Risk Profile Analysis and Portfolio Selection - Assignment Example

? MONEY MANAGEMENT FINAL Table of Contents Introduction 4 Risk Profile Analysis 4 Objectives and Asset Mix 5 Determining Time Frame of Investment 5 Money Management through ETF 5 Portfolio Selection 7 Asset Allocation 8 Equity Investment 9 BLDRS Europe 100 ADR Index (ADRU) 9 AdvisorShares WCMBNY Mln Fcsd GR ADR ETF (AADR) 11 Direxion Daily Small Cap Bull 3X Shares (TNA) 12 iPath DJ-UBS Cotton TR Sub-Idx ETN BAL 12 Bond Investment 13 AdvisorShares Peritus High Yield ETF HYLD  13 Franklin Templeton Investment Funds- Templeton Global Aggregate Bond Fund (FTAAEH1) 13 Conclusion and Recommendations 13 References 15 Introduction A portfolio is group of securities such as bonds, stocks, commodities, and derivatives where an investor invests his or her money to mitigate the risk of holding a particular asset through diversification. Diversification of investment spreads the risk over many assets. The concept of simple portfolio diversification is that some securities may not perform as anticipated but other assets might exceed in performance making the actual return of the portfolio reasonably close to anticipated return. Investing the entire sum of money in a single stock exposes the investor to the risk of that asset. So, in case when the price of that security falls in the market due to any reason, the investor will suffer huge losses. This, risk of concentration of money in a single stock is mitigated through diversification. Risk Profile Analysis Investments are subject to market risks and a rational investor always prefers to minimize risk over given investment return of maximize return over given risk. The risk profile of a portfolio is determined on the basis of risk appetite of investor. If the investor is risk prone then such investor would prefer investing larger portion of portfolio in risky assets such as common stocks or growth EFTs where as an investor with a lower risk appetite would prefer investing in safer assets to ensure protection of principal investment. The logic or procedure to determine the amount to be invested in risky assets is determined on the basis of time horizon, objectives, and diversification. Objectives and Asset Mix The main objective of the portfolio is to get adequate amount of long term growth in income. In order to achieve this objective, substantial amount of the investment corpus should be invested into equity class ETFs and fewer portions should be invested in debt instruments. This is because, while the equity will ensure long term capital growth for the investor through proper diversification, debt portion of portfolio will ensure fixed and stable income for the investor. Proper diversification will help reduce the overall portfolio risk by spreading stock specific risk into combination of securities. Determining Time Frame of Investment In order to evaluate the performance of the portfolio, sufficient time horizon should be chosen since the objective of portfolio is long term capital growth and not speculative trading. Keeping the objective of portfolio, a time horizon of minimum five years will be chosen to evaluate the performance of the securities. Money Management through ETF On the basis of the portfolio objectives, time frame of investment and risk profile analysis discussed earlier it can be said that Exchange Traded Funds (ETF) can be an effective money management tool. ETFs are investment funds that are often traded as commodity in the stock markets. Thus, ETF funds are traded similar to stocks in the stock exchanges but at the same time it is essential to know the process of buying and selling of ETFs in the stock exchanges. The process allows market players to determine ETF prices by analyzing the forces of demand and supply of ETFs in the market throughout the day. If appropriate strategy is not formulated then the investor might be adversely affected from price fluctuations throughout the day. Further the investment objective will determine whether the portfolio will be able to provide sufficient returns to the investors to attain such objectives during chosen time horizon. Longer time frame of investment will ensure elimination of short term volatility or fluctuations in the current prices of ETF funds. It is also important to remember that a prudent investor would always invest in a basket of securities instead of putting all the money in a single asset class. For instance, at least 30% of the portfolio should be invested in fixed income securities so as to ensure the safety of principal. Further another important aspect is that an investor must not invest the entire sum allocated for portfolio at single go and should invest regularly in a disciplined manner. Various investment options such as systematic investment plans or SIP routes are available which helps the investor to regularly invest in the portfolio irrespective of market movements. The benefit of such investment strategy is that when the market falls then the investor will not lose the entire money and the