Risk Management and Investment - Essay Example

? Risk Management and Investment (Portfolio E) Executive Summary This study’s aim was to go through the portfolio E, analyze it and identify risks after which I was to come up with possible recommendations to contain the risks and cushion the company in its aim to meet maximum income at the minimal cost possible. I opted to use the bottom up approach analysis which I felt would work best for this portfolio and came up with the following recommendations: To Reduce the cash weighting Remain invested in Equities. Reduce the number of sectors they have invested in and instead invest in more profitable ventures. The recommendations I made are with the aim to cover the long term and short term goals having analyzed the market and economy trends as at present and the likely trends of the future. With the adoption of these recommendations, the firm is expected to reap maximally from the market (Accounting Education Change Commission, 1993). Introduction Investment management field involves decision making by considering the market in terms of whether to sell or invest. The fact that it involves predictions and analysis makes it a risky venture hence the need for professionals specialized in the area to provide good advice on how better to have good investment. However, it may not really imply that the market trends will turn out as they predicted. It entails three major pillars, analysis of economic factors, industrial factors and the company factors before making the decision on whether or not to invest. Investments are made with knowledge of market expectations and fluctuations (Best Invest, 2013). The current portfolio is facing quite a number of challenges which expose it to risks in the market such that despite the higher levels of investment the return in terms of interest is too low. The fact that it has diversified the investments to a number of sectors is an attempt to avoid the risks. It has invested in oil, travel and leisure, telecommunication, commodity, shares, banks and bonds. The main challenge is the fact that some sectors are giving very little income compared to the investment which is in turn affecting the portfolio negatively therefore the need to change on the same (Bhattacharyya, 2011). History of the Portfolio The portfolio at its inception had a value of ?12,712,642 a value that has steadily depreciated to ?11,784,648 a net loss of ?927,995 a 7.3% loss a negative return which is not good for the portfolio. This could be attributed to a number of issues which include lack of growth and poor investment choices. This hence necessitates the need for analysis for prevent the accelerated rate of depreciation in the values of the Company (Cadez & Guilding, 2008). The investments we placed at inception have all different levels of funds placed in them but to date the highest growing has been TUI Travel which was at its inception having an investment of value of ?196.960 which bought us 80,000 shares. It has since grown by a margin of 32.25% increasing its value to ?260,480, a one third increase. The positive growth reported in the investment has earned dividends worth ?18,000these dividends have significantly been utilized by being re invested in other more business ventures the Company is endeavoring in (Clinton & Van, 2006). The down fall is that even though this is our most promising investment at cut of date in the portfolio it is weighted unevenly and different investments hold a different weighting depending on how much money was invested in them. The weighting for TUI travel was only 1.55% at inception and has now increased to 2.00% which shows growth in weighting but shows that it only accounts for a minute section of the portfolio. Showing that the substantial growth of 33.25% is shadowed by the fraction of weighting it holds. The volatility has been an issue to as over period of the investment the share price valuation has dropped to maximum of -9.00% and the highest gain being around 6% but since May 2012 the share price has been steadily rising this being a promising sign to keep the investment(Clinton, Matuszewski, & Tidrick, 2011). The worst performing investment to date is I shares Brazil it has produced the greatest loss of 28.53% which has reflected in the overall weighting of the portfolio and has contributed largely to the loss in overall value. At inception I shares Brazil was invested with ?800,000 and has only ever produced a dividends of ?15,703,29 which in comparison to TUI travel dividends of ?18,000 from ?200,000 shows the failure of the investment. This maybe down to the long term holding of the investment and could be easily avoided with a short term strategy in place and if the investment was sold as soon as losses or a rise in share price had been achieved (Cole, 2003). This can also be seen by weighting of the portfolio as at inception I shares Brazil held 6.3% in the overall portfolio this having dropped by the cut of date to 4.86%. As well as this analysis of the share price shows that since inception the share price has gradually been declining and hasn’t seen the same price it was purchased for since inception and has lost nearly 25% of value per share. The best decision would be to sell this investment and due to constant losses and re invest the funds gained in another venture (Commission on Local Governance, 2000). Gold is the most valuable commodity in the worldwide over but despite this its value has gone down considerably owing to a number of issues affecting the market. Its performance cannot be judged as high neither is it low, owing to the bare fact that it’s not really producing so very big profits but still on the other side it is not producing any losses. Since its inception in the market it has significantly grown in terms of its share value (Dearden, 2010). Approach Investment will deal with valuation of shares, we look at the present share value and try to establish that is it underestimated or overestimated in the market. There is also another aspect that tends to be ignored