Investment: Equities, Fixed Income, Commodities - Essay Example

Global Investment Contents Introduction Asset Allocation: 2 Details of Investments 3 US Large Cap Equities Index: 4 2.US Small cap equities Index: 5 3.MSCI EAFE NON U.S Developed Market 5 4.MSCI Non US Emerging Market Equity: 5 5.US & Non US Fixed income Bonds: 6 6.Emerging Market Fixed Income Bonds: 6 7.Global REITS: 7 8.Commodities: 7 9.Private Equity: 7 10.Infrastructure Funds: 7 Conclusion: 8 Bibliography 9 Introduction Asset allocation has always been an integral part of portfolio selection. The optimal asset allocation is referred to as the allocation that is best in terms of risk and returns. In order to meet the expenditure requirement and maintenance of real returns, active asset allocation is necessary when mere selection of 60% equities (large cap & Small Cap) and 40 % fixed income investments were not proved to be successful. The allocation which has now been designed takes exposures in US based stocks and bonds along with non US stocks, bonds and alternative investments. The diversification at the global level gives two advantages 1. The risk return trade becomes more favorable 2. The investment becomes less risky because of low correlation between assets. The Asset allocation process requires in depth analysis off each category of investment to fulfil the complete requirements of investment policy. A good fund manager makes smart fund investments in accordance to the investment policy statement to earn suitable returns for the investor (Gibson). The portfolio allocation is based on the following 17 investments 1. US Large Cap Equities 2. US Small Cap Equities 3. MSCI EAFE NON U.S Developed Market 4. MSCI Non- US Emerging Market equities 5. High Yield Corporate 6. International Govt Bonds 7. Intermediate Govt/ Credit Bonds 8. Emerging Market Fixed Income Bonds 9. Cohen & Steers 10. Mortgage RE Capped ETF 11. Asia Developed RE 12. International Developed RE 13. IShare Gold Trust 14. Power Share Global Listed private equity 15. IShare Global Infrastructure Funds 16. IShare Emerging market Infrastructure Funds 17. SPDR S&P Global Infrastructure Following paper is based on the allocation strategy. The explanation of each of the above investments is mentioned below. Asset Allocation: The Assets allocation can be seen as follows. Table 1: Asset Allocation As per the investment policy statement the total investment in US must not exceed 40%. The contribution of US based investment is 39.31%, which is in accordance with the investment policy statement. The details of US based investments can be seen in the 4th column of the asset allocation table above. In US and Non US Fixed Income security the returns 95 % of the 5% allocation to US and Non US fixed income fixed income bonds are US based bonds. Similar is the case with global Real estate investment trust category of assets i.e. 20% of Global REITS is US based remaining 80% is Non US based. In addition to this, infrastructure funds also include the US based funds. Therefore, the allocation is managed in a way that it cannot exceed the 40% to US based funds. The return earned is 9.68%, which covers both the spending requirement of 6.5% and the inflation adjustment. Therefore the return exceeds the required return of 8.7% and the risk level is within the specified range as mentioned in the policy statement. Details of Investments Table 2: Details of Investments As shown in the above table, the details of investments are shown along with the risk and return of each category of investments. A short description of each of the investment category is mentioned as follows 1. US Large Cap Equities Index: US large cap equities comprises of S&P 500 large cap stocks. The 5 year return is 15.61 %, and the standard deviation of returns is 13.17%. It covers all the stocks that cover large market capitalization in the stock market. The returns generated by large market capitalization is relatively higher to most of the other categories but due to restriction in investment policy statement the allocation cannot exceed the limitation of 40% of the US based investments. The 40% allocation to US based investment also includes the other US based investments as well such as small cap stocks, fixed income investments and alternative investments. The allocation made to US large cap equities index is 15% of the total portfolio. 2. US Small cap equities Index: The small cap equities are referred to as those stocks, which have small market capitalization. It can give the opportunity to the small investors to beat institutional investors (Bares). The reason is that the mutual funds have the limitation to make investments with large amounts. The small investors can enter in the market with the help of small cap stocks with reasonable returns. The 5 year return used for the asset allocation is 14.3% and the standard deviation is 15.2%. S&P small cap index is used for the purpose of asset allocation. The allocation is 8% of the total portfolio. 