losses will be limited to the extent of investment. Further, disciplined investment helps to improve market sentiments. Long term as well as short term investments will be focused on the allocated sum of $500 and the basket of securities will consist of not only ETF funds but commodities, cash, bonds and stocks as well. This investment strategy is expected to provide sufficient risk coverage and yield decent returns after maturity of portfolio. Another important area to evaluate during money management is liquidity. All securities are not equally liquid at same degree which means that the liquidity of different asset classes will vary. For instance, gold is much less liquid than cash, when it comes to selling in a bear market. This is because commodities like gold are considered as safe havens and such asset classes have inverse relationship with market movements. In other words, when the market moves up the gold prices tend to come down and when the market moves down gold prices go down since people prefer to hold gold in bearish markets for safety of investment. The same relationship also holds true for Gold ETFs where significant portion of the portfolio is invested in gold. Hence, if the objective of the investor is long term investment such as securing children education with help of personal education fund, then this type of strategy of monitoring liquidity monitoring will be useful at the time redemption on or before maturity. But the most important point is to ensure well balancing of portfolio by allocation total investible sum into different asset classes to efficient diversification, risk mitigation and protection of investment. The main reason as to why ETFs may be chosen as investment tool since they are easily accessible in the financial markets and they are also flexible (providing investors the opportunity to invest in stocks, bonds, and commodities) which is not only low cost but significant transparent in pricing. With the help of investing in through ETFs the investor would also not require any intermediate agent that will save the transaction costs considerably. Portfolio Selection The objective of the portfolio is to get adequate amount of long term growth in income. In order to achieve this objective, substantial amount of the investment corpus should be put into equity class and fewer portions should be invested in debt instruments. This is because, while the equity will ensure long term capital growth for the investor through proper diversification, debt portion of portfolio will ensure fixed and stable income for the investor. In addition to that, the fund aims minimizing risk of capital loss through portfolio diversification. The portfolio will be monitored, analyzed and reported upon over the chosen time horizon and also before the portfolio inception date. The return of the funds is evaluated relative to index such as S&P 500. Proper diversification will help reduce the overall portfolio risk by spreading stock specific risk into combination of securities. Diversification refers to the investment in different kinds of securities with a view that in case of a market decline all the assets of the investors will not flow out. Investment has been made in each of these asset categories since the objective underlying the purpose of investment differs according to the category. The categories are- Stocks- It will help the portfolio to grow with an expectation of high return along with the risk attached to it. Bonds- It will bring in fixed income with low risk. The return generated from bonds is less fluctuating as compared to stocks. The primary motivation for an investor to buy an ETF fund is cost saving. In other words, the degree of diversification that an investor would achieve by investing in blue chip companies is far more cost efficient through ETFs compared to individual stock picking and portfolio selection. The investor will however have to pay a minor commission for purchase of each ETF paper that carries cost related to accounting, advertisement, fee, and storage. The advantage of preferring ETFs over Mutual funds is evident from the fact that while average fund management fee of assets in US is more than 1% of asset, the same for ETF is approximately 0.45%. Asset Allocation As discussed earlier, a rational investor has the option to either create portfolio that minimizes risk for given return or maximizes gain for given risk. Among the two approaches, it is preferably wise to choose the first strategy since in this case the only source of income would be income from salary. Risk can be significantly lowered by reducing the proportion of investment in common stocks and channelizing this reduced portion into fixed income securities such as bonds which protects the principal investment as well as yields regular interest on investment till maturity of bonds. In order to judge the performance of the portfolio properly, it should be revised periodically so that the most efficient allocation of assets achieved that are in line with the objective of the portfolio. Revising