Investment Appraisal of Pension Fund - Assignment Example

? Table of Contents Introduction 2 Fund Investment 2 A)Review of Current Portfolio 3 Performance 4 B)Recommendations regarding Portfolio weightage 5 C)Review of Property Investment 6 References 10 Investment Appraisal of Pension Fund Introduction Pension funds are managed by professionals with experience and expertise. These are the funds based on contributions made by employers and employees. The basic idea behind such funds is to accumulate enough money, so that the company can handle the pension provisions of its employees after their retirement. The fund is collected from different sources. The money accumulated is then invested in various investments, so that it generates further income. It is made sure that the income generated is enough to payout the pension benefits provided to the employees. The management of the funds is not necessarily separate from the management of the company. Usually these managers have expertise in investment techniques, in order to maximize the return upon the investments made. The fund portfolio is evaluated as how much percentage is invested in each portfolio. Also, it is taken into consideration how the return from each investment is accounted to the performance, of the fund as a whole. Based on the performance of the funds the investment appraisal is carried out. Fund Investment The pension fund is the accumulated fund, collected from the employers and employees. The earnings that this fund generates is accumulated within itself. The fund is managed by professionals with expertise in the related field of investment. The funds are to be utilized in fulfilling the financial needs of the company, which it has to bear in terms of constructive liability. The constructive liability being, to pay pension and other after retirement benefits to the employees. Pension fund are the accumulation of funds that are invested in various investments, where the returns are generated. There are various criteria which are used in order to evaluate the efficiency of the investment. Wherever the management decides to invest, the risks associated and the return that the investment can provide are the prime concerns of the management of the funds (Cmpbell, 1996). The performance of the investment is dependent upon the return, the market and industry that the investment is concerned with. The current portfolio is invested diversely in four divisions of investments, namely, UK Equities, Overseas Equities, UK Gilts and UK Property. A mere 5% of assets also exist in the form of cash. A) Review of Current Portfolio In the current portfolio of the assets, UK equities have a weightage of 50% of the fund. The assets held by the funds should not lose value and should be able to provide a handsome amount of return. Based on the risks associated with the assets of the fund, the main cause of concern is whether the fund performance is persistent and increasing or not (Christopher, et al., 1998). The portfolio of the funds consists of 25% of UK gilts investment which are the least risky of all the investments and also provide the least return. The appropriation of the funds in the current portfolio elaborates that 5% of cash is held. With the total fund size amounting to ? 1billion, this amounts to ? 50 million. This is an asset that is not invested and is losing value over the time. The cash that is retained in the portfolio is not considered to be healthy. Other liquid assets, such as equity stock, can easily be traded in the market. It should be considered as it will benefit the fund. This is because it shall be providing a return, thus minimizing the impact of inflation and reduction in the value of money. The majority of the portfolio consists of UK security and amounts to the ? 500 million. This amount is invested in the equity stock of the companies listed in the stock exchanges in United Kingdom. The performance of the fund is mainly concerned with the amount of return and the rate of return that it provides accounting for the risk associated with it too (Chan, et al., 1995). The performance of the market of United Kingdom is an essential element for the better performance of the fund, as 50% of the portfolio of the fund consists of it. Besides the performance of the market as a whole, the performance of the equities that the fund has invested in a major issue of concern is well. The UK gilts in which the fund hold 25% with the total amounting to ? 250 million. These investments are the least risky investments and are guaranteed to provide return. The investments made in these investments are the most secure investments, as these are the government bonds. The return rate of these bonds are considered to be the risk free rate benchmark, which the market will offer. Although the rate of return of gilts are less than the other investments in the market, the fact that that there is no risk in investing in these bonds and investments make them the best option. These become an even better option when a risk aversion policy is to be adopted. Safety and security of such an investment is, usually, never a concerned. In the portfolio of the fund, there are investments that are made in the equities outside the United Kingdom. These investments amount to a total of ? 