Modern Portfolio Theory - Coursework Example

Introduction Investment objective To diversify the risk so as to attain maximum return with minimum chances of loss remains the main aim of this investment. A total of £250,000 has been equally distributed among all four firms: British Petroleum (BP), Unilever, TESCO and Fidelity. In this regard, it is important to mention that each firm is unique and totally different from firms. This is the main thought behind the objective of diversification in which portfolio must not be reflecting whole investment in a single set of firms instead it must be reflecting appropriate share of investment across different firms. Additionally, modern portfolio theory (MPT) has been used as a base investment theory used for analysing the selected portfolio by discussing range of risk factors, return chances, and investment long term returns. In the following parts of this paper, first, MPT has been defined and discussed as well. After this part, each investment is separately highlighted and discussed before summarizing the paper in the conclusion part. Modern Portfolio Theory (MPT) Modern portfolio theory is comprised of the trade-off between risk and reward in the backdrop of portfolio (Shun, 2005). Xidonas et al. (2012) explain that the MPT is an investment theory aimed to maximise return for a given set of portfolio risk along with diminishing risk to a certain level through selecting a careful bunch of numerous assets for the sake of investment. MPT is a basic economic model developed to ascertain and establish a linear relationship between risk and return of an investment (Marcinko, 2005). Among other factors, this theory is based on the concept of diversification (Gregoriou, 2008). This theory remains a major attracting point for various risk-averse investors as it provides incentives for diversifying risk through its quantification; Harry Markowitz developed and introduced this concept by suggesting that it is not sufficient to only consider risk and reward perspective of any particular stock instead diversification can be adopted for generating more returns through selecting the right set of stocks (Investopedia, 2015). In other words, MPT is not a conventional way to consider about the investment from the single perspective in which both new and experienced investors use risk and reward criterion for judging the future viability of any asset. More important perspective is looking for diversified investment through right selection of assets. Keeping this view in mind, all four assets do not represent any single industry instead they represent diverse and different industries. For example, BP represents oil and gas industry whereas the Unilever has diverse range of products and brands in consumer goods as it has both manufacturing and distribution of its products. In contrast, TESCO is totally different from the Unilever as it only sale services in the form of retail services. A totally different portfolio is reflected by Fidelity as this firm is only related to investment of different equities. Fidelity is a renowned investment portfolio that is more actively involved for collecting savings from different institutional and non-institutional investors and invests in different funds and other securities. Overall, the selection of four different securities clearly highlight that each selection is even not close to other. Based on this selection, it has been attempted to ensure that the concept of diversification has been adopted in this investment strategy. At the same time, it is worth mentioning that each firm has different industry, unique and different risk factors and more importantly each one faces different kinds of unsystematic risk which is always unique to the industry and firms operating within that industry. Figure 01: British Petroleum (BP) Source: (Share, 2015d). Costs A total of £250000 has been allocated for purchasing the shares of BP. The last quoted price of the firm was £468.60 per share. When this amount divides the total available outlay for the investment in the BP, the subsequent result brings 533 shares. Rationale The BP remains the most important multinational oil firm based in the United Kingdom. This firm operates in one of the basic industries that are highly essential for the long term survival of any economy. For example, petroleum products provide fuel which is used to run engines of various manufacturing facilities. In every sector of human life, petroleum products are essential and they have long term future and its demand will not decline in the long run but will continue to rise along with economic stability and growth as well. In other words, it is reasonable to highlight that this oil and gas industry will remain in demand despite the fact that alternative fuel energies are underway in various forms. What features suggest strong growth in future? Currently, the recovery of global economy remains the major positive indicator. During the year of 2007, the global economy started to decline as the problem of the global financial crises began to affect the whole global economy in which many firms, banks, including Lehman Brothers, filed for bankruptcy. This recession period did not end until the end of 2012 when the major economic indicators started to show some positive trends, showing that the global economy has come out from the black whole of the global financial crises. Since then, many firms and national economies, including the UK economy, registered stable and strong growth as well. Risk measures However, the recent history suggests