and this is the bottom up approach which involves the company’s shares, securities and bonds. The analysis is done in both short term and long term basis. We aim to protect the company from wrong timing of buying or selling of the shares in the stock market. Management decisions related to investment have rational and scientific influence the accurate decisions taken by investors (Diy Investor, 2013). As previously stated in the introductory section, we are majorly doing the overview and analyses of the portfolio with an aim to reduce risks and maximize on income mainly using the bottom up approach analysis. This entails firstly analyzing the economy in general, this entails looking at the current state of the economy, its past and using them to make forecasts on the future economic trends. Owing to the fact that this portfolio is restricted to investing in the UK alone, we will mainly look at the state of the UK economy and the various sectors in the economy and clearly indicate how they are actually performing in the market (Dutta, 2003). With this picture in mind, we will be in a position to decide which sectors are doing better and where best we should invest in. We then narrow down to the industries involved in the market and analyze them before we decide on which particular sectors to put our investment in, hence therefore the analysis of the shares and share value in the market of any particular sector will play a key role in determining the particular sector that we will settle for in terms of investing (Ethics Scoreboard, 2006). With this bottom up approach analysis in place, we will comfortably be able to take up better decisions and make better recommendation on the best investments and how to go about the market. The bottom up approach is a strategy of investment in which any decisions undertaken are based on sound arguments of financial nature. The analysis involves four major steps which include establishing initial investment criteria then doing a stock screening. This step is then followed by doing an analysis of the financial statements and ratio analysis, then doing a stock valuation, and lastly making an informed decision regarding buying. Therefore, these steps are important in knowing whether an investment should be made in a particular industry or sector. One of the key factors that have been ignored in this portfolio is the adoption of upcoming industries as a strategy of gaining income with lower interest in sectors where not so very many companies have ventured into (Fulton, 2012). In our study and the bottom up approach we have adopted, we wish to systematically do our analysis from economic analysis, industrial analysis, company analysis, the companies financial statement analysis, ratio analysis, cost benefit analysis and lastly the risk analysis, after which we will do recommendations on the way forward on how best to improve our portfolio. The analysis of the market and determination of investment decisions depend on the mood of the market. Share price in the market depends on the company’s performance in the past, present and the future, with its future the focal point. In the course of our investment, we aim to invest in growth oriented companies which will ensure income growth (Governor's Office of Planning and Research, 2012). We also consider the share value in terms of its estimation, whether it is under estimated, over estimated or at its fair price. Underestimated shares will be bought by the company, while overestimated shares will be sold by the company and the fair shares will be held by the company. Risk occurs in the chance that the expected outcome in a business venture may not be as predicted. Risks are varied and extend from default, financial, liquidity, maturity, call, interest rate, inflation, exchange rate, business all the way to total and country risk (Govindarajan &Shank, 1989). Economic Analysis using the bottom up approach Economic aspects are very critical in investment decisions which an investor makes to take a gain and earn better returns. Economic analysis and company performance forecasting are crucial factors a company considers before making any investment. The more risky the decision, the more difficult it is to implement in the investment by the investor. The investor is able to make a forecast before taking the decision whether to invest or not. This allows him to gain the maximum yield by selling, buying and holding at the right time. Economic indicators are a crucial factor in analysis of the economy. The economic indicators include factors like the fiscal policy, monetary policy, GDP, stock prices and the financial market (Henderson, 2006). An investor depending on the sector he is investing in may be tempted to save depending on factors like: rise in saving, need for more employment opportunities, high interest rates, population growth and other factors that work to the favor of the sector he wishes to invest in. Economic forecasting will depend on a number of issues like the economic state and stability alongside the political state and stability. These factors will be judged based on the economic policies and how they affect industries and sectors of concern. The economy will be assessed to determine whether it is at the boom, depression or the recession state (Hiriyappa, 2008). Another aspect of economic analysis in this study is the stability of its share prices in the stock market. This is very essential in measuring the position of the stock of the company because id directly links to the profit of the company. To that effect, it would be of interest for the investors to obtain a trend analysis report of the previous performances of the organization and perform as critical comparison with other potential competitors. The trend analysis should be easy to interpret in the sense that it should communicate the possible risks that the investment can experience. Alongside each risk, there should be a measure of the risks addressed in two perspectives. The first perspective of measurement is the probability of the