Investment Process - Portfolio Construction and Management - Case Study Example

Portfolio Investment strategy Course Professor’s Name Name of the Institution Date Portfolio Management An investment philosophy can be defined as a coherent way of thinking about markets, how they work and the types of mistakes and risk that are consistent with the underlie behaviour of the investor (Yunusoglu and Selim 2013). On the other hand, investment strategy is more narrow in perspective and involve putting in practice a given investment philosophy. Furthermore, investment philosophy is a set of core beliefs one can check back and act as a reference point for generating new strategies (Yunusoglu and Selim 2013). All investment philosophies to large extent begins with a view concerning human behaviour and how this behaviour adapt to different situations more so ones to do with investment. After learning human behaviour, you have to generate views concerning market behaviour and focus on failures, view on market efficiency and inefficiency as these forms the basis of philosophy (Yunusoglu and Selim 2013). Use the combination of investor behaviour and market characteristics to come up with investment philosophies. Investment process can be described as below From the case study, it can be seen that the above chart has been followed and some of the philosophoes that can be derived include: Portfolio construction and management: It should be noted that each and every market shows different characteristics, gives different returns and possess different risk. The investment should focus on the diversification of the portfolio during its construction and it should be structured across all market segments as this will help keep investors focused on all sectors (Harris and Mazibas 2013). Risk management: This is very important and one of the measures taken to reduce riskiness of the portfolio is the diversification. The nature of the client should be factored in whether he is risk averse or risk tolerant. Risky assets have higher return while at the same time less risk assets have lower return. This should be done in a way that risk from one area is mitigated with other sectors and explains reason behind diverse portfolio (Harris and Mazibas 2013). Asset allocation: each and every client should have their own unique portfolio and individual performance benchmark. Individual investor should have specific mix of stocks, bonds and cash which is very important investor goals and aims. The return on investments majorly depends on the portfolio selection and not the timing or the stock selection (Yunusoglu and Selim 2013). Asset allocation can be defined as the attempt to allocate and implement an investment strategy that helps in balancing the risk verses the reward by adjusting the percentage of every asset in the investment portfolio and this is done according to the investor’s risk tolerance, goals and investment time frame. The various asset allocation strategies include; strategic asset allocation which focuses on the base policy mix which is based on the expected rates of return. Second asset allocation strategy is constant weighting asset allocation which is mostly a buy-and-hold strategy (Yunusoglu and Selim 2013). Thirdly is the tactical asset allocation, it is relatively rigid, it adopts market timing and economic condition as strategies being used in investment analysis. Dynamic asset allocation is another strategy that can be used, it will constantly adjust to the mix of assets as markets rise and fall and as the economy grows (Harris and Mazibas 2013). Investment selection: this must be done carefully to ensure the balance of the investment goal of the investor and his financial goals. This philosophy champion for proper research concerning available investment opportunities which are available (Harris and Mazibas 2013). Portfolio design: this is another philosophy which can be used in this case study. It helps in strategizing investor’s investment portfolio. It ensures diversification of investment both in bonds, stock and other alternative cash investments. In this case, client portfolio are built based on extensive efforts to understand and define client investment goals and his level of risk tolerance (Guerard et al., 2015). The success of any investment strategy starts with proper investment portfolio design and these are the common steps that can be followed in making design. a) To identify the financial starting point b) Identify the finish line (Goals) c) Establishing time horizon d) Ability to save e) Required annual average return f) Defining investment personality (Risk) g) Establishing the portfolio asset allocation h) Determining diversification guidelines i) Developing written investment policy j) Identification