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The Financial Reporting Council’s new audit tender guidelines aim to help organisations develop an effective tender process. Last week, the Financial Reporting Council (FRC) issued best practice guidelines for audit tenders. The guidelines, which are the result of roundtable discussions with audit committee chairs who recently experienced the audit tender process or were about to do so, highlight how audit committees can approach the process and achieve the best outcome. The guidelines place a strong emphasis on involving the entire audit committee in the process; engaging with the firms before the process starts to ensure that the right teams are presented; the long lead time required for an effective and smooth running process and appropriate engagement with investors. The background The FRC’s 2013 best practice observations were designed to help audit committees conduct a tender process following the October 2012 update to the UK Corporate Governance Code, which required FTSE 350 companies – on a ‘comply or explain’ basis – to put their audit out to tender every 10 years. The Competition & Markets Authority later issued an order following the Competition Commission’s investigation into competitiveness in the FTSE 350 audit market requiring retendering. Since then, many companies have put their audit out to tender and further best practice has started to emerge. Subsequently, EU legislation in the form of the Statutory Audit Regulation and Directive came into effect on 17 June 2016. In the UK, the Statutory Auditors and Third Country Auditors Regulations 2016 (SATCAR) introduced a requirement for all public interest entities to conduct a tender at least every 10 years and rotate auditors after at least 20 years. Fresh insight According to Melanie McLaren, Executive Director of Audit and Actuarial Regulation at the FRC, the testing of the market for audit on a regular basis is now required in the UK and across Europe. "Feedback from companies that have changed auditors since this requirement was introduced is that there are benefits to be gained from fresh insight,” she said. “Even if the current firm is reappointed, the experience of the tender process can reinvigorate the audit approach." To read the 14-page guidance document in full, click here.

The CRO’s Maureen O’Sullivan outlines the impending changes to mandatory electronic filing, and advises users on how to prepare for the 1 June 2017 deadline. The Companies Registration Office (CRO) will introduce mandatory electronic filing for the submission of the following forms from 1 June 2017 in accordance with S.I. No. 458 of 2016 and Section 897, Companies Act 2014:   B1 – annual return (including financial statements and electronic payment); B2 – change of registered office; B10 – change of director and/or secretary, or a change in their particulars; and B73 – nomination of a new annual return date. These forms can currently be filed electronically, though at present it is not mandatory to do so. Users are advised to begin filing these documents electronically now to avoid any surprises on 1 June 2017 when filing becomes mandatory for all Irish companies and all presenters. Benefits of electronic filing A large proportion of CRO’s customers are already enjoying the benefits of electronic filing which in recent years has delivered substantial savings in paper, printing and postage costs as well as in filing fees. The major benefits of e-filing these documents are:   There is NO FEE for filing Forms B2, B10 and B73 electronically; The fee for filing an e-B1 is €20 compared with the current €40 fee for filing a paper B1; Errors on documents are minimised as the user is alerted if any of the information they enter is inconsistent with the information already held on CRO’s records for that company; Registration is faster and more efficient; and The amount of paper to be printed and posted to the CRO is reduced to one page in most cases or no pages at all if Revenue Online Service (ROS) certificates are used.  Changes to Filing Form B1 From 1 June 2017, the sole means of filing a B1 and financial accounts and paying for an annual return will be in electronic form. However, the signature page must still be printed off, signed and submitted manually to the CRO (unless digitally signed using ROS). For presenters who have filed B1’s electronically in the past, the main changes from 1 June are as follows. PDF of financial statements All financial statements MUST be uploaded as a PDF attachment on CORE/software package within 28 days of the date of the e-B1 being submitted. Hard copies of the financial statements will not be accepted by the CRO after 1 June. The PDF of the financial statements can be attached to the e-B1 in your Workspace in CORE/ software package, in much the same way as you attach a document to an e-mail. The B1 signature page must not be delivered to the CRO until after the financial statements have been uploaded as a PDF. Please note that the signature page will be returned by the CRO if the financial statements have not been uploaded at the time of receipt. Electronic payment The filing fee and any late filing penalties must be paid electronically by credit /debit card or by CRO Customer Account. You will not be able to complete the submission of the e-B1 without first making the payment at the submission stage. It will not be possible to pay the filing fee of €20 and/or any late penalties by cheque, postal order, money order or bank draft. However, it will continue to be possible to top-up a Customer Account by cheque et cetera after 1 June. Filing a form electronically for the first time All forms can be filed electronically using CRO’s online filing system (CORE) or through a secretarial software package. To file electronically on CORE, you must first register as a new user. Once you are registered, you can log in and go to “File a Form”, select your submission (for example, B1) and complete the form. There are links on CORE to help you if you encounter any difficulties when filing online. Signing a B1 form filed electronically  When filing the B1 form the company has three options for signing the form.  