Investment and Fund Management - Essay Example

INVESTMENT AND FUND MANAGEMENT Table of Contents Introduction 3 Analysis of Current Portfolio 3 Investment Objectives and Strategies 8 Risk Management and Diversification Strategy 9 Security Analysis 10 Asset Allocation 16 Recommendation for Alternate Portfolio 16 Performance Evaluation 17 Summary and Conclusion 21 Reference 22 Introduction Fortunes Inc. is a successful print shop in London. It is a co-operative that was set up about a decade earlier after an industrial dispute. The company currently employs 25 workers and has a flat management structure. It is given that the employees of Fortune lack management skills. The current difficulty that the members of Fortunes are facing now is regarding the portfolio of pension provision. According to the current provisions, the members will be paid lump sum based upon individual contributions. But a careful analysis of the pension fund portfolio reveals that it was built up in an undisciplined manner. Hence, the current portfolio is considered inappropriate since the global markets are facing downturns. The objective of the study is to carefully analyse the current portfolio and recommend suitable adjustments so that Fortunes Inc. can meets its pension provision in the coming years. Analysis of Current Portfolio Tottenham Hotspur Fortunes Inc. has bought 2000 ordinary shares of Tottenham Hotspur plc which was founded in 1882 and it owns Tottenham Hotspur FC. It falls under entertainment sector. The total revenue of the company at the end of 2011 was £261.90 million. The company has experienced a growth rate of over 45% during one year. BAE Systems BAE systems plc is multinational British defence aerospace and Security Company. It is the world’s largest defence contractor and third biggest in terms of revenue. It falls under aviation sector. The total revenue at the end of 2012 was £17.84 billion with net profit over £1billion. Tesco Tesco plc is a multinational British general merchandise and grocery retailer and is the third largest retailer in the world. It falls under consumer goods sector. The total revenue of the company for the year ending 2012 was over £65.5 billion with net profit over £3.9 billion. Whitbread Whitbread plc operates in hotels and restaurant business. As of 2012, the company has over 619 hotels and over 385 restaurants. The total revenue of the company for the year ending 2012 was GBP 1.9 billion with a net profit of GBP 281 million. Barclays Bank Barclays plc is a leading banking and financial services providing multinational company which is headquartered in London, UK. It is public limited company and is traded as BARC on the London Stock Exchange (LSE). It falls under banking and financial services sector. For the year ending 2012, the company reported total revenue over £24 billion with bottom line about £235 million. The company specialises in Investment banking, corporate banking and Wealth banking. Helical Bar Helical Bar plc is a holding company operating in property investments and development. It falls under the realty sector. The company leases or owns land and properties for the purpose of trading and selling. The company booked profits of over GBP 7.65 million from a total revenue over 65.85 million. Cable and Wireless Communication It is a global telecom service provider that offers broadband, mobile, television, and fixed lines to customers. It falls under the entertainment sector. In October 2011 the company has sold its 50% interest to Mauritius based Telecom Company known as Vanuatu ltd. In the year 2012, it sold 49% stake to Fiji and formed an amalgamated entity known as Fintel. In April 2013, it announced the sale of majority stake to Monaco & Islands division. For the year ending 2012, the company suffered a net loss of GBP 55.49 million. Flybe Group It is UK based domestic airline company and it falls under aviation sector. As on 2012, the company reported to own 19 aircrafts but it suffered a net loss of GBP 22.30 million. Lazard UK Alpha Retail Inc Fund The fund does not charge any initial fee currently however, earlier it used to charge at 3.75%. The minimum initial investment is £1000 with minimum monthly £50 and minimum top up of £250. The fund came into inception on November 1999. The fund is UK large cap blend equity with net assets over £130 million. The year to date return is 8.60% with net yield of 2.02%. Royal Bank of Scotland Floating Rate Bond (minimum 3.9% per annum) It is the holding company of global banking group through various subsidiaries. It offers services in retail baking, wealth management, global transactions, insurance, and non-core divisions. The company has unsecured consumer loans and booked losses over GBP 5.5 billion for the year ending 2012. Nationwide BS Instant Access Account It provides instant unlimited access to customers including the flexible options such as withdraw or deposit of money at any time through e savings. It requires the minimum age of customer to be 16 years and minimum deposit amount of £1. The customer is entitled to earn a net 0.36% p.a. with effect from January 2009. Skipton BS Fixed Rate Bond (5% until 20/8/14) It is similar to Nationwide BS Instant Access Account and also offers minimum deposit of only £1 and a 5 year fixed Skipton bond offers 3%. Problem with the Current Portfolio From the analysis of the current portfolio it can be said that the pension fund of Fortunes Inc. was built up in an undisciplined or chaotic manner. This is because from the analysis of existing portfolio, it seems that portfolio was created from ad hoc decisions made by the trustees of Fortunes Inc. at their monthly meeting. Probably their decision was based on whatever seemed sensible at that time. The problems with existing portfolio is that there are overlapping in few sectors such as aviation and banking. As already discussed, some companies have booked losses and for them dividend distribution in short term would be impossible. According to given case study, two members of