Money Management and Type Investment - Essay Example

My Investment Plan Introduction According to Bodie et al an investment is a commitment made at a point in timewith the hope or expectation of gaining a benefit later. The benefit may be having enough funds to take the first step towards a dream. My current commitment is to make a lump sum investment now and every month so that I will have sufficient funds to attain at least one goal involving a large outlay of funds. There are several investment opportunities available. Therefore, care needs to be taken to ensure that the benefits outweigh the costs and that the particular investment chosen will facilitate goal attainment. Investing with exchange traded funds ETFs is an easy way to ensure diversification in any portfolio involving stock, bonds and commodities without having to invest in the individual shares, bonds and commodities themselves. They enable investors to access sectors that would not be available to individual investors (Morningstar 2014b). This takes some of the hassle out of investing. Investment Goal I am very adventurous and I tend to have a liking for the sea. Therefore, my aim is to own a yacht within the next seven (7) years. In order to achieve this specific goal I will be making some medium to long term investments so that I can make a substantial deposit on a new yacht in five (5) to seven (7) years time. The yacht is expected to cost in the range of £300,000 to £500,000 by the time I get to the point where I am able to make a substantial down payment. Risk Profile My risk tolerance is medium and so I am willing to take a moderate level of risk in order to achieve a favourable return on my investment. Costa (2011) indicates that the returns that I would achieve are proportional to the risk taken and so I expect moderate returns. My risk profile is consistent with a balanced profile. A balanced allocation has between 0% and 25% cash; 40% to 70% bonds; and 30% to 60% stocks (Costa 2011). This portfolio is characterised by limited risk; however, it can still obtain good returns because of the proportion of stocks that it contains. It is also consistent with the time horizon that I have in mind, which is five to seven years. Amount and Type Investment I have a total of £50,000 to invest and this will be invested in accordance with the guidelines provided in relation to a balanced risk profile (See Costa 2011). However, I would also like to include a commodity related ETF involving physical gold which is one of the best ways of maintaining asset value. The majority of my investment will take place through the use of exchange traded funds (ETFs). An ETF is an investment product which represents a set of securities which track an index such as the S&P 500 or the NASDAQ (Bloomberg 2014). They are traded in a similar manner to stocks on an exchange (Bloomberg 2014, Costa 2011). Traditionally, the term ETF was used in reference to redeemable shares held by an investment company on an exchange (Abner 2010). The decision to allocate assets to a mix of securities is a very important decision for an investor. The right mix of cash, stocks, bonds and other commodities is essential to goal attainment. Morningstar (2014b) indicates that adequate diversification within each of the aforementioned asset groups can affect returns in a significant way. This diversification can be made possible through ETFs. Allocation of Funds In order to establish an investment portfolio a decision has to be made on how to allocate the funds that I have available. The broad asset classes in which investment assets are categorised are stocks, bonds, real estate, and commodities (Bodie et al 2011). A breakdown of my proposed investment in asset classes is shown in Table 1 in Appendix 1. The information indicates that 10% (which equates to £5,000) of my total investment of £50,000 will be kept as cash; 40% (which equates to £20,000) in bonds; 40% (which equates to another £20,000) and the balance of 10% (which equates to £5,000) in gold. This will allow me to access good investment opportunities without having to dispose of assets currently held in a hurry. Holding some cash means that if things go bad I still have a portion of funds in hand to make further investments as I wish. It will also facilitate quick investments without having to wait until I dispose of assets held before I can invest again. In other words, some of the