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Wealth Management

FIN6A8 Individual Coursework
Issued: Week 2 of the current term
This is an INDIVIDUAL Summative Assignment. Section 1.0
You must prepare a well-defined investment plan and framework with initial hypothetical value of 2,000,000. You should clearly specify the asset allocation per category (i.e. physical and/or financial assets) in your plan.
Hypothetically the 2,000,000 is to be invested in shares and/or other financial instruments and/or physical investments and you should choose only investments whose prices are quoted in the Financial Times, or are obtained from other reliable sources, which you must identify.
Cash balances can be invested to earn LIBOR 1%. Any borrowing will be at LIBOR + 1%. Interest should be calculated daily and included in valuations. Allow for dividends and other distributions.
You investment plan should include sections on macroeconomic, industry, country and political risk analysis, but also specify the size and composition of an investment portfolio with clear strategies in risk diversification and hedging.
Your entire well diversified wealth growing portfolio OR a part of it should be fed to a portfolio simulation engine online with results observed daily, but recorded weekly. If the entire portfolio could not be re-created in one single portfolio engine or platform, you can either use more than one platform (i.e. Bloomberg, FX, Etc.) or simulate only part of it through an online portfolio engine. You should properly justify you choice and any possible technical constrains.
You should manage it in a dynamic fashion, with transactions made at appropriate points in the price evolution path of a well-diversified portfolio. You should investigate the effects of portfolio optimization through a comparative portfolio pricing framework.
A. Euler
You should compute portfolio risk and return as part of the Markowitz framework and investigate the use the Sharp model in the context of portfolio re-pricing and draw clear conclusions of its usefulness.
Further on, you should investigate both passive and active portfolio management tactics. Clearly state and justify your portfolio management style (i.e. active versus passive).
Identify and use (if and when appropriate) any other financial information such as 1) share prices and headline impact on share price, 2) retained earnings, 3) dividend payouts, 3) ratios such as liquidity, efficient use of assets, leverage, and profitability, and other financial information you would consider necessary to create a good understanding of the attractiveness of each investment.
Use relevant articles, journals in your research (which you should clearly identify) to support your work in setting up and managing wealth through a well-diversified investment portfolio.
You should also explain the investment strategy you have followed. Your strategy statement should include a statement on your attitude to risk. You should provide details of the transactions you have undertaken, with a critical evaluation of these transactions in the context of your investment strategy, identifying the theoretical basis for your investment decisions.
You should comment on the overall investment performance of your portfolio from the day it was set up (i.e. Week 7 or earlier) to the close of business on Friday of Week 11, and of the components that make it up. Your evaluation should include measures of performance and comparisons with appropriate indices for the types of investment and sectors that you have chosen. Although the portfolio observation is time-boxed, this does not mean that it has to be set up as a short term investment. It might be set up as a short term, a medium or long term investment portfolio, as neither minimizes or negates the positive effects of the theory that underpin the investment portfolio set up and management with proper asset and capital allocations.
In your comments on portfolio performance, you should explain what you have learned from the exercise, and what if anything you might change if i) you did the same thing again as an academic exercise, and ii) you were investing your own money.
A. Euler
You should explain to what extent you might expect professional wealth managers to follow a strategy similar to the strategy that you adopted during the course.
Your work should be referenced, and contain a list of the sources of (i) your evidence and (ii) the theory that underpins your analysis and commentary.
Section 2.0
CW Report Marked on a 100% scale, but weighted at 60% of the overall module mark.
You are required to produce and submit a final report with a word count between 2500 to 3500 words, excluding calculations, tables and appendices, and should be shown in your report
1.0 Introduction
            Planning of my portfolio will begin by a careful allocation of assets. Some of the most important factors to consider during asset allocation include time horizons, risk tolerance, and the goals for investment. All these factors are closely related and none of them is less important when planning for an effective asset allocation. I will pay a close attention to all of them in order to determine how I will allocate the available cash in different assets, and the extent to which resources will be required at different stages in my life.
            Family situations and age are closely linked to my goals for this investment. In general, I am quite young and can tolerate moderate risks in my investments; since I can manage to wait for bad times to pass and bail pay back the variation during the better times. Time horizons essentially refer to the duration of time that I will require to redeem the money that I have invested. Some common examples include the time that a child takes to commence schooling or the time that I will work before retiring. Notably, time horizons that are longer, allow for investments that have relatively higher risk because a short slump cannot negatively affect the long-term plan (Merton 1969). Asset allocation is the strategy that investors use to put their money into different asset categories that have different characteristics. This involves putting the asset in reverse directions in order to diversify and maximize returns, while at the same time reducing the portfolio’s overall risk. Ideally, my objective is to allocate my investment prudently so I can realize my retirement goals.
1.1 My goals
            A good asset allocation plan starts with determination of personal goals. As a young investor, my investment time horizons are fairly lengthy. It will take quite a while before I redeem my investment out of the retirement kitty.  As such, I will tend to tolerate a bit of risk and adopt a rather aggressive approach to investing. To achieve my ultimate goals, I will endure potential short-term market variations.
1.11 Aggressive asset allocation model portfolio
            In an aggressive model, I will hold several assets in my portfolio. Essentially, stock will take up the largest share of the mix. In choosing such a mix, I will have assumed that the stock’s long-term growth potential will offset the risks. Other assets that will round out my portfolio include commodities, land, and real estate, which will provide potential for capital appreciation. Others are cash and bonds, which will cover just a small proportion because I am in my early years.
2.0 Portfolio   
2.1 Portfolio Composition
The $2,000,000 will be allocated amongst stock, commodity, bonds, cash, currencies and physical property in accordance with my time horizon and risk profile, as discussed earlier. The stocks will take the lion’s share; that is, 75% while the other categories will take the remaining share. The distribution of the $2000,000 is suggested as shown in the table below:






