Portfolio Management, Risk Management, and Investment - Essay Example

RISK MANAGEMENT AND INVESTMENT II and Risk Management and Investment II Executive Summary When making the investment decisions, the key factor taken into consideration is the risk management. The purpose of this report is to fully measure the portfolios performance comprising of the 8 stocks and 2 bonds. The major aim of this investment is to maximize returns through increased growth of the capital. The performance will be based on the historical prices of the stocks. The report will also try to identify and measure the risk likely to be faced in the portfolio. This is the risk that may hinder the funds from fully achieving the objectives. This will involve identifying the stock specific risk as well as explaining the asset allocation procedure that will be used in allocating a new asset to the portfolio. Past Performance of the Portfolio This part will comprise of the analysis of the past performance of the portfolio of investment portfolio. The portfolio comprises of stocks and bonds from 10 companies. The investment portfolio includes the I shares FTSE Bric 50 Fund, whose ticker is BRIC, the BP Plc whose ticker is BP., the TUI Travel whose ticker is TT, the Barclays PLC whose ticker is BARC, the Lloyds Banking Group PLC whose ticker is LLOY, the ETFS Gold whose ticker is BULP, I Shares MSCI Brazil USD ETF whose ticker is IBZL, the I Shares FTSE/Xinhua China 25 whose ticker is FXC. The bonds include the BT 5.75% 2028 Bond and Standard Chartered 7.75% 2018 Bond. Ishares FTSE Bric 50 Fund This is described as an exchange traded fund whose main aim is tracking the performance of FTSE BRIC 50 closely. The performance from the stock investment is measured through the use of the net asset value of the given stock. The currency that will be used in this analysis is the United States dollar (USD). The details included an outline that the investment was established on January 1st 2011. In other words, this is the assumed inception date. The net asset value of the stock before the deduction of the charges that the fund managers are given the mandate to deduct from the funds on the 1st of January 2011 was 34.014801 dollars. This is quoted as the total return net asset value. The total net asset at that point in time of BRIC was 1,320,347,000 dollars (Blackrock Advisors (UK) Limited, 2013). The total number of shares that were issued at that time amounted to 41,200,000 shares while the benchmark level was 1414.2400. One year later, on January 2nd 2012, the total return net asset value amounted to 27.213216 dollars. The total net assets in that year amounted to 898,770,000 dollars. The total shares that were issued by then were 35,900,000 shares and the benchmark was 1128.3300. The readings today the 16th of April 2013 as per the stock quotes depict that the total number of shares amount to 30,400,000 shares at a benchmark of 1182.786614. The net asset value is 28.1928238 while the total net assets amount to 769,442,000 (Blackrock Advisors (UK) Limited, 2013). Watching the trend closely, it can be concluded the performance has declined form the year 2011 to date (Blackrock Advisors (UK) Limited, 2013). This can also be denoted by the decline in the amount of the shares that are offered from 41 million to 30 million in a period f 2 years. However, during the analysis of the performance, it is recommended that the performance is not measured in terms of the gain or loss by how the net asset values matches or relates to the investment benchmarks set. The benchmark could be based on the index or the sector. In this analysis, I will base the benchmark with the FTSE BRIC 50. Judging from the results obtained from the historical analysis of the BRIC data, the funds of the stock fall in the median quartile. This is to imply that the funds are doing quite well in the market. Performance of the shares can also be determined by comparing the funds according to the total amount of charges they levy. The most comprehensive measure that is used for evaluating the charged is the expense ration (TER). It is normally expressed in percentage. The benchmark or the standard that the investors use is the extent of the charges, for instance, the funds that depict high percentage of the ratio translated to a negative net performance. The 0.75% expense ratio implies that the funds are of low charges. This means that the volume of trading in the market is not submerged by the total charges that are incurred. The cause of these charges is attributed to the transaction costs, the annual costs and the rebalance costs as well as the portfolio optimization. The performance will be measured by the difference between the funds return and the index return (Blackrock Advisors (UK) Limited, 2013). The chart above was obtained from the Ishares website. It depicts the trend from the year 2010 to date. The funds return -11.68% compared to the index return of -9.46%. The minimal difference implies achievement of the goals of every portfolio manager (Blackrock Advisors (UK) Limited, 2013). BP Plc The currency that will be used in this analysis is the Great Britain pound (GBP). BP Plc deals with the petroleum products. The stock of the company is listed in the London stock exchange. The distribution of dividends by this company from the years 2011 to