Investment Policies of Morris Capital Fund - Case Study Example

 Report on Morris Capital fund Table of Contents Summary 3 1. Morris Capital Fund – overview of status and performance 3 2. Investment environment 4 3. Alternatives for plausible strategic asset allocations 5 4. Asset classes – active v. passive investment approaches 7 5. Conclusion and recommendations 9 References 11 Summary One of the most important characteristics of modern market is the ability of investors to choose among a series of financial products, which have different characteristics and structure in accordance with the benefits offered to the investor. In most cases, the management of funds is based on specific criteria, like their structure, their level of risk but also their ability to guarantee the protection of investors’ rights and capital. Through the years, it has been proved that the distribution of risks among financial products can offer a high level of safety to the investors – there is also the view that highly risky financial products lead to high profits but this is not always the priority for investors. Current study focuses on the identification of methods for reducing the annual losses of Morris Capital, a charitable fund established in UK; these losses – they have been estimated to 3% annually – are related with the inequality between fund inflows and fund withdrawals especially for the 5 years that follow. It is proved that the limitation of the fund’s performance can be avoided but only under specific terms and conditions. 1. Morris Capital Fund – overview of status and performance Morris Capital Fund is a fund created in order to support the development of educational projects; despite the fact that the fund is a charitable one its management present many similarities with the common funds. The fund is relatively new – it was established in 2005; however, its current status can lead to the assumption that through the years its performance is continuously improved. More specifically, in the beginning of 2010 the value of the fund’s assets have been estimated to 13,5 million – which is a high amount if taking into consideration the short presence of the fund in its market. The above figure – value of assets of Morris Capital fund – is encouraging; this figure is an indication that the firm is adequately covered in case of severe financial turbulences; the problem for the firm seems to be its liability to pay its contributors – referring to those contributors who have become eligible to withdraw their funds – in accordance with the relevant agreement between the firm and its investors/ contributors a period of 5 years is required for the establishment of this right. Up today, the fund’s performance can be characterized as satisfactory; however, its stability would be under threat for the next 5 years; the limitation of the fund by 3% for each one of the following five years would lead to a total decrease of the fund by 15% which is a significant percentage; policies should be implemented for the limitation of this loss – as possible; the understanding of the investment environment and the identification of alternative asset allocations would be necessary in order to protect the fund in the long term – i.e. not only for the 5-years period in which the level of withdrawals is expected to cause severe pressure over the fund’s financial basis. The current policies of the fund’s management team (see also the fund’s official website) would be carefully reviewed as of their appropriateness – taking into consideration current market trends but also the prospects for future growth. 2. Investment environment The British investment market is primarily monitored and regulated by the Financial Services Authority (FSA) and the Bank of England. The above authorities ensure that all investment schemes developed across Britain meet specific ethical and legal requirements. Other governmental departments are also likely to deal with the control of investment activities in Britain – for example the UK Trade & Investment, a government organization that support the investment initiatives of British and foreign firms in UK. British regulation supports the development of any form of business activity in the particular country; however, current recession would be a threat for any investment project that is not carefully studied and supported. Morris Capital – because of its structure – can be characterized a valuable vehicle of investment – even in current financial crisis – being based mainly on equity and bonds – a percentage of 20% of the fund is based on UK government bonds which offer to the investor a high level of protection compared to other funds available in the British market. 3. Alternatives for plausible strategic asset allocations Commonly, asset allocation is one of the most important parts of fund management; fund managers need to provide to the investors the chance to choose among a series of alternatives deciding on the risk related with their investment; by choosing a specific type of asset allocation investors take the risk for the performance of the relevant financial product but this risk is not unlimited; in fact, the firm that manages the specific product is obliged to take all necessary measures for the limitation of risk. In case of a fund’s severe losses the allocation of responsibility for the damages caused will be based on the level of protection undertaken by the fund managers but also the terms under which the investors participate in the specific fund. In accordance with the above, the identification of the alternatives for asset allocation in funds needs to be ethical and aligned with the terms of agreement between the investor and the firm – provider of the fund. If one of the above requirements is not met, the party that failed to respond to its conventional obligations or the ethical rules will have the responsibility to cover the damages – in case of decrease of the fund’s performance. It should be noted at this point that asset allocation is differentiated from the concept of diversification; the latter focuses on the limitation of the risk while asset allocation ‘maximizes the risk-adjusted return, namely the enhancement of return and the reduction of risk’ (Frush, 2006, 176). The fact of the importance of alternatives for asset allocation in funds is highlighted in the study of Madura (2008); the above researcher notes that in funds that have a specific classification – the tax-free funds are mentioned as an example – ‘various alternatives with different maturity characteristics are available, so that investors can select a fund with the desired exposure to interest rate risk’ (Madura, 2008, 627). In other words, investors are likely to have the major responsibility for the risk undertaken by a particular fund – even in this case the responsibility of the fund manager and the fund provider cannot be completely eliminated. In the above study the interest rate risk is set as a criterion for choosing alternatives for strategic asset allocations; other criteria could be also used in accordance with the fund’s type, the benefits provided to the investors, the ability of investors to take their investment – exit from the fund – in any point of time and so on. On the other hand, it is noted by Anson (2006, 11) that ‘the lack of constraints allows alternative asset managers a high degree of freedom’ – compared with the traditional asset managers. Because of their ability to choose among a series of alternative investment schemes, alternative asset managers are considered to share a significant part of the responsibility involved in the performance – and the losses – of funds that are based