Vinculum Equity

Performance Solutions

Capturing Economic Quality

The StockR8 Investment Process
IM Vinculum Funds, an umbrella Open Ended Investment Company (OEIC) with variable capital was
th
incorporated in England and Wales on 18 November 2011. The OEIC and its first sub-fund, the IM Vinculum
Global Equity Fund, will be launched in January 2012. The OEIC is classified as a UCITS scheme under the rules
of the Financial Services Authority.

Absolute Return Partners LLP, trading as Vinculum, will be the investment manager and distributor of the OEIC.
Absolute Return Partners LLP is a limited liability partnership registered in England and Wales under registered
no. OC303480 and is authorised and regulated by the Financial Services Authority. Registered office: 16 Water
Lane, Richmond, TW9 1TJ.

IFDS Managers Limited, a limited company incorporated in England and Wales and authorised and regulated
by the Financial Services Authority, will be the authorised corporate director (ACD) of the OEIC. Registered
office: IFDS House, St Nicholas Lane, Basildon, Essex SS15 5FS

Vinculum Fund Management LLP (VFM LLP) is a limited liability partnership registered in England and Wales
under registered no.OC358306, registered office: Staple Ash House, Froxfield Green, Froxfield, Hampshire
GU32 1DH. Vinculum Fund Management LLP is an Appointed Representative of Absolute Return Partners LLP
(trading as Vinculum) for the marketing of all long-only equity investment products using the StockR8
investment process.

Vinculum is the trading name of Absolute Return Partners LLP for all long-only equity investment products
using the StockR8 investment process. The objective is to create, over time, a series of long-only equity
portfolios aimed at professional investors and advisers and designed to provide long-term capital appreciation
in excess of that of the relevant equity market benchmark. All of the long-only equity fund portfolios will be
constructed according to the StockR8 investment process for which Vinculum Fund Management LLP has
exclusive global usage and branding rights*.
Fondsmaeglerselskabet StockRate Asset Management A/S (StockRate) - a limited liability company
incorporated under the laws of Denmark - will act as a Sub-Investment Adviser for all Vinculum branded long-
only investment products.

Vinculum is a trade mark of Vinculum Fund Management LLP, registered (no. 257620) in the UK with the
Intellectual Property Office (the Mark). This Mark has been licensed to Absolute Return Partners LLP (trading
as Vinculum), IFDS Managers Limited and IM Vinculum Funds.

*Excluding Denmark, Faroe Islands, Iceland and Greenland.

1. Summary

The over-riding aim of the StockR8 investment process is to create equity

portfolios comprised of companies of the Highest Economic Quality which
offer investors the potential for long term capital growth.

The process comprises an eight stage empirical method of identifying and

then rating the relative economic quality of around 35,000 listed companies
worldwide.

The rating is arrived at by calculating a series of financial ratios relating to

combined earnings and financial strength - all of which are derived from
publicly available audited data coupled with a stability overlay filter
designed to track the consistency of a companys financial performance over
time.
There are two kinds of
The approach looks to minimise subjectivity in the investment decision investors: those who dont
process. The methodology is factually driven and rooted in empiricism know where the market is
headed, and those who
where knowledge comes from evidence and proven experience. dont know that they dont
know. Then again, there is
a third type of investor
the investment
2. History professional, who indeed
knows that he or she
doesnt know, but whose
livelihood depends upon
appearing to know.
The StockR8 process has been developed by Bjarne Jensen over almost
twenty years. William Bernstein

Early in his career, Bjarne worked as a portfolio manager at ATP, Denmarks

largest pension fund. He then held a senior position at Danske Bank during
which time he also lectured in External Accounting at the Copenhagen
Business School. He started his own financial consultancy, Bjarne Jensen
Consult (BJC), in 1993 and BJC continues to own the intellectual property
rights to StockR8.