date has been consistent every three months. The amount of dividends paid to the share holders has been increasing since inception, according to Market Watch (2013). The price paid in February 2011 was 4.3372 pounds while the price paid 2 years later on February 2013 was 6.0013 pounds. The increase in the price of the dividend is a good measure of the performance of the stock. The implication is that the stocks are being traded profitably in the stock market. The stock prices have been averaging between 484 and 445 pounds. When compared to the benchmark level, that is, the FTSE 100, the BP Plc is found to be positively correlated with the market. For instance, there is the point where the stock is overlapping. The implication of the overlapping is that the risk represented in the amount overlapped can be mitigated through holding the BP Plc that matches the market portfolio. On analyzing the correlation with the market, the highest price of the BP Plc was found to be 15.5. The implication is that an increase in the market returns will definitely lead to an increase in the BP Plc but at a lower margin than the market (Market Watch, 2013). The current total asset amounts to 257.11 billion pounds. The average volume of shares traded in the year 2011 was 41,111,200 shares. In the year 2012, a year later, the amount decreased to 29,927,800 shares. In the year 2013, the average of shares traded amounts to 24,274,500 shares (Market Watch, 2013). The decline in the number of shares sold or bought is a depiction that the performance of the stock relative to the prices is not adequate. However previous prices have also shown that the volume is independent of the prices. When evaluating the performance of this stock, it is worth noting that this investment would do well if used to protect the fluctuations caused by the small markets. For instance, if one would invest a total of 15,125 pounds in the BP Plc one month ago, on March 18th 2013, and sold it on 17th April 2013, the return on the investment would be 0.175 or roughly 25 pounds. The daily returns that are being generated by the BP Plc based on the past returns is approximately 0.01%. The assumption however, is that there is a 0.07% volatility of the returns in the period stipulated. Assuming that BP Plc is trading in 30 days, it is expected that it will generate more return compared to the market. The comparison with the market is dependent on the company’s ability to generate about 0.14 returns per the risk unit compared with the -0.16 per the risk unit generated by the market (FTSE 100). The performance of the BP Plc is noted to be moderate and close to the market (Market Watch, 2013). TUI Travel The stock of TUO Travel is listed in the London Stock Exchange (Market Watch 2013). The currency is therefore, the Great Britain Pound (GBP). Currently the price of the stock is 305.30 pounds with the last close denoted in the 16th of April 2013. The tour and travel company use the benchmark index of FTSE 350. The exchange market is approximated to be about 10,000 in size. The price per earning ratio of the company from September 2011 has increased from 6.33 to 9.07 in 2012. The dividend cover has also however, decreased from 3.03 to 2.28 in the period of the two years. The company’s earnings per share have been reported as 24.21% in the year 2011 and have declined to 9.32% in the year 2012. The divided yield has also declined from 5.225 to 4.83%. The closing price for the stock in the year on January 2011 was 3.7 with a total of 5700 share traded on that month (Market Watch 2013). On January 2012, the closing price of the stock was 3.05 dollars with a total of 11 thousand shares trade that very day. Currently the closing price of the stock is 4.85 with unknown average volume. The company has however, not reported any payment of dividends to the shareholders. Based on these historical prices, the performance of the investment has been improving. This is defined by the positive 31.08% change per day when benchmarked against the FTSE 350. Barclays PLC The Barclays Plc denoted as BARC: LN in the London exchange rate is a financial sector docket. The stock is currently trading at 298.900 but is expected to close with a different figure. The volume currently traded is 10,208,492 shares. The rating up to date is 35.91% positive (Market Watch 2013). Lloyds Banking Group PLC The Lloyds Banking Group Plc just like all other stock market companies has its ticker code detailed as LLOY in the London Stock Exchange. On January 2011, the share price of the Lloyds Banking Group PLC was 67.84 pounds. In one years time that is, on January 2012 the share price had dropped to 27.04 pounds. Currently, the shares are trading at 48.35 pounds per share. The trend in prices from 2011 to date shows that the performance of Lloyds Banking Group PLC over the last two years has not been consistent (Market Watch 2013). The volume of shares traded has however, increased over the period a move that qualifies competitive stocks in the stock exchange market. The total shares that have been issued currently are 70404.964 million pounds. The change in the share prices is roughly 0.13% on a daily basis. The price per earning ratio is 47.42. The implication is that the group is doing well in the stocks market, given the historical data. The historical dividend payout has