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investment mangement

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35 views41 pages

PPT

investment mangement

Uploaded by

crystalspring
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Investment Analysis and Portfolio Management

First Canadian Edition By Reilly, Brown, Hedges, Chang

Chapter 2 The Asset Allocation Decision


Individual Investor Life Cycle The Portfolio Management Process The Need for Policy Statement Constructing the Policy Statement The Importance of Asset Allocation

Copyright 2010 Nelson Education Ltd.

2-2

What is Asset Allocation?


Asset Allocation
process of deciding how to distribute an investors wealth among different countries and asset classes for investment purposes

Asset Class
group of securities that have similar characteristics, attributes, and risk/return relationships
Copyright 2010 Nelson Education Ltd. 2-3

What is Asset Allocation?


Investor:
Depending on the type of investors, investment objectives and constraints vary
Individual investors Institutional investors

Copyright 2010 Nelson Education Ltd.

2-4

Individual Investor Life Cycle: Preliminaries


Life Insurance: Providing death benefits and, possibly, additional cash values
Term life and whole life insurance Universal and variable life insurance

Non-life Insurance
Health insurance & disability insurance Automobile insurance & Home/rental insurance

Cash Reserve
To meet emergency needs Equal to six months living expenses
Copyright 2010 Nelson Education Ltd. 2-5

Phases of an Investors Life Cycle


Accumulation phase
Early to middle years of working career

Consolidation phase
Past midpoint of careers. Earnings greater than expenses

Spending/Gifting phase
Begins after retirement

Copyright 2010 Nelson Education Ltd.

2-6

Phases of an Investors Life Cycle

Copyright 2010 Nelson Education Ltd.

2-7

Life Cycle Investment Goals


Near-term, high-priority goals Long-term, high-priority goals Lower-priority goals

Copyright 2010 Nelson Education Ltd.

2-8

Benefits of Investing Early and Often

Copyright 2010 Nelson Education Ltd.

2-9

Portfolio Management Process: Policy Statement


Specifies investment goals and acceptable risk levels Should be reviewed periodically Guides all investment decisions

Copyright 2010 Nelson Education Ltd.

2-10

Portfolio Management Process

Copyright 2010 Nelson Education Ltd.

2-11

Need for Policy Statement


Understand investors needs and articulate realistic investment objectives and constraints
What are the real risks of an adverse financial outcome, and what emotional reactions will I have? How knowledgeable am I about investments and the financial markets? What other capital or income sources do I have? How important is this particular portfolio to my overall financial position? What, if any, legal restrictions affect me? How would any unanticipated portfolio value change might affect my investment policy?
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Copyright 2010 Nelson Education Ltd.

Need for a Policy Statement


Sets standards for evaluating portfolio performance
Provides a comparison standard in judging the performance of the portfolio manager Benchmark portfolio or comparison standard is used to reflect the risk an return objectives specified in the policy statement Should act as a starting point for periodic portfolio review and client communication with the manager

Copyright 2010 Nelson Education Ltd.

2-13

Need for a Policy Statement


Other Benefits
Reduces possibility of inappropriate or unethical behaviour of the portfolio manager Helps create seamless transition from one money manager to another without costly delays Provides the framework to help resolve any potential disagreements between the client and the manager

Copyright 2010 Nelson Education Ltd.

2-14

Input to the Policy Statement


Constructing the policy statement begins with a profile analysis of the investors current and future financial situations and a discussion of investment objectives and constraints.

Copyright 2010 Nelson Education Ltd.

2-15

Input to the Policy Statement


Objectives
Risk Return

Constraints
Liquidity, time horizon, tax factors, legal and regulatory constraints, and unique needs and preferences

Copyright 2010 Nelson Education Ltd.

2-16

Investment Objectives
Risk Objectives
Should be based on investors ability to take risk and willingness to take risk

Copyright 2010 Nelson Education Ltd.

2-17

Investment Objectives
Risk tolerance depends on an investors current net worth and income expectations and age
More net worth allows more risk taking

Younger people can take more risk

Careful analysis of clients risk tolerance should precede any discussion of return objectives

Copyright 2010 Nelson Education Ltd.

2-18

Investment Objectives
Return Objectives
May be stated in terms of an absolute or a relative percentage return Capital Preservation:
Minimize risk of real losses

Copyright 2010 Nelson Education Ltd.

2-19

Investment Objectives
Capital Appreciation: Growth of the portfolio in real terms to meet future need Current Income: Focus is in generating income rather than capital gains Total Return: Increase portfolio value by capital gains and by reinvesting current income with moderate risk exposure

Copyright 2010 Nelson Education Ltd.

2-20

Investment Constraints: Liquidity


Liquidity
Vary between investors depending upon age, employment, tax status, etc. Planned vacation expenses and house down payment are some of the liquidity needs.

Copyright 2010 Nelson Education Ltd.

2-21

Investment Constraints: Time


Time
Influences liquidity needs and risk tolerance Longer investment horizons generally requires less liquidity and more risk tolerance Two general time horizons are pre-retirement and post-retirement periods

Copyright 2010 Nelson Education Ltd.

