The CII AF4 October 2020 Exam in Review

It’s now time for us to turn our attention to the October CII AF4 exam. The following will be useful reading for those preparing to sit AF4 in the near future.

If you haven’t seen the paper, you can find it here.

Question 1

The Section A question carries 80 marks, and in October, introduced candidates to Irma and Christopher who were in a long-term relationship and in their late-40s.  As is often the case, the questions included calculations – this time, Sharpe ratio, an income tax liability, and time-weighted return, as well as various theory questions covering the following subjects:

• The main differences between the Sharpe ratio and the Information ratio
• Drawbacks of using the Sharpe ratio in investing planning
• The main rules a fund must follow to qualify as a REIT
• Four main risks of equity-based investing
• Behavioural finance
• Six reasons why an adviser would use an investment trust rather than an OEIC
• Four open-ended fund structures that could be used to invest in UK equities
• Three relative differences between what is measured by alpha and beta
• Two aspects of personal taxation that would change if the clients got married
• Drawbacks of holding a fund that invests on a single theme or thematic basis

Question 1 covered what seemed to be some new areas as well as some of the old favourites.  Overall, it seemed to be one of the less difficult first case studies and should not have caused too many problems for those candidates who had prepared well.

Question 2

Question 2 concerned Catherine, aged 66 and recently retired.  She had an ISA portfolio and an onshore investment bond.  The questions were again a mix of calculations and theory.  Question (a) tested due diligence factors to consider when assessing a platform and the main income options available via the cash account.

Question (b) asked for a calculation of the shortfall in Catherine’s target income based upon her current pension and ISA income.  This was for just 4 marks and part (ii) of the same question asked for a description of how the investment bond could be used to generate the figure in the previous answer and state the basic tax treatment of the figure – this was for 5 marks.

Question (c) tested sequencing risk and the actions that could be taken to mitigate the effects of this.  This is something recently included in some of the investment modules, so it should have been no surprise to see it tested at this advanced level.

Question (d) asked candidates to identify the main differences between an interim and a final dividend for 6 marks.

Question (e) asked for a description of what ‘correlation’ in relation to investment planning meant, and finally, question (f) asked candidates to identify the four components of an economy’s current account.  There is often a question on economics, and this seemed to be one of the easier ones asked than in the past and only for 4 of the total 40 marks for Question 2.

Question 3

Finally Question 3.  This time we weren’t introduced to clients but instead to Gregor, an investment adviser.  We were told his client has an existing portfolio of collective funds invested in UK and international equities.  The client also had two UK listed equities held on a direct basis, and details of these were given including the share price, EPS, price-earnings ratio, dividend per share, and dividend cover for one or the other company.  We are also told that the client has an ethical preference to investment.

The questions were varied but started with a four-part question on the main forms of ethical investment, followed by which other non-equity asset classes could be used for the new money to diversify the existing portfolio while maintaining an overall ethical approach, three reasons why an equity-based ethical investment strategy could out-perform an equity-based non-ethical investment strategy, and four fund-specific factors that an adviser would consider when researching ethical funds for potential inclusion in the portfolio.  These were all part of Question (a) and although only low-mark individual parts, the total question was for 14 marks.

Question (b) included more calculations; candidates had to calculate dividend yield and dividend cover and state the reasons for the difference in dividend cover between the two companies.

Question (c) asked a question from what appeared to be a new angle; candidates had to use the financial information given in the table to identify one ratio that would appeal to a growth-orientated fund manager and one ratio that would appeal to a value-orientated fund manager and state 2 reasons for each section.  The question was for 6 marks and might have been a challenge for some, but at this advanced level, it is good to see that examiners are expecting analysis to be demonstrated.

Question (d) tested more economic knowledge. We are told the adviser believes that the economy is moving into the latter stages of the business cycle, and candidates had to state two reasons why this view would have a positive impact on one of the company’s share price, and part (ii) asked for two reasons why this view would have a negative impact on the other company’s share price.

Finally Question (e), and candidates had to explain to the client the main differences between ROE and ROCE – this final question was for 5 marks.

All in all, this seemed a good paper, with a variety of topics being tested with a good balance of theory and calculations, which the well-prepared candidate should have been happy with.

Comparing with October 2019’s AF4 Exam Paper

Let’s see how it compared with the previous October’s paper; at that sitting, the following topics were tested:

• Benchmark return and fund performance
• Benefits and drawbacks of using stocks and shares ISA compared with a pension
• Diversification rules for a retail UCITS OEIC
• ATR and capacity for loss
• Key principles of modern portfolio theory
• Use of a DFM and the potential risks
• Behavioural finance
• Risks of investing in high yielding alternative income products
• The main types and characteristics of preference shares
• The benefits and drawbacks of transferring existing assets to a platform
• The main categories of benchmark used by fund managers
• The key differences between MO and M4, how the Bank of England can reduce money supply and the effect on interest rates
• P/E ratio and ROCE and the general limitations of using investment ratios
• Factors that could affect a company’s share price
• How a SEIS can be used to mitigate CGT and the initial income tax treatment
• Momentum and contrarian investment styles

As you can see, there is little in the way of overlap and is another reminder of how much can be tested within the AF4 syllabus.  Anyone studying for this in the future will need to use J10 as their main source of revision and ensure their study schedule is detailed enough to cover all the potential areas that could be tested.

Grab the resources you need!

If you’re studying for your CII AF4 exam, and you’re wanting some extra practice, grab our free taster to try out one of Brand Financial Training’s resources for yourself.  Click the link to download the AF4 mock paper taster now!