The option chosen will dictate what, if any, additional documents must be delivered to the CRO.   Manual signing: the signature page must be printed and signed by a director and secretary. The signature page must then be sent to the CRO, O’Brien Road, Carlow.  The submission is not complete until the manually signed signature page is received in the CRO. The company’s electronic filing agent signs digitally using ROS Certificate: two pages are required – a patch page, which is provided by CORE/software package, and an overall certification for the uploaded financial statements signed by a director and secretary. A director and secretary sign the B1 digitally with ROS Certificates: this process is fully electronic and there is no requirement for any paperwork to be physically delivered to the CRO. Signatures on financial statements Financial statements presented to the CRO do not need to carry the manuscript signatures of directors or auditors. Instead, financial statements filed with the CRO must contain:   The typed name(s) of the director(s) who signed the financial statements on behalf of the board of directors; The typed name of the auditor (where applicable); and The date on which each document was signed. Important points to note when filing a B1 form Once an eB1 is submitted online not later than 28 days after the ARD, the company has a further 28 days to either digitally sign the B1 (in which case no paperwork may need to be delivered to the CRO) or manually sign and deliver the signature page to the CRO. If the B1 signature page is not printed, signed and delivered to the CRO within 28 days of the B1 being submitting online, the annual return will be late and the company will incur late penalties and lose audit exemption in the current year and in the following year. Financial statements must also be uploaded as a PDF no later than the end of the second 28 days and before the signature page is delivered to the CRO. Changes to Filing Form B2. B10 and B73 Forms B2, B10 and B73 can currently be filed electronically for free. There is no change to the electronic filing system for these forms, which can be signed using Revenue Online Signature or, as above, a signature page can be printed off and sent to the CRO. The only change is that, it will not be possible to file the forms Forms B2, B10 and B73 on paper after 1st June 2017. For further updates, visit www.cro.ie. Maureen O’Sullivan is the Registrar for Companies at the Companies Registration Office.

Is there a lesson for the accounting profession in the recent controversy surrounding a statue of Cecil John Rhodes? Sean Power uses this example to explain why the accounting profession, an important cog in the economic system, must continuously adapt to remain relevant. What is the meaning of a statue in a public space? Does it represent underlying institutional or societal values? These questions have been brought to the fore at Oxford University by students operating under the banner of “Rhodes Must Fall”. The discourse relates to a statue of Cecil John Rhodes at the university’s Oriel College. The Rhodes Must Fall movement originated in South Africa, where student activists at the University of Cape Town successfully demanded that a statue of Rhodes be removed from its central campus location in April 2015. Those unfamiliar with southern African history may ask: who is Cecil John Rhodes? In a South African context, Rhodes came to prominence in the late nineteenth century as a mining magnate who co-created the De Beers diamond monopoly and Consolidated Gold Fields. He was also a politician who would become Prime Minister of Cape Colony in 1890 and an ardent British imperialist. In neighbouring Zimbabwe, calls for statues of Rhodes to fall have long been redundant. In the country’s second largest city, Bulawayo, a statue of Rhodes was removed from its city centre location to a remote garden behind the Natural History Museum soon after the country gained its independence in 1980. The comparatively swift removal of the statue was arguably a consequence of Rhodes’ most ambitious imperial venture: the British South Africa Company. The British South Africa Company In 1888, emissaries of Rhodes obtained a disputed concession from an indigenous king which granted exclusive mining rights over present-day Zimbabwe. Rhodes planned to use a chartered company to exploit the territory but, first, he had to win over the British political establishment. Initially, Rhodes was not favoured as a candidate for a royal charter in London and Whitehall; a contribution of £10,000 to Parnell’s Irish Nationalists in 1888 did not help his case. Nonetheless, he overcame the obstacles through a series of amalgamations, selective board appointments and deceptive legal manoeuvres. In 1889, the British South Africa Company, a commercial corporation with the powers of administration, was established by royal charter. This limited liability corporation would be used as an imperial instrument to govern, develop and exploit the Zimbabwean territory. The royal charter would remain effective between 1889 and 1924; a period of time also characterised by a general absence of accounting regulation. British company law – particularly the Joint Stock Companies Act of 1856 which included a simple template for the presentation of a balance sheet – provided