Investment Strategy and Portfolio Management for Morris - Case Study Example

Table of Contents Table of Contents 2 Introduction 3 Morris Fund 3 Investment environment: The opportunities arise 4 A diversified portfolio for Morris to choose from 5 Asset Allocation 5 Conclusion 6 Bibliography 9 Introduction Investment can be perceived as the process of generating wealth over a period of time. In the process of investing, a person effectively allows a second person or entity to use his funds and in exchange, provide with a return. This return serves as an add on to the person. Investment has been a lucrative activity because of its ability to generate high volumes of wealth, when done properly. Investment strategy depends on risk return trade off. The greater is the risk associated with the investment, the higher return is expected (Siegel & Shim, 1991, p.42). In the modern world, there are a number of avenues that promotes itself as an investment avenue and promises to generate varying returns for the investors. Means of investment have grown larger to include new avenues like gold, real estate, commercial papers, commercial deposits, mutual funds etc. The advantage of investing in a pooled investment vehicle is the size of investment. A pooled fund has a larger corpus than an individual investment and hence can utilize a broader opportunity of investment. Any investment fund needs to have its objective, based on which it decides the avenues of investing. Another important determinant of the fund is the risk appetite of the investors. A fund must have a pre decided risk taking ability so that the asset allocation can be decided. There are certain other factors which need to be taken into consideration such as the required liquidity, the maturity period and the tax considerations (Davis & Steil, 2004, p.52-55). Morris Fund The charitable fund created by a group of investors to generate wealth in order to pay for the educational expense of the children of the investors has a lock-in period of 5 years. The fund, in its very essence, appears to be a moderate risk bearing fund in the sense that it needs to ensure availability of funds for the educational purpose of the investor’s children. Currently, the members of the investment committee are apprehensive of withdrawals of the corpus exceeding the inflow of funds by a margin of 3% in the next five years. For the sake of analysis, it needs to be assumed that the cost of higher education will be rising and hence the need for funds will keep on rising as well. The main purpose of the fund should be to ascertain that the difference between fund inflow and outflow does not get misbalanced in a way that it jeopardizes the very existence of the fund. Investment environment: The opportunities arise The investment environment post financial crisis has remained all across the world and UK has been no exception to this. Equity markets have been hit with the FTSE recording severe lows and many privet equity firms suffered with erosion of investment due to financial crisis (Capital, 2008). With passage of time and government intervention, the situation is slightly better. Paul Davis finds that though there has been resurgence in the capital markets, they are still to touch the pre-crisis levels. This is an indication that Morris find, with its heavy equity allocation might have undergone capital erosion during the recession. Considering the present economic scenario of Europe it appears that to achieve sustainable growth in long term a balance need to be developed between consumption and saving. As the economy is recovering in UK, soon there will be high demand for labour and wage rate will appreciate, which in terms would increase the overall income status of the people (Annunziata, 2010). The income funds are on the right track this year. The investors, who are looking for decent yield, can go for the income stocks which look striking once again (Ross, 2010). However the scenario is not same for the corporate as the financial downturn has put them in a trembled financial situation. Considering the present market scenario hedge fund appears as a good investment instrument. The regulators in European Union have come forward to control and monitor the private equity and hedge funds. Surely this move would be able to inject more faith and interest in these funds. This financial downturn has given an opportunity to the private equity funds to represent themselves as the asset class. Rising tension in government bond market has made this investment opportunity quite gloomy to the investors. Banks are unable or unintended to provide credit to the companies, who are still burden with huge obligations. At this time, even government, with