In 2008 Bjarne founded Fondsmaeglerselskabet StockRate Asset

Management (StockRate) A/S to develop the StockR8 process. Targeting
primarily Danish family offices and private clients, StockRate has c. 100
million of funds under management.
In 2011 Vinculum Fund Management LLP acquired the exclusive global
usage and branding rights* to the StockR8 process to develop a range of
long-only investment products (for which StockRate Asset Management will
act as the Sub-Investment Adviser) aimed at international professional
investors and advisers.

*Excluding Denmark, Faroe Islands, Iceland and Greenland

3. Insight

The StockR8 process is broadly predicated on four inter-connected

observations:

i) Absolute certainty resides in the past. We can know for sure

There are two kinds of
what has happened; we cannot know for sure what will investors: those who dont
happen. know where the market is
headed, and those who
ii) Company behaviour is more predictable than market
dont know that they dont
behaviour. Company behaviour is more driven by habit (an know. Then again, there is
internal force) than the market which is more driven by a third type of investor
the investment
circumstance (an external force).
professional, who indeed
iii) Human error is the most common cause of investment knows that he or she
underperformance. No fund manager ever skilfully doesnt know, but whose
livelihood depends upon
underperforms!
appearing to know.
iv) A long term perspective is more likely to deliver a real return
on investment in equities than a short one.
William Bernstein

4. Our Investment Philosophy

We believe that the companies that offer investors the highest probability
of delivering a superior long term return are those which can demonstrate
the Highest Economic Quality.

We judge the economic quality of a company not by what we, or anyone

else, estimate it might achieve, but by what it has actually achieved.

Underlying StockR8 is the belief that a companys historical financial

performance is a much better guide to its future financial performance than
 When an analyst first
makes a forecast for a
companys earnings two
years prior to the actual
predictive measures such as level of valuation, earnings estimates or event, they are on average
wrong by a staggering 94
analysts forecasts; all of which are subjective rather than proven. per cent. Even at a 12-
month time horizon, they
We define economic quality as a combination of earnings strength (i.e. are wrong by around 45
those companies with the highest proven ability relative to a universe of per cent!

around 35,000 companies worldwide - to generate profits for its James Montier The Little
shareholders) and financial strength (i.e. those companies with the highest Book of Behavioural
proven ability again relatively to preserve capital at hand). Measures Investing.

which are based not on conjecture but on fact sourced from audited,
publicly available data.
Analysis should be
penetrating not
We also hold that company behaviour is repetitive. Broadly speaking, good prophetic.
companies repeatedly do the right things (though not necessarily the same
Ben Graham
things) and bad companies repeatedly do the wrong things.

A successful companys progress is derived from an operational process and

sequence of decisions largely (but not always) controlled by its The only way to remain
great is to keep on
management. Unless the company is hit by external factors beyond the applying the fundamental
managements control, or the company fundamentally changes its modus principles that made you
operandi, we believe it is fair to assume that it will continue to progress in great.The point is to
first get self-disciplined
line with its historical financial performance. people who engage in very
rigorous thinking, who
Therefore, rather than just identify those companies which currently exhibit then take disciplined
the Highest Economic Quality, we also look to establish the consistency and action within a consistent
system.
stability of those companies financial performance over time. We track
combined earnings and financial strength over a minimum five year time Jim Rogers
period in order to pinpoint the companies which have serially achieved the
Highest Economic Quality.

Lastly, we are in principle agnostic as to what a company does. StockR8 has

no favourites nor bias whether to do with size, sector, style, theme or
geography. So long as hard historical data exists and the companies are
listed on a recognised international stock exchange and meet our liquidity I can calculate the
requirements, we make no pre-judgements. We consciously seek to motions of heavenly
bodies, but not the
minimise subjectivity and human interference in the stock selection process
madness of people.
and are interested only in identifying what we believe to be the best
companies based on fact not fiction. Sir Isaac Newton
5. The 8 Stage Process

1. Universe Definition

2. Rating

3. Stability Overlay

4. Final Assessment

5. Implementation

6. Company Monitor

7. Portfolio Management

8. Rebalance

1 Universe Definition
.
The StockR8 process begins by collating publicly available financial
information derived from published company annual reports on a
universe of around 65,000 companies (across nearly 150 countries)
from a database supplied monthly by an external data provider: to
date audited data going back as far as 25 years has been collected.

