Investment Strategy and Portfolio Management of Morris Capital - Case Study Example

Introduction The existing economic environment is one of the most volatile in the modern history of the world as developed countries of the world suffered heavily due to economic meltdown. Not only the confidence of investors is low but the overall aggregate demand also remained low during most part of the last two years or so. The pace of economic growth during last two years therefore remained one of the sluggish in the history of UK and economic forecasts are indicating the negative growth rates for current year. In such economic environment, it is relatively risky for investment managers to adapt strategies which may potential threat the capital protection and increase the overall risk profile of the fund. As such it is therefore required that the more conservative approach must be adapted in order to ensure that the volatility is kept at low. The upcoming situation for Morris Capital is that of critical importance because the total withdrawals are going to overrun the total inflows and as such fund may have to borrow funds or increase its sales and marketing efforts in order to generate enough liquidity to pay off to its unit holders. The next meeting is going to discuss about the potential strategy to tackle this issue. The purpose of this report is therefore to brief the committee on the current issues in the investment environment, macro economy as well as discussing the option of whether the firm shall exercise a passive or active investment strategy considering the overall economic environment. Existing Situation As discussed above that the UK’s economy is not performing well due to multiple factors that resulted into its current state. The financial meltdown and resulting economic downturn forced government to rescue large institutions such as RBS Bank as well as supporting other smaller institutions. The overall consumer demand declined owing to lack of credit to the consumers hence the aggregate demand level declined sharply over the period of last two years. Some estimates indicate that the growth rates of the UK’s economy are relatively more sluggish as compared to its growth rates during 1930s and during last quarter of 2009, economy only grew at a rate of 0.1%.(Stewart,2010). UK’s economy experienced negative economic growth rate during 2008 and most part of 2009 whereas the growth prospects for the current year are also not healthy and as such the overall investor confidence will remain low. Such volatile economic condition therefore indicate that the investors may prefer to remain conservative even if economy starts to show the signs of recovery because investors will remain cautious about the potential impact of the policies adapted by the government to strengthen various financial institutions and safeguard the financial system of the country. Another important issue that is faced by the UK economy is its budget deficit which is becoming one of the central issues faced by the economy.(Conway,2009). Due to huge injections made by the government, UK government is effectively running budget deficit which ultimately result into the increase in taxes in future. This is also because of the fact that the overall budget deficit run by the government during 2009 was well over £90 B signaling a drastic cut into the government spending in the future. Financial Stability According to IMF’s report on financial stability, it is mentioned that the overall systematic risk to the financial system has subsided due to improvements in key economic indicators. (IMF,2009). Due to greater public support the overall macroeconomic fundamentals have shown stability however, there is still an emphasis on strengthening the banking system of the advanced countries. What is also significant to note that this report claims that the equity markets have started to show the signs of positive recovery and asset prices have started to rebound from their historic low prices during the last two years? Such healthy signs of recovery not only in developed countries but in developed countries also indicate that the overall investors confidence, on international level, may start to pick up in near future and overall certainty may be removed paving the way for new investments. In UK, Two major bank failures occurred during past 2 years i.e. RBS as well as Northern Rock. RBS was probably the most significant bank failure which raised many questions over the ability of the UK’s financial system to sustain external shocks. This impact was felt on the asset management firms also due to their relatively smaller sizes as compared to Banks and the overall crisis of confidence emerged among the investors. Asset Management in UK In order to understand the current trends in the industry as well to decide whether to pursue a more conservative strategy or not and to better allocate the resources, it is necessary that a general overview of the asset management industry must also be undertaken. Investment through asset management firms is generally considered as safe as compared to directly exposing oneself to the volatility of the various asset markets. By utilizing the expertise and skills of asset management companies, investors basically attempt to hedge themselves against the certain risks. Keeping that fact in mind, it is therefore critical that the Morris Capital provides services which are aimed at providing consistent and secured returns to the members for the education expenses of their children. The total size of the asset management industry in UK is over £3000 B with more 500 funds working in the industry. Such large size of the industry indicate that the industry has the confidence of its investors and people are preferring to use alternative channels such as asset management firms to manage their wealth. The growth in sales is also another important indicator of the overall growth in the industry and how it is basically catering to the needs of more than 15 Million customers. The overall asset management industry in the country is divided into four important classifications under which most of the funds are classified. These include capital protection funds, income funds that offer regular stream of income to unit holders, Growth funds that offer capital appreciation opportunities and Specialist funds Morris Capital Morris Capital offer specialized services to its customers and aim to provide secured investment services to its customers. Classified as a charitable fund, the overall asset allocation of the fund indicates that the portfolio is well diversified with major concentration into UK equities and Government bonds. Exposure in equity market, though expose fund of this nature to larger risk, however, it still offers an opportunity to meet