of available assets to purchase k) Monitor, rebalance and adjust the investments l) Measure the portfolio annual rate of return A good portfolio design will ensure that all of the investor’s goals and investment decisions are complimentary and supportive to each other and helps in maintain the financial goals. Therefore, this is a very important strategy which should be embraced by all investment analyzed Tax management: impact of tax on the investor financial return is far reaching and adequate measures should be taken to ensure that this is proper covered. This philosophy will ensure that there is minimal impact of taxes on the chosen type of investment. This will focus on tax management to help potentially enhance after tax return (Guerard et al., 2015). Portfolio components, indicating the selected assets / securities and the magnitudes of investment in each. For the construction of this portfolio taking in consideration of the various philosophies like diversity and risk. The portfolio must be diversified and must reflect the risk averseness of the investor in this case (Guerard et al., 2015). The portfolio sheet consist of four assets from different companies and different industries all together. In this, we will develop and calculate the return and riskiness of this portfolio. The different industries shows the philosophy of diversity while the philosophy of asset allocation is shown by the four different assets which is being used to construct the portfolio (Das 2016). The industries include:- Name ADELAIDE BRIGHTON AGL ENERGY ALS ALUMINA GICS Industry Construction materials Multi-utilities Professional services Metals and mining R1 R2 R3 R4 Standard Dev. 0.068508 0.03829 0.105814 0.108837 Variance 0.018598 0.014768 0.026217 0.027013 0.000709 0.00075 0.004228 From the excel calculation, the volatility of the different assets can be seen and it is characterized with low volatility throughout the portfolio. This can further be done using forward portfolios which include the following Time Period Contract Forward Forward Futures Futures 1 25 12300 492 5336 133,400 2 10,000 49,500,000 4950 123,750 133,400 3 106 524,700 4950 123,750 13,400 Total 50,037,000 10392 252836 280,200 The risk free rate for the portfolio will be given by Given the Risk-Free rate is: 5.00% OPTIMAL PORTFOLIOS Risk Ratio Return Std. Dev. Premium RP/SD AGL ENERGY 0.1126 0.1606 6.26% 0.390 0.115 0.1548 6.50% 0.420 0.12 0.1494 7.00% 0.469 0.125 0.1475 7.50% 0.508 ALS 0.1283 0.1471 7.83% 0.532 0.13 0.1472 8.00% 0.543 0.14 0.1509 9.00% 0.596 0.15 0.1572 10.00% 0.636 0.16 0.168 11.00% 0.655 0.17 0.184 12.00% 0.652 0.18 0.2045 13.00% 0.636 0.19 0.2282 14.00% 0.613 ALUMINA 0.2075 0.3278 15.75% 0.480 Recommendation from the various portfolios It is obvious from the analysis and investment strategy, that there is diversification of risk from the various assets which the investors are intending to invest on. This has help in reducing the risk of the overall portfolio investment. Asset allocation has held in diversification of the risk and overall investment opportunity (Das 2016). Diversification is the safest way to reduce risk as it is not easy and it is impossible to eliminate risk from all kinds of investment. The tax management on the investment strategy further reduced the tax expenses while the overall return after tax is high due to low tax in the selected asset portfolio (Feldman et al., 2014). Forward contract are stochastically dominate to other market derivatives in the market. Investment selection is also important and has also been taken in consideration. Another important philosophy that has been successfully utilized within this strategy is portfolio design philosophy which has been used in this case study. It helps in strategizing investor’s investment portfolio overlay and return. Reference Das, S.K., 2016. Construction of Portfolio Using Sharpe Index Model With Reference To FMCG Industry in India. Adhyayan: A Journal of Management Sciences, 4(1). Feldman, R., Govindaraj, S., Liu, S. and Livnat, J., 2014. Optimal Portfolio Construction Using Qualitative and Quantitative Signals. Communication and Language Analysis in the Corporate World, p.140. Guerard, J.B., Markowitz, H. and Xu, G., 2015. Earnings forecasting in a global stock selection model and efficient portfolio construction and management. International Journal of Forecasting, 31(2), pp.550-560. Harris, R.D. and Mazibas, M., 2013. Dynamic hedge fund portfolio construction: A semi-parametric approach. Journal of Banking & Finance, 37(1), pp.139-149. Yunusoglu, M.G. and Selim, H., 2013. A fuzzy rule based expert system for stock evaluation and portfolio construction: An application to Istanbul Stock Exchange. Expert Systems with Applications, 40(3), pp.908-920. Read More