Finance Investment Advice to Bill Gosset - Case Study Example

Investment Advice to Bill Gosset Name: College: Course: Tutor: Date: Bill Gosset has earned himself a $2 million inheritance. The amount is too much to consume directly. It is prudent to save or invest such an amount of money. Bill chooses to invest his inheritance. An investment is an allotment of riches into an assortment of assets with anticipation that they will yield income or returns in the future. Arriving at a suitable investment choice is not a walk in the park. There are varieties of investment assets that are separated by risk and returns. Risk and return are, to some extent, correlated; the greater the risk, the higher the return. A stringent process has to be followed in arriving at the most fitting investment plan for the investment pool. The process entails the allotment of funds to various asset classes, performance appraisal and investment review. The allotment stage is the most crucial and engaging. It involves looking at the various investment assets available, and how they are transacted, risk tolerance and the investment period as well as settling on the optimal investment combination. Performance evaluation is essentially looking at the returns and the risk that occurred. Then the investment has to be reviewed to determine whether the expectations were met and what alterations can be made. Investment Selection Investment opportunities can be broadly stated into three categories; financial markets, derivatives markets and international markets. Investment assets range from cash assets, equity instruments, fixed asset instruments and property assets (Reilly & Brown, 2012). In Australia examples of these assets include Asset/Instrument Investment examples Cash 180-day treasury bills 90-day treasury notes Equity Managed funds Foreign stocks Australian company stocks Property Commercial property Residential property Fixed-interest Debentures Government bonds 3-year commonwealth government bonds The goal of investment is to minimize risk as one maximizes returns. Bills investment will entail both low risk tolerance assets and high risk tolerance assets. Bill intends to be out of the country for a period of over two years. It is thus desirable to choose a long-term holding that is concentrated more on the probable risks and the anticipated returns. It is still prudent to consider short-term holdings that shift in respect to changes in the fundamental market environment. Bill will not be personally involved in the investment activities. Investment is a compound and overpowering exercise. There are two main management options; active management approach and passive management approach. Active Approach versus Passive Approach An active approach is an investment strategy whose endeavor is to outperform the market. Outperformance is achieved by beating a set benchmark. It entails an active search for information and gathering insights to help arrive at an investment decision. This is common in the managed funds under the watch of skilled and active managers. The managers consider that owing to the disorganization, indiscretion, and anomalies in the capital markets, they can make a kill using their insight and skill. Prices take time to respond to information allowing the managers to outperform the market. According to John Wiley & Sons (2008), a truly disorganized market should mount to a profit-making opening. There are many methods of active management that include macroeconomic analysis, quantitative analysis, technical, and analysis of basics. Passive approach is also referred to as indexing. This form of investment strategy is based on investing in precisely alike securities and in similar amounts as an index such as S&P 500 and Dow Jones Industry Average. The manager aims at duplicating the feat of an index as intimately as possible. Different sectors of the markets are considered. Passive managers are ready to allow average returns from various asset classes. Unlike active managers, passive managers believe that market prices are always fair and quickly adapt to information. Passive managers still accept as true that outperforming the market for investors is a difficult task. They therefore do not make an effort to pound the market but to go with its performance. Both approaches have received unyielding support from different parties. Each approach has its benefits and demerits. The investment will involve both the active and passive management (John Wiley & Sons, 2008). Managed Funds Managed funds constitute an investment pool of many individual investors like Bill. The pool is invested by a skilled manager in different asset classes. An individual investor is then to be paid on a number of units thus becomes a unit holder. This is an active investment aimed at outperforming the market. This is a suitable investment for Bill since it makes available an accurate amount of running it without engaging in time-consuming management. Managed funds are very beneficial. They suit an individual investor. The investor can choose a fund that offers a regular and stable income or a capital growth investment. There is also liberty on the amount of risk involved. A managed fund is open to different fund managers, asset classes, countries and markets. Bill can achieve this diversification given that he has large sums to invest that are usually called upon in the case of diversification. Bill can as well benefit from skilled management. Fund managers are equipped with resources, familiarity, and know-how. They have an easy admission to information, make inquiries, and have the knowledge to investment processes not obtainable by individual investors like Bill with good grace. Bill also will have entry to classy investment apparatus. According to SPIVA Australian Scorecard (2012), a bulk of active funds underperformed their particular benchmarks crosswise in asset classes considered. However, Active Australian