cash in hand can be used to increase my investment in bonds, stocks or commodities. A pictorial representation of how the funds are allocated is shown in a chart labelled as Figure 1 in Appendix 1. Security Analysis There are many securities available but each has its own advantages and disadvantages associated with it. Based on cost and flexibility ETFs are my preferred option. Costa (2011) provides information on various advantages associated with this investment option. Investing in stocks, bonds and commodities through ETFs is considered to a one of the most stress free ways of investing. This means that I will not have to invest too many individual stocks which would be difficult to keep track of. Instead, I have few securities to think and worry about in respect of my investments. Justification of Allocation The allocation is well diversified in terms of the types of ETFs – stock, bonds and commodities. Additionally, stock/equity ETFs are diversified in terms of the number of sectors and countries in which the funds are invested. The stock element is the riskiest of the investments. However, it is not expected that all the countries will experience economic problems or that all sectors will be negatively impacted at the same time. A well diversified investment is critical to maintaining a balanced fund as it better able to withstand the effects of market instability. Bonds are considered to be risk free and so this effectively balances the portfolio. Cash Allocation The amount of investable funds held in cash can be used to make additional investments which appear attractive without having to sell ETFs before they reach their peak values. There are times when some ETFs are undervalued and these represent investments that can only improve in value. It reduces the need to sell an ETF before the time is right. Stock Allocation My choice of investment in stocks is through the iShares International Select Dividend (IDV) and PowerShares International Dividend Achievers (PID) ETFs. Both funds track an internationally diversified portfolio. However, one is less volatile than the other. An ETF provides a flexible approach to invest and investors can invest in several stocks through this medium. Therefore, instead of taking on the task of deciding which stocks to invest in so as to achieve a favourable return and instead of engaging in frequent trading which would involve high transaction cost the tasks is left to passively managed ETFs at a relatively small fee. IDV ETF On April 16, 2014 the year to date total return on the IDV ETF was 3.95%. If the current trend continues this could return more than 12% for the year. IDV provides exposure to well established and top quality international companies. (See iShares 2014). With this fund I will have access to stocks on various stock exchanges in developed countries. Therefore, I will utilise this investment as a means of expanding my strategy of earning income from international markets. This fund tracks an index which consists of stocks from non-US developed countries which pays high dividends (iShares 2014b). The IDV ETF is traded on the New York Stock Exchange and consists mainly of equities – approximately 99%. The investments are in equities in the developed countries of Australia, France, UK, Germany, Finland, Canada, Italy, Sweden, New Zealand, Switzerland, Spain, Hong Kong, Belgium, Netherlands, Japan, Portugal, Norway, Singapore, Greece, Israel and other countries (iShares 2014b). Approximately, 75% are invested in stocks in the first 10 aforementioned countries, each of which is fairly stable. Table 2-1 provides further information on the percentage of funds invested in stocks in the countries identified. IDV ETF funds are invested in approximately 11 sectors. These sectors include: Financials, Utilities, Industrials, Telecommunications, Consumer Services, Oil & Gas, Basic Minerals, Technology, Consumer Goods, Health Care and S-T Securities (iShares 2014b). Approximately 90% of the funds are invested in the first six aforementioned sectors with negligible amounts in Health Care and S-T Securities (iShares 2014b). See Figure 2-1 for more information on the sectors in which the funds are invested. The benchmark for the IDV ETF is the Dow Jones EPAC Select Dividend Index and its total expense ratio (TER) is 50% (iShares 2014b). PID ETF According to Morningstar Analyst, Woodham (2013), the PID ETF tracks the