Managing Investment Portfolio: Objectives, Strategies And Evaluation

FIN206 Investment Management

Providing the rational for the allocation and indicating whether it is appropriate, as per the objectives are currently expressed

There are both strengths and weakness of the current strategic asset allocation, which could have negative impact on performance of the portfolio. The strengths or the benefits from the SAA are depicted as follows.

• The major benefit that could be provided from the SAA is the limited risk associated with the investment, while the income is fixed for the investment. Moreover, the benefit funds are forced on delivering lower risk, which has allowed the benefit fund to improve their current rate of return even in the risky platform. The aim of investors is to minimise the level of risk involved in investment by utilising the weight factors, which preparing the portfolio. This allows the investor to maximise the return, while reducing the risk, which could be obtained from the investment.
• The second benefit that has been portrayed by the SAA is the fixed return on investment, as the Strategic asset allocation aims in identifying investments, which could provide constant annual returns. ABC investment could eventually allow the obtain the level of returns by utilising the strategic allocation method. Kahn and Lemmon (2016) indicated that investors aim in formulating a portfolio, which could help in improving the level of returns from investment, while reducing any kind of risk involved in investment.

There are certain limitations, which is associated with SAA, as it might hinder performance of the organisation. The limitation of the Strategic asset allocation for the benefit funds are depicted as follows.

There is extensive limitation for the benefit funds that has been created by using the Strategic Asset Allocation method, as the fund is heavily invested in interest paying instruments. Maximum of the funds allocation is invested in Australian fixed interest and International fixed interest, which restricts the portfolio to achieve higher growth and abnormal returns from investment. In this context, Fenderet al. (2017) stated that investor mainly use the portfolios to minimise risk and maximise returns from investment, which can only be achieved by increasing their exposure in the equity market.

From the evaluation of the case study, it could be detected that the measures taken by Strategic asset allocation is accurate, where the investor are only keen on receiving fixed return from investment. On the other hand, the restriction of strategic balanced fund for acquiring additional investments from different investors is directly affecting the capability of fund to increase the total return and maximise profits by increasing investment in the alternative instruments. The fund mainly focuses on conservative asset allocation process, where its first priority is to reduce risk from investment, while maintaining a constant return that could be generated from investment. On the contrary, Van, Plantinga and Scholtens (2016) argued that funds adopting the conservative process mainly reduces their capability to maximise the level of returns, as they are focused in reducing the risk from investment instead of maximising returns. Fender, et al. (2016) further elaborated that investors increase their exposure in high yielding risk for raising the level of income by mitigating the risk using adequate weightage method. Therefore, from the evaluation it could be detected that the current SAA method is only focused on constant returns and low risk, which is directly affecting the capability of the funds to achieve abnormal returns from investment.

The benefit fund is mainly assigned two new objectives, which is to increase the level of long term investment and accommodate additional investors into the fund. This method directly affects the level of profits, which could be obtained by the investment fund, as the it focuses on increasing the level of capital and investors into the investment scope. However, from the evaluation it could be detected that the SAA fund indicates that the funds does not support the new objective of higher return from investment, as it focuses only on constant returns. According to Park, Chae and Cho (2017), investors can use different type of investment options such as Fama French for detecting the investment opportunity, which could increase return, while reduce risk from investment. The current functionality of SAA benefit does not comply with the new objective, where modifying the new SAA approach could help in accommodating increased investment and additional investors into the fund. Thereafter using the Fama French factor model can help organisations to increase the level of income, which could be generated from investment, while reducing the total risk involved in the scenario.

Indicating whether the SAA is appropriate for the two new objectives that has been formulated previously, while providing recommendations and explanation for the objective

However, with the use of Fama French three factor model the overall investor could increase the level of returns, which could generate from investments conducted in the portfolio. In this context, Kotsantonis, Pinney and Serafeim (2016) stated that companies using the three-factor model is able to comprehend the capital market volatility, while reducing the risk involved in investment, which is conducted for increasing returns from stocks. However, Carlsson and Nilsson (2017) argued that the limitation of Fama French model can be detected from its incapability to analysis future performance of the stocks, as it only focuses on historical patterns and does not comprehend for any future alternations that could incur in the investment.

The alternative approach, which could be used for investment purpose is Fama French three-factor model, which allows investors to detect different investment opportunities that have high return and low risk. This change in the asset allocation might benefit the fund trustees and maximise the level of income from investment. In addition, the use of small cap with the current fixed investments can help in mitigating the high risk from equity section and maximise the level of income for the benefit fund. Al-Shawabkeh and Kanungo (2017) mentioned that investor use different types of investment instruments such as small cap, fixed investment and large cap stocks to maximise the level of returns, while reducing total risk.

