Risk & Management

Risk Management & Investment Process

The Board recognises that a sound framework of risk review, risk management and internal control is fundamental to good corporate governance.

The Audit and Risk Committee has the ongoing responsibility for determining the Firm’s risk management policies and procedures and reporting them to the Board for approval. It is recognised that these risk management policies and procedures need to be designed to ensure that the Firm’s operations are run efficiently and potential exposures to risk are appropriately managed.

The Company also has to consider the expectations of its shareholders and active investors to ensure that the Company’s reputation and the success of its operations are not threatened. The risk management policies have been designed after considering factors which bear upon the Company’s continued good standing with its shareholders.

This policy defines a risk as a chance of something happening that will have a significant impact upon the achievement of the Firm’s business objectives. Risks are threats or hazards, uncertainty or exposure and lost opportunity that could have a material adverse effect on the Firm.

Material business risks faced by the Firm are required to be identified, and where possible, internal controls and procedures implemented to ensure that risk exposures are appropriately managed. Material business risks faced by the Firm are required to be continually reassessed with policies and internal control procedures modified as appropriate.

Inherent Investment Risk

Ideal Stock Exchange companies invest in equities listed on the American Securities Exchange. Equity investments represent well over 90% of the Firm’s total assets. These equity investments are not subject to market risk as the market value of investments fluctuate over time. The objective of market risk management is to manage and control market risk exposures within acceptable parameters, whilst seeking to optimize the return to shareholders and active investors.

The investment portfolio is spread over a large number of entities operating in a number of market segments so as to reduce the market risk of a fall in value of a particular investment or an economic decline in a market segment.

The Firm holds equity investments for the long term and does not act as a share trader nor does it invest in speculative stocks.

An assessment of the inherent risks associated with companies and industry sectors is untaken as part of the Firm’s stock selection and continuing evaluation processes.

Funds are also invested in term deposits. Credit risk relating to term deposits is minimized by the Firm only placing term deposits with a limited number of major American financial institutions who have been approved by the Board and have acceptable credit ratings determined by a recognised credit agency. Limits are also set on the amount of total term deposits that can be deposited with any one financial institution.

The Firm maintains a risk management framework to ensure that it invests and operates within acceptable levels of risk.

Risk Management Framework

The following procedures summarize the risk management framework adopted by the Firm.

Identification and Analysis of Risks

Risks are identified taking into account equity investment and economic risk history, forecast economic conditions, changing trends, legal and regulatory requirements and the Firm’s operational structure.

The likelihood of a material risk materializing and the Firm’s ability to reduce the impact of that risk is then analyzed.

Areas of risk addressed by the Firm cover:

1. strategic
2. reputation
3. investment
4. operational
5. technology, including accounting systems
6. staff, including knowledge transfer on the change of a key staff members
7. legal and compliance and
8. financial and other reporting requirements.

Maintenance of a Risk Register

Where a significant risk is identified within the areas listed above it is recorded in a Material Risk Register.

These risks are subject to ongoing reassessment by the Company Secretary / Chief Financial Officer, who is responsible for maintaining the Material Risk Register, and the Audit and Risk Committee. New risks identified are also required to be reported to the Audit and Risk Committee.

Documentation and Assessment of Controls to Mitigate Risks

For each risk listed in the Material Risk Register, a summary of policies, internal controls and other processes and procedures, designed to manage or mitigate the risk, are required to be listed.

It is recognised that, for policies, procedures and internal control processes to be effective in managing or mitigating risks, they must be communicated, correctly implemented and monitored. It is the responsibility of the Company Secretary/Chief Financial Officer to maintain the Firm’s Policies, Procedures and Controls Manual.

Monitoring of Risk Management Policies and Procedures

The Company Secretary/Chief Financial Officer is also responsible to the Board for monitoring compliance with risk management policies and procedures. The Board requires the Company Secretary/ Chief Financial Officer to report to it each six months whether operational, financial and compliance risks are being managed effectively.

The Company Secretary/ Chief Financial Officer is required to report to the Board at the end of each half year and financial year that his/her declaration under Section 295A of the Corporations Act is founded on a sound system of risk management and internal control and that the system is operating effectively in all material respects in relation to financial risks.

Other Monitoring of Financial Control Systems

A Compliance Manager reports to each Board meeting on his/her review of the key controls of the company.

The Firm’s external auditors also assess the internal financial control systems as part of their audit of the Firm’s financial statements and reports any weaknesses identified to the Audit and Risk Committee.

Investment & Process

Security Selection

Ideal Stock Exchange employs a fundamental research process in identifying investment ideas from our investment universe. Investment ideas come from monitoring economic and industry trends as well as extensive contact with company management and industry sources.

Once identified, investment opportunities are screened to ensure they are of an investment grade. A full qualitative assessment of the proposed investment is completed to establish whether the business is of a suitable quality and attractively priced.

Investment Ideas and Opportunities

Investment opportunities emerge from close examination of industry trends. These developments may include economic, political or legislative changes that impact the structure and competitive environment in which a company operates. Investors in many instances are slow to identify and price these changes.

The best investment ideas present a unique view, are relevant to the value of the business and are not currently reflected in the share price.

Qualitative Review

Once a suitable investment opportunity has been identified, a full review of financial performance will be completed. This is usually followed by a meeting with management to further develop an understanding of the business and the management philosophy. Where possible, members of the investment team will also meet with suppliers, regulators, competitors and customers to gauge the competitive environment.

Short Selling

Ideal Stock Exchange employs a similar security selection process as outlined above, but is looking for the opposite qualities in companies to borrow and sell. We believe the best “shorting” opportunities are found in companies with weak fundamentals that can be sold for more than they are worth.

When targeting companies to borrow and sell (short), we look for the following:

1. A history of inferior returns
2. Management with a poor track record.
3. Businesses that are highly competitive and struggling to grow
4. Securities that are expensive on a range of valuation measures

Portfolio Construction

Unlike a traditional fund, Ideal Stock Exchange constructs two portfolios, a long and a short portfolio with the weighting of each investment in each portfolio loosely correlated with the level of conviction around individual investment ideas.

This process ensures we construct portfolios around the best individual investment ideas, with the highest conviction, while retaining a bias in favour of good, well managed companies to buy (long), and weaker businesses to sell (short).

The relative size of the two portfolios is a consequence of the quantity and quality of investment ideas we can identify to buy and sell. Macroeconomic and sector research along with a full range of risk metrics, will influence the overall weighting of each investment.

The relative size of the long and short portfolios will determine the net market exposure. The larger the short portfolio relative to the long portfolio the lower will be the net market exposure and the higher the cash weighting. If the portfolios are of equal size the fund is market neutral with no net market exposure.