on the investment schemes. In any case, investors are free to set the criteria on which their choice on a particular fund will be based; the relevant choice would be also based on criteria of different type like ‘the investor’s goals, philosophies and risk tolerances’ (Darst, 2007, 455) while the quality of ‘information on the practice of asset allocation’ (Darst, 2007, 455) is likely to affect an investor’s decision to invest on a specific fund. The above criteria cannot guarantee the performance of the fund; in fact, the profit generated through this fund can be highly differentiated – even eliminated – under the influence of facts that cannot be controlled or predicted by the investor or the fund manager – referring for example to the case of turbulences due to unexpected political or financial turbulences, to weather conditions that prohibit the normal development of the market for a long period of time or the change in the terms of operations of a financial market (introduction of new laws regulating the investments in a specific market, increase in interest rates of investment or increase in the level of the fund provider’s fee, also increase in the level of tax imposed on specific investment products) as a result of the change of the priorities or the goals of the government. 4. Asset classes – active v. passive investment approaches The choice of investors on particular funds is based – as explained above – on a series of criteria; however, two can be considered the most important factors for choosing a specific investment product: the risk undertaken and the profit expected – i.e. the performance of the fund either in the short or the long term. Under an active investment approach, the investor can choose ‘instead of securitizing, funding the purchase of mortgage pools by issuing debt’ (Dempster et al., 2008, 130); the above approach could lead to extremely high profits but the risk undertaken could be also high. At the next level, the investment approach chosen by fund managers can be depended on the characteristics of the chosen financial product. Towards this direction, it is noted by Haslem (2003) that ‘fund portfolio holdings and allocations become more conservative as the stated target dates approach; stock allocations are reduced and bond and money market fund allocations increased’ (Haslem, 2003, 178); commonly, the investment approaches used by fund managers are divided into two major categories/ types: active and passive. An example of an active investment approach is presented above (see the study of Dempster et al., 2008, 130); among the targets of active investment approach is the identification of the sources of active risk (Litterman et al., 2003, 200); on the other hand, it is in the context of active investment approach that the ‘ investor’s active equity portfolio’ (Litterman et al., 2003, 200) is analyzed – referring mainly to the structure of the portfolio. The difference between the active and the passive investment management can be made clear through the study of Litterman et al. (2003); in accordance with the above researchers ‘active managers create portfolios that do not replicate, but rather attempt to outperform, indexes’ (Litterman et al., 2003, 26). Generally, active management is based on the practice of active trading under the term that the specific investment can exceed the market averages on a constant basis; in other words, active investment approach is based on the continuous trading – as in opposition with the passive investment approach where the trading is limited and the investment is based on a long – term profitability scheme rather than on a high profit within a short period of time. It is for the above reasons that Litterman et al. (2003) suggested that ‘active risk should be taken only when there is an expected positive net return (after fees and after taxes) associated with it’ (Litterman et al., 2003, 26). The choice of the investment approach used in each investment scheme belongs to the fund manager; investors should be informed on the available options, taking into consideration their priorities – referring to the choice between profitability and safety of their funds. In any case, it is expected that ‘investor asset choices exists under a wide range of investment constraints’ (Schneeweis et al., 2010, 14) – the issue of regulation and its constraints on the investor’s choice is used as an example in the above study. 5. Conclusion and recommendations The issues developed above prove that the development of investment policies in relation to a specific fund need to be based on specific criteria; even if in all investment schemes the investor undertakes part of the risk this fact could not lead to investment decisions of extreme risk – referring to current market conditions. In Morris Capital, the allocation of asset classes has been based on the following criteria: a) potentials for a moderate – but stable – profit in the long term, b) limitation of risk, c) availability for choosing higher risk investment schemes – through the overseas equities; even in this case, pillars of protection continue to exist – no stocks have been incorporated in the fund’s portfolio in order to avoid the exposure of investors to products of extreme risk. On the other hand, there is the standardized period of 5 years – as a minimum – for the return of investment – this gives to the firm the ability to control the fund, identify any potential signs for limitation of the investment’s performance. The above characteristics of Morris Capital offers to the specific fund a competitive advantage towards its rivals in the British market; currently, the only challenge that the fund managers in Morris Capital need to face is the standardization of the investment performance so that the limitation of the 15% - in total for the next five years – of the fund’s capital to be effectively covered; this challenge would be faced through the following initiatives: a) increase of the fund’s attractiveness in the British market, possibly by a slight increase of the interest offered, b) increase by 1-2 years of the minimum period for the return of investment and c) differentiation of the fund’s assets classes: increase of UK government bonds by 5% and limitation of the UK corporate bonds by 5% accordingly; the passive investment approach on which Morris Capital is based should not be changed as it is one of its key advantages towards other funds available in UK. References Anson, P., 2006. Handbook of alternative assets. John Wiley and Sons Darst, D., 2007. Mastering the art of asset allocation: comprehensive approaches to managing risk and optimizing returns. McGraw-Hill Professional Dempster, M., Pflug, G., Gautam, M., 2008. Quantitative Fund Management. CRC Press Frush, S., 2006. Understanding Asset Allocation. McGraw-Hill Professional Gregoriou, G., 2008. Encyclopedia of Alternative Investments. CRC Press Haslem, J., 2003. Mutual funds: risk and performance analysis for decision making. Wiley-Blackwell Litterman, R., 2003. Modern investment management: an equilibrium approach. John Wiley and Sons, 2003 Madura, J., 2008. Financial markets and institutions. Cengage Learning Schneeweis, T., Crowder, G., Kazemi, H., 2010. The New Science of Asset Allocation: Risk Management in a Multi-Asset World. John Wiley and Sons Zietlow, J., Seidner, A., 2007. Cash & investment management for nonprofit organizations. John Wiley and Sons Online sources Morris capital fund, official website, available at http://www.morriscapitalmanagement.com/competitive_strengths.asp UK Trade and Investment, official website, available at http://www.ukinvest.gov.uk/Who-We-Are/en-GB-list.html?nav Read More