The use of formula Rjt – Rft = aj + ejt + hj HMLt + sj SMBt + bj(Rmt – Rft) can be conducted during the investment purpose, as it helps in maximising the level of income that could be generated from investment. The approach might allow benefit the fund to maximise its return generation capability and reduce any kind of risk that might be involved in the investment process. Therefore, with the use of Australian and International equities the benefit fund could increase the level of income that might be generated from investment. Hence, the new investment approach could accommodate equities, and fixed interest paying bonds, which might help in mitigating the risk involved in the investment process. However, the approach currently used by the benefit funds only restricts the investment scope to conservative point, which focuses on fixed income with low risk involvement.

The advantages and benefits associated with the AAA approach are depicted as follows.

• The AAA approach mainly benefits the investors to maximise the level of income that could be generated from investment, while reducing any kind of risk. The probable maximum return, which could be generated from investment is mainly detected achieved from AAA operations. Polearu? (2018) stated that investors with the highest possible investment strategy is mainly able to maximise the level of returns from investment, while reducing the negative impact from volatile capital market.
• In addition, AAA approach also suggests that investors need to maximise their exposure in large cap funds, which might help in generating higher returns from investment.
• AAA also focuses stocks that have the higher level of winnings, while reduces the level of loss that could be generated from investment. Sandstrom, Kylaheiko and Collan (2016) indicated that the use of diversification process allows investors to minimise the risk level that is presented to the created portfolio.

There are certain limitations or disadvantages to the Active Asset Allocation process.

• The major scope that is presented by AAA approach is only for large-cap firms, which does not allow the investor to achieve abnormal gains. Hence, the ignorance of investment in small cap fund mainly reduces capability of the investor to obtain high or abnormal gains from investment.
• The Active Asset Allocation (AAA) strategy also forces the investor to modify the assets in real time, which increases the limitation for reduced added value for the portfolio.
• The strategy of AAA mainly depends on the managers luck to select stocks, which can generate higher rate of return from investment. Therefore, the selection process of the strategy is mainly focused on selecting the stocks on luck, which is problematic for investment purposes. Engle, Focardi and Fabozzi (2016) stated the without adequate research investors are not able to detect the viable investment options, which could increase return, while reduce the risk from invested capital.

The balance fund mainly aims in delivering higher return on investment, while reducing any kind of risk from investment. However, inclusion of Fama French model, active asset allocation approach and arbitrage pricing theory could help in generating higher rate of return from investment. With the help of theories, the balance fund might help in maximising the level of returns, while reducing the risk that might be involved from investment. The stock segregation process can be improved with the accommodation of the identified approaches, which in turn might help in generating higher rate of return in real time.

Proposing an alternative approach to setting the SAA for the defined funds, while discussing the current approach

Moreover, the balance funds are mainly concentrated in Australian equities, which is one of the developed markets. Hence, concentration in international equities such as emerging market could be beneficial for the balance funds, as the return from investment is huge, which can be seen from the above figure. The return that could be generated from emerging markets is at the levels of 1,848.28%, while the emerged markets have only provided 720.62% from investment. Thus, investment in international equities and indices could allow the balance fund to generate higher rate of return from investment, while the reduced exposure in Australian equities might help in improving the level of income from investment. On the other hand, Kim, Kim and Fabozzi (2018) criticises that investment in emerging markets might help in generating higher rate of return on the cost of increased risk, which hampers the investment capital.

Certain guidelines need to be declared for SAA benefits, which can be used for reviewing the fund for maximising returns and lowering the risk from investment. The review of investment fund can be conducted every three months to identify the level of investment options and detect the risk that is affecting the capability of fund to achieve the projected return from investment. Hence, organisations such as Goldman Sachs and Morgan Stanley mainly use credit risk management feature for monitoring the investment and detect risk and return attributes of the portfolio. Therefore, using a time frame of 3 months might help in evaluating the balance fund, which might increase profitability and generate higher return, while reducing the total risk that might hinder the projected return from investment. According to Kahn and Lemmon (2016), the maintenance of monitoring process actually allows the investor to detect the changes in return of the created portfolio and actively change the invested stock to maximise return and mitigate risk from investment.

There are certain benefits of moving to more active re-balancing strategy, as it helps the investor to increase the potential returns, which could be generated from investment. In addition, the adoption of re-balancing strategy allows the investors to consciously approach the rebalancing method and minimise the negative impact from market drift. Hence, from the evaluation it could be detected that re-balancing strategy is only useful if the invest if it is invested with the SAA approach, as it maximises the level of income that could be generated from investment. The re-balancing strategy also ensures that the intended position is managed carefully, while the risk attributes is being controlled or offset by the market drift. Moreover, the SAA (Strategic Asset Allocation) approach used for the portfolio creation mainly changes to EAA (Enhanced Asset Allocation), which increases the level of returns that could be generated from investment. Therefore, changes in the investment scope might help in maximising the level of returns and reducing risk from investment.

