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Introduction to Investment Management

Presentation Outline

Overview & Introduction Investment Management Process Creating Investment Policy Statement Selecting a Portfolio Strategy Selecting the Assets Measuring Performance by Portfolio Evaluation

Terms & Definitions

Investment Management / Investment Combining securities of investment in a portfolio tailored to the investors

preference and needs, monitoring and evaluating its performance Job planning, implementing and overseeing the funds/ money of an

individual or an institution; Commitment of current funds in anticipation of receiving a larger flow of

funds in the future;

Portfolio A collection of various investments

Asset Allocation Division of assets among different classes of investments;▪ E.g. real estate, stocks, etc.

Investment Management Process

Asses Goals &

Risks

Create Investment

Policy Statement

Structure Portfolio

Select the assets

Review Performanc

e & evaluate Portfolio

Investment Policy

Definition: It is a formal description of an investment philosophy that may be utilized for any given fund, retirement plan or other

investments the investor may want.

How to create an investment policy statement?

Purpose: What is the money intended for? Retirement? New house fund? Children’s education?

Investment time horizon: When will the money be needed?

Asset allocation: Will the portfolio be all stocks or all certificates of deposits or some combination?

Rebalancing: How often will you rebalance?

How to create an investment policy statement?

Return expectation: This section is optional but if you have an idea of what kind of return you are expecting then write it down.

Investments: This section should outline what type of investments are eligible for your portfolio – i.e. large cap stocks on the S&P 500, index funds, and so on.

Benchmarks: Another optional section – If you are an active investor then you might choose to measure your portfolio against an appropriate set of stock and bond indexes.

It can be difficult to stick to your original strategy for several reasons

Memory - it’s not easy to remember a strategy that you came up with several months or years ago.

Greed and Temptation – if you have a conservative strategy and the market is going

straight up then it can be difficult to stay with the original strategy.

Losses – tough markets make for tough investing. It’s easy to forget or dismiss your original plan

when the going gets rough.

Type of Investor

Retail Investor

Individual investors who buy and sell securities for

their personal account, and not for another company or

organization.

Institutional Investor

A non-bank person or organization that trades securities

in large enough share quantities or dollar amounts that they

qualify for preferential treatment and lower commissions.

Institutional investors face fewer protective regulations because it is

assumed that they are more knowledgeable and better able to

protect themselves.

Retail Investor VS Institutional Investor

Investment Funds Logistic thinking Profession expertise Targets

General Portfolio Strategy

Passive Portfolio Strategy: A strategy that involves minimal expectation input, and instead relies on diversification to match the performance

of some market index.

A passive strategy assumes that the marketplace will reflect all available information in the price paid for

securities.

Active Portfolio Strategy: A strategy that uses available information and forecasting

techniques to seek a better performance than a portfolio that is simply diversified broadly.

Passive Portfolio Strategy

Buy and hold

Buy & Hold is forming a portfolio by appropriate allocate the funds, but once in a position, is not concerned with short-term price movements and technical indicators.

Indexing

Most of fund manager unable exceed the market performance, therefore, they prefer to bond

indexing. In this case, to determine a fund manager success or not is based on the performance both of

portfolio and index.

Active Portfolio Strategy

Interest rate anticipation Valuation analysis

Credit analysis Yield spread analysis

Technical Analysis

Factors in Choosing Portfolio Strategies

The client’s or the fund manager’s view of the marketplace price efficiency

The client’s risk tolerance

The nature of client’s liabilities

Selecting the Assets

Forms of Financial Assets

Form Definition Example

1. Real Asset Actual tangible assets

Real estate, precious metals, precious gems, collectibles, others

2. Indirect Equity Can be acquired through placing funds in investment companies

Mutual fund, Pension Funds, Whole Life Insurance, Retirement Accounts

Forms of Financial Assets

Form Definition Example

3. Direct Equity

Represent ownership interests include common stock as well as other instruments that can be used to purchase common stock, such as warrants and options

Common Stocks, Warrants, OptionsWarrants – convert to one share and are long termOptions – based on 100 share units and are short term in nature

Forms of Financial Assets

Form Definition Example

4. Creditor Claims

Rate of return is often initially fixed, though actual return may vary with changing market conditions

Savings Account,Money Market Funds, Commercial Paper, Treasury Bills, Notes, Bonds, Municipal Notes, bonds, Corporate Bonds

Forms of Financial Assets

Form Definition Example

5. Preferred Stocks Hybrid form of security combining some elements of equity ownership & creditor claims

6. Commodity Futures

Represent a contract to buy or sell a commodity in the future at a given price.

Wheat, corn, financial instruments as Treasury Bonds

Financial Assets

Future Benefit Claim Debt instrument – fixed amount claim Equity Claim (Capital Stock) – varying or

residual claim

Securities that fall under both claims Preferred Stock – subject to fixed payment only

after debt instrument holders are paid Convertible Bond – allows the investor to

convert debt to equity under certain conditions

Financial markets

Types of Financial Markets By type of claim By issuance of claim By maturity of claim

Classification of Financial Markets Short-term – maturity of one year or less Long-term

Functions of Financial Markets

Economic Functions of Financial Markets

Price Discovery Process- market determines the prices of the assets

Liquidity- market provides venue to convert assets into cash

Transaction Cost Reduction- refers to buyer & seller search costs, information collection to assess investment merits

Globalization of Financial Markets

Globalization – refers to integration of financial markets throughout the world

Factors that lead to globalization: Deregulation or Liberalization Technological Advancements

- monitoring world markets, executing orders, analyzing financial opportunities

Increased Institutionalization of financial markets- no longer dominated by retail or individual investors

Relevant Terms in the World Financial Markets

Emerging Equity- stock market in rapidly growing markets

Euroequity Issues- securities initially sold to investors simultaneous in several national markets by an international syndicate

Euroband- bond that is underwritten by an international syndicate, offered at issuance simultaneous to investors in a number of countries, and issues outside the jurisdiction of any single country.

