because to get that higher target the manager is going to have to gear the portfolio, in one form or another


    Realistically, the pain of losing half of one's portfolio once every five years or so is more than most investors can bear, irrespective of the additional return expected and we have yet to come across a single instance where the risk profile of these "15% per annum" portfolios has been properly explained to the investor


    Think back to our speed limit analogy. Driving at the speed limit of 60 kms per hour in a suburban street will mean the risk of the driver causing an accident (either to himself or to others) is quite low. Common sense tells us, however, that driving at 90kms an hour in those same suburban streets means that the risk of accident is not quite low plus a little bit, it is quite low plus a lot. Increase one's speed to 120kms an hour in the suburbs, and the risk of accident moves significantly towards a certainty. It is the same with markets


    We will only base projections on what we believe to be well-supported by the data. If that results in investor disappointment, we would much rather that disappointment come upfront before we start managing money, rather than when half the investor's portfolio inevitably goes up in smoke



    Have you ever stopped to think why the speed limit on a road is set at the level that it is?

    As anyone who has ever incurred a speeding fine will be able to attest, the speed limit is not the maximum speed that a car can reach on the road - indeed the limit is probably nowhere near what most drivers can reach, let alone what a professional driver in a racing car could get to

    Rather, the speed limit is the maximum speed at which a driver of regular skill in known conditions can drive without unduly endangering himself, his passengers or other users of the road

    Sounds logical, if expensive for the lead-footed driver at times? We encourage you to think about markets in the same way

    For the major markets, we have decades of data showing what those markets produce over the long-run. While returns for individual years can fluctuate significantly, the long-term returns have been remarkably consistent over time. To keep the analysis simple, in general terms these returns have been (expressed as the return above the relevant cash rate): 2% to 4% annum for bonds and 5% to 6% per annum for equity markets

    We also need to consider the volatility of those returns. Taking the US share market - as the market with the longest data history - if we were to go back 80 years to 1935, the market has produced a mild negative year (a loss of up to 15%) 18 times, or about one year in five, on average, and a deeply negative year (a loss of over 15%) on four occasions, or about one year in 20, on average. The other 58 years - or about three years out of four - the market has produced a positive return

    So, using history as our guide, an equity investor can expect an annual return of about 6% per annum above the cash rate. The long-term investor can also expect a mild loss year about one in five years and a significant loss year about one in twenty, on average. The longer the investor remains invested, the more likely it is that his returns, and the volatility of those returns, will be similar to the long-run averages


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