the investment needs of the members as the funds to be withdrawn will generally be consumed in education of the children. As discussed above that the equity markets are heating up and prices are started to increase and as such the overall liquidity of the total portfolio may increase. As equities become more liquid, fund may be able to resell them at relatively higher prices in order to generate sufficient liquidity to meet its emerging withdrawal requirements. This is however, may be a temporary phenomenon and as such fund need to take a critical look at its portfolio composition and must match it with its overall objectives. Since the aims and objectives of the fund is to provide consistent returns for the education purpose of the children of members, it would therefore be more appropriate if asset allocation is done with more strategic outlook. The overall strategy of the firm is to offer the withdrawal after five years therefore the gap between the withdrawals and the inflows may force the firm to look for external borrowings. Another important implication of this gap may be to re-evaluate and reconsider the existing asset allocation strategy of the firm. Asset Allocation Considering the economic situation of the country as well as peculiar situation at hand, Morris Capital needs to look at the different strategic alternatives that it can exercise in order to ensure that it generates enough liquidity to meet the emerging challenges. Thus the overall composition of portfolio shall be made in such a manner that it not only remain liquid but also provide consistent stream of income. Strategic allocation of assets within the portfolio must be done in order to rebalance the portfolio periodically. This is done in order to ensure that the portfolio remain hedged against the various risks while at the same time providing an acceptable rate of return.(Gibson,2007). Since the overall aim of the fund is to offer investment opportunities for the education of Children, it is therefore more prudent that the firm must periodically ensure that it is rebalanced so that the inflows and outflows are balanced and firm is able to redeem the units held by its members after the period of five years. It is however, important to understand that the strategic allocation strategy of the firm may not work on the long term basis. Such rigidity therefore requires that the asset allocation strategies may be changed periodically. Tactical allocation of assets therefore may serve as another important alternative strategy that Morris Capital may look into. In tactical asset allocation, a firm basically attempts to change the proportion of the assets held under the portfolio. (Flavin & Wickens, 2001). This is important because of the fact that it allows a fund manager to take advantage of the timing differences in the market. By periodically changing the percentage of the various assets, Morris Capital can take advantage of the favorable market conditions by reacting to the favorable market conditions more rapidly. Though tactical asset allocation strategy is not as active as it is considered as moderately active investment strategy however, it still allows a firm to take advantage of the small windows of opportunity that may persist in the market for short period of time. The tactical asset allocation strategy therefore allows a firm to take short term profit however; it must be executed with greater discipline. Considering the overall composition of the asset portfolio of the firm, it is therefore critical that the Morris Capital must rebalance its portfolio by changing the percentage of different assets held under portfolio. This therefore will require that the firm may systematically withdraw its investment from real estate sector because of its high risk profile and re-balance the portfolio with investment into government bonds as well as equities. Another important consideration therefore shall also be to look into the opportunity of expanding the portfolio of assets held abroad as Morris Capital has significant investment in non-UK equities. However, higher exposure in non-UK equities may expose the fund to higher risks that exist in international market. Conclusion and Recommendations The above discussion indicates that there is a great need to rebalance the portfolio in order to meet the future challenges to the firm. Considering the existing economic situation and overall suppressed equity and debt markets, it is therefore critical that the fund must reallocate its assets in a more disciplined manner and must ensure that it is earning a consistent stream of income at minimum possible risk. In this regard, following strategic alternatives may be recommended: 1. The overall composition of the portfolio does not reflect the aims and objectives of the firm. It is therefore critical that the portfolio must be rebalanced. 2. Moderately active investment strategy must be adapted because it will be more in-line with the intended objectives of the firm. A moderately active investment strategy will allow Morris Capital to focus on generating consistent stream of income with minimum acceptable risk. 3. Fund shall focus on investing into emerging markets where the overall probability of earning higher returns is greater as compared to UK. Emerging markets offer more lucrative opportunities and their risk profile is considered within acceptable range too. 4. Exposure in housing market must be replaced with less risky class of assets. Considering the current volatility in the market and lack of price appreciation, there is very small probability that the firm will be able to earn handsomely against this portfolio. Further, a higher investment into housing sector will reduce the overall liquidity of the fund also. References 1. Conway, E (2009) UKs budget deficit will leave pound weak until at least 2014 Telegraph, Available: http://www.telegraph.co.uk/finance/economics/6360466/UKs-budget-deficit-will-leave-pound-weak-until-at-least-2014.html Last accessed 6th April, 2010 2. Flavin, Thomas J. & Wickens, Michael R. ( 1998), A Risk Management Approach to Optimal Asset Allocation, Economics, Finance and Accounting Department Working Paper Series n851298, Department of Economics, Finance and Accounting, National University of Ireland - Maynooth. 3. Gibson, R (2007). Asset Allocation: Balancing Financial Risk. 4th ed. New York: McGraw-Hill Professional, 4. IMF, (2009) Financial Stability Report Summary, Bank of England, Available: http://www.bankofengland.co.uk/publications/fsr/2009/fsrsum0912.pdf Last accessed: [7th April, 2010] 5. Stewart, H (2009) GDP up – thanks to public spending and car scrappage Guardian, Available: http://www.guardian.co.uk/business/2010/mar/30/gdp-up-public-spending-car-scrappage Last accessed[ 6th April, 2010] Read More