Management at Schumpeter Finanzberatung GmbH - Assignment Example

Portfolio Management Report

(Schumpeter Finanzberatung GmbH)

Word Count: 2,500

• Introduction

The current assignment majorly focused on constructing an efficient portfolio using different stocks and indexes. In this case, the portfolio was analyzed in different perspective where the most appropriate portfolio was determined. The portfolio performance evaluation was based on the calculated standard deviation and hence different mix of stocks and indexes were considered in determining the most appropriate portfolio and hence evaluation of the risk and return rates was achieved using standard deviation where it is considered to be a statistical tool employed in measuring the fluctuation level in the returns of a given portfolio (Rouwenhorst 1999). In this case, larger standard deviations are associated with higher fluctuation level based upon the average return of a given portfolio. The portfolio investment was divided across stocks and bonds (T-bill) where T-bill was included for the purposes of diversification. In this respect, the aim was to minimize risk as well as maximize return. As such, it was very critical to know the characteristics of the risk return of the considered asset classes

• Question 1

Based upon the provided data, it is clearly evident that the return on the considered stocks is more uncertain when compared to the bonds. This therefore implies that stocks are riskier than bonds. There is high certainty in the return rate earned on the Treasury bill (T-Bill) investment and hence it is known as money market securities (Otten and Schweitzer 2002). In this case, it provides the most appropriate way for the investor to have money market security. It is pertinent to note that investment return uncertainty in terms of definition is not able to differentiate between gain and loss. In this respect, uncertainty can be quantified where a possible range of outcomes is estimated. Thus, these estimates are considered to be very crucial tools in the assessment of performance as well as in portfolio construction since the investing principal assumption is to attain a given degree of return where, lower risk investments with higher risk are considered.

Based upon the provide data, evaluation of the risk and return rates can be achieved using standard deviation where it is considered to be a statistical tool employed in measuring the fluctuation level in the returns of a given portfolio. In this case, larger standard deviations are associated with higher fluctuation level based upon the average return of a given portfolio. For our case, the given portfolio has an average return of 0.39% and standard deviation of 2.17%.This therefore means that the returns must be within -1.78 and 2.56 in the given observations. The considered investment is seen to have more risk and hence it will give a higher expected return level that will have to compensate the associated high levels of uncertainty. This means that such higher returns cannot be realized for a given period of time. As such, lower risk investments are seen to be the most preferred than those with higher risks.

• Question 2

Investment allocation is very critical where the allocation based upon various asset classes is a critical strategy as it helps in risk minimization as well as gains increase. In this case, the most critical step is to understand optimal allocation of asset as well as its benefit in relation to appropriate asset mix. As such, asset allocation involves categorizing investment portfolio in different assets types such as money securities and bonds (Stahel 2005). In simple terms, it is an effective and organized diversification method. For our case, the portfolio investment was divided across stocks and bonds (T-bill) where T-bill was included for the purposes of diversification. In this respect, the aim was to minimize risk as well as maximize return. As such, it was very critical to know the characteristics of the risk return of the considered asset classes.

In the constructed portfolio, it is evident that equities are seen to have the highest return potential, but are as well associated with high level of risk. Treasury bill, on the other hand is seen to have the lowest risk because they are known to be backed by a given government, they are as well associated with lowest return potential. In relation to diversification, it is termed as risk return trade off, which states that return potential rise is associated with risk increase and hence asset allocation in terms of diversification is considered to be very critical (Stahel 2005). This is because various assets are associated with different market fluctuations and risks. The reason for including T-bill was to insulate the entire portfolio from the downs and ups of the given class of securities. Therefore, if a portion of the constructed portfolio has securities that are volatile with higher returns, the other portfolio portion will have to remain stable. Due to the protection exhibited, the allocation of asset is very critical in terms of return maximization and risk minimization.