Fortunes, Inc. would be retiring in 5 years or less. So, in order to provide them with minimum average return of £5000, the short term loss making companies from the portfolio have to be replaced. Most members would be retiring in 10 to 15 years. The portfolio should be created keeping this time horizon in mind and that the company would require paying at least (£5000 x 10) £50,000 and maximum £75,000 in 10 to 15 years as pension. Thus, the portfolio should invest into companies which have strong fundamentals with very less volatility in long term yield. The volatility can be estimated with beta and then the new portfolio can be determined accordingly by keeping in mind the short term and long term objectives of the required portfolio. Investment Objectives and Strategies A portfolio is group of securities such as bonds, stocks where an investor invests his or her money. By diversifying money into a combination of securities, the investor mitigates the risk of holding a particular asset. The investment objectives of the given portfolio must be made according to requirement of funds at specific times in future. The following data was provided in the case, Years to retirement Number of members 5 or less 2 5 to10 5 10 to15 10 15 to 20 5 More than 20 years 3 So, from the above table it can be said that Fortunes, Inc. will have to start paying pension within 5 years or less as 2 members are expected to retire in less than 5 years. This means that portfolio should be strategized in such a manner that the overall portfolio return must be sufficient to cover up pensions of the 2 members in short run. Also, from the above table it is given that 10 members would be retiring within 10 to 15 years. This means that there will be a sudden jump in cash outflow from the investments from the 10th year onwards in form of pension funds to members. The objective of the portfolio should be to achieve long term growth of capital. So, if the main objective is to get adequate amount of long term growth in income, substantial amount of the investment corpus should be put into equity class and fewer portions should be invested in debt instruments. This is because, while the equity will ensure long term capital growth for the investor through proper diversification, debt portion of portfolio will ensure fixed and stable income for the investor. Risk Management and Diversification Strategy Diversification of investment spreads the risk over many assets. A diversified portfolio gives the assurance of obtaining the anticipate return on portfolio. The concept of simple portfolio diversification is that some securities may not perform as anticipated but other assets might exceed the expected return making the actual return of the portfolio reasonably close to anticipated return (Hagin, 2004, pp.3-5). Investing the entire sum of money in a single stock exposes the investor to the risk of that asset. So, in case when the price of that security falls in the market due to any reason, the investor will suffer huge losses. This, risk of concentration of money in a single stock is mitigated through diversification. Diversification can be done on the basis of sectors (banking, manufacturing, services, automobile, telecom and IT), instrument (stocks, bonds, derivatives, commodities, metals, etc.), currency (dollar, euro, pound, Canadian dollar, etc.), domestic or international companies, and so on. The problem with current diversification is that the existing portfolio, whose objective is to cover pension fund for retiring member, was built up in ad-hoc manner. There is overlapping between Flybe and BAE systems, RBS group and Barclays, cable and wireless and Whitbread. Also, companies like Flybe and Helical bar have high beta implying investment into these companies is risky. But since, there is a global slowdown in the economy and the possibility of recessions, also not to mention euro zone crisis, investment into companies with high beta is not advisable. Another reason for such diversification strategy is that the company would require paying pensions to retiring members starting in less than 5 years. The numbers are expected to rise exponentially within the next 10 to 15 years. In such case, undue risk might lead to shortage of funds when Fortunes, Inc. would actually require funds to pay pensions. The new portfolio of Fortunes, Inc. should be constructed in such a way that it must address all the diversification strategies discussed above. Security Analysis The security analysis was conducted on every security that Fortunes Inc. has kept in their portfolio and the following results were found from the analysis: Royal Bank of Scotland Group plc (Source: Financial Times, 2013) The Beta (β) of the company is 2.50 (High beta implies aggressive and risky security) Net profit margin of the company is -31.40% Operating profit margin is -28.8% Net cash flow per share is -0.35 Debt equity ratio is 2.34 (very high implying that capital structure of company is highly leveraged. Fortunes Inc. has invested in floating rate bond of the company that yields at 3.9% p.a. but since the company’s performance is down and beta is high RBS group’s credit may be downgraded. This would mean that the chances of default would increase. From the above security analysis of RBS, it is recommended that Fortunes, Inc. should replace this group from their existing portfolio. Lazard UK Alpha Retail Inc. The fund summary is shown below, (Source: Yahoo Finance, 2013) The fund’s total expense ratio 1.55% and performance summary is as follows (Yahoo Finance, 2013) From the above discussion it can be said that for short term Fortunes Inc. should keep this fund in their portfolio. Flybe Group plc The gross margin of the company is 21.76% The net margin of the company is -3.63% The operating margin of the company is -3.60% The return on asset and return on equity is -5.52% and -22.54% The return on investment of the company is -10.13% The cash flow per share is -0.1091 Debt equity ratio is 1.28 (stable and not highly leveraged) (Source: Financial Times, 2013) On the basis of the results of security analysis of Flybe Group plc, Fortunes Inc. is recommended to replace this security from their portfolio. Cable & Wireless Communications plc After conducting security analysis on the company the following results were found: (Source: Financial Times, 2013) The beta of the company is 0.75 One year % change is positive implying that in the long term the company has chance to recover as the market condition is expected to improve in future. The net profit margin is 1.3% and operating profit margin is 10.02% Return on investment is 2.12% 5 year dividend growth rate is -6.30% (not a good sign for short term since in next five years the Fortunes will start paying pension to retiring members) Cash flow per share is 0.1 and debt equity ratio is 0.86 From the above discussion it can be said that Fortunes may keep this company in their portfolio for their long term objectives the fundamentals of the company is strong. But for short term, this company is not advisable. The remaining securities including Tesco plc, BAE systems, Helical Bar, Barclay’s bank, Tottenham Hotspur, Whitbread plc have been found to perform well and will be able to attain both the short term and the long term objectives of Fortunes Inc. The investment in fixed rate bond of Skipton BS would ensure regular income for the company. Asset Allocation In the given case, the existing portfolio invests into sectors such as telecom, baking and financial services, entertainment, realty sector, consumer goods sector, and aviation sector. The company has bought also bonds apart from stakes into companies belonging to different sectors. As discussed earlier, the problem with current asset allocation is that in the existing portfolio there is overlapping between Flybe and BAE systems, RBS group and Barclays, cable and wireless and Whitbread. Also, companies like RBS and Flybe have high beta implying investment into these companies is risky. Recommendation for Alternate Portfolio On the basis of security analysis conducted earlier it can be said that the alternate portfolio will replace three securities namely, Flybe plc, Cable & Wireless Communications plc, and the floating rate bond of RBS plc. These securities may be replaced by the following three new securities: 1. Royal Dutch Shell plc 2. BHP Billiton plc 3. Fidelity Capital and Income Fund Performance Evaluation Royal Dutch Shell PLC Royal Dutch Shell plc is a public limited multinational oil and gas company whose head quarter is in Netherlands and registered office is in London, UK. It is one of the most valuable company and the largest company in terms of revenue. The total revenue of the group for the year ending 2012 was over $467 billion with a net profit over $26 billion. The company is listed in Lon stock exchange and it also one of the constituents of FTSE 100. It specialises in petrochemicals, power, oil and gas exploration, production, refining, distribution, trading, and marketing. (Source: Morning Star, 2013) The company plans to invest in many emerging technology companies that encourage innovation and also add shareholders’ value. The company’s long term strategy is to include global oil exploration base, focused acquisitions, and continuously improve portfolio. Such investment strategy will make the future of the company more prosperous and hence would ultimately help to attain the objectives of Fortunes Inc. BHP Billiton plc BHP Billiton is multinational petroleum and mining company whose headquarter is in Australia while the chief management office is in London, UK. According to a report in 2011, it was the largest mining company in the world in terms of revenues and third largest in terms of market capitalisation. (Source: Morning Star, 2013) (Source: Morning Star, 2013) The company is a public company actively traded in London Stock Exchange and New York Stock Exchange. The company’s total revenue from operations for the year ending 2012 was over $72 billion and a net profit over $23 billion. The change in company’s stock return during last one year was 2.45% compared to 14.75% in FTSE 100 index indicating that investment in the company is safe as the stocks are less volatile. Fidelity Capital and Income Fund (Source: Fidelity Fund Research, 2013) The daily Y-T-D of the fund is as follows and the fund returns 10.47% in five year. The fund’s objective is to provide the investor with a combination of income and capital growth by investing in subordinated debt and equity securities. Rise in interest causes price of debt security to decrease and since the foreign market is volatile, it can also increase the risk of investor. Summary and Conclusion From the analysis of the current portfolio of Fortunes Inc. it was found that the pension fund of Fortunes Inc. was built up in an undisciplined or chaotic manner. The problems with existing portfolio is that there are overlapping in few companies in sectors such as aviation and banking. According to given case study, two members of Fortunes, Inc. would be retiring in 5 years or less and most members would be retiring in 10 to 15 years. The securities of Tesco plc, BAE systems, Helical Bar, Barclay’s bank, Tottenham Hotspur, Whitbread plc have been found to perform well and will be able to attain both the short term and the long term objectives of Fortunes Inc. The investment in fixed rate bond of Skipton BS would ensure regular income for the company. Hence Fortunes Inc. need not replace these securities from their portfolio. However, on the basis of security analysis it was found that the alternate portfolio will replace three securities namely Flybe plc, Cable & Wireless Communications plc, and the floating rate bond of RBS plc. These securities may be replaced by the following three new securities Royal Dutch Shell plc, BHP Billiton plc, and Fidelity Capital and Income Fund. Reference Hagin, R., 2004. Investment Management Portfolio Diversification, Risk, and Time – Fact and Fiction. New Jersey: John Wiley & Sons, Inc. Read More