accountants with basic guidance, but there was a dearth of detailed regulation on what should be disclosed in the reports or how the accounting figures were to be calculated. In addition, the professional accounting associations in both England and Ireland had only recently been established: the Institute of Chartered Accountants in England and Wales was established just nine years earlier in 1880, while the Institute of Chartered Accountants in Ireland was established the previous year in 1888. Notwithstanding the lack of regulation, the provisions of the charter required the company to prepare annual accounts, which were subject to an independent audit. An examination of archival information relating to the company provides a narrow glimpse into the state of the accounting and auditing professions in London around the turn of the twentieth century. Furthermore, brief analysis of correspondence between the company’s directors reveals a held opinion on the responsibilities of auditors at the time. The accounts The accounts of the British South Africa Company were prepared, predominantly, on a cash basis. The company prepared a balance sheet with an embedded profit and loss account. Balance sheets were presented across two pages with debit accounts appearing on the left page and credit accounts on the right page. In contrast to current practices, the debit accounts included share capital, liabilities and accumulated surpluses from commercial sources. The credit accounts included the company’s assets, compensatory amounts due from the British government, and accumulated deficits from the company’s administrative activities. A relatively detailed breakdown of the general profit and loss for each year was presented on the credit side of the balance sheet. Details of guarantees given by the company over the debentures of various railway companies were disclosed on the face of the balance sheet. The company also depreciated some of its assets, such as public works. The audit A London-based firm, Cooper Brothers & Co., was appointed to act as the company’s auditor throughout the duration of the charter. The firm would later, through a series of mergers, become a component of the present-day firm, PwC. The audit report was attached to each balance sheet as a footnote and was short in length, containing an average of 117 words per report. The wording of the audit opinions were consistent, stating: “In our opinion the Balance Sheet is full and fair and exhibits a true view of the state of the Company’s affairs.” An opinion on the responsibilities of auditors An examination of letters sent between the company’s directors reveals an opinion on the assumed responsibilities of auditors at the time. In 1909, the directors discovered that a manager had an unsecured personal debt of £38,000 with the company. The following paragraphs feature extracts from a letter written by a director to the company’s president: “In particular, it seems that our Auditors have failed in their professional responsibility to the Company. It was their duty to draw the attention of the Board to the manager’s increasing debts and to require evidence that they were authorised. I think we ought to call upon the Auditors to explain why they have failed year after year to report that the manager… was drawing upon the Company’s funds for personal objects... Besides such improper use of the Company’s funds, the Auditors also saw his general indebtedness to the Company increasing yearly but never warned us. Directors are entitled to rely upon the Auditors to bring matters of this kind to their notice in the most definitive way.” Outlining possible courses of action, the director suggests that the directors write to the auditors “instructing them in the future to make a special report to the Board as regards any sums owing to the Company from employees”. Conclusion The late nineteenth century saw an escalation in the colonisation of Africa – an epoch known as “the Scramble for Africa”. Rhodes and the British South Africa Company played significant roles in the colonisation of territories in southern and central Africa during this time. The majority of colonised African nations would only regain their political independence in the latter half of the twentieth century. The recent controversies surrounding statues of Cecil John Rhodes highlight a limitation with public statues. Public statues possess longevity but are static by nature, whereas the values, beliefs and norms of the societies, that surround them are in a constant state of change. Yet, in a post-colonial world, even a century-old statue of an imperial icon is, seemingly, not exempt from the broader sociocultural context. In contrast, the accounting and auditing professions have proven their ability to adjust over the last century. Practices and regulations have evolved considerably since the British South Africa Company first prepared its accounts in the late nineteenth century. This evolution was in response to challenges arising from changes in the structure of Western economies which intensified throughout the twentieth century: significant growth in enterprises, the widespread use of corporations, the sophistication of capital markets and the extensive separation of the ownership and control of businesses. The above examples emphasise that the ability to adapt to changing societal needs and expectations is an important factor in ensuring relevance in the long run. As an important cog in the prevailing economic system, it is crucial that the profession continues on the path of adaptation in the face of new societal challenges. Dr Sean Power ACA is a lecturer at DCU Business School. This article is based on ongoing research, funded by Chartered Accountants Ireland Educational Trust.

