Investor Policy Statement Details - Math Problem Example

1. Introduction and summary of IPS Investor Policy Statement (IPS) is a document drafted between a fund manager and a client that outlines major terms and conditions for the manager managing the portfolio. This statement provides the general investment goals and objectives of a client and the strategies that would be adopted by the manager to meet those objectives. IPS includes specific information pertaining to asset allocation, risk tolerance, and liquidity requirements. In the current case, Anderson is the client and James is acting as a wealth manager on behalf of Australian Wealth Professionals (AWP). The IPS would state Anderson’s investment objective which would then determine his portfolio allocation, his annual returns in today's dollars given a certain rate of inflation. It could also include what the individual wants to leave behind to loved ones when he dies. There are 4 essential parts of an IPS which are as follows: a) Required Return It is imperative for investors to actually translate their return objectives in to an actual defined statement quantifying their returns in ASX or percentage terms. For instance, Anderson’s portfolio should be designed such that it would earn his a certain return over and above the inflation rate of 2% with an orientation towards growth (capital appreciation). b) Risk Tolerance Risk tolerance refers to risk capacity and risk propensity. “Capacity” relates to financial circumstances such as a person’s net worth, income needs, and lifestyle requirements. On the other hand, “Propensity” relates to the investor’s willingness to contemplate the possibility of very large losses in the short term in pursuit of higher returns in the longer term. c) Time Horizon Time Horizon refers to is a situation for which the investment is being designed. Events like college education, starting a business, buying a vacation home or retiring could determine the approximate time horizon for the investor. Here, Anderson is middle-aged looking for saving for his retirement which is a long-term objective. d) Liquidity needs Liquidity needs are also a part of IPS based on future events. It would show how the required income stream could vary up or down. IPS sets out investment aspirations in a policy format which further clarify the decisions to be taken for the investor’s portfolio.  2. Objectives [should not exceed 1 page] a. Returns required by the investor. This should be calculated using IRR on annual net cash flows. Please ensure nominal pre-tax returns, and hence an appropriate inflation rate should be used. b. Risk Tolerance of the investor. This should be analysed by evaluating Willingness and Ability to take risks. Risk objectives should also be considered by evaluating any downside risk (VaR) objectives established by the client. If such a requirement was not provided than you need to establish one for the client and justify it. 3. Constraints [should not exceed ½ page] a. Liquidity requirements of the investor. Both anticipated (on an annual basis) and unanticipated liquidity requirements should be clearly stated and included in the cashflows. These should be mentioned in percentage terms as well as in dollar terms. An Investor Policy Statement not only considers investment objectives but investment constraints as well. Fund manager must identify constraints including liquidity, time horizon, tax concerns, legal and regulatory concerns and unique circumstances. The same liquidity needs may either be planned, for instance, child’s college education in 15 years or may be unplanned such as a medical emergency. However, both require ready ability to convert investments into cash or in other words, determine how liquid the assets are. In case Anderson invests in real estate it would take considerable time to sell while corporate bonds may impose early withdrawal penalties. However, Real Estate Investment Trust (REIT) is an option which offers liquidity and daily price quotations. Also, unlike direct real estate holdings, they are a liquid asset that can be sold fairly quickly to raise cash or take advantage of other investment opportunities. Furthermore, investing in REITs is also attractive due to the large cash dividends that they usually pay. b. Investment horizon of the investor. Investment horizon and stages of investment horizon should be detailed. Time horizon particularly refers to the time at which an investment objective is supposed to be met. Objectives like saving for a house may have a short time horizon, while retirement or endowment planning have longer horizons. Additionally, time horizon influences the ability to accept risk which eventually determines a manager’s asset allocation strategy. Therefore, investors with little tolerance for temporary return fluctuations may need a different plan than would be suggested by time horizon alone, and multiple time horizons can further constrain allocation decisions. 4. Economic Outlook [should not exceed 1½ page] a. Short term (next 1 year), mid-term (5 years) and long term economic outlook should be provided for the country assumed as domestic country. Please use research reports, economic commentary, and/or media to source this information. Australia has been assumed to be the domestic country in Anderson’s case. The Australian residential property sector has performed remarkably well over the last few years. However, it is expected by analysts that house price gains will be less than inflation. This is based on 12 months data ending in February 2010 when capital city house prices rose by just 0.8%. At the same time, rising energy costs and rising wages suggest that the authorities remain concerned about rising inflation.  