Kaplan Capital: Investment Strategy and Portfolio Management - Case Study Example

Kaplan Capital - Investment Strategy & Portfolio Management Id: Word count: 2,075 “Investment Strategy& Portfolio Management” INTRODUCTION ABOUT THE FUND KAPLAN Capital is a UK based fund. It provides an investment medium to the investors to contribute to their fund but; it is actually for educational point of view. Basically it’s a charitable fund which serves students of all ages by paying school, college or university fees of the students not capable of affording it. Their motive is to assist students achieve their goals. The fund was established in 2007 and after five years it allows its investors to withdraw their funds. Kaplan fund is working on the same strategy or basis on which other funds are working. The funds current worth is 30,500,000 pounds. It has invested in different securities to earn good returns. At the completion of five years there will be some investments that will be maturing and the contributors might want to withdraw their funds. In order to conduct a meeting of the fund investors on March 31st, 2012 there is some analysis which has to be made on the fund’s performance & strategies. CURRENT STARTEGY The current strategy clearly shows that after a five year plan the investors have a choice of withdrawing their funds or rollover it. Several of the investors might keep their funds with the company and roll over it for some period at the time of maturity. It forecasts that the inflow from new investors will be more then the outflow of funds by old investors. Below are the few points that emphasize on the fund’s existing approach: 1. APPROACHING LONG TERM: Most of the investment made by the fund is in long term portfolio. In a long term portfolio the maturity of the investment is above 5 years. With 30.5 Million pounds as the total assets at present; the fund has invested in the following from where it gets returns: 30% in UK equities 15% in overseas equities 20% in UK corporate bonds 25% in UK government bonds 10% in cash & short term instruments UK Equities: Investing major chunk in UK equities means investing over 5 years which reflects a long term program of the fund and even the rule of thumb is investing in riskier securities gives you higher return (Reilly 2002). A study shows an average annual return from UK equities is 5.7%. Illustration 1: If Kaplan invests only 1,000 pounds in UK equities for 5 years; it generates: ((1 + 5.7%) ^ 5) * 1,000 = 1,319 pounds (approx) If we compare the same with the cash or short term investments it returns: ((1 + 2%) ^ 5) * 1,000 = 1,104 pounds (approx) Hence; it clearly shows that the average annual return on cash is lower than the return on equities. Since cash investments means keeping your money with a bank in a deposit account which is a safer investment and does not yield higher returns as investing in riskier assets. The above given illustration also second are rule of thumb. Investment in UK equities and expecting a better return totally depends on the country’s financial & economic situation. Year 2011 has been the most unpredictable year for UK equities due to low growth and debt crisis in Europe. Overseas Equities: Funds that invest their money only in companies of one country carry more risk than investing their funds over many other countries. If you invest in larger companies the price fluctuations are relatively higher (Reilly 2002). When we invest in other countries there is always a risk involved known as “currency risk” though it can be a good thing for long term portfolio but bearing a risk of fluctuation in exchange rate. Apart from this exchange rate risk we should also take into account the “political risk” of that country you are investing in and the local tax charged on overseas investments. One can reduce the risk of loss from fluctuation in exchange rates by hedging with currency futures. Illustration 2: If you have US $ 100 and you want to anticipate that in future US dollar will devalue in respect to another currency. You will make a hedging contract and fix the rate of USD against that currency in order to prevent risk of devaluation. UK Corporate Bonds: This investment part is attractive meaning it gives attractive returns. It is also less volatile then investing in equities. Bonds issued by companies are normally known as corporate bonds. Investing in bonds of companies that have strong financial position with good earning and high credit ratings are safer investment bonds (Reilly 2002). The safe investment depends on the following: a) The corporate bonds you are investing in. b) Company’s performance whose bonds you are investing in. c) Inflation. If inflation or interest rates rises eventually bond prices will fall. Normally corporate bonds offer lower risk and higher returns. Corporate bonds are even considered liquid hence seeing the situation of Kaplan Fund it’s a good investment. UK Government Bonds: Bonds issued by UK government are also called “Gilts”. These bonds pay a fixed interest rate or you can say a risk free return and are safer mode of investment since they are backed by the government so the chance of default is very low (Horne 2008). Short term period of these bonds is from 1 to 7 years. This time period is ideal for the Kaplan fund. Cash & Short Term Instruments: Keeping cash with some bank and maintaining a deposit account with them is another safest way of investment whether it’s a remunerative or non-remunerative account. Investing in short term instruments means placing your funds for a period of 1 year or less. Kaplan fund has invested very lesser percentage in this plan which is usually to fulfill working capital requirement. This is seen the only strategy of Kaplan which is not towards long term. MODIFICATION OF INVESTMENT STRATEGY: Keeping in view the current situation of UK and the fund I think the fund should modify its current strategies. Reason being the maturities of some investments are nearby and while some investors will withdraw their money from the fund there will be other new investors too who has contributed to the fund. In order to pay back to the investors who wants to withdraw Kaplan; should engage its funds in different tenor of assets or