While Ireland’s short-term economic prospects remain positive, the country is not immune to global headwinds and must tackle its debt pile and ongoing housing shortage, writes David McNamara. 2015 looks like something of a turning point for the Irish economy – provisional data show that Gross Domestic Product (GDP) grew by a staggering 7% in the first nine months of last year. Looking ahead to 2016, Irish GDP should continue to grow close to 4%, the fastest pace of growth in Europe. Irish GDP is now 7.3% above its pre-recession peak in 2007, in line with the UK. However, the recovery has been led by the multinational sector. Exports are now 41% above their last peak in 2007, while consumer spending is still 2.5% below peak and employment 8.7% from peak. Recovery has further to run Some have been concerned that these staggering rates of growth reflect an overheating in the economy similar to the tail-end of the Celtic Tiger, but an unemployment rate of 8.8% and weak inflation suggest otherwise. In fact, a timely confluence of positive factors combined to supercharge GDP growth last year. Ireland has benefitted from a weaker euro, which boosted exports and tourism; low oil prices, which increased disposable incomes; and quantitative easing from the European Central Bank, which raised asset prices and lowered borrowing costs. Of course, these tailwinds won’t last forever. Oil prices could quickly spike and the euro has regained ground against the dollar and sterling since the trough in April 2015, but the recovery is also built on more solid foundations. The fall in unemployment from a peak of 15% in 2012 to the current 8.8% has meant more spending by households, thereby boosting the domestic economy. Indeed, the consumer spending numbers probably provide a truer reflection of where the economy is currently. In Q3 2015, consumer spending was up 3.6% on the year which is in line with the gains in the labour market. Wage growth is now starting to emerge and businesses are feeling sufficiently confident about the future to begin investing again, neatly illustrated in the 41% gain in new commercial vehicle sales last year. Crucially, both households and businesses are continuing to pay down legacy debt, building up resilience to future downturns. Acute housing shortage Some emigrants may now be thinking about making the move home. They can expect a strong recovery in the short-term at least but may struggle to find suitable housing in Ireland’s cities. As a consequence of deep cuts in housebuilding during the downturn, Ireland now faces an acute shortage of housing. This has been reflected in soaring house prices and, more recently, in higher rental prices as stricter mortgage lending rules have constrained potential first-time buyers to an ever-crowded rental market. Nonetheless, house prices in many regions still remain relatively cheap compared to incomes, and emigrants with savings built up will find it much easier to get on the property ladder. Ireland’s housing shortage has been costly, but it does provide opportunities. A pick-up in the construction sector could provide a third leg to the recovery after exports and consumer spending recoveries – providing employment opportunities for the still sizeable cohort of former construction workers both at home and abroad. It will also ease pressure on property prices. The construction recovery has already begun in Dublin with significant investment in new office space to meet ever-growing demand in the multinational sector, but new housing has been slow to come to market as yet. Threat of global headwinds Although all looks rosy for the Irish economy in the short-term, it is not immune to global headwinds. Much has been made of recent financial market turbulence, led by slowing growth in China. Ireland’s exposure to China is minimal, but a sharp decline in Asia could impact on confidence in Europe and the US, Ireland’s biggest trading partners. A disruptive exit from the EU by the UK (Brexit) also has the potential to derail our recovery given the importance of our neighbour for trade and investment. With these risks in mind, Ireland’s government must continue to pursue prudent fiscal policy. The government deficit will be all but closed in 2016, but the debt pile remains sizeable at nearly 100% of GDP. Promises of tax and spending giveaways by the various parties jockeying for position in the general election are therefore disingenuous. Indeed, new EU fiscal rules provide very limited space for the next government to loosen fiscal policy. This means that tax cuts and spending increases should be targeted to provide the best return for our money. Given that Ireland is a small, open economy with much of the policy levers such as interest rate setting beyond its control, it must continue to run its affairs in a prudent manner to maintain the hard-earned recovery. David McNamara is an economist with Davy.

