Risks Associated with Manu Fund and Prop Fund - Case Study Example

Risk analysis report Contents Contents 2 Risks associated with Manu Fund and Prop Fund 3 Quantitative Easing 6 Ways of implementation of QuantitativeEasing 7 Impact of Quantitative Easing on manufacturing sector (Manu Fund) and real estate sector (Prop Fund) 8 References 10 Risks associated with Manu Fund and Prop Fund Manu Fund is an investment fund consisting of companies mainly from the manufacturing sector of UK. Prop Fund is another investment fund consisting of companies in the real estate sector of UK. As fund manager, it is required to analyze the risk contained in the investment in the above mentioned funds. Following is a report on risk analysis of Manu Fund and Prop Fund of UK. Looking at the current economic conditions, the government of UK is experiencing a fiscal crisis for which a Monetary Policy Committee of The Bank of England has been set up with an aim to control the inflation rates and contain the growth rates of several sectors like manufacturing, real estate, etc (Bank of England, 2013, p.1). Due to the financial crisis in subprime mortgage markets, the global meltdown has hit the major economies in the world like UK. Due to the financial, the benchmark FTSE recorded a fall of 31% in 2009 as compared to previous year. Due to ongoing effect of the recession, the real estate and the manufacturing sector in UK had been badly hit in terms of growth and profitability. This wiped away the value of stocks due to the market risk. The prices of real estate properties in UK are subject to devaluation on the face of global financial crisis that started in 2007. The banks in UK have a higher exposure to the real estate properties considered as mortgages for granting loans. The devaluation of underlying mortgages leading to the devaluation of loans resulted in heavy losses to the lenders in UK. This resulted in erosion of confidence for the investors, both individual and institutional. As a result, the valuation of stocks fell due to risks involved and subsequent losses incurred. Thus the risk associated with Prop fund which contains companies majorly from real estate is quite risky looking at the macro economic conditions, global recession and fall in the price of properties. The Manu Fund which is formed of companies from the manufacturing sector of UK is also facing a downfall in their performance, revenue and overall profits due to tough market conditions that started after the liquidity crunch in the global markets. There is an overall decrease in demand from the domestic and overseas market as a result of the global recession for which the production of the UK companies have seen a downfall compared to earlier years. The growth rates of the manufacturing companies declined with their scale of production decreased beyond imagination. The stocks of theses manufacturing companies have thus experienced a fall in price due to lack of confidence of the investors. As a result of the impact of financial crisis, the UK markets in real estate and manufacturing witnessed job cuts, unemployment resulting into public distress. These factors constitute the potential risk of the Manu Fund for which investment in the stocks of Manu Fund has become risky. As a fund manager, the factors contributing to individual risk of both the funds need to be considered before investing the money of public in those funds. The risk associated to Manu Fund and Prop Fund lies in the uncertainty of returns form the investment in the manufacturing and real estate companies in those two funds. The risk of investment in these two funds can, however, be hedged by adopting an appropriate mix of diversified investments in these two funds. Manufacturing companies have witnessed reduction in exports not only due to financial crisis and crisis in the Euro-zone but also as a result of stiff competition from the overseas market. As a result of the risk and losses incurred due to reduction in output across several sectors, the government of UK experienced a fiscal crisis. This can be experienced from the fact that the export of UK fell by 1.1% in 2010-11 whereas the imports fell by 0.6%. The fiscal crisis of UK also has a macro-economic impact on the performance of the Manu Fund and Prop Fund. A graphical representation of the declining trend of output of manufacturing sector as compared to the services sectors and GDP growth rate is given below. The below graph shows the decrease in the activities and transaction in the real estate sector in the recent times after recession. The graph shows a clear declining trend in the output of real estate sector in UK after the period of global recession as indicated by the blue line. The loans granted by the banks reduced drastically which is a sign of tighter liquidity in financial sector that hampered the productivity of real estate. Tighter credit lines ensured that the real estate performance in UK slows down for its own good. All these factors affecting the manufacturing and real estate sectors in UK would bring a factor of risk to the two funds Manu Fund and Prop Fund that are comprised mainly by the manufacturing and real estate companies respectively. These are the associated risk that needs to be considered as a fund manger of Manu Fund and Prop Fund. Quantitative Easing Quantitative Easing is a monetary policy or an unconventional form of monetary policy of the government in order to increase the monetary supply to the economy. The central banks in order to inject more money in the financial system purchase assets from the financially weak entities which may be commercial banks or private companies. By purchase of these assets which comprise mainly debts in the existing balance sheet of the companies, the central