International Dividend Achievers Index which purchases ADRs, GDRs and common stock which trades at volumes in excess of US$500,000 daily between 2008 and 2013. Approximately 40% of the fund is invested in Canadian and UK companies with the rest being spread among developed countries - specifically Europe and Asia. In terms of the level of diversification the sector weightings of this ETF are mostly in energy, telecommunications and health care with weightings of its holdings being 21%, 15% and 14% respectively (Woodham 2013). PID is mainly allocated to stocks with large market capitalisation. In terms of fees the fund charges 0.56% a year which is considered high when compared to other ETFs (See Costa 2011). It represents the best alternative to the IDV which not only has a lower fund charge of 0.50% compared to PIDs 0.56% but is the only fund to beat PIDs total return since 2008 (Woodham 2013). Other alternatives which may be cheaper in terms of the charges to be paid include SPDR S&P International Dividend and WisdomTree DEFA with expense ratios of 0.48%. Although these options have higher yields they are more volatile and therefore are not consistent with my risk profile. Morningstar’s take on PID is that the companies in which the fund invests have experienced increases in their dividends over the last five years. The advantages of PID is that it focuses on companies that pay dividends that are sustainable and avoids those that engage in paying unsustainable dividends (Morningstar 2014a). One of the criticisms of this fund is that because it has a limited universe of investments with investments mainly in companies listed on London and New York exchanges, there is little investment in Australian companies, it is recommended as just a supporting investment in an allocation towards international equity. Therefore, it is included here because of its low volatility when compared to other ETFs falling in the same category. It provides a perfect complement for the IDV which has over 20% of its investments in Australian stocks. Bond Allocation In terms of bonds there are several fixed income ETFs available on the market. One of them is the iShares Euro Government Bond 10-15yr UCITS ETF (IEGZ). This ETF is benchmarked to the iShares Barclay Euro Government Bond 10-15 Year Term Index closely. These ETFs are under the management of BlackRock and is listed on the London Stock Exchange. The size of the fund was €32.0 million on April 17 2014 and the TER at June 30, 2013 was 0.2% (Morningstar.co.uk 2014). The net asset value (NAV) of this ETF on April 17, 2014 was €149.55 (Morningstar.com 2014). The graph labelled Figure 3-1 suggests that the chosen ETF has performed better than those in its category and has outperformed its benchmark. The BlackRock Group provides investment management advice to clients all over the world and iShares is part of this Group (iShares 2014a). iShares has ETFs representing different classes of assets all over the world and this is indicated in their welcome statement –‘Whatever your investment objectives we will have an ETF to help you deliver your strategy’ (iShares 2014) In fact, the main stock/equity ETF that I intend to invest in is an iShares ETF. (See section on stock allocation). The year to date return was € 6.98 and the 3 years annualized return €7.35. Morningstar has a five star rating for this ETF at March 31, 2014 and at that date both the risk and the returns were high over the three year period when compared with bonds in the EUR Government Bonds category in which it falls. Bonds are generally categorised as risk free investments and so the risk rating given here is relative to the other bonds in the same category. This rating does not affect my risk profile in any way. The closing price of this particular ETF on April 17, 2014 was €149.57. Commodity Allocation Commodities provide an interesting means of ETF investments. The price of gold has been edging up for quite some time and so I think investing in gold through ETFs is a good way to gain access to this precious commodity. In fact, the correlation of gold ETF to the price of gold is very good and it is considered to be the simplest way of gaining exposure to the physical product (The Telegraph 2009). The fund has custody of the asset and so the counterparty risk is considered to be low (The Telegraph 2009). Despite, the advantages mentioned there are also disadvantages. The charges