Relevant Terms in the World Financial Markets

Tranche- refers to one of several securities offered at the same time of ownership of the underlying stock of a foreign corporation that the band holds in trust

Mortgage-Backed Securities- securities that are backed by a pool of mortgage loans. Mortgage loans that are pooled and used as collateral for as security is said to be securitized

Asset-Backed Securities - securities that are backed by assets that are not traditional mortgage loans

Futures and Options Market

Contracts that specify transactions to be completed at a later date are for derivative markets.

- financial assets, commodities, precious metals

Types of Derivative Contracts:

1. Option Contract- Gives the contract owner the right but not the obligation to buy (or sell) a financial asset at a specified price from (or to) another party

2. Futures Contract- An agreement whereby two parties agree to transact a financial asset at a predetermined price at a specified future date

PORTFOLIO EVALUATION

Portfolio Evaluation

Portfolio evaluating refers to the evaluation of the performance of the portfolio.

It is essentially the process of comparing the return earned on a portfolio with the return earned on one or more other portfolio or on a benchmark portfolio.

Portfolio Evaluation

Portfolio evaluating refers to the evaluation of the performance of the portfolio.

It is essentially the process of comparing the return earned on a portfolio with the return earned on one or more other portfolio or on a benchmark portfolio.

Portfolio Evaluation

Portfolio evaluation essentially comprises of two functions, performance measurement and performance

evaluation.

Performance measurement is an accounting function which measures the return earned on a portfolio during

the holding period or investment period.

Performance evaluation , on the other hand, address such issues as whether the performance was superior

or inferior, whether the performance was due to skill or luck etc.

Portfolio Evaluation

The ability of the investor depends upon the absorption of latest developments which occurred

in the market.

The ability of expectations if any, we must able to cope up with the wind immediately.

Portfolio Evaluation

Investment analysts continuously monitor and evaluate the result of the portfolio performance.

The expert portfolio constructer shall show superior performance over the market and other factors.

The performance also depends upon the timing of investments and superior investment analysts

capabilities for selection.

Portfolio Evaluation

The evaluation of portfolio is always followed by revision and reconstruction.

The investor will have to assess the extent to which the objectives are achieved.

For evaluation of portfolio, the investor shall keep in mind the secured average returns, average or below

average as compared to the market situation.

Portfolio Evaluation

Selection of proper securities is the first requirement. The evaluation of a portfolio

performance can be made based on the following methods:

a)    Sharpe’s Measure b)    Treynor’s Measure c)    Jensen’s Measure

Portfolio Evaluation

The objective of modern portfolio theory is maximization of return or minimization of risk.

In this context the research studies have tried to evolve a composite index to measure risk based

return.

(a) Sharpe’ Measure:

Sharpe measures total risk by calculating standard deviation.

The method adopted by Sharpe is to rank all portfolios on the basis of evaluation measure.

Reward is in the numerator as risk premium.

Total risk is in the denominator as standard deviation of its return.

We will get a measure of portfolio’s total risk and variability of return in relation to the risk premium.

The measure of a portfolio can be done by the following formula:

SI =(Rt – Rf)/ fσ

Where,▪ SI = Sharpe’s Index▪ Rt = Average return on portfolio▪ Rf = Risk free return▪ f = Standard deviation of the portfolio return.σ

(a) Sharpe’ Measure:

(b) Treynor’s Measure:

The Treynor’s measure related a portfolio’s excess return to non-diversifiable or systematic risk.

The Treynor’s measure employs beta.

The Treynor based his formula on the concept of characteristic line.

It is the risk measure of standard deviation, namely the total risk of the portfolio is replaced by beta.

The equation can be presented as follow:

Tn =(Rn – Rf)/βm

Where,  ▪ Tn = Treynor’s measure of performance

▪ Rn = Return on the portfolio

▪ Rf  = Risk free rate of return▪ βm = Beta of the portfolio ( A measure of systematic

risk)

(b) Treynor’s Measure:

(c) Jensen’s Measure:

Jensen attempts to construct a measure of absolute performance on a risk adjusted basis. This measure is based on CAPM model.

It measures the portfolio manager’s predictive ability to achieve higher return than expected for the accepted riskiness.

The ability to earn returns through successful prediction of security prices on a standard measurement.

The Jensen measure of the performance of portfolio can be calculated by applying the following formula:

Rp = Rf + (RMI – Rf) x β

Where,▪ Rp = Return on portfolio

▪ RMI = Return on market index

▪ Rf = Risk free rate of return

(c) Jensen’s Measure:

Types of Benchmarks

1. Market indices are equity indexesEx: Dow Jones Industrial Average, Standard & Poor’s 500 Composite, NASDAQ Composite Index, New York Stock Exchange Composite Index, etc

2. Generic-Investment-Style Indices – developed by various consulting firms to measures various investment styles

Ex: Frank Russell, Wilshire Associate Prudential Securities, etc

Types of Benchmarks

3. Sharpe Benchmarks – because of the difficulty of classifying a money manager into any one of the

generic investment styles, benchmark can be constructed using multiple regression analysis

from various specialized market indices

Ex: Russel Price-Drive Stock Index, Russel Earnings-Growth Stock Index, Salomon Brothers

90-Day Bill Index, etc

Types of Benchmarks

4. Normal Portfolio – is a customized benchmark that includes a set of securities that contains all of the

securities from which a manager normally chooses, and weighted

THANK YOU!

Group 1 Vicky Billy James Esi