However, a Reuters report states that underlying inflation seems be at decade low. Another fact about the economy is that the unemployment rate is still relatively low at just under 5% and Australia’s population is still rising enough to stimulate demand. In the short-term, it has been forecasted that global growth will be strong in 2011 and 2012 according to National Australia Bank Head of Industry Analysis Dean Pearson. He was also of the view that the Australian dollar (ASX) will peak later during the year at around US$1.05, and through until the end of 2012 will remain high at around US$0.90. In addition, house prices are tipped to rise 3 per cent across Australia over the course of next year. Thirdly, consumers are cautious about their spending habits and are likely to remain so for the next 12 months. Additionally, interest rates are also likely to rise in May, topping out at around 5 per cent later while recent floods may push up inflation further during the year. Dean also mentioned that the floods indirectly impacted 10 per cent of businesses across Australia, with 37 per cent of business losses not even covered by insurance. It is also pertinent to note that 75% of tourism revenue in Australia is derived from domestic sources while strong ASX is increasing offshore tourism by 13 per cent. Despite ups and downs, the overall economic outlook for Australia remains quite positive and the franchise sector is also tipped to remain strong. According to Standard & Poor's, mortgage arrears have touched their peaks since April 2009. It also found that the number of loans in arrears have also increased lately. The company's long-term economic outlook for Australia was positive, with S&P saying the economy would support a stable housing market in 2011. Additionally, its latest quarterly update on mortgage delinquencies for 4Q2010 also show that delinquencies have also risen in the recent period. Recent indicators suggest that conditions will remain sluggish in the near term with subdued business and consumer activity. However, mining sector would be an exception supported by exceptionally high terms of trade and a healthy growth in volumes.  5. Asset Class and Sector/Industry Outlook [should not exceed 1½ pages] a. Domestic, International Developed and International Emerging markets should be evaluated. Activity in the developed world remains subdued with unemployment at high levels. Financial crunch in the euro region have further contributed to downside risks. Policies to redress fiscal imbalances and to repair and reform financial systems in advanced economies are also needed. Emerging economies have been characterized by buoyant activity, strong inflationary pressures and overheating driven in part by strong capital inflows. Countries in this region have been witnessing strong growth including sub-Saharan Africa. Global output is projected to post a growth of 4.5% in 2011 while downside risks to the recovery remain high. Therefore, it is imperative to get to the roots of the problems and overcome the prevalent sovereign and financial troubles. Additionally, overheating pressures need to be in check with facilitation of external rebalancing in key emerging economies. Global activity expanded at an annualized rate of just over 3.5% in 3Q2010 down from 5% in the previous quarter while the third-quarter rate came out to be even better than forecasts. This was primarily due to stronger-than-expected consumption in the US and Japan with stimulus measures playing key role. Also, private consumption has started to gain momentum as of late particularly in major advanced economies. IMF reports indicate that global recovery is led by emerging economies with China likely to lead the way this year at 9.6% percent followed by India at 8.2%. However, it also warns of possible downside risks including inflationary pressures in emerging economies whose asset markets are booming, and the impact of surging oil prices fueled by uprisings in the Middle East. The IMF report also predicts advanced economies to grow 2.4% in 2011 with United States to grow at 2.8% and EU at 1.6%. b. Real Estate and the two types fixed income securities should be analysed for the domestic economy only. c. These details should be summarised in a spreadsheet as follows: Fixed interest instruments have their own pros and cons. Although they do not deliver the highs of shares or property trust investments, it is also relatively resilient to economic shocks and volatility. These might include instruments like cash or government or corporate bonds. Cash: Cash can be referred to as the most liquid instrument placed in bank deposits which is as liquid as that held in hand. James could build a defensive portfolio which invests in Australian short-term cash deposits and cash equivalent securities with very high credit ratings. The same should aim to deliver a return similar to the performance benchmark but may also strategically hold securities with maturities longer than the 90 day bank bill index (out to 3 years) so as to passively capture the expected interest rate premium further out along the yield curve. Anderson’s investment would be safe this way with a focus on absolute capital preservation and market-competitive returns. Government/Corporate Bonds: Fixed interest investments issued by the Commonwealth Government, state governments, semi-government authorities, banks and other corporations, both locally and overseas, to raise capital for projects are referred to as Government bonds. These are longer tenor instruments spanning over 10 to 30 years. Australian bond maturities range from one to 10 years while US bonds can extend up to 30 years. Investment in such securities yields benefits from diversification, lowers risk, and provides opportunities for higher returns without resorting to lower grade, higher risk debt. There exist around 300 such securities in the Australian market. Corporate bonds are those issued by large public companies to fund expansion and other major projects. Corporate bonds differ from government bonds with regards to yield and credit quality. Generally, corporate bonds have a higher level of risk compared to government or semi-government bonds, therefore offer higher rates of return. REIT: High property occupancy levels in Australia have also led to greater popularity of REIT in the country. However, recently home prices have skyrocketed, household debt has risen, and currency has also appreciated significantly. 