equity small-capitalization funds considerably outperformed their benchmarks. The funds exhibit a brawny active performance. Stocks within this category are generally under researched compared to large-capitalization funds, which makes it possible for active managers to pound on any mispricing openings in the market. Well over 80 percent of all Australian equity small-cap funds beat the benchmark over a one year period or more. In addition, the managed funds sector in Australia has taken advantage of a healthy 3.3 percent per-annum average growth rate in GDP from 1998 to 2009. The main enlargement drivers are a sturdy insurance sector, an increasing high-net-worth and retail investor sector. The report details that only 16 percent of Australian equity small-cap funds were outperformed by the respective index in the quarter. This reflects to 15.79 percent, 20.73 percent, and 20.78 percent in the one-year, three-year and five-year periods respectively. The equal- and asset-weighted average returns of the funds reveal that the funds outperformed the index across all time periods by a considerable scope. The report also indicates that the asset-weighted returns were higher than the equal-weighted returns across all time periods. Survivorship is comparatively healthy (82.89 over the five-year period) which is the uppermost amongst the peer groups over the similar period. Equal-weighted fund returns Quarter (%) One-year (%) Three-year annualized (%) Five-year annualized (%) Australian Equity small-cap -10.54 -7.15 11.22 -3.47 S&P/ASX Small Ordinaries Index -15.30 -14.61 3.39 -8.89 Source: S&P Dow Jones Indices, Morningstar Asset-weighted fund returns Quarter (%) One-year (%) Three-year annualized (%) Five-year annualized (%) Australian Equity small-cap -10.00 -6.02 11.62 -3.03 S&P/ASX Small Ordinaries Index -15.30 -14.61 3.39 -8.89 Source: S&P Dow Jones Indices, Morningstar According to the Reserve Bank of Australia Bulletin (2003), the retail fund management fees have three rudiments; entry, ongoing and exit fees. Individual fund managers charge varying fees based on the asset types and size of funds. Active management is comparatively costly as a result of the research undertaken and the higher transaction costs. Performance-based fees are also present in fund management. The fees are altered to meet demands of individual investors. The fees are much lesser for pooled funds than individual mandates. Performance-based fees offer an inducement for fund managers to keep up a wholesome fund size that capitulate the most favorable return. Pooled Australian equities attract a 27 percent fee on all funds invested compared to 49 percent for individual mandates. Bond Market The Australian bond market is characterized by fixed-interest class securities and long securities (usually exceeding one year). Interest payments are made at intervals of either six or twelve months. A range of bonds exist; government bonds, corporate bonds, scrutinized products such as mortgages and local or semi-government bonds. Governments bonds are less risky and therefore attract a very low return as opposed to corporate bonds that are very risky thus attract high returns. Bonds are traded in informal secondary markets with some corporate bonds finding their way in the Australian Securities Exchange (ASX). Gains from bond instruments are privy to ordinary income tax at the investor’s own tax rate. The table below summarizes the percentage returns on various government bonds; Bond instrument 1999 2001 2003 2005 2007 2009 Australian government 2-year bond 6.06 4.63 5.48 5.29 6,72 2.54 Australian government 3-year bond 6.26 4.96 5.57 5.31 6.66 4.83 Australian government 5-year bond 6.49 5.33 5.71 5.34 6.46 5.25 Australian government 10-year bond 6.74 5.82 5.76 5.35 6.21 5.47 Local/semi-government bond 6.94 5.58 5.90 5.58 7.01 5.84 Source: Reserve Bank of Australia Investment in a three-year government bond would be appropriate considering Bill’s time frame. Conclusion There is a wide range of investment asset classes. The choice of an asset class is dependent upon the risk involved and the returns. A higher the risk translates to a higher return. Given Bill Gossets case, investment in both active and passive management is desirable. Active investment is managed funds is the best option given the flexibility it enjoys. Passive investment in government bonds is also very suitable as Bill can purchase a three-year government bond a hold it up to its maturity as he concentrates on his career. References Al-Khelaiwi, F.T. et al. (2011). Advanced Wells: A Comprehensive Approach to the Selection Between Passive and Active Inflow-Control Completions. SPE Production & Operations. 25 (3), 305-326 Cumby, Robert E. & Glen, Jack D. (2012). Evaluating the Performance of International Mutual Funds. The Journal of Finance. 45 (2), 497–521 Daum, P (2012). Investment Portfolio Selection and Performance Measurement. Santa Cruz, CA: GRIN Verlag, Gresham, S. D (2011). Advisor for Life: Become the Indispensable Financial Advisor to Affluent Families. Hoboken, N.J: John Wiley & Sons. Haight, G., Glenn, R & Morrell, S. O. (2007). How to select investment managers and evaluate performance a guide for pension funds, endowments, foundations, and trusts. Hoboken, N.J: Wiley. John Wiley & Sons (2008). Handbook of Finance, Financial Markets and Instruments. Hoboken, N.J: John Wiley & Sons. Reilly, F. & Brown, K. C (2012). Investment analysis & portfolio management. Mason, OH: South-Western Cengage Learning. Reserve Bank of Australia Bulletin (2003). Changes to the Reserve Bank of Australia’s Index of Commodity Prices. Retrieved October 19, 2012 http://www.rba.gov.au/publications/bulletin/2003/oct/pdf/bu-1003-2.pdf SPIVA Australia Scorecard (2012). S&P indices versus active funds scorecard (SPIVA Australia Scorecard). Retrieved October 19, 2012 http://www.australianprivatecapital.com.au/files/spiva-australia-mid-year-2012.pdf Read More