Investment Strategy and Portfolio Management - Morris Fund - Case Study Example

Investment strategy and portfolio management Table of Contents Investment strategy and portfolio management Introduction 3 Morris Fund 4 Investmentopportunities prevailing in UK market 5 A wide range of products in the horizon of investment 6 Allocation of assets 7 Conclusion 8 Reference 10 Bibliography 11 Introduction ‘Investment’ has been defined variously by different authors. However according to the non-exhaustive traditional definition ‘investment’ is defined as a process of generating wealth over a period by investing it in various kinds of assets (OECD, 2006, p.148). The concept of investment is not new to the world. In the past, people allowed other individuals or organisations to use their funds for a specific time in exchange of certain predefined returns. Till date the concept of investment has remained a lucrative activity not only for the individuals but also for other entities such as banks, insurance companies and mutual fund companies. The whole concept of investment is based on risk return trade off strategy, where a high return with low risk is the most preferred option Contemporary market has several avenues of investing the fund; few of the instruments are gold, bonds, stocks, debentures, commercial paper, real estate, bank deposits, etc. Each instrument has its own characteristic quality depending on the specific risk and rate. The period of maturity also varies from instrument to instrument. Investment business is growing at a fast rate and the concept of pool investment is gaining attraction among the fund management committees. In contrast to individual investment, pooled fund have a large corpus which can be diversified to reduce the risk while keeping the return unaffected. The basic strategy of pool investment is to maximise the return, maintain the capital safety along with ensuring healthy state of liquidity and cash flow (University of California, n.d.). The concept of pool investment is quite simple. Here different individuals invest small amount of their saving in the fund for a pre-specified time. The time however varies from fund to fund. Once the fund gets accumulated, the fund managers need to develop the portfolio and invest the fund in different capital market including the debt market. The proportion of the investment in each of the product depends directly on the risk appetite of the investors. Morris Fund Morris fund is a charitable fund which was created by a group of investors for generating wealth. The main aim of the investors was to pay the educational expenses of the children in near future. This fund was started in June 2005, and had a lock –in- period of five years. The early investors can start withdrawing the fund from June 2010 onwards when their investment will mature. The fund withdrawal is expected to exceed the fund inflow by 3 percent. At present the Morris fund has a well balanced portfolio where the risk is diversified by investing the fund in different avenues. The present corpus held by Morris fund is £13.5 million, 35 percent of it is invested in UK equity, 20 percent in overseas equity, 15 percent in corporate bonds, 20 percent in UK government bonds, 5 percent in commercial properties and 5 percent is kept as cash and short term instrument. It seems that the fund has parked its corpus in both long term as well as short term instrument to have a better return at moderate risk. Till date, the supply of fund was good and the cash out flow was almost absent but in the near future scenario might change. Hence the major concern of the management is to develop a balance between cash inflow and cash outflow without disturbing the rate of return. Investment opportunities prevailing in UK market The market scenario has changed its dynamics after onset of recession. This resulted in the downturn of the whole financial market. Back in 2006 when Morris fund was formed, the market was in a pretty good state, the share prices were booming and returns generated by them were quite high. Such positive ambience attracted the management to invest 35 percent of its capital in the equities listed in UK stocks and 20 percent in overseas stocks. However the economic recession of 2008-09brought a major shock for the stock markets throughout the world and UK stock market was no exception (Annunziata, 2010). To stabilise the condition, UK government has taken many steps and injected liquidity to boost demand. According to the market experts, performance of stocks in 2010 is expected to be satisfactory (Fletcher, 2010). Conditions are quite stable now, but undoubtedly Morris Fund had undergone erosion of capital. The fund has also invested certain portion of its capital in overseas stock markets. When compared to UK and US, the emerging economies performed quite well. Country like China, India and Brazil were less affected by the economic recession and due to strong financial fundamentals they managed a “V” shaped economic recovery. These countries have a bright future and their stock markets are supposed to perform well. Morris fund can expect to enjoy a good return on their investment. Due to recession when the government reduced the interest rates, bonds became more attractive instruments for investing. However with the changing market scenario when the rates will again hike and bonds will lose their attractiveness (Financial Times, 2010). Huge debt pressure on the big companies has disturbed their position. Moreover the market and corporate bonds no longer remain a safe place for investing until the balance sheet of these corporate players get stabilised and they attain a position to pay their standing debts. In the coming years when economic conditions will improve, corporate bonds will regain its charisma. According to the market experts, economic condition is improving in different parts of the world but still there exists a doubt whether this recovery will continue in the coming future or some hurdles will arise and will deteriorate the recovery path. Therefore the fund managers prefer to invest in certain hedge funds to diversify their risk. Real estate conditions are yet poor and there is an uncertainty regarding their recovery, so better to avoid it till the real estate market improves. A wide range of products in the horizon of investment The investment strategy of a company would depend upon the respective goals of the investors. There are few factors which can influence the investment strategy of Morris fund. These factors include the tax status of the investors, preferable maturity period and risk appetite of the investor. A wide range of opportunities are available in