2-22

Investment Constraints: Taxes and Interest Income

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Investment Constraints: Taxes and Interest Income


Interest Income: 100% of all interest income is taxed at an investors marginal tax rate in Canada. Assuming a marginal tax rate of 26%, an investor that receives $2,000 in interest income will have a $520 tax liability ($2,000 X 26%)
After Tax Return on Investment (AT -ROI) AT - ROI = Pre-tax ROI X ( 1 Marginal Tax Rate)

Copyright 2010 Nelson Education Ltd.

2-24

Investment Constraints: Taxes and Interest Income


Interest Income: 100% of all interest income is taxed at an investors marginal tax rate in Canada. So an investor if you received $2,000 interest income on a $100,000 investment that would be a 2% ROI on a pre-tax basis
After Tax Return on Investment (AT -ROI) AT ROI = Pre-Tax ROI X ( 1 Marginal Tax Rate) AT - ROI = 2% X ( 1 .26 ) = 1.48%

Copyright 2010 Nelson Education Ltd.

2-25

Investment Constraints: Taxes and Dividends


The Dividend Tax Credit Calculation

Dividend Income
Div. Tax Credit Gross Up (145%) Fed. Tax on Grossed Up Div. (26%) Fed. Div. Tax on Grossed Up Div. (18.97%) Net Fed. Taxes on Dividends Effective Tax Rate on Dividends

$2,000
$2,900 $754 ($2,900 X 26%) $550 ($2,900 X 18.97%) $204 ($754 - $550) 10.20% ($204 $2,000)

Assuming a marginal tax rate of 26%, the dividend tax credit effectively reduced the effective tax rate by about 60%
Copyright 2010 Nelson Education Ltd. 2-26

Investment Constraints: Taxes and Capital Gains


Capital gains are also taxed at an effectively lower tax rate because only 50% of a gain is taxed in Canada
Capital Gains Exclusion and Income Taxes Capital Gain Cap. Gains Exclusion Rate (50%) Tax on Taxable Cap. Gains (26%) Effective Tax Rate on Cap. Gains $2,000 $1,000 (50% X $2,000) $260 13% ($260 $2,000)

Assuming a marginal tax rate of 26%, the effective tax rate on capital gains is 50% of the marginal rate or in this case 13%.

Copyright 2010 Nelson Education Ltd.

2-27

Investment Constraints
Taxes
Unrealized capital gains: Reflect price appreciation of currently held assets that have not yet been sold Realized capital gains: When the asset has been sold at a profit Trade-off between taxes and diversification: Tax consequences of selling company stock for diversification purposes

Copyright 2010 Nelson Education Ltd.

2-28

Tax Free Investments


Earn income that is NOT subject to income taxes Tax Free Savings Accounts (TSFA)
tax-free investments

Copyright 2010 Nelson Education Ltd.

2-29

Tax Deferred Investments


Tax deferred investments
compound tax free but when withdrawn are subject to taxes

Registered Retirement Savings Accounts (RRSP)


individuals can deposit money into and earned tax deferred income

At withdrawal, all funds are subject to tax

Copyright 2010 Nelson Education Ltd.

2-30

Legal and Regulatory Constraints


Limitations or penalties on withdrawals Fiduciary responsibilities
The Prudent Investor Rule normally apply

Investment laws prohibit insider trading

Copyright 2010 Nelson Education Ltd.

2-31

Legal and Regulatory Constraints


Institutional investors deserve special attentions since legal and regulatory factors may affect them quite differently
Example: banks vs. endowment funds

Copyright 2010 Nelson Education Ltd.

2-32

Personal Constraints: Unique Needs & Preferences


Personal preferences such as socially conscious investments could influence investment choice Time constraints or lack of expertise for managing the portfolio may require professional management

Copyright 2010 Nelson Education Ltd.

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Personal Constraints: Unique Needs & Preferences


Large investment in employers stock may require consideration of diversification needs Institutional investors needs

Copyright 2010 Nelson Education Ltd.

2-34

Importance of Asset Allocation


Asset Allocation:
process of deciding how to distribute an investors wealth among different countries and asset classes for investment purposes

Copyright 2010 Nelson Education Ltd.

2-35

Importance of Asset Allocation


An investment strategy is based on four decisions What asset classes to consider for investment What policy weights to assign to each eligible class What allocation ranges are allowed based on policy weights What specific securities to purchase for the portfolio

Copyright 2010 Nelson Education Ltd.

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Importance of Asset Allocation

Copyright 2010 Nelson Education Ltd.

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Importance of Asset Allocation


According to research studies, most (85 to 95%) of the overall investment return is due to the first two decisions, not the selection of individual investments

Copyright 2010 Nelson Education Ltd.

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Importance of Asset Allocation


Historically, small company stocks have generated the highest returns, so have the volatility Inflation and taxes have a major impact on returns Returns on Treasury Bills have barely kept pace with inflation

Copyright 2010 Nelson Education Ltd.

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Importance of Asset Allocation

Measuring risk by the probability of not meeting your investment return objective indicates risk of equities is small and that of Tbills is large because of their differences in expected returns Focusing only on return variability as a measure of risk ignores reinvestment risk
Copyright 2010 Nelson Education Ltd. 2-40

Asset Allocation and Cultural Differences


Social, political, and tax environments influence the asset allocation decision Equity allocations of U.S. pension funds average 58% In the United Kingdom, equities make up 78% of assets In Germany, equity allocation averages 8%

Copyright 2010 Nelson Education Ltd.

2-41

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