3. MSCI EAFE NON U.S Developed Market It is referred to as the stock market index designed to measure the equity market performance of developed market other than the equity market of US. It covers the stocks of Europe, Australia & Far East (Pompian). Correlation of the EAFE Non US developed market index with US equity market index is positive but low. Its risk level is higher i.e. 14.3% standard deviation whereas only 6.5% is the return. The portfolio allocation includes 21% of the portfolio as MSCi EAFE Non US developed index. Although the return and risk characteristics are not favorable but the US based investment has reached its cap therefore, the 21% allocation is suitable to generate the optimal portfolio in accordance with the investment policy statement. 4. MSCI Non US Emerging Market Equity: Its name clearly indicates that the index covers all the emerging market stocks other than US. The emerging market index generates the returns equal to 4.5%, which is very low and the risk level is high i.e. the standard deviation is 17.2%. The reason of high risk level is that the emerging markets have more uncertain returns and the chances of losses are higher. 5. US & Non US Fixed income Bonds: The total allocation made to this category of investment is 5%. The investment includes both the US based and Non US based fixed income bonds. 95 % of the 5% allocation is in US bonds, which equals to 4.75% of the total portfolio. Remaining part of this category is invested in Non Us bonds. The investments returns 8.6%, where as the standard deviation is 6.7%. This category include three investments which are as follows a) High Yield Corporate Bonds: High yield corporate bonds include more risky bonds with more risky and can also be a part of structured financial products (Choudhry)It includes 85% of the total 5% investment in the portfolio i.e. the exact allocation to high yield corporate bonds is 4.25% and it is 100% US based. The 5 year return is 8.97% and Standard deviation is 6.68% b) International Govt Bonds: It contributes 5% of the allocation made in US & NON US based investment bonds category because of very low returns and high variability of returns i.e 6.61%. it is 100% Non US based. c) Intermediate Govt Credit Bonds It is 100% US based and its contribution towards this category is 10%. The bond index returns 8.97%, whereas the variability of returns is 6.68%. 6. Emerging Market Fixed Income Bonds: It includes Non US based bonds, which are backed by emerging companies’ issued bonds. The risk level is high but after incorporating in the portfolio it gives diversification benefits. 7. Global REITS: The allocation includes four real estate investments categories.The allocation can be seen as follows The overall return on investment in this category is 7.93%. The first two categories i.e. Cohen & Steers and Mortgaged RE capped ETF are 100% US based, whereas Asia developed RE and international developed RE are 100% Non US based. The total contribution made in this category is 6% only. 8. Commodities: The five year returns of most of the commodities show very low or even negative returns. Therefore, only 1% is allocated in IShare trust which gives return of 2% , whereas the standard deviation is very high i.e. 19.97% 9. Private Equity: Individually investment in private equity is considered highly risky investment and it requires specialised expertise to analyse the investments. The returns generated by Power share Global Listed Private Equity is 10.84 %. The allocation to this category is 15%. The reason is that it gives more diversification benefit because of very low correlation with US based stocks and bonds. 10. Infrastructure Funds: It includes the following investments The total allocation to this category is 14%. The risk return characteristics are favorable. The funds are normally suitable for institutional investors seeking investments in core infrastructure in the global market. All of the three infrastructure funds are partially or completely US based. It may reduce the diversification benefit but the allocation suggests better results Conclusion: The Asset allocation completely fulfils the requirements of investment policy statement. The return level fulfills exceeds the required return of 8.7%.It covers both the spending requirement and the inflation adjustments. Secondly, the risk level is in the required range between 10 and 18% i.e. the standard deviation is 10.48%. In addition to this, the exact allocation to US based investments is 39.31%, which is approximately equal to the maximum level of investment allowed in US based securities. The Total number of investments is 17, which is beyond the minimum level of 15 and the investments are not made in individual stocks but in ETFs and other commingled instruments. Therefore, the asset allocation is proved to be optimal with respect to investment policy statement. Bibliography Bares, Brian. The Small Cap Advantage. Jhonson Wiley & Sons Inc., 2011. Choudhry, Moorad. Corporate Bonds & Structured Financial Products. Elsevier Butterworth-Heinemann, 2004. Gibson, Roger C. Asset Allocation: Balancing Financial Risk. McGraw Hill, 2000. Pompian, Micheal. Behavioral Finance & ivestor Types. Wiley , 2012. Read More