risks occurring in the investment leading to loss of revenues and subsequent drop in the share prices. The second aspect is the impact of the risks. This implies that in case the risks occur, there is a certain amount of financial loss that the investment will experience. The impact can range from minor losses to critical massive financial loss that threatens to bring the operation of the organization to a sudden end. The risks should also have actions list that can actually be taken to mitigate them, as well as the internal controls which are the preventive mechanisms to guard against inherent risks. Industrial analysis using the bottom up approach analysis Industries are involved in conversion of raw material to semi complete or complete goods for the market consumption. Industries vary depending on the raw material they consume to produce particular products. The same could also be said about their products, the products they produce vary depending on the market such that the market demand will determine the existence of any industry and its flourish in business. Industries undergo cycles which determine the investor willingness to invest in them. The cycles include the fast growing companies, growing companies, stagnant companies and declining companies (Live Charts, 2013). An investor will be keen to avoid the latter two companies when making an investment and would prefer the former two types of companies with preference especially for the first group of companies. This is because the fast growing companies always have increased activity which will mean higher production and hence more profits. This however unfortunately declines as more entrants join the market and scramble for a share of the market and hence the evolution of the cycle (Newyork Times, 2013). In analysis of an industry before making an investment, the major factors to consider are the past, present and future trends of the industry, analyzing the past sales and earnings of the industry, to know the stage of growth of the industry, the government rules and regulations towards the industry, knowing the present labor conditions, to analyze the competitive conditions and industry share prices in the market and to analyze the industrial cycle and its effects (Securities and Exchange Commission, 2009). Asset Allocation The risk management analysis of the UK leads us to believe it is volatile and this likely to continue for a while. Therefore the buy and hold strategies will still play a key role in the investment field but owing to the volatility of the market, the investors will have to adopt a tactical asset allocation means to reduce the investment loss. This can be achieved by allowing flexibility in terms of rebalance in the percentages invested in the asset categories depending on their valuation. This is done with a particular aim to overweigh the undervalued asset classes and under weigh the overvalued classes so as to increase the profits. With lower interest rates and the slow recovery after the major inflation sometime back investor will surely weigh very carefully before they invest (Threadneedle Investments, 2012). Allocation of assets will help us to identify the risks involved in our investments. In our portfolio a lack of diversification in our investment exposes us to risks that affect the general outcome. For instance we have heavily invested in oil which in not proving to be any profitable to our business venture. I therefore feel that proper diversification by properly allocating the equities and assets will help us to majorly reduce our losses and risks hence impacting positively on growth of the portfolio. Diversifying could mean that we reduce the shares in the loss producing sectors and re invest them in other more income generating sectors by investing in equities and bonds (Fulton, 2012). Our analysis show that in the current portfolio, the largest holdings in Oil, Banking and I shares which are about 75% of the total portfolio BP contributing about 30%. From our analysis the banking sector is losing while the BP is almost on a similar trend. With the giant shares they occupy in the portfolio, this could only mean that the entire portfolio as a whole is on the downward trend hence the losses and therefore to change this, there is the need to diversify so as to ensure we are getting a positive value in the portfolio. The same losses are also witnessed in the shares investment in FSTE Bric 50 fund, MSCI Brazil USD STF and FSTE/ Xinhua China. Some of the recommendations I feel will positively impact on this portfolio include: Sale of the Lloyds Banking Group This decision will actually benefit the organization eventually as the Lloyds Banking Group is a volatile entity with a review of its history a clear indicator of the fact that it is contributing to the looses experienced in the portfolio at a greater percentage. To turn around our fortunes, we will have to sell this and re invest in another more profitable venture, because at the rate of contributing to about more than 20% losses since its’ inception, this will only serve to show us that the venture will hurt us more if we retain it in our portfolio(Fulton, 2012). The further aggravation of the situation is brought by the fact that one of its major share holder who are the government of the UK are planning to pull our stake, a factor that could lead to their immediate decline. They have reacted to this by dropping their share price which could only serve to make our portfolio more vulnerable. To avoid this there is only one major solution that is to sell (Fulton, 2012). Sale of the BP The sale of BP is inevitable as it has contributed to losses and because of the risk factor involved in it. Considering is history, reputation, current and future plans the BP does not fit well into the portfolio especially with its plans for an upsurge in income generation. BP is struggling to rebuild it already damaged reputation owing to the oil spillages that occurred in the Gulf of Mexico which led to the drop in their market value and even led to some