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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