Discussing the benefits and disadvantages of the AAA approach in general

There are certain costs associated with the re-balancing strategy, as the portfolio needs to be amended constantly to enhance its performance. The changes in investment will directly alter the number of shares that needs to be traded for the re-balancing strategy, which will increase the transaction cost of share buying the selling. The commission on the purchase and sale of share needs to be conducted adequately, which is considered to be the cost associated with re-balancing strategy. In this context, Carlsson and Nilsson (2017) stated that increase in transaction level would directly have an impact on performance of the portfolio, as commissions needs to be delivered on each transaction.

The three hedge fund characteristics are depicted as follows.

Hedge funds illiquid:

The first and foremost characteristic of hedge funds is that they are illiquid in nature, as manages of the fund limit the overall value, which can be withdrawn from the fund. In addition, locking period of capital that is used in the hedge fund directly helps in maximising the level of returns, which could be generated, while reducing the risk from investment. This locking mechanism is actually conducted, as hedge fund invest in funds from the perspective of long term growth.

Managers receive bonuses for the fund performance:

The second characteristic of hedge fund is the proposition of bonuses, which is received by managers managing the fund. The higher growth and return generated from the investment will raise the level of investment that will be given to the managers of the fund. The benefits of managing the fund will eventually motivate the manger for reducing the level of risk and maximise profits from investment. Therefore, the characteristics aims in reducing the level of risk from investment, while increasing the overall returns (Al-Shawabkeh and Kanungo 2017).

Hedge fund uses Aggressive investment strategy:

The third characteristics of the hedge fund is the use of aggressive investment strategy which are mainly used for increasing the level of returns from investment. The hedge fund manager only focuses on generating higher rate of return by conducting aggressive investment strategy, which helps in maximising the level returns from investment. Hence, the aggressive investment stance allows the hedge fund to maximise the level of income from investment, while reducing the total risk.

References:

Al-Shawabkeh, ?. and Kanungo, R., 2017. Credit risk estimate using internal explicit knowledge. Investment Management and Financial Innovations, 14 (1), 55-66.

Carlsson Hauff, J. and Nilsson, J., 2017. The impact of country-of-origin cues on consumer investment behavior: The moderating influence of financial brand strength and investment management style. European Journal of Marketing, 51(2), pp.349-366.

Engle, R.F., Focardi, S.M. and Fabozzi, F.J., 2016. Issues in Applying Financial Econometrics to Factor-Based Modeling in Investment Management. Journal of Portfolio Management, 42(5), p.94.

Fender, R., Adams, R., Barber, B. and Odean, T., 2016. Gender Diversity in Investment Management: New Research for Practitioners on How to Close the Gender Gap. Research Foundation Briefs, 5(1), pp.1-16.

Fender, R., Adams, R., Barber, B. and Odean, T., 2017. Gender Diversity in Investment Management: New Research for Practitioners on How to Close the Gender Gap. Research Foundation Publications, 2017(1), pp.37-38.

Kahn, R.N. and Lemmon, M., 2016. The asset manager’s dilemma: How smart beta is disrupting the investment management industry. Financial Analysts Journal, 72(1), pp.15-20.

Kim, J.H., Kim, W.C. and Fabozzi, F.J., 2018. Recent advancements in robust optimization for investment management. Annals of Operations Research, 266(1-2), pp.183-198.

Kotsantonis, S., Pinney, C. and Serafeim, G., 2016. ESG integration in investment management: Myths and realities. Journal of Applied Corporate Finance, 28(2), pp.10-16.

Park, H.Y., Chae, S.J. and Cho, M.K., 2017. Controlling shareholders’ ownership structure, foreign investors’ monitoring, and investment efficiency. Investment Management and Financial Innovations, 13(3-1), pp.159-170.

Polearu?, V., 2018. Investment Management Resources in the distribution channel of international oil companies. development.

Sandström, J., Kyläheiko, K. and Collan, M., 2016. Managing uncertainty in long life cycle investments: unifying investment planning, management, and post-audit with a fuzzy DSS. International Journal of Business Innovation and Research, 11(1), pp.133-145.

van Duuren, E., Plantinga, A. and Scholtens, B., 2016. ESG integration and the investment management process: Fundamental investing reinvented. Journal of Business Ethics, 138(3), pp.525-533.