Explanation of the Investments that Is Due to Inherited by Dr Foster - Case Study Example

Investment Banking Contents Introduction 3 Discussion 3 Explanation of the Investments that is Due to Inherited by Dr. Foster 4 Addressing the Comments made by one of the Colleagues of Dr. Foster 8 Queries of Wealth Manager before Designing Portfolio for Dr. Foster 9 Recommended Portfolio for Dr. Foster 9 The Fixed Instrument Segment 10 The Balanced Segment 11 The Equity Part 11 Conclusion 12 Reference List 13 Introduction Wealth Management is an important aspect for all individuals engaged into professional and commercial services in order to understand their long and short term financial objectives. Wealth management also reveals the difference between the actual wealth possessed by an individual and the perceived level of wealth he or she should have acquired in order to serve his/her financial purpose on a specified time (Maude, 2010). Proper wealth management ensures individuals that they will be able to maintain similar lifestyle, for example after 20 years that they are maintaining today (Kendall and Rollins, 2003). This becomes possible through efficient management of finances by constructing a portfolio that includes different asset classes, keeping in mind the age, risk taking capacity and expected rate of annual increment of income of the individuals. In this era of rapid privatization, though the average income and probability of getting a handsome job have increased, job sustainability and financial security has been radically decreased. Therefore, in order to secure the future monetarily, every individual must involve into construction of sound portfolio without any delay (Marston, 2011). In this paper, a portfolio will be designed for a 50 year old university lecturer, Dr. Foster for creating her retirement corpus. Discussion Being a partner in a wealth management firm, the primary responsibility is to design investment portfolios for clients, especially for high net worth individuals. Dr. Foster is a potential and new client of the firm who has given an appointment at 2pm on 5th May 2015 for obtaining professional advice on his existing holding. She is also expecting suggestions and recommendations on how the investible surplus of her can be distributed among various asset classes effectively so that she can withdraw good return at the time of her retirement. According to the existing information, Dr. Foster is free from any debt obligations. She owns a residential property. The existing investment portfolio of her is expected to fetch her 600,000 at the current age of 50. This portfolio is diversified in the following distinct holdings such as M&G Index Tracker Fund and Ordinary shares in a constituent of the FTSE-350 (M&G Investments, 2015). Explanation of the Investments that is Due to Inherited by Dr. Foster The existing portfolio of Dr. Foster holds M&G Index Tracker Fund and ordinary shares of FTSE-350. Such construction of portfolio indicates that it is highly equity oriented. Thus it is severely exposed to risk with an expectation of high return. Considering M&G Index Tracker Fund, it is an equity oriented mutual fund that replicates the index movement of London Stock Exchange. In fact, it has chosen FTSE All-Share Index. Therefore, movement and return of the fund highly depends on the fluctuation and return of FTSE Index (FTSE, 2015). One positive aspect of selecting index fund is that such funds include passive fund management. In other words, the investor does not need to rely on the potential and capabilities of the fund managers. Hence, only market risk is associated with such investment, no risk related to the fund managers’ decision can affect the return possibility of the investment (M&G Investments, 2015). Therefore, the fund management charges and brokerages for churning the fund tends to be low as compared to any other equity funds. As the investment horizon for this fund of Dr. Foster is not known, it is assumed that Dr. Foster had kept the money into the fund for either 1 year or 5 years. Figure 1: Return from M&G Index Tracker Fund over 1 and 5 years respectively (Source: Morningstar, 2015) Considering that, Dr. Foster had invested for 1 year, from the above graph it is evident that the fund has encountered high fluctuations over the period of time and has been able to generate a return of 6.6% which is almost similar to the returns of dent funds. Whereas, over a long period of 5 years the same fund has grown, sharply generating a return of more thn 11% (FTSE, 2015). In general, it has been noticed that though the idex fund takes the opportunity of upside trend of market, there is no scope for downside protection when the market is falling steadily. In fact, the scope for churning the portfolio is very less. For instance, in a balanced fund, when the porfolio manager suspects that the marekt is going to be bearish, he shift certain amont from the fund to some debt instuments so that the fixed return can be obtained and the aggregate porfolio does not show a negative return. Therefore, by investing in the M&G Index Tracker Fund, Dr. Foster has to forgo as such possibilities that she should acquire through investing in other funds (M&G Investments, 2015). Dr. Foster also purchased ordinary shares under FTSE-350. The shares under FTSE-350 are the stocks of the largest 350 British companies listed on London Stock Exchange, in terms of their market capitalization. Similar to the case of previous investment, if it is assumed that Dr. Foster had invested in those equities either for 1 year or for 5 years, the market had shown a return of 4.29% over one year and 8.11% for the period of 5 years (Financial Times, 2015). Figure 1: Return from FTSE-350 over 1 and 5 years respectively (Financial Times, 2015) However, the