investors pulling out all together. The spillage led to a loss worth $40bn and also led to an eventual explosion at the US which was claimed to be one of the biggest explosion in history, this only meant that they were having conflicts with the US another factor that is damaging their already wanting reputation. This in effect led to the boards members not receiving bonuses in return a factor that also led to the issues in the management of the BP. Although they recovered and began issuing dividends sometime back, with bp.co, reporting a $4.2 billion profits in the first quarter of the 2013 financial year, some investors were tempted to leave their investment in the firm but I would advise against the portfolio retaining its shares in this firm as it has shown that it is going through a lot a risk factor that leaves us unsure of how long they can maintain their stability. BP would take long to finally be stable in the market as they are still trying to win back the trust of people in the market by carrying out several strategies like environment restoration after the oil spills. The sale of this would only allow for the diversification of the portfolio funds a measure that will help significantly reduce the risk involved. They are setting our principles and policies in key sustainable issues such as safety, environment and society with an aim to enhance safety and manage risks, all this in an effort to win clientele trust. They have invested $1 billion in the restoration project after the oil spill accident in order to restore back the environment to the normal. All these efforts they are putting in place with an aim to win back the trust of their investors and the world as a whole is consuming so much of their anticipated income and this is also affecting their market position and dominance they have enjoyed over the years. The upcoming of alternative energy that is safer and renewable is another factor that is also adding to the woes of BP. They are always in constant threat that with the innovation of new energy producing alternatives, they may in the long rum face stiffer competition in terms of market and income generation (Fulton, 2012). Sale of BP appears to be a great move considering the good will that BP has developed through international trading over so many years of excellence. The sale should therefore maximize the gains that are expected from the deal, by inviting many potential buyers. Out of the buyers, the sales and marketing department decides on the best bidder to qualify for the purchase. Purchase of GSK GlaxoSmithKline is a the largest health company in the UK and with offices situated in more than 100 countries and well managed major research centers in the UK, USA, Belgium and even China. Based on its strategies of increasing growth, reducing risks and improving long-term performance (gsk.com), the GSK is a worthwhile investment with well predicted growth and security always. They are a firm working to improve their innovativeness in terms of the products they produce like medicines, vaccines and healthcare products and enduring their products are availed to anyone and everyone who needs them. According to GSK, the company is committed to make use of cash flow which is free, so as to enhance increase of dividends. After the adoption of our recommendations to sell Lloyds Banking Group and BP shares, then we could re – invest the money we have acquired from this venture into the purchase of GSK which is a well-known, well established and a big pharmaceuticals company operating globally with well anticipated upward growth an aim of the portfolio. They are also a firm that does business in the UK and supply the NHS with their products a factor that will not only enable us monitor their market behavior but will also assure us of the stability of GSK in the market as an entity and guarantee us all time high profits (Fulton, 2012). The fact that GSK is a growing industry growing its market base and is seeking to invest in more upcoming markets like India, is a factor that guarantees us that this is a reliable place to invest and that we will gain more income in return. They are also doing business in a product that is will always have a market, pharmaceuticals, is one that encourages us to trust in the ability of GSK to bring in more income to the market (Fulton, 2012).Even though GSK is a lucrative investment, there is need to conduct a market research in order to determine the future of the institution before making a progressive move to purchase the form. The stability is a factor that has to be confirmed for a period of years so as to determine the behavior of the company stock during good times and during the bad times of financial depression. Financial constrains and irregular performances in the trend analysis can enable the decision makers to realize the efforts they have to apply to mitigate the risks of financial losses. In essence, it is a high risk venture to purchase GSK as a stock, so long as the critical market analysis is carried out. Conclusion The new proposed portfolio will therefore help us come up with an income generating portfolio and ensure profits as long as the recommendations are completely adopted and implemented. It is an improvement of the previous portfolio that did not generate any income but led to a lot of risks which were affecting the company negatively. The new portfolio has taken into consideration the economy the sectors and the actual business in order to make a solid judgment as with a passive approach, this new portfolio is set to reduce this diversification risk, asset allocation risk and oil risk along with the smaller risks that were previously identified, by having reduced cash weighting, the weighting in oil and having a focus on companies with renewable and different energy sources. References Accounting Education Change Commission, 1993. Issues Statement Number 4: Improving the Early Employment Experience of Accountants. Sarasota, FL: American Accounting Association. 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