The accuracy of the data collected is then analysed. Where data is

missing or the quality of the data is questionable, or where there is
less than 3 years of consecutive audited data available, a company is
eliminated from the screening process.

In this way a screened universe of around 35,000 companies is

produced.
2. Rating
A series of key financial ratios is calculated using proprietary
algorithms from each companys balance sheet, profit and loss
account and cash flow statement against the remaining universe.
Each companys combined earnings and financial strength is then
rated against the remaining universe. In this way the process
identifies those companies which demonstrate the highest combined
earnings and financial strength, relative to the universe.

EARNINGS FINANCIAL
STRENGTH STRENGTH
TEXT HERE
Companies with Companies with
the highest ability the highest
relatively to ability relatively
generate profit to preserve capital
for shareholders at hand

The rating results are presented in a traditional two-dimensional

scatter-gram (the Power Grid) with earnings strength plotted off
the X axis and financial strength off the Y axis. The highest rated
companies are found in the top right hand corner of the grid (see
Figure 1 below).

Figure 1. The Power Grid rating model

For company
illustrations see
Appendix 1.
 Each company is represented in the Power Grid by its ticker symbol
(see Figure 2).

Figure 2. Illustration of the Power Grid rating model

Having rated all 35,000 companies, the process now focuses on only
those with the highest ratings what are termed 5 star
companies.

At this stage discrete listings can also be compiled according to

category be it: geography, sector, size, theme or style. The wider the
category the more the number of higher rated companies it will
comprise: the narrower the fewer. Consequently, the number of
stocks in any individual portfolio will likely range between 50 in the
Global portfolio and 25 in, for instance, the European portfolio.
See Appendix 1 for
company illustrations.

3. Stability Overlay

To take the Global portfolio as an example:

The top 100 global companies from the now rated universe of
35,000 companies are picked out. These are the highest rated of the
5 star companies in the top right hand corner of the Power Grid
and effectively constitute the best of the best.
To these 100 companies a stability overlay (the third dimension to
the Power Grid) is applied to track and determine the consistency of
their performance over time. This measures a companys staying
power its ability to maintain its relative combined earnings and
financial strength over a sustained period of time and which is
measured by calculating the variance of the combined earnings and
financial strength score over the last 5 years.

The stability factor is applied to the Power Grid by colour coding the
ticker symbols with light green denoting those companies which
have delivered the lowest variation in financial performance (good
or bad) over time (see Figure 3).

Figure 3. Illustration of the stability overlay on the Power Grid.

The shortlist of companies which are of the Highest Economic

Quality - alpha generating companies which have demonstrated
their relative combined earnings and financial strength serially over
time - is now able to be assembled. These are the companies
marked light green in the top right corner of the Power Grid.
 EARNINGS FINANCIAL
STRENGTH STRENGTH
STRENGTH
ALPHA

STAYING
POWER

4. Final Assessment
The final assessment of the shortlisted stocks comprises two parts;
firstly a check on their liquidity and secondly, a quality check of the
data behind the rating of each company.

Liquidity is assessed by reviewing each companys market

capitalisation and average daily trading volume (as measured over
the previous 3 months). The objective of this review is to ensure,
within reason, that any security position held can be liquidated
within 5 business days of trading - without any trade being more
than approximately 20% of actual trading volume for that security in
any one day. The liquidity criteria are updated and may vary over
time according to fund or relevant market size, or, in the instance of
a segregated account, according to specific client requirements.