4.0 Question 3

Based upon the calculations below, it is clearly evident the return on the considered stocks (STOXX Europe) is more uncertain when compared to that of Germany T-Bills. This therefore implies that the equities stocks are riskier than Germany T-Bills. There is a high certainty in the return rate earned on the Treasury bill (T-Bill) investment and hence it is known as money market securities. In this case, it provides the most appropriate way to the investor to have money market security. This uncertainty can be quantified using risk metrics where the possible outcomes are estimated. Thus the estimates are considered to very crucial tool in assessment of performance as well as for portfolio construction since the investing principal assumption is to attain a given degree of return where, lower risk investments with higher risk are considered.

Risk metrics can be used successfully based on the selected measure relative to the objectives of the portfolio as well as the underlying limitations of the provided data (Stahel 2005). For our case, absolute risk measure will be considered as a measure of the estimates in terms of performance. In this case, there are subsets that fall under this category and include shortfall, risk of loss, value at risk and standard deviation. Based upon the provided data, the most appropriate subset to be considered is the standard deviation where it is mostly used in measuring fluctuation level of the return of a given portfolio. As such, higher standard deviations are associated with greater fluctuation levels of the average returns of the given portfolio. As seen in the calculations below, average return is 0.39% while the standard deviation is 2.17%.This therefore means that the returns must be within -1.78 and 2.56 in the given observations. This clearly shows that it is not suitable for investors who are more interested in positive returns, but more scared about the negative returns. Furthermore, it is assumed by standard deviation that the returns are normally distributed and hence it is limited to returns considered not to be normally distributed

Q3.

German T-Bills

STOXX Europe TMI

Mean

0.02%

0.64%

Standard Deviation

0.03%

3.62%

Weight

40%

60%

Portfolio

0.39245%

Covariance

-0.0000027154

Standard Deviation

2.17%

• Question 4

Based upon the calculations below, it is evident that Deoleo SA has a higher beta than that of ThyssenKrupp. This implies that Deoleo SA outperforms ThyssenKrupp and hence considered to be the most appropriate stock to invest in. However, it is considered to be a riskier stock. Also, both betas are seen to be greater than 1.0 and hence they are considered to be greater than the market stock or index and this can mean that they outperform the market stock or index. Therefore, both stocks have higher returns relative to high risks when compared with the index which has a beta of 1.0.

Q4.

ThyssenKrupp AG

Deoleo SA

Covariance

0.0024

0.0025

Variance

0.0013

Beta

1.814

1.924

• Question 5

Before commenting on the impact of adding each share (ThyssenKrupp AG and Deoleo SA) to the portfolio (with STOXX Europe TMI and Germany T-Bills), it is pertinent to note that the portfolio with STOXX Europe TMI and Germany T-Bills is seen to have a standard deviation of 2.17% and STOXX Europe TMI has 3.62% while Germany T-Bills has 0.03. This implies that the return on the on stock (STOXX Europe) is more uncertain when compared to that of Germany T-Bills. When, ThypssenKrupp AG is added to the portfolio, the standard deviation is seen to increase to 2.235% (the standard deviation of ThypssenKrupp is 10.93%). On the other hand, when Deoleo SA is added to the portfolio, it leads to an increase of standard deviation to2.241 % (where; Deoleo SA itself has 14.96%). Based upon these observations, it can be noted that addition of both of this stocks to the portfolio, there is an increase in the standard deviation. Furthermore, since Deoleo SA has a higher standard deviation than ThypssenKrupp, it causes a higher increase in the resultant portfolio. As such, both stocks when added, they lead to increase in the portfolio standard deviation and hence, this implies that the resultant portfolio will be riskier with higher returns than the previous one (in question 3) since it has a higher standard deviation where; the higher the standard deviation, the higher the risk and rate of return. In this respect, higher standard deviations are associated with greater fluctuation levels of the average returns of the given portfolio.