degree of return largely varies on the movement of the purchased stocks. Therefore, if the return prospect is kept aside (as which shares were bought by Dr. Foster is not know) from the choice of investment instruments, two things are prominent. First, Dr. Foster had invested in same asset classes i.e. equity. As a result, the probability of diversifying the risk arising out of investment is very limited for Dr. Foster. In fact, in equity also, Dr. Foster had selected a mutual fund which is linked to FTSE-350 Index and she had also invested directly to the scripts under FTSE-350 (Financial Times, 2015). Therefore, much more diversification would have been possible if the investment was done under guidance of professional wealth managers and value of the portfolio might have been much more than 6, 00,000 which she is going to inherit at present. Addressing the Comments made by one of the Colleagues of Dr. Foster As Dr. Foster has very little understanding about finance and investment, she discussed with her colleague regarding various investment options and the return percentage she should get over a period of 10 years. According to her colleague, if she can properly re-invest the corpus of 6, 00,000 which she is expecting to obtain in this financial year, the corpus should definitely grow to 1 million within 10 years of time. Therefore, as per the client’s comment, Dr. Foster should anticipate for a return of 16%-17% annually. Obtaining a return of 16% is very much relevant for an individual to expect but such return anticipation must align with the age of the investor, the time horizon of investment and the purpose of investment. For example, if a profession within the age group of 30-35 expects a return above 15%, he can be advised to enhance his investment exposure to equity as much as possible. High risk exposure may result in high return for the individual; however, if the market crashes, the professional has much time to absorb the loss and recover it before his retirement (Zwecher, 2010). Now, if similar portfolio is designed for a 50 years old individual, exactly like Dr. Foster, he or she may find it difficult to recover the loss as she is approaching towards her retirement. Moreover, as age increases, the priority also changes. If investment is done for achieving a short term goal, for instance, with a motive to purchase a car or planning for a holiday, such plan can be postponed if the investment fails to procure the expected level of return. In contrast, if an individual is planning for a retirement corpus from which he will be withdrawing a part of his monthly pension and availing medical facilities, no compromise can be done in this regard. Such investment should be planned in such a way that it may fetch comparatively low return but it should not deviate much from the expected level so that all his necessities can be addressed without fail (Pompian, 2011). Queries of Wealth Manager before Designing Portfolio for Dr. Foster Before constructing an ideal portfolio for Dr. Foster, the wealth manager should know if she is having any definite purpose behind the investment, the tenure for investment as well as short and long term financial objectives that she is expecting to accomplish through enchasing the investment. As the meeting with the client is scheduled on 5th May 2015, the manager structured a questionnaire to understand the following aspects. The first question the manager asked Dr. Foster was whether she wanted to invest whole amount of money for next 10 years or if she needed to withdraw some part of it after 3 or 5 years (Reilly and Brown, 2011). Next, he asked her, if she is having any liability that she will have to accomplish in the upcoming years. Such responsibility includes child’s higher education and child marriage. The wealth manager also needs to know if Dr. Foster will receive any medical facility from his university after his retirement as well and whether this will be the only investment he will do for constructing her retirement fund or is she having other investments as well and this fund will only enhance his existing retirement fund (Pompian, 2011). If she is having other investments too, the portfolio manager is also required to know what kind of investments she is having; more specifically, the asset class in which the investments have been done, expected return, tenure of the investments etc (Reilly and Brown, 2011). Only after obtaining the answers of all his queries, the manager will be able to design the portfolio for Dr. Foster. Recommended Portfolio for Dr. Foster From the obtained information from the client, the manager has come to know that presently Dr. Foster is 50 years old and she is willing to retire at the age of 60. This means that she is having 10 years before her retirement. Therefore, the portfolio should be constructed in such a way that she will be able to enjoy the return out of his investments immediate after his retirement. Moreover, as she is approaching towards her retirement, the wealth manager should make Dr. Foster understand that in spite of getting influenced by the words of any layman, she should shape his investment in a professional and justified way (Zwecher, 2010). According to the thumb rule of investment, an investor should invest in equity less than a percentage which can be obtained by subtracting her age from 100. That means, in case of Dr. Foster, her equity exposure should be (100-50) = 50% or less. Rest of the 50% or more should be invested on fixed income instruments, debt and balanced instruments of investment (The Telegraph, 2014). Dr. Foster should also follow the thumb rule for obtaining a secured return in her old age. Following the principle, the portfolio for Dr. Foster will be segregated into three following segments. The Fixed