shown that the group has been consistently paying dividends until 2008. The dividends paid out were constant throughout the period until the year 2008 when the showed a slight increase (Market Watch 2013). The earning per share reported in the period is -0.0204.however the estimated amount is 0.0410. The implication is that the group has been making losses over the last period. This translates to low performance. The group rather anticipates growth in the next period as evidenced by the estimated price earning ratios and earnings per share. ETFS Gold According to Spence (2013), the ETF gold miners (GDX) are ranked the largest gold miners but have dropped by 31.6% when benchmarked with the market vector as depicted by the New York Stock exchange. The loss is reported to have tripled the loss that was earlier reported by the SPDR shares of gold (GLD). The industry is valued at 300 billion dollars. The share price has fallen consistently since the year 2009, with the SPDR gold shares declining by 2%. A small cap fund that is overseen by the gold miners has declined by about 42% according to NYSEArca: GDXJ. The ETFS commodity securities gold is listed in the London stock exchange as BULP. The shares are currently selling at 1,156.97. This is a negative 2.00% change from the previous change of 23.65 pounds. The volume of the securities traded amounts to 10,592 shares. The company has not reported the payment of dividends yet. In the recently traded scenario, 44.06% of the shares were sold whereas 55.94 5 were bought. The selling price has been noted to be on the increase. The implication of this is that investors are still confident of the company, despite the fall in the net income reported over the period. The performance in the stock market has been mitigated by the funds that the company saves to aid in investor confidence, in such situations (Spence, 2013). I Shares MSCI Brazil USD ETF This stock is listed in the New York stock exchange. The currency therefore, used is the United States dollar. The current net asset value for the stock is 76.95 dollars. The share price as of the previous close was 52.51 dollars. The volume of shares traded amounts to 12,701.100 Dollars. The dividend yields return was reported lastly as – 2.615. The company has being paying dividends with the lat pay amounting to 0.129 dollar per shares. The share price in 2011 was reported as 73.20 dollars. Currently, it is valued at 53.71 dollars (Market Watch 2013). I Shares FTSE/Xinhua China 25 This fund invests 90 percent of the total assets in the index underlying (FTSE 25). The dividends yield as reported lastly was 2.69%. The expense ratio for this stock is low, at 0.74. The stock is currently trading at 34.83 dollars per share. The net asset value is 35.130. The trust fund reported a premium of -0.85%. Based on the figures above, the funds are presumed to be performing. The minimum expense ratio proves that the charges that the funds carry are less compared to the returns of that stock (Market Watch 2013). Risk Identification Hedge Funds These funds are unregulated and therefore, no protection from thee federal government (Gregoriou, 2006). The funds are normally accredited to investors who earn a stipulated minimum net worth. Due to the fact that these funds are used to maximize the return on a given investment, the risks that are attributed to the funds are high. Hedge funds in the past years have not been experiencing the high rated risks. According to (Guidotti, 2012) some of the risks that are encountered by managers as a result of the hedge funds include the counterparty risk, the risk of information asymmetry, regulatory and compliance risk, the rating risk, the headline risk, the stock price risk, detection risk and the competitor/obsolescence risk. The Information Asymmetry Risk The hedge funds that are used to maximize the returns of these investments are shared or pooled together by many investors. The investors have the urge to know the categories of the portfolio securities and the pricing of each stock. The investors also will question on the funders of the trades as well as the counterparties that hold assets in the portfolio. This will require the mentioning of all the companies that have issued the shares contained in the portfolio. The investors will always want to be kept in the loop regarding the day to day investment changes for instance regarding the unusual movements that take place when the markets open for trading. The risk of unavailing this information regarding the composition of the portfolio has consequences ranging from investors withdrawing the hedge funds. The investors will therefore, want to know the 10 companies that are offering the shares, among them Barclays, the standard chartered, the ETFS. The Counterparty Risk The counterparty risk emerges whenever there a lot of partners who own an investment portfolio. The risk that one of the partners may not fulfill their obligations or may default in their obligations is a significant problem when it comes to use of hedging funds in the maximization of the investment returns. The implication of this risk has led to people stripping cash from the prime brokers and advocating of the tri-party collateral. The investment portfolio presented in this listing is basically composed of investors who have pools in their resources