some challenges for oil and gas industry. For example, the international oil and gas prices have substantially declined and this slump has recorded more than 100 per cent decline in the recent history, clearly demonstrating that the BP faces the risk of further profit decline as the oil prices have direct influence over the revenue and net profit of such firms. In this regard, it is important to mention that the decline in oil prices have both effects on the BP. For example, the decrease in oil prices have increased demand for oil and gas products which indirectly boosts demand for more production and consumption. In contrast, this situation causes decline in the net profit and revenue of oil and gas firms. Overall judgement The BP has strong and stable financial history and the same has also been proven by the figure 01 which is the reflection of the shareholders trust over the current management of the firm. Thereby, it is reasonable to buy and retain this asset for generating expected return. Figure 02: Unilever Source: (Share, 2015c). The share price of Unilever is the highest indicator reflecting and authenticating that the investment would generate stable and better returns in the coming days. The trend clearly exhibits that the firm has established and recognised goodwill among shareholders and investors as well. From an investor perspective, the above-mentioned figure is a clear indication that the firm has put in place strong operational, financial and performance variables that ensure attainment of respective objectives. More importantly, the figure 02 has not shown any significant decline during the reported period, demonstrating that the current long term strategic policies, practices and strategies have remained highly successful for attaining their long term respective objectives. Costs A total of £250000 has been allocated to the Unilever. When this amount is divided with the quoted share price (£2875) of the firm, the subsequent result generates 87 total numbers of shares. In this regard, it is important to mention that the share of Unilever is very expensive when its share price is compared with the share price of other portfolios. Thereby, it is a reasonable to deduce that the expensiveness of this share is also a stable rationale that can be used for buying this share. Rationale Unilever mostly produces consumer goods. The firm has strong and stable brands, such as Lipton, dove, Vaseline and Persil (Share, 2015). In this regard, it is important to mention that this firm is not mainly involved in retail servicing instead it mostly produces and distributes its own products and brands as well. Under this situation when the firm owns strong and stable brands in consumer goods, this shows that the firm can be selected for the sake of investment as these are those indicators that highlight that the firm can be trusted for its strong management along with its strong brands which are highly popular in the global consumer goods market. What features suggest strong growth in future? Brands and manufacturing are two important factors that highlight the optimistic future growth in the sector. Unilever works in the production of consumer goods industry. This industry does not work in the technology firms which are highly volatile and unstable when they are compared with the non-technology firms. In this regard, it is important to mention that the technology firms face the risk of price reduction as soon as new or latest version of any technology model is lunched or introduced in the market. Basic needs and luxuries are two different requirements. For example, food is a basic need where car or having a mobile phone is not a basic need but a luxury. Based on this difference, basic need is essential for performing routine works whereas the luxury items are not needed for carrying out the routine works. Based on this difference, it can be deduced that the Unilever, which mainly deals with the manufacturing and sale of basic human needs, the firm has strong prospects for stable price share and future growth in the market as well. Overall judgement Unilever faces restricted risk when it is compared with the risk which is being faced by the BP. For example, BP is directly affected by the international oil price changes whereas consumer goods are not frequently affected by the change in their prices because the prices of consumer goods are less elastic when they are compared with the oil and gas prices. Based on this analysis, it is reasonable to buy the share of Unilever. Figure 03: TESCO Source: (Share, 2015b). The figure 03 clearly highlights that the firm’s share price has been constantly decreasing over the period of last five years. TESCO is an important retailer based in the United Kingdom. The firm is mainly involved in the retail services as it has both online and offline superstores and supermarkets across the United Kingdom and certain other countries as well. Costs During the analysis period, TESCO’s share price was £225. When the allocated amount of £250000 is divided by the share price, the subsequent outcome reveals that the ownership of 1111 total shares. When this ownership is compared with the ownership obtained through purchasing the shares of Unilever, it becomes clear that the purchase of TESCO shares has generated more shares. This proves that this selection has generated more shares but with high risk of loss because the firm’s history unequivocally indicates unstable and declining share price performance over the period of past five years. In this regard, it is relevant to mention