to investors equate to 0.4p per year and a commission is required every time trading takes place (The Telegraph 2009). It therefore means that trading too often would be disadvantageous to investors. The commodity ETF that I have decided to use for the commodity allocation is the SPDR Gold Shares GLD ETF. This ETF is traded on the New York Stock Exchange (NYSE). The custodian for the gold bullion is HSBC Bank USA. The gold is held in HSBC’s vault in London or in the vaults of sub-custodians. It is a cost effective way of investing in gold as the transaction costs associated with this ETF is lower than those associated with purchasing, storing and insuring physical gold (SPDR 2008). The price of each ETF is based on 1/10th of an ounce of gold. The total expense ratio for this ETF is 40% and although this ETF can be traded 24 hours per day it is not advised since any gain can be lost through transaction fees. An additional advantage associated with this ETF is its flexibility. Calculation of Net Asset Value (NAV) The Net Asset Value of the investment portfolio is £49,986. See Table 5-1 in Appendix 5 for details. The information in the table indicates that only PID is showing a value above the amount invested. However, the bond value is lower than the initial investment by £3. The NAV is calculated before the deduction of expenses. The expenses range from 0.20% at the lowest to a high of 0.56. This is negligible and will not have a major impact on the value of the investments at this time. PID has the highest expense ratio of 0.56%. The different asset classes are expected to grow at different rates and additional funds will be invested monthly. Projections for Growth in Investments The tax adjusted return on IDV was 18.13 for the past year, 7.15 for the last 3years and 21.38 over the past 5 years. It is uncertain as to what will happen over the next seven years but if the rate continues to be positive over the next 5 to 7 years it would be a great investment to keep. The return for this ETF over the past five years has been high and the risk above average (Morningstar 2014). Additionally, the fund has been rated five stars (Morningstar 2014). The tax adjusted returns has shown high levels of instability over the period. The graph labelled as Figure 5-1 provides information on these returns over the last year, 3-year and 5-year periods. The trend line which is dark blue in colour indicates that there will be moderate growth in the future. The returns profile for the past five years for PID is similar to that of IDV – high. However, the risk is considered low for the past 3-year period and high for the past 5-year period. The fund has also had mixed ratings of four stars over the past 3-year period and five stars for the past 5-year period. The graph shown in Figure 5-1 provides a pictorial representation of the tax adjusted return for the 1-year, 3-year and 5-year periods. The trend line which is pink in colour indicates that there will be moderate to high growth in the future. The returns and risk profile for IEGZ – the Bond ETF was high for the 3-year period (Morningstar.com 2014). There was no information for either the 1-year or 5-year period for this security. However, this ETF has a five star rating (See Morningstar 2014). The trend line which s shown by the yellow line indicates decreasing returns in the future. No risk or return profile was provided for GLD – the Commodity (Gold) ETF for the 1-year, 3-year or 5-year periods. However, the tax adjusted return was a negative 19.51 for the 1-year period, a negative 3.92 for the 3-year period, and a positive 6.68 for the 5-year period (Morningstar.com 2014). There is insufficient information at this time to determine the trend of the Gold ETF. It may be necessary to invest in a commodity ETF offered by UBS in the near future. Conclusion The indication at this point is that the stock ETFs with Ticker symbols IDV and PID are likely to experience growth and this is very encouraging. However, there is some uncertainty surrounding the bond and gold ETFs. More research is necessary to make a determination on the next step that is required to facilitate goal attainment. If the goal is to stay in focus, early action is required. This analysis is not only required for the bond and gold ETFs but also for the stock ETFs in order to ensure the success of the investment. References Abner, D.J. (2010). The ETF Handbook: How to Value Exchange Traded Funds. Hoboken, New Jersey: John Wiley & Sons, Inc, BlackRock. (2013). Squeezing Out More Juice: 2014 Investment Outlook. [Online] Available from http://www.blackrock.com/corporate/en-us/literature/whitepaper/bii-2014-outlook-us.pdf [Accessed on 13th March 2014] Bloomberg. (2014). About ETFs. [Online] Available from http://www.bloomberg.com/markets/etfs/etf_about.html [Accessed 20th February 2014] Bodie, Z., Kane, A and Marcus, A.J. (2011). Investments. 