to own the portfolio. There is a risk that one or two of the partners in this investment may withdraw the hedge funds in their proportion due to a change of heart. Some of the measures that investors are taking to ensure that this risk is mitigated include clearing the over the counter contracts as well as collateralizing the bilateral trades. The Regulatory and Compliance Risk According to Beattie (2011) the risk here arises due to the relationships that exist between the legislative or the regulatory authority and the business. For instance, if one company in the portfolio has defaulted to adhere to a regulation or a guideline from the authority, mainly the government, the likely cause of action will be receiving a constraint from the government. A constrain made on the corporation affects the holdings of an investor in that organization. This risk comes about due to the ever changing business environment, for instance, imposition of new standards or guidelines that are contrary to the existing ones, also, introduction of new taxes or an antitrust suit. Many of the organizations are reluctant in implementing these new regulations. The government may impose a regulatory risk in its obligation of acting as a cartilage between corporations and the public. This happens if the business strives on satisfying its interests while endangering the public. The government which mostly of the time legislates favoring the public may direct constrain that may affect the various investments in the company (Beattie, 2011). Detection/Headline Risk According to Spence (2013) ETFS Gold once lied to investors about the true nature of the investment. The reality of the matter was that the gold miners were making losses but reported something different to the investors. Once it was revealed, the investors who had lacked confidence in the company withdrew their investments. The gold miners purported to report the true situation of the company in an effort to attract more investors. This risk happens when the auditor or the entity carrying out the compliance fails to report the information that reflects the financial situation of an organization either through ignorance or error. Once this information is released to market, the reckoning happens. The reputation of the company when damaged reduces the confidence levels of the investors (Gregoriou, et al, 2000). Competitor Risk The risk emerging from an entity offering the same services at a more affordable rate would submerge the profitability of the other organization. The implication of this is that the company will finally be drawn out of the market. In an investment portfolio, where there are many companies involved, the risk is high. The investors react by shifting their investments from business to other investments or other business (Gregoriou et al, 2000). Volatility of Stock Price According to (Lamb, 2011) the prices of stocks as evidenced by the past analysis are not constant. They vary from time to time depending on a number of factors. Any company that is seeking to raise funds will always benefit when the prices of their stock are high. Whenever the stock pries decline however, the number of traded stock in the day will decline. Most of the trading will be buying of the stock which many will prefer not to due to low or no returns at all. There is the risk that the stock prices will take some time before gaining value. There is also the risk that the prices will not remain constant but will change in either direction. Risk Measurement Numerical Risk I will use the standard deviation to calculate the price volatility risk. I will use the data of each individual stock to look for the standard deviation of each stock and then finally look for the standard deviation of the portfolio. The standard deviation of the portfolio was 7.362. The high figure implies that the risk is high hence high returns are anticipated. The calculation is available in the spreadsheet (Brigham and Houston, 2009). Non-Numerical Risk The manager in charge of the hedge funds was measured according to their experience and abilities as evidenced by his or her past performance (Barufaldi, 2012). A stock –picking ability was best suited when determining the manager keeping in mind that the investment comprised of stock. The back office operations, the compliance and the trading systems should measure up to the same scale. The scale is another measure that used to evaluate the success of the hedge fund given the ability of the manager to handle the funds. A soft scale was used. This indicated that the hedge funds were doing well in terms of returns and therefore, no additional investors would be required (Lhabitant, 2006). New Asset Allocation The graph below shows the return difference in all the 10 stocks. The call to have a portfolio constriction is to maximize the expected returns (Baker and Filbeck, 2013). The stocks with the high returns are coincided by high level of risk. The shares that are depicting low returns will greatly influence the decision to allocate a new asset to the portfolio. According to the portfolio theories, (Lum, 2012) the allocation of the asset is a step in the portfolio construction. According to Lee (2000) the four steps that are involved in the construction of the portfolio include the following. The first involves the creation of