6. Critique the current asset allocation [should not exceed 1½ pages]. a. Please ensure the critique is based on both, investor’s profile as well as the capital market outlook. Specific may be detailed in this section. James plans to construct a portfolio for Anderson with index funds encompassing 6 diverse asset classes. These include (i) Cash and Bills, (ii) Corporate and Government Bonds, (iii) Domestic Equities, (iv) Emerging Market Equities, (v) Developed Market Equities, and (vi) Real Estate Investment Trusts. Investor profile: Our analysis suggests that Anderson, the investor, is already 50 years of age a decade away from retirement. Therefore, he needs security of his money as well a steady stream of income to live a comfortable life post-retirement. Therefore, his money will need to be placed in secure financial instruments yielding him a fixed rate of return over and above the inflation rate so that his real income stays positive. Furthermore, investor should himself be educated about the different available financial instruments so as to analyze his own investments. Equities would therefore be a risky asset class to invest Anderson’s money in as returns are relatively volatile in the capital market. Current asset allocation and capital markets: Australia is expected to benefit from strong economic growth in emerging markets with a subsequent positive impact on resources and commodity prices. Similarly, significant infrastructure and resource project investment along with a boom in the mining sector bodes positive for Australian economy. Strength in Australian dollar in 2011 with economic growth on an uptrend, the Australian equity market also remains attractively valued against the global backdrop.   Domestic Equities: According to Aviva Investors’ December ‘Market Monitor’, the overall equity market is trading on a price-earnings ratio of ~12.7x, compared with an historical average ratio of 14x. This suggests a possible re-rating upwards in the near-term. The profitable sectors worth investing in would be resources and cyclical sectors such as media and retailers.  emerging equity markets : JPMorgan on Monday recommended investors increase positions in emerging equity markets, saying developing economies are expected to slow down less than their developed counterparts in the next few months. Emerging market equities: Gap between returns posted by emerging markets and developed ones may increase in the following months if investors shift their portfolios. Benchmark MSCI emerging market stock index has gained nearly 9% lately while MSCI World stock index of developed countries is relatively flat. Therefore, returns would relatively be more secure with investment in emerging markets rather than developed economies. Developed economies: On the other hand, 2011 growth forecasts for developed market equities have been downgraded by economists recently due to higher international oil prices and Japan's earthquake and nuclear crisis. Overall, equity funds posted collective inflows of $8.39 billion compared with $1.16 billion for bond funds with money market funds witnessing outflows. An Australian Real Estate Investment Trust (A-REIT) can also be used as an investment instrument by James for Anderson. REIT refers to a pooled portfolio of property assets, listed on a stock exchange, in this case, the Australian Stock Exchange (ASX). This tool would own a portfolio of large properties, which, due to their size and value, cannot be bought by the average private investor. These large investments are then broken up into units of smaller value that can be purchased by private investors, who become unit holders. Anderson’s portfolio may also include international real estate which could enhance return while reducing risk. 7. Asset Re-Allocation [should not exceed 1 page] a. Create an asset allocation using only the above mentioned asset classes/sectors. Please ensure that sectors/industries are not specifically weighted. b. Justify your allocation with regards to the investor profile and capital market expectations mentioned above. Please note that the capital markets may or may not be able to provide for the requirements of your client. This must be detailed in your assignment in addition to any changes you recommend to the investor. After studying the investor profile of Anderson, I believe he should reallocate his assets towards safer instruments such as fixed income securities which would include cash and bills and government ot corporate bonds with a small portion in REITs. Equities should only be considered if the investor is willing to take some risk with his money over a longer time horizon. I would therefore suggest an allocation between Cash and Bills: 30%, Government/ Corporate Bonds: 60% and REIT:10%. If equities suit investor profile then the proportion should be altered to Cash and Bills: 20%, Government/ Corporate Bonds: 60% and REIT:10%, and Domestic Equities: 10%. I have chosen domestic equities because Australia’s economy is showing signs of recovery which would bode positive for the domestic equity market thus improving portfolio returns for Anderson. Bibliography Prudent Investment Practices: A Handbook for Investment Fiduciaries, published by the Foundation for Fiduciary Studies “Investment Policy: Winning the Losers Game,” Charles Ellis, Irwin Publishing “The Management of Investment Decisions,” Trone, Albright & Taylor, McGraw-Hill "ASX A-REITs". Australian Securities Exchange. Archived from the original on 2008-08-01. Retrieved 2008-08-22.  Whitman, 2004, 5  Jackson, Thomas (2001). The Logic and Limits of Bankruptcy Law. Oxford Oxfordshire: Oxford University Press. p. 32.ISBN 1587981149  "Increased Customer Satisfaction Increases Stock Price" Read More