higher budget deficits, is putting huge demand on the bond market (Barber, 2010). Consequently the corporate bond market is getting squeezed. So it seems that neither government bond nor corporate bonds can give the growth and income which is much important for Morris fund. Last year a number of companies have defaulted in their debt payment (Mackenzie & Bullock, 2009). The option to invest in corporate bonds would remain risky this year as most of the companies would be trying to get themselves restructured. Though government bonds are known as less risky, but at the same time reap little return. Yield on a five year UK government bond is as low as 2.98 % (Financial Times, 2010), though it is on its rising phase. The weak numbers of the 10 year bond yields suggested that the budget deficit is going to be worse in future (Oakley & Hope, 2010). The equity market has seen rise this year. FTSE 100 has marked record gain, since July (Elder, 2010). So the prospect in equity indices is quite high. A diversified portfolio for Morris to choose from The way Morris would like to invest would depend upon the investment goals, tax status and the preferred time period; at the same time it would depend upon the risk Morris is willing to bear during this period (Securities Industry and Financial market Association, 2010). Morris has a wide option of investment opportunities. Morris can have its asset allocation in hedge funds, stocks, fixed income securities, equity indexed funds and government bonds. Each of them has their risk return trade off. Investing in equity can be an attractive option for any investor who would be looking for high return. At the same time this would bear high risk with it aligned with that high return. Equity indexed funds are managed by imitating the stocks in the benchmark indices. Some index funds can have the stocks available on the respective index but in different proportion. All of them are actively managed. There are a number of index funds which have the same stocks on benchmark and that too in the same proportion. These funds can be passively managed as they blindly imitate the benchmark index. There is no iota of doubt that the passive funds would cost much lesser than the actively managed funds. Some analysts say that funding can be cost effective if actively managed funds can be matched with passive tracker funds. It is better to have blend of both active and passive assets in the portfolio (Vincent, 2010). Hedge funds are meant to minimise the volatility in the portfolio and maximise the return at the same time. Fixed income securities are good investment options for long term investors. Holding fixed income securities can let cash inflow to take place in a fixed interval. Though government bonds reap very low return, still they are the least risky investment option available. The asset allocation in a portfolio would depend upon the risk appetite of the investor. Asset Allocation One can change add new asset funds; eliminate some of the new existing assets or doing the both (Watson Watt, 2009). The fund managers should look for a portfolio which would reap the highest possible return, both in short term and long term, at a moderate risk. The underlying assumption is that as the fund is meant for bearing the cost of education, it can not afford to take much risk. At the same time as the inflow to this fund is quite low than the outflow, Morris would surely try to match that up. In that case Morris would not be able to avoid taking moderate risk in its portfolio. Morris should look for income and growth funds which would be profitable both in short and long term (Financial Times, 2010). While choosing the fund Morris must make sure that it would provide income in short run and capitalisation growth in long run. As right now these funds are doing quite well, Morris can put a good amount of investment in these. In stocks, Morris have option to invest in oil and gas, utility sectors as these sectors are rising high these days (Financial Times, 2010). Equity linked with FTSE 100 would be a great option for Morris to take on, as the index is on rising spree and at the same time well diversified too. Though it is better to have most actively and passively managed funds in one’s portfolio; still as the index is doing quite well now, it would not be quite wrong to place the higher amount in passively managed funds. To hedge the volatility in the portfolio, Morris must have an investment in hedge funds. As hedge funds are now monitored by the European Union regulators, they are going to be an enhanced investment option. Therefore these hedge funds will comprise the major part of asset portfolio of Morris Capital. As the situation is quite