Macquarie Infrastructure Company LLC

CurrencyShares Japanese Yen Trust (FXY)

CurrencyShares Canadian Dollar Trust (FXC)

iShares S&P GSCI Commodity-Indexed Trust (GSG)

Bonds and cash

 Real estate



2.11 Stock
            As discussed, stocks will take the largest share in my portfolio (75%). This is particularly because of their potential for generating high returns in the long-term. However, stocks tend to fluctuate so frequently, but to me this is not a hindrance because my dream as a young investor is to accumulate wealth over a long period of time. In addition, I have recognized the fact that bad timing or bad lack can sink my returns, though this will be mitigated by the long-term investment approach that I have opted. Furthermore, there is no guarantee of generating positive returns even in the long-term, but I will mitigate such risks by diversifying my stocks over different companies and geographical regions, such that the chance of having all the four stocks performing poorly is extremely rare (Little, 2012).
2.12 Physical Assets
            Physical assets are the tangible investment such as land and real estate. Inclusion of such assets in my portfolio will not only serve the purpose of profit creation, but also fulfill my status and desires because owning a house, for instance, will make me proud and experience my assets in a physical manner. Besides, investment in real estate will generate fixed income in form of rentals and cater for asset appreciation, for example because the value of land will undoubtedly continue to increase in the future. What’s more, I will invest my physical assets in different geographical locations hence providing a sense of diversification.
2.121. Real Estate
            I have included real estate in my portfolio for its numerous advantages including capital appreciation, rental income, and tax advantages among others. In the long-term, it is expected that the value of real estate will go up significantly. In regards to tax advantages, the implication is that a rental property operates like a business and the expenses incurred thereof are tax deductible.
2.122 Land
            Land is the other physical asset, which is very useful in a long-term investment approach. By including it in my portfolio, my goal is to hold it in the long-term such that its value will appreciate. I also found this kind of investment very advantageous because it is a rule of thumb that land does not depreciate in value, therefore, I am guaranteed of positive returns anytime I want to sell it.
2.13 Commodities
            It is important to invest in commodities because this will increase my returns while at the same time lowering my risk. One of my investment objectives is to create a diversified portfolio. That means that if part of my portfolio is performing poorly, the other one could be performing well – this makes it essential to have assets that belong to different categories. The main reason for inclusion of this asset category in my portfolio is the fact that it is negatively correlated with stocks and bonds, hence offering a perfect tool for diversification in my portfolio. This means that, when commodities are heading south, stocks will tend to head north.
2.14 Bonds
            Investment in bonds will be minimal considering my income needs and tolerance for risk. Bonds constitute a safer investment opportunity even though they have fewer returns over time. These low return assets represent the cost of doing away with a high level of volatility. Bonds will add value in my portfolio, for example by providing a predictable source of income flow. Also, the bonds will help by facilitating savings for a new home or education of my children, as well as increasing my retirement income among other financial goals.
2.15 Cash
            Although I have a long term approach as a way of achieving my investment goals, I must keep in mind that sometimes emergencies or short-term needs happen, when I am needed to have some liquid cash in my disposal. This is the primary reason why I am including cash investment in my portfolio, which will be in form of money. Furthermore, the cash investment will be meant to lower the risk potential in my portfolio. For example, during volatile seasons, the cash position can be used to offer remedy to such an experience. Other uses of cash will include meeting of short-term need such as personal expenses. Although I intend to begin with a very small proportion of cash, as I approach my retirement, I will tend to increase this proportion in my portfolio such that it keeps in line with changing time horizons.
2.16 Currencies
            I will also invest in foreign currency, including Canadian and US Dollars for several reasons. Most importantly, this is to enjoy the diversification from potential risks associated with the US Dollar, which is offered by the foreign exchange market.  However, the proportion that will be dedicated for this particular category will be very minimal especially because of the high risks associated with it, such as high leverage for direct investments and high volatility as a result of bank interventions and other factors.
3.0  Diversification
