Investment Strategy and Portfolio Management - Report Example

Investment Strategy and Portfolio Management Introduction This report gives a strategic insight into the present global investment environment. The market has turned in a different direction since the beginning of 2010, from what it was in 2009. As the market conditions have changed, the current portfolio of Morris’s fund need to be revised. The current allocation of the 13.5 million of assets involves 35% in UK equities, 20% in overseas equities, 15% in UK corporate bonds, 20% in UK government bonds, 5% in commercial property and 5% in cash and short term instruments. This report consists of a detailed view of the current investment environment, different possible asset allocations, the extent to which active and passive investment style to be used by the company, and actions to be taken by the fund. Main body For the best allocation of assets, a detailed insight about investment environment is imperative. This part of the report deals with the investment environment and major issues relating to it. The main component of investment environment is economic condition. Global economy is currently in a growth path. United Nations gave out a projected growth of 2.4% for the world economy. The United Nations were also cautious on the implementation of right policies by nations so that the world could achieve the predicted growth. “The UN report credited massive policy stimuli injected worldwide since late 2008 for the expected rebound. It recommended that the stimuli continue at least until there are clearer signs of a more robust recovery of employment growth and private sector demand.” (United Nations, 2010) Emerging markets, China and India will be the growth drivers in 2010, the expected growth rate being 8.8 and 6.5 respectively. The main reasons for the robust growth would be a better performance of global equity markets, increase in international trade, and better industrial production. Russian economy is also expected to post a better economic growth. “In the industrialized world, the U.S. economy is forecast to grow by 2.1 percent in 2010 following an estimated decline of 2.5 percent in 2009, the U.N. said.” (Associated Press, 2009) Europe and Japan will be the slowest growing economies in 2010. The growth rate of these regions as per UN is 1%. However, there are certain issues that can adversely affect the positive investment environment. They are enlisted below. Withdrawal of financial stimulus: Though the UN was positive on the investment environment of 2010, the UN has warned that a premature recovery of stimulus would take the economy again to a recessionary trend. Asian Development Bank (ADB) had recently expressed their concerns on the impact of withdrawal of stimulus in developing countries. “ADB chiefs statement comes at a time when India is debating over the timing of withdrawal of three stimulus packages provided to the industry to combat the impact of global slowdown.” (Business Standard, 2009) In case of a premature withdrawal of stimulus, the markets world over will be affected badly. Thus global portfolios are likely to be affected. India, which will be one of the leading growth drivers in 2010, is planning for a gradual withdrawal of stimulus in 2010. However, the country will be continuing its stimulus measures till robust recovery is seen in the developed nations. The present growth in the market will be sustainable only if the stimulus measures continue till the world economy becomes stable. Thus the fund managers should be cautious on the exposure taken to stocks of stimulus driven industries. Widening United States trade deficit: Another cause of concern for the market is the rising US trade deficit. “The U.S. trade deficit surged to a larger-than-expected $40.18 billion in December, the biggest imbalance in 12 months. The wider deficit reflected a rebounding economy that is pushing up demand for imports.” (Associated Press, 2010) This figure was much higher that what was predicted by the experts. Experts feel that the deficit would be higher in 2010, as the country has more demand for imports than there is for exports. Though the exports will be performing better due to increased demand in the overseas market as well as due to depreciation in the dollar, the imports will be much higher than the exports. One reason for the widening of trade deficit is the steep rise in oil prices. When the trade deficit of US continues, it can lead to economic instability in US. Any such instability is expected to have its contagion effect on the world economy. The impact on the market can be either on specified sectors or on every sectors of the economy. The US economy is financed mainly with debt. Thus when the trade deficit widens and the other nations ask the US to repay the debt, there will be a crisis. As a result the confidence on the economy will be eroded, thus leading the investors to pull out their investments in United States. Asset bubble: Asset bubble