gloomy for corporate and government bonds, it would be better to have lesser amount allocated to these areas. In fixed income securities Morris should look for coupon bonds which would give annual coupon to the investors. In case, they can look for high yield bonds (Bain, 2010). In that case Morris would match the cash outflow with the coupon inflow; although for the time being, suggestion would be not to have these securities on the portfolio. As many companies have defaulted on their debt last year, these securities can be proved quite risky this time. As the situation would become better for the bond market, Morris should look for investing in this. Morris must have government bonds in its portfolio, though they reap very low profit. As these bonds are of low risk category, this investment would help Morris to offset the risk it is going to take with other assets in its portfolio. Conclusion Many fund managers were caught by surprise at the arrival of the financial crisis. Focusing on smart and flexible strategies is very much important in this current market (Watson Watt. 2009). Investment strategy depends on risk return trade off. Investment with lesser risk and better return is always preferable. Inappropriate investment strategy incurs risk without sufficient reward attached to it (Stanford, 2004). A portfolio which seems to be the right one at a time may not seem so in an altered environment. Most of the economy has been badly impacted by the recent recession. That is a reason that corporate bond market is not so attractive this time; but surely situations will change in future. Even there can be a change in the risk appetite of the investors. In both the situations the asset allocation needs to be changed aligned with the events. So it is very much needed to actively manage this fund in accordance with the economy and the risk appetite of the investors attached to this fund. The managers, who are managing the fund, must have their money invested in the same fund, so they would be more responsible to maximise the profit of the funds. Moreover the fund needs to be well diversified to minimise the unsystematic risk as much as possible. Reference Annunziata, M. February 10, 2010. Corporate debt’s role in the eurozone recovery, Financial Times. Available at: http://www.ft.com/cms/s/0/9548d2a8-1637-11df-8d0f-00144feab49a.html?nclick_check=1 Last accessed 4th March, 2010 Bain, D. February 22, 2010. The Case for High-Yield Bonds. Available at:http://online.wsj.com/article/SB10001424052748703787304575074941945872852.html?KEYWORDS=Equity+investment+in+UK Last accessed 5th March, 2010 Barber, T. February 15, 2010. European bond tensions hurt lending, Financial Times. Available at: http://www.ft.com/cms/s/0/f6976c2a-1a26-11df-b4ee-00144feab49a.html Last accessed 5th March, 2010 Capital, S (2008) FTSE 100: Highlights from a turbulent 2008, Telegraph. Available: http://www.telegraph.co.uk/finance/markets/4044435/FTSE-100-Highlights-from-a-turbulent-2008.html Last accessed 10th March, 2010 Davis, P. E. & Steil, B. 2004. Institutional Investors. MIT Press. Elder, B. February 19, 2010. BT bounces as FTSE maintains rise, Financial Times. Available at: http://www.ft.com/cms/s/0/d27baacc-1d23-11df-b12e-00144feab49a.html Last accessed 11th March, 2010 Financial Times. 2010. Bonds & Rates Overview. Available at: http://markets.ft.com/markets/bonds.asp Last accessed 11th March, 2010. Financial Times. 2010. Markets data. Available at: http://markets.ft.com/markets/sectorsAndIndustries/sectors.asp?s=600280&ss=WSODIssue&encodedName=Telecommunications Last accessed 11th March, 2010. Financial Times. 2010. UK Equity Income & Growth. Available at: http://funds.ft.com/UKUnitTrustsandOEICs/UKEquityIncomeGrowth Last accessed 10th March, 2010. Mackenzie, M. & Bullock, N. August 19, 2009. Corporate bond defaults hit record, Financial Times. Available at: http://www.ft.com/cms/s/0/28aa86cc-8cef-11de-a540-00144feabdc0.html Last accessed 9th March, 2010. Oakley, D. & Hope, K. February 18, 2010. Gilt yields rise amid UK debt concerns, Financial Times. Available at: http://www.ft.com/cms/s/0/7d25573c-1ccc-11df-8d8e-00144feab49a.html Last accessed 11th March, 2010. Ross, A. February 5, 2010. Equity income funds back in favour, Financial Times. Available at: http://www.ft.com/cms/s/2/acb4cd72-1284-11df-a611-00144feab49a.html Last accessed 11th March, 2010. Stanford. 2004. Investment strategy for the long term. Wealth Management/fall 2004 Securities Industry and Financial market Association. 2010. Strategies. [Online]. 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Available at: http://www.ft.com/cms/s/0/b34cdcd4-0202-11df-8b56-00144feabdc0.html Last accessed 29 February, 2010. Read More