In the case of the IM Vinculum Global Equity Fund, those companies

retained will be required to have an average daily trading volume in
excess of US$2.5 million (as measured over the previous three
months) and a market capitalisation of at least US$1 billion. At the
funds inception, any stock that cannot meet these criteria will be
removed from the shortlist.
 Accessibility is also taken into consideration at this stage. For
example it is sometimes not possible to trade local Chinese shares. In
the same vein, opening up the domestic Indian market can be
expensive and time consuming and therefore prohibitive.

For the final check each of the remaining companies on the shortlist
are analyzed in order to double-check and revalidate their 5 Star
rating. Reviewed are: the quality of the data input, access to
information (companies, for instance, which do not produce annual
reports in English are usually excluded) and recent news flow (i.e.
information relating to a companys combined earnings and financial
strength which has appeared since the publication of the last annual
report and which might affect its 5 Star rating).

Also at this stage a common sense view is taken regarding the

political situation of a particular country. In a country experiencing
extreme political unrest, for example, it might be concluded that this
could have an adverse effect on either the company rating or on the
ability to trade in that stock. Under these exceptional circumstances
therefore, it might be decided to remove the company from the
shortlist.

With the final checks complete, the final list of the top 50 rated
global stocks is compiled.

5. Implementation
On all portfolios the investable amount will be applied to the
selected investments on an equally-weighted basis.

In the global portfolio for example, which will be composed of the

top 50 selected stocks, 2% of the investable amount will be invested
in each of the companies.

For narrower portfolios (e.g. some regional or sector portfolios) the

same equal weighting principle will apply but over a smaller number
of stocks. For a portfolio comprising 25 selected stocks, for instance,
4% of the investable amount will be invested in each of the
companies.

Similarly, all subscriptions and redemptions will be apportioned

across a portfolios investments pro rata to its existing composition.
 For example, a company which accounts for 2.7% of the portfolio
value on 1st October will, as a rule of thumb, be allocated 2.7% of
any new money coming into the portfolio on 1st October.

6. Company Monitor
All portfolio holdings will be set up on Bloomberg and filtered to
show corporate actions, earnings announcements, SEC filings and
the like. These are monitored daily.

The purpose of this is to detect any sign of anomalous behaviour

among the selected companies. i.e. events or actions which
materially differ from the established behaviour of those companies.

These might include, for example, a radical decline in a companys

cash or net equity position or a fundamental alteration to a
companys established business model; actions which signal either
an actual or potential deterioration to the rating of our invested
companies.

In the event of a substantial deterioration to the rating, either actual

or imminent, the company will be removed from the portfolio and
replaced by the next best 5 star rated stock. The replacement
stock will initially be weighted at 2% of the portfolio. Any differential
in allocation versus the removed stock is compensated for by either
an increase (in the case of an outperforming stock being removed)
or a decrease (in the case of an underperforming stock being
removed) to the funds cash position.

In the event of a potential deterioration, the invested company is

put under alert. If actual deterioration then materialises it is
removed from the portfolio. If not, it remains in the portfolio.

Only in exceptional circumstances would a company be removed

from a portfolio in between the annual rebalancing (see below). The
historic economic quality of the selected companies make them
unlikely to be subject to sudden, dramatic deterioration other than
through externally induced factors.
7. Portfolio Management
The StockR8 database of worldwide companies is updated monthly
to incorporate all the latest published audited company financial
information. Whereas the majority of companies have a December
financial year-end and publish their annual reports in March or April,
there are companies which report to a different time period. The
monthly update provides new data throughout the year.

Every month, therefore, the stock ratings are re-calculated using the
new audited financial data.

Having done so, the ratings are realigned accordingly. Where a new
5 star stock is identified it will be added to the portfolio but only at
the expense of a substantially deteriorating company (see above).

Historically this has resulted, on average, in a relatively low turnover

in the portfolios during the course of a year.

8. Rebalance
Once a year on or around 1st June the portfolios are rebalanced so
that each stock position is once more equally weighted at 2% per
company in the 50 stock global portfolio, for example.