risk in China is a cause for concern in the investment environment in 2010. Chinese Central Bank advisor Fan Gang recently said that China has much higher probability for an asset bubble among the emerging markets. “Low interest rates sustained by the Federal Reserve, a weakening dollar and capital inflows to emerging markets have added to the dangers, Fan said.” (Leung & Wong, 2009) He also opined that a possibility for a second recession is from the Asian region, mainly due to the higher liquidity injected by the central banks around the world. Asset bubbles are expected to happen in Equities, real estate and commodities. As China has devalued its currency, the exports of the country are growing at a higher rate. At the same time the imports have become unattractive. This scenario if continues, will lead to excess liquidity in the system and thus to asset bubbles. As China and India are the most promising capital markets in 2010, the possibility of an asset bubble is a cause of concern for the investment environment. Alternatives for plausible strategic asset allocation The major issues in the investment environment are seen above. Considering those factors and other major developments in the investment environment, Morris Capital should take into account the following factors for selecting the right investment strategy. Countries to invest: “If you want to pick the best markets, you should look for those with solid balance-of-payment and funding positions, and very little distortion from fiscal “stimulus.”” (Hutchinson, 2009) Not all markets in the world will be attractive in 2010. Some of the most promising markets are Albanina, India, China, Japan, Korea, Taiwan, Australia, Indonesia, Poland, Germany and Brazil. However, some of these markets like China and Brazil are expected to perform well in the first half of the year and relatively lower performance in the second half. First half of the year will be characterized by rising commodity prices. Brazil will be a very competitive market in the year 2010. The one factor that will contribute to this will be the rising growth in the middle class of the country. China is expected to face a serious inflation problem. Therefore, it is expected to perform well only in the first half of the year. The second half growth will be slower as the government will be tightening monetary policy to curb the inflation. Strong foreign reserve position is what gives a positive outlook for Korea and Taiwan. The only problem that will be faced by Australia and Indonesia will be rising commodity prices. Until then the market will perform well. Indian market will be a top performer in the year. Morris Capital should thus look forward for investment in these markets in the year 2010. Gold: Gold will still stay as a sure bet for investment. “Gold performed exceptionally well in 2009 mainly because of the global financial crisis. One more reason was the weakness in the dollar.” (Moneycontrol, 2010) A continuous growth in the initial months and a gradual fall in the later months are expected in case of gold prices in 2010. Dollar weakness in the coming months will ensure that gold will be a safer and cheaper bet for investors. Thus gold can be a sure shot profitable investment and a considerable portion of the fund can be invested in this. Bonds: It is always better to have a risk free portion in the portfolio. Bonds are the best option for this. Not all bonds across the world are attractive. In the case of US corporate bonds, the rising interest rates are making it unattractive. “The pressure of trillions of dollars of U.S. government debt issuance is expected to push interest rates higher next year, causing yields to rise and weighing on prices of bonds of all stripes, including corporates.” (Parry & Aubin, 2009) Thus investment in US treasuries will be unattractive in 2010. However, investment can be made in corporate bonds issued by selected companies. The UK Government Bonds are expected to be volatile in the year 2010. Recently there has been poor rating given to Greece by the credit rating agencies. This was followed by monitoring of Spain and the next probable region in the spotlight is UK. There are concerns about UK’s credit rating too. Thus, for investors, it is better to reduce the exposure to UK Government bonds. Possible Alternatives: The Company can consider following alternatives for Asset allocation. Alternative 1: Sl No Category Percentage 1 UK Equities 30 Poland: 40% Germany: 60% 2 Overseas Equities 25 India: 25% China: 25% Korea: 25% Taiwan: 25% 3 UK Corporate Bonds 20 4 UK Government Bonds 10 5 Gold 10 6 Cash and Short term instruments 5 Total 100 Alternative 2: Sl No Category Percentage 1 UK Equities 30 Poland: 40% Germany: 60% 2 Overseas Equities 25 India: 35% Korea: 35% Taiwan: 30% 3 UK Corporate Bonds 20 4 UK Government Bonds 10 5 Gold 13 6 Cash & Short term instruments 2 Total 100 Alternative 3: Sl No Category Percentage 1 UK Equities 25 Poland: 40% Germany: 60% 2 Overseas Equities 30 