Instrument Segment The first investment instrument the wealth manager should recommend is the United Kingdom 5% Treasury 2025. This is a 10 years treasury stock issued by the government of United Kingdom. The rate of interest is fixed at 5% which is payable semi annually on 7th March and 7th September. The treasury stock was introduced in the year of 2012 and is traded in the secondary market. The investment will be redeemed on 2025 and both the principle and the appreciation value of the treasury stock will be paid to the investor at the time of redemption (United Kingdom Debt Management Office, 2012). Investing on this investment instrument, Dr. Foster will be able to safeguard her capital from market risk. Apart from that, as the return is available half yearly, Dr. Foster will also gain a source of additional income to meet her short term obligations, if any, as well as his regular expenses. Therefore, she should be recommended to invest at least 40% of her disposable surplus in this investment option (United Kingdom Debt Management Office, 2012). Figure 3: Portfolio Allocation for Dr. Foster The Balanced Segment Considering the rest of amount, instead of increasing his exposure on M&G Index Tracker Fund which is completely equity oriented, Dr. Foster should choose from wide range of balanced or debt mutual funds available in the market. Under debt mutual fund, which are promised to pay a moderate but secured return over a certain period of time, Dr. Foster may go for EUR Bond - Long Term or Global High Yield Bond - CHF Hedged. All these funds are expected to pay an average of 8.27% to 8.97% over a period of 5 year. Hence, the fund will get an opportunity to grow at a sound rate till 5 year with minimum risk possibilities. After 5 years, she will also get a chance to reinvest the fund so that the aggregate return can be much more than investing in a single fund for 10 long years. Balanced funds such as Fidelity Balanced and Buffalo Flexible Income are also better than M&G Index Tracker Fund for investing at an age of 50. This is because, in balanced funds, when the fund manager predicts that the market is going to give a negative return in upcoming time period, he transfers the asset holding from equity to any fixed instruments so that the investor can still enjoy the positive return from such instruments at the time when the market is yielding a negative return. In the opposite scenario, when the market is in full swing and rising sharply, such funds provide the investors the essence of equity market as well. Therefore, Dr. Foster should invest another 40% of this corpus in these balanced and debt mutual fund. The Equity Part The rest of the 20% surplus amount, it should be distributed among blue-chip equities which will be directly purchased from the London Stock Exchange. While purchasing shares of blue chip and Fortune 500 companies the most important factor required to keep in mind is the time of entering the stock market. Dr. Foster should enter the market while the market is down and the market values of the stocks are showing a price close to it “52 weeks low” price. However, it is better not to square off the position frequently in order to avoid the possibility of lowering the rate of return due to obligation of payment of brokerage charges. In general, if Dr. Foster keeps aside the equity part of her portfolio for a long horizon of 10 years after investing, it will provide an average return of 10%- 15%. Therefore, Dr. Foster should design her equity participation in this manner. In aggregate, Dr, Foster can expect an average return of 7.75% annually which is higher than the return from bond market and close to average return from large cap equity market. Conclusion An ideal portfolio should be constructed is such a way that should be able to address all the requirements of the client and enable him or her to derive a return that can beat the market return. The expected return should not be so high that the inherent risk may thrash the investors’ expectation and it should not be so low that it does not even beat the inflation. Considering the existing investment profile of Dr. Foster, her previous investments were more of equity oriented which is not suitable according her age and purpose of investment. Therefore, the suggested portfolio is designed in a manner that will provide her a fixed return as well as give her an opportunity to enjoy the high spirit of equity market. Reference List Financial Times, 2015. FTSE 350 IDX. [Online] Available at: [Accessed 3 March 2015]. FTSE, 2015. FTSE UK Index Series. [Online]. Available at: [Accessed 3 March 2015]. Kendall, G. L. and Rollins, S. C., 2003. Advanced Project Portfolio Management and the PMO: Multiplying ROI at Warp Speed. London: J. Ross Publishing. M&G Investments, 2015. Index Tracker Fund. [Online] Available at: [Accessed 3 March 2015]. Marston, R. C., 2011. Portfolio Design: A Modern Approach to Asset Allocation. New York: John Wiley & Sons. Maude, D., 2010. Global Private Banking and Wealth Management: The New Realities. New York: John Wiley & Sons. Morningstar, 2015. M&G Index Tracker A Inc. [Online] Available at: [Accessed 3 March 2015]. Pompian, M., 2011. Behavioral Finance and Wealth Management: How to Build Optimal Portfolios That Account for Investor Biases. New York: John Wiley & Sons. Reilly, F. and Brown, K., 2011. Investment Analysis and Portfolio Management. Boston: Cengage Learning. The Telegraph, 2014. The best foundations for a solid portfolio. [Online] Available at: [Accessed 3 March 2015]. United Kingdom Debt Management Office, 2012. Auction of £2,500,000,000 5% Treasury Stock 2025. [PDf] Available at: [Accessed 3 March 2015]. Zwecher, M. J., 2010. Retirement Portfolios: Theory, Construction and Management. New York: John Wiley and Sons. Read More