securities to timely pay its contributors. ASSET ALLOCATION: Making your portfolio a balance between different types of investment, taking into account the risk, financial position of the fund and its goals is what asset allocation is all about. You should make investments in such manner that if there is a “fall” observed in one investment then it should be compared with a “rise” in the other investment (Reilly 2002). We have seen that a major area where Kaplan fund is focusing is the long term avenue. Whereas; I believe there should be a mix of short term and long term investment. Long term investments generally means above 5 or 10 years whereas the maturity of some investments at Kaplan are in 5 years. Hence; there should be an aging agenda set which showed different investment maturities and Kaplan’s plan to pay them. Firstly; Kaplan should invest in securities keeping in mind its risk tolerance capability. Allocation of investment in future: Cash & S.T. securities 20% Fixed Investment 35% UK Equities 20% Overseas Equities 15% Gold or other commodities 10% Investing the major percentage in UK equities is not a good idea as there are a lot of predictions given by the analysts that UK equities will fall by a larger percentage in the year 2012. Secondly; overseas equities investment percentage sounds sensible as Kaplan can take into account the hedging concept of currency futures to overcome the exchange rate risk. One should also be aware of the economical situation of that particular country which can be negative or positive like the economic union in Europe. Cash is a very stable investment but it provides low returns. It’s like maintaining a deposit account with a bank or investing in short term (S.T.) securities; ones issued by government or any other. Fixed interest investments are moderately stable and involves lesser risk (known as bonds) some are issued by government and some by the companies for instance; corporate or government bond (Horne 2008). The tenor of both should not be more than 5 years which lies under short term period. UK equities involve greater risk. They are volatile in short term but gives higher return in the long term. Keeping above two in short term this can be invested for a long term period. Overseas equities are similar to the UK equities involves high risk plus the risk of currency but are not much fruitful in long run unlike UK equities. Ideally we need to invest in liquid instruments since cash outflows are high however we need to generate at least 6% in order to meet the outflow. Avoid investing in ill liquid assets and keep it a mixture of bonds and equities. Hence; gold is another possibility as it is the premier investment and its ROS is greater than other commodities and real estate. It can also be wheat or sugar futures or private equity if not gold. The minimum return has to be 6% and the equity portion can be both actively and passively managed. Passively managed in the sense that purchase of stocks which gives a dividend yield of +6%. Actively by adopting a trading strategy and using superior research and stock-picking abilities to generate abnormal returns (in excess of 6%). Investing in different asset classes will give a better return then only investing in one asset which has a higher possibility to go down any time. If we spread our investment in a manner as discussed above; a fall in any one market will not impact our overall returns much. Once the fund has established its strategy; it should focus more towards tactical asset allocation; in order to ensure how to fulfill its strategies and goals (Reilly 2002). In year 2012; maturities of assets must be analyzed to create liquid assets to meet current obligations. Probability of cash outflow must also be foreseen. Below are some assumptions given on the basis of 6% average annual inflow to the fund. Assumptions can also include no taxes on dividends, capital gains and coupon interest. No transaction cost and no restriction on short-selling that way we can take short-positions in a few items as well (such as certain currencies or commodities). The below assumption shows the inflow and outflow of funds and the total assets at the end of year 2012; it also highlights the current status of the fund’s total assets. Outflows Inflows Total Assets Sterling Pound millions Sterling Pound millions 2012 Assumptions 30.5 30.5 Assumptions (%) 21% 15% 6.4 4.6 28.7 (Balance 2012 end) Probability to increase fund 6.4 4.6 Amount by which fund will increase per annum on average 0.060 6% Making an assumption that if the out flow of funds (21%) are more than the inflow (15%) then the total outflow (21%*30.5) is 6.4 which is more than the new investors who have contributed to the fund that is 4.6. Hence; the fund will increase by 6% annually on average by the given formula (cash outflow – cash inflow) / total assets. CONCLUSION & RECOMMENDATIONS: To pick and choose where to invest your funds is the most difficult and important part of the strategy even challenging. Investing in a fund without taking into account the risk measures can result in complete failure. One should keep in mind the past experiences too but living in the present is more important. In order to turn out to be a successful investor you must have knowledge about different investment plans and economical scenarios (Reilly 2002). Since; Kaplan is a not for profit organization and is known as a charitable institution it does not need to earn much higher profits or in take very high risk. For investment purposes Kaplan can also look forward to tax free investments as at the end of the day what matters is that what you are getting after all the deductions. Diversification is an important concept that the fund can apply in overseas equities and corporate bonds. The fund can also relax the five year holding period requirement; since the fund is facing competition to attract new investors. Hence; the five year lockout period may be a restriction. References: Frank K. Reilly, 2002. Investment Analysis and Portfolio Management. 7 Edition. South-Western College Pub. J. Van Horne, 2008. Van Horne: Fundamentals of Financial Management (13th Edition). 13 Edition. Prentice Hall. 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