            One of the most important steps for creating a successful portfolio is efficiently dividing assets within scores of different investment types. Some of the most important classes of assets are bonds, stocks and cash. The performance of these investments depends on the prevailing conditions of the economy. Therefore, a good balance is required to maintain the portfolio strong in different economic situations. Accordingly, the allocation of assets becomes the most important way of diversification. More so, classes of assets carry different amounts of risks. This means that the best an allocation will depend on various factors relating to my investment profile (Yaari 1965).
            Diversification will be an important parameter that will determine successful growth of my portfolio over time. There are different strategies in my disposal for ensuring diversity of my portfolio, namely across assets, within assets, geography wise, across capitalization, across style, and across time diversification. Portfolio diversification goes beyond investing in multiple assets of the same class, to include diversification at different levels. The following are some of the types of portfolio diversification in intend to use in my investment:
 3.1 Across Asset Class
            Across assets class will entail diversifying my investment in various categories such as stocks, real estate, commodities, bonds, cash, and physical assets. The essence of undertaking such a diversification is because I am not an expert in any particular asset category and hence I cannot effectively manage a lone category.
3.2 Within Asset Class
            Within the individual asset categories, I will also go further and invest in different kinds of companies, sectors or instruments. A case in point is the stock category, which I intend to invest in stocks of five different companies including APPLE, CITI, GE, Macquarie and EXXON. Besides these stocks belonging to different companies, most of these companies also belong to different sectors/ industries.
3.3 Geography Wise
            I will also diversify my portfolio along locations. For example, I can invest in real estate in the UK and US. Alternatively, I can decide to invest in real estate across different cities within UK. Part of my stock portfolio will also come from different parts of the world. Apparently, it is important to invest in assets from different countries because the security returns amongst different countries differ. This is because different countries vary in terms of resource endowment, industry structure and macroeconomic policies. This variation also results from the fact that different countries have business cycles that do not occur simultaneously, meaning that a particular country could be experiencing a boom while another one experiences recession at the same time. As such, securities from the same country undergo similar macroeconomic policies, and business cycles thus their security returns are highly correlated, which is risky if not diversified (Fleischer, 2003).
3.4 Across Capitalization
             This involves investing in large cap funds, small cap funds, small companies, and big companies among other related characteristics. This strategy will mostly come in handy if I decide to invest in mutual funds. The strategy will results in spreading of the assets across varied risk and return potential.
3.5 Across Time
            In addition, I will diversify my portfolio across time. This includes integrating long-term investments such as stocks with short-term investments such as bonds and cash, as well as medium term investments. As explained earlier, despite the fact that my primary goal is to have a long-term investment in preparation for my retirement, I cannot ignore the fact that I will require money on short notices; therefore, it will be imperative to combine my long-term investment with short term and highly liquid investments such as bonds and cash.
3.6 Across Style
            Diversification across style means investing for the purpose of generating fixed incomes or mainly for growth purpose. At the same time, I can invest for speculative purposes or for the purposes of creating value. For example, I will invest in stocks and land mainly for the purpose of appreciation, but invest in bonds and rental assets for the purpose of generating fixed incomes.
 3.7 Risk/return diversification
            This type of diversification is in recognition that different assets have different risk/return profiles, and combining those with different profiles will help in balancing of risk and return profile in my portfolio. Risks that are high pave way for greater rewards. However, these rewards are not of any value if they are not available when the money is required. Stocks provide investors with the best growth prospectus in the long run. Stocks do better than all other investments in the long run. However, stocks are quite volatile, hence making them very risky. Within a short time span, stocks can lose a lot of value. Stocks that are individual may not be able to be at par with the entire market. At the same time; they may completely lose value, for instance, if the bank is declared bankrupt. Bonds constitute a safer investment opportunity even though they have fewer returns over time. These low return assets represent the cost of doing away with a high level of volatility. My portfolio will, for the purpose of risk/return diversification, contain all these asset categories, among others.
4.0  Markovitz Framework
      The Markowitz framework is normally referred to as the mean-variance framework.  The following are axioms (assumptions) of this model.

