FM 131: Investment and Portfolio Management

Topic 5: Fixed Income Securities

Fixed income securities are financial instruments that provide regular, fixed payments to investors over a specified
period, typically in the form of interest or dividends. These securities are a popular investment choice due to their
predictable income streams and relative safety compared to equity investments. They are issued by governments,
corporations, and other entities to raise capital and are an essential component of the financial markets.

Characteristics of Fixed Income Securities

1. Fixed Payments. The primary feature of fixed income securities is the provision of regular payments,
usually in the form of interest (for bonds) or dividends (for preferred stocks). These payments are typically
made at fixed intervals, such as semi-annually or annually.
2. Maturity Date. Most fixed income securities have a specific maturity date, at which point the principal
amount (the initial investment) is repaid to the investor. The maturity period can range from short-term
(less than one year) to long-term (several decades).
3. Face Value (Par Value). This is the amount that the issuer agrees to repay the investor at maturity. It is
also the basis for calculating periodic interest payments.
4. Coupon Rate. For bonds, the coupon rate is the annual interest rate paid on the face value. It can be fixed
or floating, depending on the terms of the bond.
5. Issuer. Fixed income securities can be issued by a variety of entities, including governments,
municipalities, corporations, and financial institutions. The creditworthiness of the issuer is a crucial factor
in determining the risk and return of the security.

Types of Fixed Income Securities in the Philippines

Fixed income securities in the Philippines encompass a variety of instruments designed to provide regular income
through interest payments. Treasury Bills (T-Bills) are short-term government securities with maturities ranging
from a few days to one year. These are sold at a discount and redeemed at face value upon maturity, making them a
popular choice for investors seeking short-term, low-risk investments. Treasury Bonds (T-Bonds), on the other
hand, are long-term government securities with maturities exceeding one year. T-Bonds provide periodic interest
payments (coupons) and return the face value at maturity, appealing to those looking for stable, long-term returns.

Retail Treasury Bonds (RTBs) are another government-issued option tailored for retail investors. They typically
have lower denominations, making them more accessible to individual investors. Corporate Bonds are debt
securities issued by corporations to raise capital. These generally offer higher yields compared to government bonds
due to the increased credit risk associated with corporate issuers. Municipal Bonds, issued by local government
units or municipalities, are used to finance public projects and infrastructure, providing another avenue for investors
interested in contributing to local development.

Commercial Papers are short-term, unsecured promissory notes issued by companies, with maturities usually less
than 270 days. These instruments are utilized by corporations for short-term funding needs. Lastly, Certificates of
Deposit (CDs), issued by banks, come with fixed interest rates and fixed maturity dates, and are insured by the
Philippine Deposit Insurance Corporation (PDIC) up to a certain limit, adding a layer of security for investors.

Bond Valuation and Pricing

The valuation of bonds is fundamentally based on the present value of their future cash flows, which include periodic
coupon payments and the face value at maturity. The price of a bond can be calculated using the formula:

,where P is the bond's price, C is the coupon payment, r is the discount rate or yield, t is the time period, F is the face
value, and T is the maturity period.
Yield to Maturity (YTM) is a crucial concept in bond valuation, representing the discount rate at which the present
value of a bond’s future cash flows equals its current market price. This metric indicates the total return an investor
can expect if the bond is held to maturity. Additionally, the Current Yield of a bond is calculated as the annual
coupon payment divided by the bond’s current market price, offering a snapshot of the bond’s income relative to its
price. The Coupon Rate, the annual interest rate paid by the bond issuer on the bond’s face value, can be either
fixed or floating, depending on the terms set at issuance.

Interest Rate Risk and Credit Risk

Fixed income securities are subject to various risks, primarily interest rate risk and credit risk. Interest Rate Risk
refers to the potential impact of changes in market interest rates on the value of the bond. There is an inverse
relationship between bond prices and interest rates; when interest rates rise, bond prices fall, and vice versa. The
concept of duration measures a bond’s sensitivity to interest rate changes, with longer durations indicating higher
interest rate risk.

Credit Risk involves the possibility that the bond issuer might default on its obligations, failing to make interest
payments or repay the principal. Credit ratings provided by agencies such as S&P, Moody’s, and Fitch assess the
creditworthiness of bond issuers, helping investors gauge the risk associated with a particular bond. Bonds with
higher credit risk, often referred to as junk bonds, offer higher yields to compensate investors for taking on this
additional risk.

Government and Corporate Bonds

In the Philippines, Government Bonds are issued by the national government and are considered low-risk
investments due to the backing of the government’s credit. Examples of government bonds include Treasury Bills
(T-Bills), Treasury Bonds (T-Bonds), and Retail Treasury Bonds (RTBs). These instruments are favored for their
stability and reliability.

Corporate Bonds, issued by companies, serve as a means to finance business operations, expansions, or other
projects. While they carry higher risk compared to government bonds due to the potential for default, they offer
higher yields to attract investors. Corporate bonds can be categorized as investment-grade or high-yield (junk) bonds
based on their credit ratings, with investment-grade bonds being perceived as safer investments.