the risk profile. The risk can be perceived in the scale of 1 to 10. The step involves the allocation of the new asset. Judging from the portfolio already in place, the allocation of the next asset in the portfolio will be based on the risk factor and the returns. The third step involves reviewing the portfolio to enable the new asset to fit. The decision factor will be a reduction of the risk and maximizing the returns. The next asset to be selected will be therefore; more predictable in terms of the returns that it yields (Baker and Filbeck, 2013). Graph showing the returns of the portfolio comprising of 10 stocks inclusive of the bonds Detailed Analysis According to Scowcroft (2003) the main goal of any portfolio that is conservative is to protect the value. The conservative portfolio will involve protecting the value and not just attracting more investors. The goal will be to achieve the long term capital growth. This will be achieved if the new asset allocate will be a fixed income security. This guarantees high income from the bonds as well as boost the potential for a long term growth in the capital. The capital will be divided according to the various classes of assets. This will involve stock picking, bond picking, and exchange traded funds as well as the mutual funds (Klein and Lederman, 1995). Since there are two bonds that are in the portfolio and are yielding good returns, the option of adding another bond is left out. According to Strong (2009) the exchange traded funds are a better alternative to all other securities. This is because the ETFs will represent a large number of stocks that are chosen on the basis of index or other stocks. The rebalancing of the asset portfolio in an effort to allocate funds to stocks yielding high returns is the last stage in the construction of the portfolio. Rebalancing is done periodically due to growth and changes in the movement of the markets (Mankiw, 2008). Conclusion This report has analyzed the portfolio that consists of 10 securities comprising of both stock and bonds. The first part of the report involved an analysis of the past performance of this stock. The report also analyzed the risks that are likely to be faced in line with the stocks that are making the portfolio. After a through investigation of these two factors, that is the performance and the risk factor. The report has outlined the process of allocating new assets to the portfolio. This includes the process of portfolio reconstruction. The conclusion made was that adding more fixed securities in the portfolio attached to the exchange traded funds will protect the value of the portfolio and maximize the returns. Bibliography Baker, H., K. and Filbeck, G., 2013. Portfolio Theory and Management. USA: Oxford University Press. Barufaldi, D., 2012. Hedge Funds: Risks. Retrieved on April 2013 from http://www.investopedia.com/university/hedge-fund/risks.asp Beattie, A., 2011. 10 Risks That Every Stock Faces. Retrieved on April 2013 from http://www.investopedia.com/articles/stocks/11/risks-every-stock-faces.asp BlackRock Advisors (UK) Limited, 2013. Ishares FTSE BRIC 50 (BRIC). Retrieved from http://uk.ishares.com/en/rc/funds/BRIC Brigham, E., F. and Houston j., f., 2009. Fundamentals of Financial Management, USA: Cengage learning. Gallant, C., 2013. 4 Steps to Building a Profitable Portfolio. Retrieved on April 2013 http://www.investopedia.com/articles/pf/05/060805.asp Gregoriou, G., N., Hubner, G., Papageorgiou, N., and Rouah, F., D., 2000. Hedge Funds: Insights in Performance Measurement and Risk Analysis, USA: John Wiley and sons. Gregoriou G., N., 2006. Funds of Hedge Funds: Performance, Assessment, Diversification, and statistical properties, USA: Elsevier Inc. Guidotti, D., 2012. Risks Associated With Investing In Stocks. Retrieved from http://www.pfhub.com/risks-associated-with-investing-in-stocks/ Klein, R., A., and Lederman, J., 1995. Hedge funds: investment and portfolio strategies for the institutional investor, England: Irwin Professional Publishing. Lamb, K., 2011. Measuring and Managing Investment Risk. Retrieved on April 2013 http://www.investopedia.com/articles/08/risk.asp Lee, W., 2000. Theory and Methodology of Tactical Asset Allocation, New Hope, Pennsylvania: Frank J associates. Lhabitant F., S., 2006. Handbook of Hedge Funds, England: John Wiley and sons. Lum, S., 2012. Asset Allocation And Portfolio Management: Is The Industry Shifting To A New Paradigm? Retrieved on April 2013 http://seekingalpha.com/article/764801-asset-allocation-and-portfolio-management-is-the-industry-shifting-to-a-new-paradigm Market Watch 2013. BP PLC. Retrieved from http://www.marketwatch.com/investing/stock/bp Mankiw, N., G., 2008. Principles of economics, Volume 1, USA: Cengage Learning. Portfolio Construction: Managing risk and getting the Investment Mix Right 2012. Retrieved from http://www.fundsfocus.com.au/managed-funds/portfolio-construction.html Scowcroft, A., 2003. Advances in Portfolio Construction and Implementation, Burlington MA: Elsevier ltd. Spence, J., 2013. Gold Miners Target Investors as ETFs Hit Multiyear Lows vs. Bullion. Retrieved on April 2013 http://www.etftrends.com/2013/02/gold-miners-target-investors-as-etfs-hit-multiyear-lows-vs-bullion/ Strong R., A., 2009. Portfolio Construction, Management, and Protection, USA: Cengage learning. Read More