India: 25% China: 20% Korea: 20% Brazil: 20% Albania: 15% 3 UK Corporate Bonds 15 4 UK Government Bonds 10 5 Gold 15 6 Cash and Short term instruments 5 Total 100 Recommendations Three alternatives for strategic asset allocation are mentioned above. All the three portfolios have taken three different approaches in the asset allocation process. The first alternative is conservative. There is enough exposure to short term instruments and also to risk free corporate bonds. The second alternative is very aggressive as it is less diversified and exposure to cash and short-term instruments is limited. The third alternative on the other hand is moderate as it is highly diversified. In terms of equity markets, the third alternative gives better exposure to best expected equity markets. This portfolio gives better exposure to gold and also maintains a good percentage as cash and short term securities. Thus, the company can choose Alternative 3. The company should carefully use active and passive investment strategies in the portfolio. The selected portfolio is alternative 3. In the UK equities the company should use only active investments. Not all stocks in the market are expected to perform well. Careful research should be done on the sectors and stocks where, exposures have to be taken in the UK equities. The company can use passive strategy for markets like Brazil, Korea and Albania, by investing in index. This is because these markets are expected to perform exceptionally well. In the Indian and Chinese market it is better to use active investment strategy. Conclusion The report has given a deep insight about the current investment environment. Based on the current and expected investment environment the different strategies that can be adopted by the company were chartered out. The best alternative, i.e., alternative 3 will perform better based on the expected and future market conditions. Property holdings have been deleted from the portfolio as the UK property prices are expected to fall in the coming year. High illiquidity is another reason for not including it in the portfolio. But this was compensated by including gold in the portfolio. Morris Capital can surely expect the fund to mark good returns in the year 2010. Works cited United Nations News Centre, 2010. Global Economy to rise by 2.4% in 2010. [Online] Available at: http://www.un.org/apps/news/story.asp?NewsID=33128&Cr=economic+crisis&Cr1 [Accessed 21 February 2010] Associated Press, 2009. UN says global economy will grow in 2010. [Online] (Updated 2 December 2009) Available at: http://www.msnbc.msn.com/id/34243709/ns/business-world_business/ [Accessed 21 February 2010] Press Trust of India, 2009: Hasty stimulus withdrawal could derail recovery: ADB. Business Standard Online, [Internet] 13 November. Available at: http://www.business-standard.com/india/news/hasty-stimulus-withdrawal-could-derail-recovery-adb/78279/on [Accessed 21 February 2010] Associated Press, 2010. Trade deficit jumps sharply in December. [Online] Available at: http://www.npr.org/templates/story/story.php?storyId=123563226 [Accessed 21 February 2010] Sophie, Leung & Chia-Peck, Wong, 2009. China faces asset-bubble risk. [Online] (Updated 18 November 2009) Available at: http://www.bloomberg.com/apps/news?pid=20601068&sid=awonLXtlhUzE [Accessed 22 February 2010] Martin, Hutchinson, 2009. The hottest places to invest in 2010. [Online] Available at: http://www.dailymarkets.com/stocks/2009/12/10/the-hottest-places-to-invest-in-2010/ [Accessed 23 February 2010] Money Control, 2010. Gold to perform well as dollar weakens: Macquarie. [Online] (Updated 7 January 2010) Available at: http://www.moneycontrol.com/news/market-outlook/gold-to-perform-well2010-as-dollar-weakens-macquarie_434352.html [Accessed 23 February 2010] John, Parry & Dena Aubin, 2009. US Corporate bonds face rising rate hurdle in 2010. [Online] (Updated 16 December 2009) Available at: http://www.reuters.com/article/idUSN1424084220091216 [Accessed 24 February 2010] Hector, Sim, 2010. World Economy: Recession well into 2010. [Online] Available at: http://www.economywatch.com/world_economy/World_Economy_Recession_Well_into_2010_say_Dr_Doom_&_IMF.html [Accessed 24 February 2010] Dana, Anspach, 2010. What is the difference between active and passive investing. [Online] Available at: http://moneyover55.about.com/od/howtoinvest/a/activevspassive.htm [Accessed 24 February 2010] Miller, Ted, 2003. Kiplinger’s Practical Guide to Investing. United States: Kiplinger Washington Editors Inc. Harrington, R.L, 2001. UK Economy: A Manual of Applied Economics. United Kingdom: Oxford University Press. Berg, David M., Guisinger, Stephen E., 2001. Oxford Handbook of International Business. United Kingdom: Oxford University Press. Peter Nolan, 2008. Integrating China: Transition Into Global Economy. United Kingdom and United States: Anthem Press. United Nations, 2009. Economic and Social Survey of Asia and the Pacific 2009. United Kingdom: United Nations Publication. Read More