150 million. The equities around the world have offered various investment opportunities. They have also been able to provide returns based upon their relative performances. The world is a global village and markets are easy to access. Thus, the investments in the equities outside the United Kingdom seem feasible, in order to diversify the portfolio. With these investments the fund is able to account for the performance of the markets outside United Kingdom. During the last couple of years, the property in the United Kingdom has maintained its value. It is considered to be a safe investment for the future, with more chances of it going up rather than going down. The investment in the property within United Kingdom amounts to the total of ? 50 million. These investments deem to be secure, as no loses have been made even in the worst case scenarios. The investments in properties have proved to be beneficial, due to the fact, they are able to provide something back. Secondly, property investments never go on to lose their full value. Performance The performance of the fund is associated with the investments that the fund has made. The investments from the fund are made with carefully selected investments. This is to account for the maximum return that the fund can generate. It goes on considering the risk factors that are involved and the policy of the fund management regarding risks. The return from each of the investment and how much risk is associated which each investment thus accounts for the performance of the funds. The fund is managed by experts, who use different tools in order to carefully select the investments. They consider the returns and risks associated with each of the investment. They usually diversify their portfolio by making various investments. The performance of the United Kingdom equity can be assessed by considering the returns that the equity has generated and how the fund has benefited from the return. The stock market of United Kingdom has been able to perform well in the past few years. The returns generated from the investments must be beneficial for the fund unless the selected funds have not performed in accordance with the market (Piotroski, 2000). The selection of the stock in which the investment is made is crucial for the performance of the fund. 50% of the fund portfolio consists of the UK equity. The selection of the equity stock depicts the performance as each stock differs in many ways, with regards to the returns and risks. The investments of the funds in the equity and the performance of the equity accumulates to the overall performance of the fund. B) Recommendations regarding Portfolio weightage The selection of the stock plays a vital role, as the stock in which investment is to be made must satisfy the requirements of the fund. As the majority of the amount is to be invested in the stock, the risk associated with each of the stock must be evaluated and considered while ranking the investment opportunities for the fund. There are many other factors that are to be considered in order to evaluate the present performance of equity and forecast the performance while considering the past trend. The selected stock must be tested for the investment appraisal. The net present value of the stock is to be evaluated and the decision is to be made based upon it (Nicholas & Barry, 2010). Similarly, for the evaluation of the stock regarding performance, the capital asset pricing model is used. This accounts for the risks that is involved in the investment and relates it with the market. Thus, it is able to provide a better insight regarding the performance of the equity (Eugene & Kenneth, 2004). The overall performance of the fund is the accumulated performance of the individual investments that the fund has made. The split of performance must be such that it takes the risk to the minimum level and maximize the returns. The safe investments such as UK gilts must be lowered. This is because they give the minimum rate of return. This risk free rate does not seem enough to contribute to future expenses. The careful selection of equity stock in which the investment is to be made depicts the performance of the fund. Hence, the selection criteria must be evaluated and more investments in the other divisions must be made. This is because they provide a return that is much more than the return provided by the gilts. The split in the investment should be diversified. This is so that the fund can enjoy the performance from various investments and the risks associated with them is accounted for too (Daniel, 1997). The investments in different types of investments is considered to counter the risks that is faced, as opposed to all the investment made in one place. The percentage of cash that is held in the fund portfolio should be lowered and should be invested, as money deteriorates over time and loses value. This fact is elaborated by the purchasing power parity theory. C) Review of Property Investment Since property has been allowed to be foreign owned by many countries, the property market has been globalized. The upward trend has also been due to international reporting standards and common investment vehicles, an example being REITs. With the help of international reporting standards, it is now easy to compares investments in different countries with each other. Another factor for the growth of this market is the introduction of global property funds. Now you may invest a property company rather than buying a property directly. This method is quicker, simpler as well as cheaper. (MCQUEEN, 2010). The world is going global, thus, investing in the property of UK only may be considered