Norris Capital - Investment Strategies, Active versus Passive Investing - Case Study Example

Norris Capital Investment Table of Contents Table of Contents 2 Introduction 3 Assumptions 3 Investment Strategies 4 Active versus Passive Investing7 Investment Diversification 8 Conclusion and Recommendation 9 References 11 Introduction The global financial crisis has lead to economic instability in most of the countries. This creates an obstacle in the investment environment of these countries. The financial crisis in Europe has resulted in the decline of foreign direct investment (FDI) by 3 percent in 2011. Despite this fact United Kingdom has been the most preferred location for making investment after China. The United Kingdom has become the leading FDI location among all the European countries. It was the fourth largest place for FDI in the year 2008. UK received 19 percent of the total FDI inflows in the European Union. The current recession in UK has affected the investment activities in the country. The excessive credit crunch in UK is one of the reasons behind the recession in UK. Due to the failure of several financial institutions in UK, the investors lost their faith in investing in these institutions. This loss of faith of the customers is causing the decline of the economy of the country. Encouraging large scale investment in the United Kingdom can reduce this credit crunch and give a break to the current recession. Assumptions The assumptions that are to be made while preparing this report are: The cash withdrawals of the fund invested in Norris Capital will be allowed after 5 years of their investment. The cash outflows will exceed the cash inflows by 3 percent. The suggestion of the investment strategy is provided for the next 10 years. An amount of fund will be taken by the trustees in the trust to utilise for charitable purposes. The organization is charitable in nature and hence is free from taxes. Investment Strategies Stock Market Investment- The investment made in the equity shares of a company is known as the stock market investment. The owner of these shares will receive a part of the company’s profits and will also be allowed to take part in the company’s decisions (Hafer, Hein, 2007). If the earning of the company is high, then the stock prices increase which results in higher profitability for the investors. If the company belongs to a growing market, then investment in its equity is highly profitable. The stock market investment outperforms all other investment strategies which mean that with time the invested money will grow more if the investment is done in the stock market (Fontanills, Gentile, 2002). The companies which have their stocks listed in the stock market enjoy the facility of covering a large range of industries and services. The buyer of the stocks earns dividends as the stock market releases some portion of its profit as dividend for the stock holders. However, investment in stocks involves certain risks. If there is a decline in the economy, then it will put all the stocks of the company in risk, even if the management team or the brand of the company is very strong. In the period of high inflation the amount invested by the investors is valued much less as compared to the actual value. Although investment in stock market involves number of risks and is highly volatile, it will return with high yield return (Rosen, 2008). Thus investment in the stock market may be beneficial for Norris Capital if the investment is made after a proper financial analysis of the market. Commodities Investment- Commodities are the raw materials involved in a commodity market like food, energy or metals which form a part of our day to day life. The investment in the commodities can be advantageous compared to the other traditional methods of investment and provides huge profit to the investors. It does not involve investment in a particular company or the government, but covers the physical product markets. The main advantage of investment in the commodity market is that it protects the investors from the inflation and the uncertain economic conditions. When the economy of a country is declining, more money is printed in order to stimulate the economy. If more money will be printed then it will increase the amount of the invested money in the commodities. Thus the demand of the commodities will also increase resulting in the increase in its price. It is always advantageous for a company to invest in the commodity market as it is an important component in the diversified portfolio of investment. If the stock market declines, then the investment in commodities like gold can be advantageous for the investors (Fabozzi, Fuss and Kaiser, 2008). But the price of the commodities is highly volatile. If the prices of the commodities go down rapidly, then it can result in a loss for the investors within a short period of time. Thus it can be recommended to Norris Capital to invest in the commodity market like gold as it will help the company to maintain the financial stability when the financial market is in a declining situation. Foreign Currency Investment- It helps an investor to diversify the investment. It helps the investors to hedge their position against the fluctuations in the currency without moving the invested amount offshore (Wasendorf, 1998). This pattern of investment involves transparency and the prices cannot be manipulated by the traders easily. Investors wish to participate in the foreign currency investment in order to take advantage of the short term as well as the long term opportunities. In some cases it may not yield a good return to the investors due to the unexpected changes in the currency rates. However, it can be beneficial for Norris Capital to invest in the foreign currencies. Bond Investment- In any financial plan, the bond is the core element to invest and get a good amount of return. A bond is a debt that guarantees an additional value as interest after its maturity period. It is relatively safe for the investors to invest in bonds. If an investor buys bonds from a stable government then it guarantees a risk free return always (Larimore, Lindauer and LeBoeuf, 2006). It may be beneficial to invest in the bonds at the time of recession as it includes low level of volatility. Moreover it helps the investors to stabilize their portfolio when the position of the stock market is deteriorating. If any investor needs to make an access to a large amount of money in the future, then investing in stock is very risky. In such cases, investment in bonds is a safe investment decision. The maximum return on investment in bonds is from the interest. The fluctuations in the bond prices possess a very little impact on the actual amount of the investment. Moreover the price changes are inversely proportional to the interest rate changes (Katariina Tanhua-Tyrkkö, 2011). It provides consistent income to the investors by coupon payments. There are some risks involved in the bond investment also. One of them is the interest rate risk. Reduction in the interest rates will reduce the fixed income of the investors to some extent. Another risk is any default by the organization issuing these bonds. In the case of such default the rest of the amount of investment will be lost by the investors. Despite of these risks, investment in bonds can be beneficial for Norris Capital. Thus it can be recommended to the company to invest in the bonds which will help it to gain fixed returns even when the investment made in the stocks is suffering. Real Estate Investment- Real