Bria Murphy considers the potential impact of future interest rate hikes on bond holdings and how investors might protect their pensions from the fallout. When it comes to plan-ning for retirement, investors generally opt for what they perceive to be a low-risk strategy. In terms of portfolio construction, this typically translates into a sizeable allocation to bonds as bonds are considered low-risk and therefore, ideal for pension funds. However, interest rate hikes could dent the value of bond holdings – and consequently, pension funds – for  unsuspecting investors. Bonds have consistently proved popular with pension fund investors. In fact, some of the largest bond-holders in the world include pension funds. As an asset class, they are perceived by many to be risk-free and for that reason, it is not uncommon to see pensions with concentrated bond allocations. The perception that bonds are risk-free has become particularly apparent in recent years with the proliferation of ‘lifestyle pension funds’. The majority of pension schemes offer managed lifestyle funds as their default option to new and existing members. These funds do not take current market conditions into consideration when setting their asset allocation, however. They instead use a formulaic approach to investing by automatically transitioning assets from higher risk equities to lower risk bonds as the investor nears retirement. In some cases, up to 70-80 per cent of your pension could be invested in bonds as you approach retirement. If bond yields rise, as expected, many investors could see the value of their pension pot fall just as they are about to retire. Low-risk or no-risk? From an investment perspective, bonds will always play an important role in a well-constructed pension portfolio as they can offer protection in times of crisis. But bonds are not entirely risk-free. If you buy an AAA-rated sovereign bond from a reputable government, the risk that it will not pay a coupon and return your capital is very low. It could therefore be considered a low-risk investment but like a stock, the value of a bond can rise and fall over its lifetime. Bond prices have an inverse relationship with interest rates. When interest rates rise, bond prices fall and bond yields rise. For example, if you buy a bond today paying a high coupon or yield and interest rates fall tomorrow, the price of that bond will rise as investors are willing to pay more for the higher level of income. The reverse is also true. If you buy a bond today with a low coupon and interest rates rise tomorrow, that bond will no longer be as attractive to investors and its price will fall. The Bond Iceberg graphic on the right depicts this relationship. It illustrates the likely fall in value for bonds of different durations where yields increase by one per cent. For example, a one per cent per annum increase in yields on a 30-year German bond would result in a fall in bond value of 22 per cent. Long-term bull market It is easy to see why bonds have become popular with pension funds in recent years. Bonds have enjoyed one of the longest bull markets in living memory. Never in economic history have interest rates been so low for so long. During the recent financial crisis, central banks across the globe slashed interest rates close to zero and implemented the unorthodox policy of quantitative easing (QE), which essentially created new money. With that new money, central banks primarily bought bonds to urgently inject liquidity into the system. Together, the US Federal Reserve (the Fed), the European Central Bank (ECB), the Bank of England (BoE) and the Bank of Japan are estimated to have created a staggering $10 trillion of new money since the start of the crisis. This flood of money has pushed bond yields down to today’s low levels. Where’s the risk? The ECB remains committed to its programme of QE but both the Fed and the BoE look set to raise rates in the not-too-distant future. Although the timing and magnitude of interest rate hikes is uncertain, both banks have been relentless in communicating future rate increases. The primary catalyst for the hike is an improving economic outlook in both countries. So how is the bond market likely to react to the prospect of higher rates? We need only look back as far as 1994 to get an insight into the likely response. Like today, bond yields were pushed lower by the recession of the early 1990s and inflation was falling. When the outlook turned positive in early 1994, the Fed began to raise interest rates aggressively. Between the first rate rise in February and the end of the year, it raised rates from three per cent to 5.5 per cent. Panic ensued in the bond market. Investors dumped bonds and trillions of dollars was wiped off the global bond market in what has become known as The Great Bond Massacre. In an attempt to avoid a repeat of 1994, it is clear that any rate increase will be well-flagged by central banks. The hope is that pension fund managers will adjust their bond portfolios in an orderly way. While this is likely to stem any sudden large losses in bonds, over the longer term it could have a detrimental impact on the performance of many pensions. Limit the impact The size of the interest rate impact is unclear but to prepare for a more challenging time ahead, there are three important steps investors can take to limit damage to their pension from rising interest rates.   Ensure your pension or portfolio is not overly exposed to bonds: in a rising interest rate environment, too high an allocation to bonds in your pension can lead to sizeable losses. If your pension has an over-concentration of bonds, you could consider reallocating some of the funds to other investments that are impacted less by rising interest rates. Stay in shorter duration bonds: in times of rising interest rates, longer duration bonds are more sensitive to interest rate moves. The shorter the maturity, the less impacted the bond should be from rising rates, as illustrated in the graphic below. Diversify: diversification is regarded as the cornerstone of successful investing. A multi-asset approach can help lower the volatility of returns over time and help offset some of the weakness in a rising interest rate environment. Bria Murphy ACA is an Equity Analyst at Davy Private Clients.