banks are able to provide a stimulus to the economy by supplying money to the organisations. Quantitative easing does not affect the interest rates of the financial system in the short term prospects. In normal monetary policy the government buys short term bonds in order to reduce the interest rates of the market. When the interest rates are reduced, no more short term bond purchase by the government could have an impact on the market interest rates (Devenney and Kenny, 2012, p.5). Quantitative easing is applied at this point of time to reduce interest rates in the long run. Quantitative easing has limitation in its implementation. Quantitative easing is aimed to control deflation. But if the technique is used more effectively, it might lead to higher inflation. Also the technique of quantitative easing would be ineffective if the banks to do not lend their surplus reserves. Ways of implementation of Quantitative Easing The Monetary Policy Committee of the Bank of England decided to lower the bank rate by 0.5% looking at the liquidity crunch in the markets of UK. However, with the increasing demand of liquidity in the market, the bank rates could not be practically reduced below this below. The Monetary Policy Committee thus decided to adopt the policy of Quantitative Easing through purchase of assets in the form of mainly Government debts. By this way of adding stimulus to the monetary supply in the UK economy, Quantitative Easing was implemented by the Bank of England. With this extra spending, the MPC (Monetary Policy Committee) hopes to reduce the inflation rates to a targeted 2% of the consumer price index (CPI). The Bank of England does not need to print monetary notes for implementation of Quantitative Easing. The Bank of England creates money electronically and uses the money in purchasing government debts and private gifts such as pension funds, etc. These debt instruments produce a low return and are thus used by their holders to purchase other assets like corporate bonds, shares, etc. This boosts the issue of new equity and shares and reduces long term borrowing costs. Thus quantitative easing is helpful in injecting the monetary supply to the economy and to control the fall of inflation rates (Ciro, 2013, p.123). Impact of Quantitative Easing on manufacturing sector (Manu Fund) and real estate sector (Prop Fund) Quantitative Easing adopted by the Monetary Policy Committee of UK would have a major impact on the manufacturing sector and the real estate sectors of UK as the injection of monetary supply through Quantitative Easing will have effects on the level of inflation rates; yield of the assets purchased through Quantitative Easing (Industrial Systems Research, 2003, p.5). Purchase of assets from the manufacturing sector and the real estate sector would help to control the fall of inflation rates. As a result of this people would have more money in hand and thus would help to boost the demand of the manufacturing sector and real estate. Thus the production level of manufacturing companies of UK which forms the portfolio of Manu fund is likely to increase. However, with Quantitative Easing, the valuation of the assets purchased is likely to increase resulting in lower yield. Taking into consideration the tighter credit lending policies of the banks, the intended boost could be given through Quantitative Easing when the banks would only lend their surplus reserves. As a result of Quantitative Easing, the foreign currency exchange rate for the Pound Sterling is likely to depreciate. This would benefit the exporters and also the companies whose debt are denominated in Pound Sterling. Thus the impact on the manufacturing sector would directly affect the stocks of Manu Fund. Similarly Prop Fund would also be impacted as a result of Quantitative Easing as increase in monetary supply would raise the demand for properties in the UK markets. The banks would play a crucial role in lending to the borrowers keeping the lending policies as tight as possible. The advantages of Quantitative Easing would not pass on to the real estate sector if the banks could not lend due to lack of credit worthiness of the borrowers (Schmitt, 2007, p.10). The valuation of the properties as underlying securities of loans are likely to show signs of recovery if the borrowers get access to injected money in the economy of UK with improvements in repayment of the loans. Thus by Quantitative Easing, the central bank would be able to pull up the economy and its manufacturing and real estate sectors which were facing down due to liquidity crunch, decrease in demand and fall in the production levels and profitability of the organizations. With Quantitative Easing, the manufacturing companies in the Manu Fund and the real estate companies of Prop Fund would show signs of recovery in their operational performance and financial performance thereby attracting investors with increased prices of the stocks. Information flowing to the market as a result of expected dividends from the stocks of Manu Fund and Prop Fund would build investor confidence and thus would attract investments in Manu Fund and Prop Fund. References Bank of England. 2013. Inflation Report, February 2012. [Online]. Available at: http://www.bankofengland.co.uk/publications/Pages/inflationreport/ir1201.aspx. [Accessed on 12 April, 2013]. Ciro, T. 2013. The Global Financial Crisis: Triggers Responses and Aftermath. Ashgate Publishing, Ltd.; Great Britain. Devenney, J. and Kenny, M. 2012. Consumer Credit, Debt and Investment in Europe. Cambridge University Press; UK. Industrial Systems Research. 2003. Manufacturing in Britain. Industrial Systems Research; UK. Schmitt, B. 2007. Real Estate Market Uk: Development of Prices in London. GRIN Verlag; Germany. Read More