portfolio will also help the investor to analyze and understand market movements in better way in addition to regular monitoring of assets. From the above discussion it may be said that since the primary source of income is monthly income from salary, it is preferable not to take excessive risk keeping in mind the losses that might occur from the worst case scenario. Even though every investment has inherent risk but at the same time the investor must calculate the risk-return ratio properly so that when the risk of investment is considerably high the investor would be compensated by higher returns at par with risk. Equity Investment Investment in equity assets will ensure higher growth in income from capital appreciation however the investors must carefully choose this type of funds since investment in equity involves significant risk as the investors would be paid after all liabilities of the underlying company are paid off. The following good funds may be chosen for investment: BLDRS Europe 100 ADR Index (ADRU) The objective of this fund is to provide sufficient income growth for the investor by investing in blue chip securities. The fund seeks to yield investment returns before expenses and other fees. The investment yield of the firm is based on BNY Mellon Europe Select ADR Index. This fund generally holds approximately 95% of total assets in this Index’s depository receipts (DR). Thus, the index basically invests in assets or securities which generates index. The fund mainly invests in large cap companies spread across different sectors including Healthcare like Novartis AG, telecommunication like Vodafone Group, energy sector like British Petroleum, financial services like HSBC holdings, and so on. The index of this fund is designed so as to reflect the performance of approximately 100 depository receipts, mostly in companies in the European market. The funds and its constituents are periodically rebalanced and weights are reallocated according to their most recent performance. The fund is basically ‘index fund’ that publicly trades US negotiable securities which are represented by non-US companies. The total asset under management for the company is over $15 million. The performance of this fund is very well, for instance, the year to date (YTD) return is 11.57%. Similarly, one year and three year performance of the fund is 18.1% and 9.1% respectively. The five year performance of the fund is lower compared to short term returns but the net asset value (NAV) of the fund is quirt high at 23.24%. The expense ratio of the fund is also very low at 0.30% and thus one of the strong motivating factors to choose this fund in the portfolio (Morning Star, 2013). A summarized performance of the fund is depicted below, BLDRS Europe 100 ADR Index (ADRU) Fund History (%) YTD 1 Year 3 Year 5 Year 10 Year NAV 1.13 16.4 10.67 -1.84 6.46 After Tax Held 0.97 15.33 9.45 -3.05 5.22 After Tax Sold 0.64 9.48 7.85 -1.84 4.82 Market Price -0.36 14.8 10.16 -2.11 6.25 On the basis of above discussion it can be said that about 15% of investment corpus may be invested in this fund which is expected to provide sufficient growth in income. AdvisorShares WCMBNY Mln Fcsd GR ADR ETF (AADR) The fund primarily focuses investment in different investment sectors such as technology, healthcare, construction or real estate, defensive sectors such as consumer goods and so on. The fund focuses on trading securities in US as well as non-US securities. Due to significant diversification of total investment into different sectors the fund has potential to provide necessary risk mitigation. The fund seeks to provide the investors with long term capital gains especially above popular international benchmarks such as BNY Mellon Classic ADR index. The secondary benchmark for tracking the performance of the stock is MSCI- EAFE index. AdvisorShares WCMBNY Mln Fcsd GR ADR ETF (AADR) 1 Month 6.14% 3 Months 10.69% 1 Year 19.96% 3 Years 9.36% The total asset under management of the fund is over $7 million and the expenses are charged at 1.25% (Morning Star, 2013). From the above table depicting the performance of this stock it may be said that investing about 15% of total investment in this fund is expected to yield sufficient returns considering the investment objective and extent of diversification in different sectors. Direxion Daily Small Cap Bull 3X Shares (TNA) The fund invests primarily into equity securities of US listed companies and the total asset under management is over $548 million. The net asset value (NAV) of TNA is approximately 62.35 and the market capitalization is over $547 million (Bloomberg, 2013). A snapshot of the funds’ performance is shown as follows, Performance for TNA 1-Month 12.87% 1-Year 91.64% 3-Month 37.55% 3-Year 39.26% Year To Date 94.38% 5-Year - Expense Ratio 0.95     After analyzing the performance of the stock it may be said that since the returns from the fund is quiet high, higher percentage of total investment should be allocated in this fund. On the basis of above information about the fund, 