a lost opportunity. The fund should purchase the property outside UK where it seems feasible. This is so it accounts for return in the fund portfolio and the investment is able to provide return in terms of better rental rates. The valuation of the property should not deteriorate. It should increase over a period of time, thus, benefiting the fund as a whole (Heinrich, 2005). The percentage of the property investment in the fund is crucial as usually a huge amount is needed to be invested in the property. Property investment is a feasible option for the fund but not much as in comparison with the investments that are to be made in the UK gilts and equities within UK and outside UK. The investment in the property is not as much liquid and cannot generate immediate cash when needed. As it is a pension fund plan thus the investments in the funds must be selected in such manner that the risk is minimized and the returns are maximized. Property investment depicts the amount that is invested in buying the property and that is held. Currently the portfolio holds 5% of its assets as in property which amounts to the total of ? 50 million. The performance of the investment that is associated with the property is ascertained when the valuation of the property is done. The value increases as compared with the previous value along with the rentals that it generates (Mary Ellen, 2010). The risk associated with the property is the deterioration of the value and the fact that the property is not that much liquid. As in hour of need, when sudden cash is required, property is not a type of investment that could be realized into cash. Although it can provide a mortgage or be used to obtain some finance lending facilities. The performance of the UK property is better than many other investments in the market. This is because it attracts those investors that are reluctant in making high risk investments, such as stocks and equities. The total value of the UK commercial property market in 2008 was estimated at ?496bn, and the value of UK residential property was estimated at ?4,1265bn (Bpf.org.uk, 2013). The industrial, retail and office sectors set up the divisions of the market. Furthermore, they are some specialist sectors and some sub sectors. Specialist sectors include healthcare, student accommodations as well as leisure. Sub sectors are those which are sub divisions of the main sector, examples being, the splitting of high street shopping centers and the regional centers of the retail sector. The main reason behind the divisions and sub divisions is the identification of similar trends and on goings between them. Hence, expecting them to have the same management and investment performance needs. Regarding the performance of the property investment, it is not as much attractive as in comparison with the equity. This is because the economy is not growing at an appropriate rate which has led to a decreased the demand of the property. The demand of the property is crucial as it depicts the value that can be realized from the property. For any portfolio for a fund, it is better that the investment in the property is made to a minimum. But it should not be so less that it does not accounts for the returns, which the property should be able to provide. The more the investment in the property is, the less liquid the investment becomes. Regarding the demand and supply of the market the return on the property, which can be realized upon the sale of the property, is minimized. The return from the property is realized in terms of rentals that is ascertained from the property and the rate at which the property can be rented out. The performance chart of the UK Commercial property and forestry property is shown in the graph below. It reflects that the performance of the forestry property is performing better than the commercial property. The return comparison of different investments are shown in the following graph: References Bpf.org.uk. 2013. Reita - Key property data. [online] Available at: http://www.bpf.org.uk/en/reita/about_property/key_property_data.php [Accessed: 3 Dec 2013]. Chan, L. K., Jagadeesh, N. & Lakonishok, J., 1995. Evaluating the Performance of Value versus Glamour Stocks: The Impact of Selection Bias. Journal of Financial Economics, 38(1), pp. 269-296. Christopher, L. C., Merton, H. M. & Andrea, M. P. N., 1998. VALUE AT RISK: USES AND ABUSES. Jornal of applied corporate finance, 10(4), pp. 26-38. Cmpbell, J., 1996. Understanding Risk and Return. Journal of political economy, 104(1), pp. 298-345. Daniel, K. T. S., 1997. Evidence on Cross-sectional Variation and Return. Journal of Finance, 52(1), pp. 1-33. Eugene, F. F. & Kenneth, R. F., 2004. The Capital Asset Pricing Model: Theory and Evidence. Journal of Economic Perspectives, 18(3), pp. 25-46. Heinrich, H., 2005. THE ROLE OF INTERNATIONAL PROPERTY INVESTMENTS IN THE GLOBAL ASSET ALLOCATION PROCESS. International Property Investments, 1(1), pp. 1-20. Mary Ellen, K., 2010. Investment Real Estate: An Alternative to Fixed Income. Journal of Financial Planning, 1(1), pp. 1-10. MCQUEEN, M., 2010. Real-Estate Investing: the Best and Worst Markets. The Wall Street Journal, 1(1), pp. 1-10 . Nicholas, H. J. & Barry, D. S., 2010. A Net-Present Value Analysis for a Wind Turbine Purchase at a Small US College. Energies, 3(1), pp. 943-959. Piotroski, J. D., 2000. Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers. Journal of Accounting Research, 38(1), pp. 1-51. Read More