Estate which is not being used by the investor as his primary residence can generate a good income. The investors who own multiple numbers of properties can use them for earning rental income leaving the one which is serving the purpose of the primary residence. The returns based on the real estate investment have very low interconnection with the returns from the investment in the other asset classes. This adds to the diversification of the investor’s portfolio. Real estate returns mean the income that is generated from the rents of the tenants. Some leases have provisions of increasing the rental income at the time of inflation. This tends to raise the rental income on the expiry of the lease term resulting in a good yield to the investors in inflationary environment (Lewis, 2003). An investor has the possibility to improve the performance of the real estate investment. This is not possible in case of other investments. But while making such investments the consideration to the cost related to the purchase of the real estates and their maintenance is very important. Sometimes investment in the real estate is very costly. However, it may be advantageous for Norris Capital to invest in the real estate and get a good return in the long run. Mutual Fund Investments- Mutual fund is a collective investment element which collects the investment of many investors in order to purchase the securities. Mutual fund provides the facility to those investors who lack investing skills by offering them a qualified fund manager. This helps the investors to acquire knowledge about the investing activities. Investment in mutual funds helps in bringing diversification in the investor’s portfolio (Investment Company Institute, 2013). Investment in a particular security involves exposure of risks related to such investment. In order to reduce the risks, it is very important for the investors to change their pattern of investment and bring diversification in their investment. If an investor takes the decision of investment diversification alone then it will involve high cost structure. Making investment in mutual fund allows investment diversification and includes low cost comparatively. Moreover, the mutual funds are regulated properly which helps the investors to make their investment decisions. It can be recommended to Norris Capital to invest in the mutual funds which will help it to make the investing decisions at a low cost and involving low risk. Active versus Passive Investing Active investment strategy is that kind of investment strategy where the fund manager takes the entire decision based on his assumptions and analysis for determining the investment portfolio. It increases the performances and reduces the risk of a firm (Schoenfeld, 2004). On the other hand passive investment strategy is that type of investment strategy where a market is chosen and all the securities in that particular market are chosen in the investment portfolio (Malkiel, 2003). Both these strategies have some advantages as well as some disadvantages. Active investment strategy involves higher risk if the chosen portfolio is wrong. Again passive investment strategies can give poor performance if the indexed securities in the market do not perform well. It can be recommended to Norris Capital to opt for passive investment strategy Investment Diversification Investment diversification is very important for reducing the risk involvement in the investment (Frontier Investment Management LLP Research, 2008). It reduces the level of volatility in the investment portfolio. Investment diversification assures that if the investment in one security cannot give satisfactory return to the investor, then it can be compensated by the returns from the other investments in the portfolio. The lower volatility can give the same amount of return as expected from a single investment, but with lesser fluctuations in the value. However the investment diversification cannot give high abnormal returns to the investors. Investment diversification also reduces the quality of the investment. Well managed mutual funds concentrate in the short term returns and lose their focus on the long term growth. It is suggested to Norris Capital to diversify its investment in order to reduce the risk of losing all the investments at one time. For example- if the stock market is not performing well then the investors may earn good return from the investment in gold. Moreover the investment diversification will enable the company to expand in the international markets as well. But in case of making investments in the emerging markets, it involves high risk because of the unstable political system. Any change in the rules by the government may result in the decreased returns to the investors. Thus it is recommended to Norris Capital that investment in the emerging markets should not be made due to the involvement of high risk. . Conclusion and Recommendation Norris Capital is recommended to make such an investment plan which will involve low risk and high returns even in the worst conditions. But this investment diversification should maintain a balance between the short term and long term securities. The recommended investment pattern to Norris Capital is shown in the following table: Investment Product Percentage UK equity market 26% UK Government Bonds 24% UK Real Estate 10% Commodity Market 8% UK Short Term Instruments 10% Investment in International Markets 4% Cash 18% Total 100% In the investment portfolio of Norris Capital highest percentage of investment is suggested in the government bonds because it will involve lower level of risk and a fixed amount of income. Higher investment is suggested in equity because under favourable conditions it will yield maximum return to Norris Capital. Investment in the commodity market will support the company with its return when the stock market is not performing well. The short term investments are required in order to avoid huge borrowings including high rate of interests. References Fabozzi, F. J., Fuss, R. and Kaiser, D. G., 2008. The Handbook of Commodity Investing. New Jersey: John Wiley & Sons. Fontanills, G. A. and Gentile, T., 2002. The Stock Market Course. New Jersey: John Wiley & Sons. Frontier Investment Management LLP Research, 2008. The Benefits of Portfolio Diversification. [online] Available at: [Accessed 4 March 2013]. Hafer, R. W., Hein, S. E., 2007. The Stock Market. Connecticut: Greenwood Publishing Group. Investment Company Institute, 2013. 2013 Mutual Funds and Investment Management Conference. [online] Available at: [Accessed 4 March 2013]. Katariina Tanhua-Tyrkkö, 2011. Diversification benefits for bond portfolios – Evidence from the euro-denominated investment grade bond market. [online] Available at: [Accessed 4 March 2013]. Larimore, T., Lindauer, M. and LeBoeuf, M., 2006. The Bogleheads Guide to Investing. New Jersey: John Wiley & Sons. Lewis, R., 2003. Real Estate Investing in New York City: A Handbook for the Small Investor. Indiana: iUniverse. Malkiel, B. G., 2003. Passive Investment Strategies and Efficient Markets. European Financial Management, 9(1), pp. 1-10. Rosen, K. D., 2008. Investing in Income Properties: The Big Six Formula for Achieving Wealth in Real Estate. New Jersey: John Wiley & Sons. Schoenfeld, S. A., 2004. Active Index Investing: Maximizing Portfolio Performance and Minimizing Risk through Global Index Strategies. New Jersey: Wiley. Wasendorf, R. R., 1998. Foreign Currency Trading: From the Fundamentals to the Fine Points. New York: McGraw Hill. Read More