that the declining trend also reflects that the shareholders and investors have shown their lack of trust over the effective management of firm affairs by the current strategic leadership of TESCO. What features suggest strong growth in future? The firm operates in highly stable industry. This industry works as a medium between buyers and sellers of consumer goods. In other words, this industry and this firm are both highly relevant and have strong possibility of generating more returns in future. However, the main problem is mainly caused by the current management of the firm. And it is expected that this management will change its strategic marketing along with highlighting and acting upon methods of cost cutting. In other words, the firm is only required to control its expenses which will enable the firm to attract more customers who will increase and stabilise the financial figures of the firm in the long run. Figure 04: Fidelity Source: (Share, 2015a). Fidelity European Values is the trust aimed to provide stable and lucrative returns to the investors (Share, 2015). The figure 04 reflects the five-year share price performance of this fund. The figure clearly shows that the policies, practices and investment decisions of the firm are generating the expected returns as the trust of the shareholders and investors is being reflected by the inclining trend by the blue line in the figure. More importantly, the figure has gained momentum from 2013 as the blue line started to generate more returns and stable outcome for the investors. In this regard, it is important to mention that this period also ends the effects of the global financial crises which started in 2007. Costs The share price is quoted in the pound sterling. During the quoted period, the share price was 178.8. When the total allocated amount is divided by this share price, the subsequent outcome generates 1398 shares in the pool. A comparative analysis with the number of TESCO shares shows that the fidelity investment has generated more number of shares. This shows that the fidelity investment is considered to generate more returns. For example, the past performance of TESCO share clearly exhibits that the firm is constantly experiencing a declining trend whereas the share price of fidelity has been going upward movement throughout this reported period. Rationale Trust and funds has become an important vehicle for generating stable returns over the past few years. Equity investment has resulted in heavy loss for various investors. At the same time, it has also been observed that the investors find it risky to invest in equity when the risk and reward analysis is compared with the trust and funds. This point is also proved by the trend reflected by the figure 04 in which fidelity share price has been constantly going up, clearly indicating and proving that the firm has largely been successful for gaining and retaining the trust of the investors. Conclusion MPT is an investment philosophy based on diversification concept. Under this investment philosophy, an investor can diverse its investment and generate maximum of returns. However, it is pertinent to highlight that the selection of right portfolio is also step in the MPT so as to minimize the risk of loss. Based on this hypothesis, four different assets have been chosen to divide the total outlay. The subsequent outcome reveals that the BP works in one of the important industries which will always be in demand. As a result, it looks highly reasonable to select this asset. Subsequently, Unilever has established brands and operates in the consumer goods market. Historically, the firm has been financially performing better. However, the important rationale is provided by the fact that the Unilever produces basic human needs. Consequently, their demand will remain largely stable and uninterrupted. As far as the TESCO is concerned, the firm has higher chances of making more returns as the company works a medium between the producer and the purchaser in the retail sector. At the same time, the investment trusts, such as fidelity, are gaining more trust. And this has also been proven by the growing trend of the firm. Moreover, the equity investment has resulted in more losses. Consequently, this has put positive effect on the trusts and mutual funds. References Investopedia, (2015). Modern Portfolio Theory-MPT. Retrieved: http://www.investopedia.com/terms/m/modernportfoliotheory.asp Gregoriou, G.N. (2008). Encyclopedia of Alternative Investments. Florida: CRC Press. Marcinko, D.E. (Ed.).(2005). Financial Planning Handbook for Physicians and Advisors. Miami: Jones and Bartlett Publishers. Share, (2015a). Fidelity European Values share price. Retrieved: https://www.share.com/find-investments/advanced-finder/company-overview/fidelity-european-values/summary/24057/ Share, (2015c). Unilever share price. Retrieved: https://www.share.com/find-investments/advanced-finder/company-overview/unilever/summary/184/ Share, (2015d). BP share price. Retrieved: https://www.share.com/find-investments/advanced-finder/company-overview/bp/summary/109/ Share, (2015b). Tesco share price. Retrieved: https://www.share.com/find-investments/advanced-finder/company-overview/tesco/summary/180/ Shun, C. (2005). An Empirical Investigation of the Role of Legal Origin on the Performance of Property Stocks within the Context of a Tactical Asset Allocation Strategy. Florida: Dissertation.com. Xidonas, P., Mavrotas, G., Krintas, T., Psarras, J. and Zopounidis, C. (2012). Multi-criteria Portfolio Management. New York: Springer. Read More