9th ed. New York, NY: McGraw-Hill/Irwin . Costa, D. (2011). The Portable Private Banker: Investing effectively through funds and ETFs. [Online] Available from https://campus.college.ch/courses/syllabus/753. [Accessed 4th December 2013]. iShares. (2014a). iShares by BlackRock. http://www.ishares.com/global/ iShares (2014b). iShares International Select Dividend ETF. Available from http://www.ishares.com/us/products/239499/ishares-international-select-dividend-etf [Accessed 16th April 2014] Morningstar.co.uk. (2014). iShares Euro Government Bond 10-15yr UCTS ETF (EUR). [Online] Available from http://www.morningstar.co.uk/uk/etf/snapshot/snapshot.aspx?id=0P0000JTTT&ClientFund=0&LanguageId=en-GB&CurrencyId=GBP&UniverseId=ETEXG$XLON&BaseCurrencyId=EUR. [Accessed 17th April 2014] Mornngstar.com (2014). iShares Euro Government Bond 10-15yr UCTS ETF (EUR). [Online] Ihttp://etfs.morningstar.com/quote?t=XLON%3aIEGZ Morningstar.com (2014a). PowerShares Intl Dividend Achievers. [Online] Available from http://etfs.morningstar.com/quote?t=PID [Accessed 15th April 2014] Morningstar.com (2014b). Using ETFs for Portfolio Construction. [Online] Available from http://www.morningstar.com/solutions/ETFSolutions.aspx?docid=291888 [Accessed 17th April 2014] SPDR (2008). SPDR Gold Shares Fact Sheet. [Online] Available from http://www.spdrgoldshares.com/media/GLD/file/GLD_SPDR_Fact_Sheet_May_2008.pdf [Accessed 12th March 2014] The Telegraph. (2009). The pros and cons of investing in gold. [Online] Available from http://www.telegraph.co.uk/finance/personalfinance/investing/gold/5970221/The-pros-and-cons-of-investing-in-gold.html [Accessed 18th February 2014) Woodham, A. (2013). Favorite International Dividend ETF. [Online] Available from http://seekingalpha.com/article/1200321-favorite-international-dividend-etf [Accessed 11th March 2014] Appendix 1– Planned Breakdown of Total Investment Description Percentage Amount (£) Cash 10% 5,000 Bonds 40% 20,000 Commodity - Gold 10% 5,000 Stock – iShares Select International Select Dividend (IDV)(20%) and PowerShares International Dividend Achievers (PID) (20%) 40% 20,000 Total invested   50,000 Table 1 – Investment Apportionment Figure 1 Appendix 2 – Stock ETF Country Percentage Investment (%) Australia 21.27 France 11.24 UK 11.17 Germany 7.17 Finland 6.70 Canada 5.93 Italy 5.61 Sweden 4.28 New Zealand 3.65 Switzerland 3.01 Spain 2.90 Hong Kong 2.37 Belgium 1.76 Netherlands 1.73 Japan 1.61 Portugal 1.41 Norway 1.39 Singapore 1.32 Greece 1.11 Israel 1.03 Other countries 2.66 Table 2-1: Countries in which IDV Investments are held Figure 2-1 – IDV Portfolio of Investments by Sector Adapted from: iShares (2014b) Figure 2-2: Trend in IDV ETF over the last 7 years Top Sectors in PID Portfolio Communication Services 17.58 Industrials 17.32 Energy 14.25 Financial Services 13.83 Consumer Defensive 10.44 Table 2-2 – Top Sectors Represented by the Fund Source: - Mornimgstar.com on 14/04/2014 Figure 2-2 Graph of 5 year movements of PID Figure 2-3 Graph of 10 year movements of PID Figure 2-4 PID Benchmarked to the S&P 500 Figure 2-.5 – PID Benchmarked to other competing ETFs Comparison with other competing ETFs in its class: Original PID in Green, S&P 500 in orange, DJ Industrial Average in lime green, Russel 5000 – light orange, S&P Mid Cap – red, Nasdaq Comp- blue, Source: Morningstar.com (2014a) Appendix 3 – Fixed Income/Bond ETF Figure 3-1 Figure 3-2 Figure 3-3 Appendix 4 Figure 4-1: Five Year movement of Gold ETF Appendix 5 Asset Class Description/ Symbol Initial Investment (£) Purchase Price NAV Units purchased NAV (£) Cash Cash 5,000       5000.00 Stock IDV 10,000 USD39.17 USD39.06 428.6390556 9971.92 Stock PID 10,000 USD18.32 UDS18.37 916.4733519 10027.29 Bond IEGZ 20,000 € 149.57 € 149.55 162.6129812 19997.33 Commodity GLD 5,000 USD 125.38 USD 125.13 66.95562214 4990.03 Total   50,000       49986.57               Table 5-1- Calculation of Net Asset Value (NAV) Figure 5-1 Read More