In 2010 the 20 funds

with the highest
turnover in the IMAs
All Companies sector
returned just 4.7% to
investors over 3
years. The 20 funds
with the lowest
turnover however,
had an average
performance of
16.8% over the same
period.
Appendix 1. / Using the Power Grid.

___________________________________________________________________________

A feature of the StockR8 process is that the rating information can be presented graphically,
at the push of a button, using the Power Grid format.

The format is that of a traditional scatter-gram with each plot representing a discrete year.
Earnings strength is plotted off the X axis and financial strength off the Y axis. The highest
rated companies are to be found in the top right hand corner of the grid and the lowest
rated in the bottom left hand corner.

The following are examples of how a number of differently rated companies are
represented on the Power Grid.

Figure 1. A highly rated

company.

Figure 2. A medium rated

company.
Figure 3. A high earnings / low
financial strength company.

Figure 4. A low earnings / high

financial strength company.

Figure 5. A low earnings / low

financial strength company.
Figure 6. A low stability
company.

Figure 7. A high stability

company.

All charts displayed in this document are sourced from StockRate as at 18th November 2011.
Appendix 2. / Related Reading.

___________________________________________________________________________

Akerlof, G., and Shiller, R., 2009, Animal Spirits: How human psychology drives the economy,
and why it matters for global capitalism (Princeton).

Balen, M., 2002, A Very English Deceit The Secret History of the South Sea Bubble and the
First Great Financial Scandal (Fourth Estate).

Barras, L., Scaillet, O. and Wermers, R., 2005, False Discoveries in Mutual Fund Performance:
Measuring Luck in Estimated Alphas (Swiss Finance Institute/Research Paper Series 08-18).

Bogle, John, 1999, Common Sense on Mutual Funds: New Imperatives for the Intelligent
Investor (John Wiley & Sons).

Brealey, R., Stewart, M. and Allen, F., 2009, Priciples of Corporate Finance (9 th edition,
McGraw Hill International Edition).

Clare, A., Cuthbertson, K. and Nitzsche, D., 2009, An Empirical Investigation into the
Performance of UK Pension Fund Managers, Journal of Pension Economics and Finance,
Volume 9 / Issue 04.

Collins, J. and Porras, J., 1994, Built to Last: Successful Habits of Visionary Companies
(Harper Collins).

Collins, J., 2001, Good to Great (Collins Business).

Fama, E. and French, K.,2009, Luck Versus skill in the Cross Section of Mutual Fund Returns
(Journal of Finance).

Fisher, K., 2010, Debunkery (John Wiley & Sons).

Greenblatt, J., 2007, The Little Book that Beats the Market (Simon & Schuster).

Hargreaves, P., 2009, In For a Penny (Harriman House).

Henriksson, R. and Merton, R., 1981, On Maket Timing and Investment Performance:
Statistical Procedures for Evaluation Forecasting Skills, Journal of Finance, Vol. 54, pp. 513-
533.

Kahneman, D. and Tversky, A., 1982, Judgement under Uncertainty: Heuristics and Biases
(Cambridge University Press).

Kahneman, D. and Tversky, A., 2000, Choices, Values and Frames (Cambridge University
Press).
Kindleberger, C. and Aliber, R., 2005, Manias, Panics and Crashes: A history of Financial
Crises (5th edition, New York).

Koller, T., Dobbs, R and Huyett, B., 2011, Value: The Four Cornerstones of Corporate Finance
(John Wiley & Sons).

Lanchester,J., 2010, Whoops! Why Everyone Owes Everyone And No One Can Pay (Allen
Lane).

Lewis, M., 1989, Liars Poker (Hodder and Stoughton).

Lewis, M., 2004, Moneyball (W.W. Norton & Company).

Lowenstein, L., 2008, The Investors Dilemma: How Mutual Funds Are Betraying Your Trust
And What To Do About It (John Wiley & Sons).