investment horizon; which one to choose would depend upon the specific requirements of the investing fund, Morris. After the financial turmoil UK equity market is again showing a high growth in these. So the funds looking for high growth can surely go for investing in the equity market. However as the fund itself has low to moderate risk appetite, in log run it would be better to go for index linked funds rather than going for direct investment in the share market. These index funds are mostly arranged by having a benchmark index, both passively and actively. Active fund managers manage and review the fund regularly, in compliance with the market condition and index movement. However passively managed firms blindly replicate the benchmark index. Morris must have to accept the fact that investing in these funds would reap it higher profit, but at the same time that would come at a cost of moderately higher risk. As the passive funds are not managed and monitored actively, the cost of investment in those funds is apparently low. However an investor would be in a better position by having both the funds in its portfolio. If Morris is thinking to make a cost effective investment, it can have more passive funds on its portfolio; however it must take into account the risk return trade off of those index funds. Another investment opportunity could be the fixed income securities. Coupon bonds can be a favourable option for the company. The risk is quite lesser in the bond investment as the bondholders would have priority to get repaid before the shareholders of a company. The investors of the fund can use their early withdrawal options. To meet the needs of the investors, the fund needs to have enough liquidity in its portfolio, which would let them to make regular cash payment. Investing in coupon bonds would make Morris fund to be entitled to get regular coupons on their investment, which could be used to make payment to the investors. Fixed income securities are a good option for long term investment opportunity (Washington State University, n.d.). Government bonds are quite suitable for the investors with low risk appetite, although they fetch a low return for them. To enhance the cash inflow, the fund can invest in short term marketable securities. Hedge funds are quite an attractive investment opportunity for the investors as they are meant to minimise the risk return volatility of the portfolio. Allocation of assets As of now, the equity market is showing quite attractive. It would be better for Morris to put the large portion of its assets in the equity linked index funds. However Morris should consider the portion of risk attached to it. As the index is doing quite well now, Morris can put its larger portion in the passively managed funds. However Morris must review its allocation regularly to make any required change in the asset allocation. At this moment Morris is in need of urgent cash; in such a situation it can move to invest in share to accelerate the cash inflow to the fund. In any portfolio diversification, would reduce the unsystematic risk of the portfolio. As the corporate bond market in UK is quite dim now-a-days, it would be rather wait for some time and then move to invest in corporate bonds. For the time being Morris fund can invest in the government bonds as they are showing the sign to recover quickly; and at the same time the risk is almost nil in this case. Morris must put a portion of its assets to the hedge funds, so that it can hedge the risk of its portfolio. To meet the urgent liquidity needs of the company the fund must put its assets in the securities with short term maturity periods. This would help the fund to enhance the cash inflow for the investors. In short, as of now, the fund needs to allocate its assets in the equity linked securities, hedge funds, government bonds and other short term marketable securities like shares. However they should carry on a continual review the assets allocation to minimise the risk and maximise the return from the investment. Conclusion The financial crisis of 2008-09 posed a major threat for most of the funds and the fall in the stock market resulted in huge capital erosion. This holds true even for Morris Fund which invested a good proportion of its fund in stock market. From June 2010 Morris Fund has to pay the investors who invested around 5 years back. While planning the portfolio Morris Fund didn’t anticipate the recession, hence they might face difficulty in managing 3 percent net cash outflow starting from June 2010. While planning the future strategy of investment the fund managers of Morris Fund need to choose that portfolio which suits present market scenario best. To have a steady flow of fund, money needs to be invested in short term securities which will add liquidity to the fund. As stock market index is improving, investing in passive instruments is a good option which not only reduces risk but also keeps the investment cost lower. To reduce the portfolio risk government bonds should be included in the portfolio but major emphasis needs to given to the overseas securities. If the above mentioned strategies are properly implemented it can be expected that Morris fund will regain its position of former glory Reference Annunziata, M. February 10, 2010. Corporate debt’s role in the eurozone recovery. [Online]. Available at: http://www.ft.com/cms/s/0/9548d2a8-1637-11df-8d0f-00144feab49a.html?nclick_check=1 [Accessed on March 05, 2010]. Fletcher, N. February 23, 2010. Wolseley outperforms FTSE 100 on surprise profit news. [Online]. Available at: http://www.guardian.co.uk/business/marketforceslive/2010/feb/23/wolseley-marketforces [Accessed on March 05, 2010]. Financial Times. 2010. Bonds & Rates Overview. Available at: http://markets.ft.com/markets/bonds.asp [Accessed on March 05, 2010]. OECD. 2006. International Investment Perspectives. OECD Publishing. Wolseley outperforms FTSE 100 on surprise profit news. [Online]. Available at: http://www.guardian.co.uk/business/marketforceslive/2010/feb/23/wolseley-marketforces [Accessed on March 05, 2010]. University of California. No date. Short Term Investment pool. [Pdf]. Available at: http://www.ucop.edu/treasurer/stip_brochure/STIP_Summary_06-09.pdf [Accessed on March 05, 2010]. Washington State University. No Date. Bond Value: Three Important Relationships. Session 3: Bond Valuation. Available at: http://cbdd.wsu.edu/kewlcontent/cdoutput/TR505r/page24.htm [Accessed on March 5, 2010]. Bibliography Bodie, Z., Kane, A. & Marcus, A.J. 2008. Investments. 7th ed. McGraw-Hill. Rutterford, J. & Davidson, M. 2007. An Introduction to Stock Exchange Investment, 3rd edition. PalgraveMacMillan. Read More