The returns’ mean and variance on different assets is the basis used by investors to make their decisions regarding the expected return and risk.
The same time horizon is shared by all the investors. This means that all the investors are only concerned with the utility of their eventual wealth, and not with the earlier state of their portfolio. All the investors share a similar terminal value.
All the investors are of one mind regarding the values and parameters used in making investment decisions, including means, correlations of returns, and variances on different investments.
Financial assets are fungible by chance

            The essence of Markowitz theory is meeting the investor’s desire of maximizing the potential return and to reduce the standard deviation of the return. The portfolio’s riskiness is measures by the standard deviation of the stock’s return.
4.1 Markovitz with excel solver
            For the purpose of this illustration, the maximum return for our stock portfolio will be calculated at a given level of risk. This will include the four stocks including Exxon Mobil, General Electric, CITI, and Apple. Then, we shall collect weekly prices for the four stocks, for a certain period of time. To begin with, we shall try to maximize the portfolio with a risk of 0.2%, at most. A sample of this model is illustrated in the excel work sheet.
5.0  SHARP Model
            The Sharpe performance measure (SHP) is a performance metric, which is adjusted for risk (Sharpe, 1994). It is a portfolio’s mean excess return, which exceeds the risk-free rate divided by the standard deviation of the portfolio. The Sharpe ratio is defined the following equation:
 = the asset return

= the return on a yardstick asset, such as the risk free rate of an index return (such as S&P 500)

 = the anticipated value of the stock return, which is above the benchmark return
 = the standard deviation of the anticipated excess return.
             The Sharpe ratio shows the extent to which an asset pays off the investors for the risk they have taken.  When two stocks are weighed against a common benchmark such as S&P 500, then the stock that has the highest ratio is assumed to have better returns for commoner risk. Just like any other mathematical model, Sharpe ratio depends on the accuracy of the data being used. For example, pyramid schemes that exhibit long period of operation would generally show a high Sharpe ratio when resulting from reported returns, though the inputs are not true. When assessing the investment performance of stocks with profits funds, the Sharpe ratio should be computed from the performance of the primary stocks instead of the returns of the funds. A Sharpe ratio can also be highly deceptive if the benchmark is wrongly specified (Jobson and Korkie, 1981).
6.0 Other information used
6.1 Dividend payout
            As part of my portfolio objectives, I intend to invest in shares that will guarantee me annual or semiannual income in form of dividends. Since I have invested in stocks from different companies, my expectation is that at least some of them will generate handsome profits and allocate a portion of it to the shareholders in form of dividends. Indeed, while assessing the best stocks to invest in, besides the long-term potential for growth, the other important factor I will consider is the company’s dividend payout history and dividend policy. However, since short-term cash flows is not my primary goal, I will not be surprised to retain stocks of the companies that pays very little or no dividends at all, provided I am guaranteed of long-term returns.
7.0 Portfolio Management Issues
7.1 Passive Portfolio Management
            Passive portfolio management involves use of index and hybrid finances. I will adopt this approach because it will help achieve my goals and it is in line with my risk profile. Most importantly, through this approach, I will minimize cost because I will not be required to hire a skillful investment manager to closely manage my funds, as the case of active investment funds.
In other words, unlike active management approach, passive management approach is cheaper because I will not be required to hire traders, analysts, fund managers and other investment expert. Since I will be required to only follow the average, little expenses will be incurred in running the portfolio, thus the returns will potentially be higher than the case of active management. Through this approach, I will adopt an asset allocation and management strategy that involves diversification through asset allocation fund and by closely following the market performance benchmark to establish how my portfolio is faring. This also entails investment in companies whose performance is in line with the benchmark. In this regards, the fund will be expected to move in the same direction with the benchmark average (Brinson et al. 1986). This approach is also preferable because it is regular, given that people are not involved in the running of the funds. Furthermore, involvement of people in the management of funds can sometimes lead to so many uncertainties and it is subject to so many human errors.
            Lifestyle funds are run up to a specific year of retirement as specified in the fund name, with each fund having a combination of bonds and stocks, which are distributed as the fund nears the planned date of retirement. Before and after the retirement date, the funds continue to change asset classes. With time, the allocation of these funds become more conservative, hence the participants are not required to keep rebalancing them……………………………………………
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