Mauldin, J., 2004, Bulls Eye Investing: Targeting Real Returns in a Smoke and Mirrors
Market (John Wiley & Sons).

Montier, J., 2002, Behavioural Finance: Insights into Irrational Minds and Markets (John
Wiley & Sons).

Montier, J., 2010, The Little Book of Behavioural Investing How Not to Be Your Own Worst
Enemy (John Wiley & Sons).

Shiller, R.J.,2000, Irrational Exuberance (Princeton University Press).

Taleb, N., 2004, Fooled by Randomness: The Hidden Role of Chance in the Markets and in
Life (Texere).

Treyor, J. and Mazuy, K., 1966, Can Mutual Funds Outguess the Market?, Harvard Business
Review, Vol.44, pp. 66-86

Welch, I., Goyal, A, 2008, A Comprehensive Look at the Empirical Performance of Equity
Premium Prediction,The Review of Financial Studies / v 21 n 4).
This material has been prepared and issued by Vinculum Fund Management LLP (VFM LLP) as an appointed
representative of Absolute Return Partners LLP, trading as Vinculum. Vinculum Fund Management LLP is a
limited liability partnership registered in England and Wales under registered no.OC358306. Registered office:
Staple Ash House, Froxfield Green, Froxfield, Hampshire GU32 1DH

Absolute Return Partners LLP is a limited liability partnership registered in England and Wales under
registered no. OC303480 and authorised and regulated by the Financial Services Authority. Registered office:
16 Water Lane, Richmond, TW9 1TJ

The material provided in this document is for informational purposes only, is intended for your use only and
does not constitute an invitation or offer to subscribe for or purchase any of the products or services
mentioned. The information provided is not intended to provide a sufficient basis on which to make an
investment decision. Any investment should be made pursuant to written subscription materials. The
information provided in this material will be subject to, and expressly qualified by, any information contained
in the subscription material.

Information and opinions presented in this material are subject to change without notice. They have been
obtained or derived from sources believed by VFM LLP and Vinculum to be reliable, but VFM LLP and Vinculum
make no representation as to their accuracy or completeness. VFM LLP and Vinculum accept no liability for any
loss arising from the use of this material. Past performance is not necessarily a guide to future performance
and an investor may not get back the amount originally invested. Nor are the results referred to in this
document a guide to future performance. The value of investments can go down as well as up and the
implementation of the approach described in this document does not guarantee positive performance. Any
reference to potential asset allocation and potential returns do not represent and should not be interpreted as
projections.

The investments discussed in this report may not be suitable for all investors. Investors should make their own
investment decisions based upon their own financial objectives and financial resources and it should be noted
that investment involves risk. Investors should also be aware that the market price of the securities discussed
in this report may be volatile. Where investment is made in currencies other than the investors base currency,
movements in exchange rates will have an effect on the value, either favourable or unfavourable. Any tax
reliefs mentioned are those currently available and are subject to change. Their value depends on the personal
circumstances of the investor.

Although certain information has been obtained from sources believed to be reliable, we do not guarantee its
accuracy, completeness or fairness. We have relied upon and assumed without independent verification, the
accuracy and completeness of all information available from public sources. Any views expressed in this
presentation are current as of the date of this presentation and are for informational purposes only. They do
not constitute a recommendation to buy, sell or hold any security and should not be construed as investment
advice. No part of this material may be (i) copied, photocopied or duplicated in any form, by any means, or (ii)
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consent of VFM LLP or Vinculum.

2002-11 Vinculum Fund Management LLP. All rights reserved.

[ Vinculum is a registered trade mark of Vinculum Fund Management LLP (VFM LLP). PAWE and Pay as
We Earn are trademarks of VFM LLP. VFM LLP has licensed Vinculum to Absolute Returns Partners LLP
(trading as Vinculum), IFDS Managers Limited and IM Vinculum Funds.]