Evaluating risk and its potential effect on future gains is an essential part of any investment strategy, write Eugene Kiernan and John Flavin. Too many investors pay mere lip service to the concepts of risk and return. They focus too much on the returns they want and not enough on the risks they are taking. Investment managers who achieve the highest returns routinely win awards but there are no glitzy ceremonies to recognise excellence by investment professionals – be they accountants, fund managers or advisors – in managing risks. That may well be down to human nature as when markets are rising, investors tend to think positive. They want their fund manager to achieve higher returns than anyone else. Those who deliver the highest returns are often viewed as the best in the business. Only the best-informed investors tend to quantify the risks being taken to get these returns, however. It is typically only when markets fall that investors’ focus shifts to risk. It is only then that they worry less about gains and more about minimising their losses. Unfortunately, many investors realise the importance of risk when it is too late and markets have already moved against them, eroding or even destroying the gains achieved when markets were rising. That is why, when it comes to deciding on how to invest, quantifying risk is every bit as important as quantifying return. The risk/return relationship Every investment professional is familiar with the mantra that they must take on higher risks to achieve higher returns. This is a theory that deserves closer scrutiny. It is true that investors who take higher risks should demand higher returns, but it is equally true that higher risks do not necessarily result in higher returns. Rather than focusing solely on returns, investors and their advisors would benefit from a greater focus on risk-adjusted returns – that is, the extent to which their gains are dependent on higher-risk investments. Measuring return alone does not paint the full picture. For example, if an investor is deciding between Fund A and Fund B, she or he may see little difference between them if Fund A has delivered 11 per cent over the past three years while Fund B has delivered 10 per cent. The picture changes dramatically, however, if the investor is then told that Fund A (perhaps containing a high proportion of tech start-ups, exploration stocks and investments in emerging markets) is a lot riskier than Fund B (containing a highly-diversified portfolio with investments across asset classes and geographies). In this example, an investor in Fund A is taking significantly more risk than an investor in Fund B, and is much more vulnerable to a downturn in a particular sector or in emerging markets. While the return is higher, is the difference big enough to justify the additional risk? An informed decision can only be made if the risk is quantified and the expected return adjusted accordingly. Measuring volatility Volatility is a key feature of risk-adjusted return analysis. In essence, volatility measures the likelihood that the return generated by an investment will fall outside a limited range. Lower volatility suggests that the return generated will be steadier and more predictable, allowing investors to meet their goals over the long-term without being hit by significant and often inevitable market downturns along the way. It was Warren Buffett who once said that the first rule in making money is making sure not to lose it. In other words, the key to long-term success is protecting against downside risk and avoiding the big drops. Irish investors, more than most, learned the lesson during the financial crash that years of gains can be wiped out in a very short time. On the flip side, it can take a very long time to repair the damage a significant downturn can do to a portfolio with significant risk exposure. There is strong evidence that riskier portfolios underperform compared to portfolios that take steps to mitigate risk. In other words, the gains riskier portfolios make in good times are outweighed by the losses suffered when markets fall. For example, a study of global equity funds by global asset management firm Blackrock that covered the performance of mutual funds between 1986 and 2014 showed that the “safest” 20 per cent of portfolios achieved significantly higher annualised returns than the “riskiest” 20 per cent. The study also showed that, when it came to comparing the risk-adjusted performance of portfolios, annualised returns actually decreased as volatility increased). The superior performance of low-volatility equities stems from their ability to protect in times of market stress. For instance, low volatility stocks performed significantly better than broad market indices in the market meltdown of 2008. They had less ground to make up than those that had fallen further, which meant that holders of riskier stocks suffered more and suffered for longer. While there is a wide array of risk measures available, most investors will focus on volatility of returns as a shorthand tool to assess risk. Indeed, most fund providers highlight this measure in their literature, as do many performance league tables. The Sharpe ratio, which looks at returns delivered, adjusted for the degree of risk being taken, is a useful way of establishing the relative efficiency of an investment strategy or fund. A high Sharpe ratio means the risk-adjusted returns are higher. Conclusion Riskier stocks do not necessarily mean better long-term returns. In fact, the opposite is true. More volatile portfolios tend to get hit excessively on the downside and fail to match gains made by less volatile portfolios on the upside. Some riskier stocks have risen in value as the market is basing a significant part of its valuation on future performance and expectations are high. When these high expectations aren’t met, the fall from grace can be severe. That is not to say that investors should shy away from riskier stocks and riskier portfolios – far from it. They are perfectly legitimate investments, but it is crucial that the level of exposure taken by an individual investor fits with her or his requirements and risk appetite. The bottom line is that serial compounding over a number of years is the basis for sustainable returns. Evaluating risk and the effect this risk may have on future gains is an essential part of any investment strategy. Ultimately, risk is not to be avoided but it must be managed well. Eugene Kiernan is Head of Investment Strategy at Appian Asset Management. John Flavin FCA is Senior Relationship Manager at Appian Asset Management.