German T-Bills

STOXX Europe TMI

ThyssenKrupp AG

Mean

0.02%

0.64%

-0.06%

Standard Deviation

0.03%

3.62%

10.93%

Weight

39%

60%

1%

Portfolio

0.39167%

Standard Deviation

2.235%

German T-Bills

STOXX Europe TMI

Deoleo SA

Mean

0.02%

0.64%

-0.68%

Standard Deviation

0.03%

3.62%

14.96%

Weight

39%

60%

1%

Portfolio

0.38544%

Standard Deviation

2.241%

• Question 6

Portfolio diversification is considered to be very critical in terms of investing basics. There are several benefits associated with index (Pan European Index) where there is much exposure of an investor to the market segment (Otten and Bams 2002). The objective of an average investor is having an opportunity of interest compounding as well as growing the investment over a long period of time. When the Index is allocated, the investors will have confident that their portfolio will at least not underperform the given benchmark (Vassalou and Xing 2004). For instance, based upon the observation that the annualized STOXX Europe average return was approximately 7.8 percent, an investor could have done better than in several individual equities in case he or she was looking for capital appreciation and stability (Spiegel and Wang 2006).

Any investment’s value as well as its associated income, has a possibility of dropping as well as rising relative to interest rates, currencies and movements in stock market. These are considered to be irrational movement and hence, they are seen to be affect by unpredictable factors such as economic events and political factors (Otten and Schweitzer 2002). This therefore implies that an investor is less likely to get what he or she invested. In this respect, individual equities cannot be cushioned from these factors and hence STOXX Europe can where it employs derivatives (this are financial tools with their values associated with price movement that is expected for the given asset) for the purposes of investment. This includes considering short and long term positions where borrowing is evident in most case. Derivatives are as well considered to protect fund value, additional income generation as well as costs reduction (Otten and Bams 2002).

• Question 7

Despite the strategy of passive investment has been applied by institutional investors for a couple of years, for individual investors, it is seen to be new. Currently, active investing has been considered to be a pronounced investment strategy where it tries to outperform the given market (Singleton 2006). Active management aims at beating a given benchmark. Active managers always search for information to help them in making investment decisions and hence, they do analyze company and economy –specific factor as well as market trend. In the end most of them have sophisticated systems and security selection and they use it in investment decision implementation with the aim of outperforming the given market (Singleton 2006). There are many active management methods as they are active managers. In this case, such methods include macroeconomic analysis, quantitative analysis, technical analysis and fundamental analysis. It is believed by active managers that due to inefficiency of the market, irregularities and anomalies in the given capital market can be handled by those who have insight and skills. There is a slow reaction of the prices to information where the skilful investors are allowed to outperform systematically the market (Singleton 2006).

Passive indexing or management refers to the approach of investment management that is based upon investing in securities that are same as well as that have same percentage, for instance, S & P 500 index (Sehgal and Jhanwar 2008). It is referred to as passive since the managers of the portfolio never come up with decisions regarding the type of security to be sold or bought. In this case, managers are rarely seen to follow a construction portfolio methodology that is same as that of index. The main aim of managers in this case is to replicate index performance as much as possible. There is investment by the passive managers in markets sectors that are seen to be broad and this are referred to as indexes or asset classes. Hence, the average returns generated by asset classes are accepted. It is seen that passive investors believe in hypothesis of efficient market. This hypothesis states that the prices or market are usually fair and are a reflection of the information. Based upon the belief in this hypothesis, passive managers never attempt to beat the market, but they only attempt matching its performance (Sehgal and Jhanwar 2008).

• Conclusion

As it is observed, the most appropriate portfolio was determined based upon mixing different stocks and bonds in an efficient way. In this case, the constructed portfolio was considered to be optimal as well diversified. In this respect, uncertainty was quantified using risk metrics where the possible outcomes were estimated. Thus, the estimates are considered to very crucial tool in assessment of performance as well as for portfolio construction since the investing principal assumption is to attain a given degree of return where, lower risk investments with higher risk are considered. The reason for including T-bill was to insulate the entire portfolio from the downs and ups of the given class of securities. Therefore, if a portion of the constructed portfolio has securities that are volatile with higher returns, the other portfolio portion will have to remain stable. Portfolio diversification is considered to be very critical in terms of investing basics. There are several benefits associated with index (Pan European Index) where there is much exposure of an investor to the market segment. Following the evaluation of the constructed portfolio, it was seen that the betas of the stocks in the portfolio were higher than the index or stock market. This implied that the stocks outperformed the stock market or index where they were considered to be riskier with higher returns. Therefore, it is suitable for investors to invest the money which they can afford to loss.