20% of total portfolio investment should be invested in this fund. iPath DJ-UBS Cotton TR Sub-Idx ETN BAL The total asset under management of this fund over $31 million and expenses are only 0.75%. The fund primarily invests in commodities and most focused sectors for investment are in agricultural sector such as cotton contracts. The year to date, 3 years, and 5 years performance of the fund are approximately 10.1%, 6.57%, and 6.32% respectively (Morning Star, 2013). Since, cotton futures are expected higher returns in future it would be wise to invest about 15% of total investible sum of portfolio in this fund. Bond Investment So far only those funds were discussed that belongs to equity type asset class. The bond investment will provide the investor with fixed income over the period and also ensure safety of principal. The following two funds may be chosen for investment in the portfolio: AdvisorShares Peritus High Yield ETF HYLD  This investment focuses to achieve returns through high yield debt securities. Investing in sectors like consumer goods, consumer services, and energy is interesting and bringing results. The total asset under management is approximately $315.14 million and 1 Year performance is 11.69 percent. This return is quiet comparable to equity returns and hence this fund has the potential to provide a good investment vehicle and also assure significant diversification (Morning Star, 2013). Hence, about 15% of total investment corpus should be invested in this fund. Franklin Templeton Investment Funds- Templeton Global Aggregate Bond Fund (FTAAEH1) This investment fund focuses primarily in government related entities and securities. Net asset value of this fund is 10.13 and total asset under management is $16.25 million. Even though year to date performance is – 4.34 percent, it is expected that investing in government related entities will get improved as economy gets improved and also lower overall risk of the portfolio (Bloomberg, 2013). Hence, about 10% of portfolio should be invested in this fund. Conclusion and Recommendations The portfolio was constructed for a time horizon of at least five to ten years which may be considered as long term investment. The objective of the portfolio was to ensure significant diversification of investment and ensure maximum return for minimum risk. A few other points were also kept in mind including short term contingent liabilities such as loan repayment, purchase of assets, medical checkups, depreciation of personal assets like car, house and so on. All such obligations in the short term will be financed from investment returns and hence are treated as items under cash outflow. ETF as an investment vehicle will help the investor to demonstrate that investment management is sustainable and that investors will be able to achieve their long term investment objective by strategizing appropriately depending upon their risk appetite. Investment in disciplined manner requires knowledge, flexibility, and accessibility market information. ETFs provide the investor to invest in a basket of securities replicating exchange traded stocks and bonds, but at much lower cost. The investor must not only assess on the basis of best case scenario but also anticipate probable losses arising from particular events. When such risky event is identified (for instance, a particular fund is consistently underperforming for years) then the investor should reallocate assets accordingly by always keeping in mind the actual objective of the portfolio. Reallocation of asset requires portfolio balancing proportionately with respective changes. Such revision successfully eliminates short term losses arising from market fluctuations. The investor should also regularly monitor the performance of portfolio to take informed decision at an early stage to avoid serious losses. Finally, it is also important to keep taxes and investment costs as low as possible so as to maximize net return from investment. References Bloomberg, 2013. Direxion Daily Small Cap Bull 3X Shares. [Online]. Available at: http://www.bloomberg.com/quote/TNA:US. [Accessed on September 23, 2013]. Bloomberg, 2013. Franklin Templeton Investment Funds – Templeton Global Aggregate Bond Fund. [Online]. Available at: http://www.bloomberg.com/quote/FTAAEH1:LX. [Accessed on September 23, 2013]. Morning Star, 2013. Advisor Shares Peritus High Yield ETF HYLD. [Online]. Available at: http://www.morningstar.com/invest/etf/51254-hyld-advisorshares-peritus-high-yield-etf.html. [Accessed on September 23, 2013]. Morning Star, 2013. AdvisorShares WCMBNY Mln Fcsd GR ADR ETF AADR. [Online]. Available at: http://etfs.morningstar.com/quote?t=AADR®ion=USA&culture=en-US. [Accessed on September 23, 2013]. Morning Star, 2013. BLDRS Europe 100 ADR Index ADRU. [Online]. Available at: http://etfs.morningstar.com/quote?t=ADRU. [Accessed on September 23, 2013]. Morning Star, 2013. iPath DJ-UBS Cotton TR Sub-Idx ETN BAL. [Online]. Available at: http://etfs.morningstar.com/quote?t=bal. [Accessed on September 23, 2013]. Read More