These fixed income securities provide various options for investors in the Philippines, each with its own risk and
return profile, catering to different investment strategies and goals. Understanding these instruments, their valuation,
and associated risks is essential for making informed investment decisions.
 Topic 6: Mutual Funds and Unit Investment Trust Funds (UITFs)
Mutual funds and Unit Investment Trust Funds (UITFs) are both popular investment vehicles that pool money from
multiple investors to create a diversified portfolio of securities. Mutual funds are investment companies that manage
this pooled money by investing in various assets like stocks, bonds, and money market instruments. These funds are
managed by professional fund managers who make strategic decisions to meet the investment objectives of the fund.
In the Philippines, mutual funds are regulated by the Securities and Exchange Commission (SEC), ensuring investor
protection and adherence to financial standards.

On the other hand, UITFs are products offered by banks and trust companies. Similar to mutual funds, UITFs pool
money from investors to invest in a diversified portfolio managed by professional fund managers. However, UITFs
are structured as trusts rather than as investment companies, and they fall under the regulation of the Bangko Sentral
ng Pilipinas (BSP). This structural and regulatory difference is key in understanding the distinct nature of each
investment vehicle, although both serve the primary purpose of providing investors with access to diversified
portfolios managed by professionals.

Types of Funds Available in the Philippines

In the Philippines, a variety of mutual funds and UITFs cater to different investment needs and risk appetites. Mutual
funds typically come in several forms. Equity funds primarily invest in stocks and aim for capital growth, while
bond funds focus on fixed-income securities like government and corporate bonds, targeting stable income. Balanced
funds offer a mix of stocks and bonds, aiming for a balance of growth and income. Money market funds invest in
short-term debt instruments and prioritize capital preservation and liquidity. Additionally, index funds aim to
replicate the performance of a specific index, such as the Philippine Stock Exchange Index (PSEi).

Similarly, UITFs in the Philippines include equity UITFs, which target capital appreciation through stock
investments, and bond UITFs, which aim for steady income by investing in bonds. Balanced UITFs combine equities
and bonds to achieve moderate growth and income. Money market UITFs invest in short-term, high-quality debt
instruments, emphasizing liquidity and safety. Unique to UITFs are feeder funds, which invest in a single collective
scheme, often an offshore fund, providing investors with exposure to international markets.

Evaluating Fund Performance

Evaluating the performance of mutual funds and UITFs involves understanding several key metrics. The Net Asset
Value (NAV) represents the value per share or unit of the fund, calculated by dividing the total value of the fund’s
assets by the number of outstanding shares or units. Total return measures the fund's performance over a specific
period, including dividends, interest, and capital gains. The annualized return provides the geometric average of
money earned by an investment each year over a given period, giving investors a sense of the fund's long-term
performance.

Expense ratios, which represent the annual fee expressed as a percentage of the fund's average assets, include
management fees and other costs, impacting the net returns to investors. The Sharpe ratio measures risk-adjusted
performance, comparing the fund's excess return over the risk-free rate to its standard deviation, helping investors
understand the reward per unit of risk taken. Alpha indicates the fund’s performance relative to its benchmark, with
a positive alpha signifying outperformance. Beta measures the fund's volatility relative to the market, where a beta
greater than 1 indicates higher volatility than the market.

When evaluating fund performance, it's crucial to consider the consistency of returns, the quality and experience of
the fund management team, and the composition of the fund’s portfolio. A history of stable and consistent returns,
experienced fund managers, and a well-diversified portfolio can be indicators of a well-managed fund.

Advantages and Disadvantages of Investing in Funds

Investing in mutual funds and UITFs offers several advantages. Diversification is a primary benefit, as these funds
spread investments across a wide range of securities, reducing individual asset risk. Professional management
ensures that fund managers make informed investment decisions based on extensive research and market analysis.
Accessibility is another advantage, with mutual funds and UITFs generally requiring lower minimum investments
compared to direct investments in individual securities. These funds also offer liquidity, allowing investors to buy
or sell shares or units relatively easily. Additionally, pooled resources in mutual funds and UITFs lead to economies
of scale, resulting in lower transaction costs.

However, there are also disadvantages to consider. Fees and expenses, including management fees and
administrative costs, can erode the returns on investments. Investors in mutual funds and UITFs lack control over
the specific securities chosen for the fund, as these decisions are made by the fund managers. Market risk is inherent,
as the value of the fund can fluctuate with market conditions. Diversification, while reducing risk, can also limit
potential gains compared to more concentrated investments. Finally, performance variability is a risk, as past
performance does not guarantee future results, and returns can vary significantly based on market conditions and
management decisions.

Topic 7: Real Estate and Alternative Investments

Real Estate Investment Opportunities in the Philippines

The Philippine real estate market presents numerous investment opportunities driven by strong economic growth,
rapid urbanization, and significant infrastructure development. Major cities like Metro Manila, Cebu, and Davao are
experiencing increased demand for residential, commercial, and mixed-use properties. Residential investments
include condominiums, house and lots, and townhouses, while commercial investments encompass office spaces,
retail spaces, and industrial properties. Mixed-use developments, integrating residential, commercial, and
recreational areas, are also gaining popularity. Additionally, the growing tourism sector fuels demand for hotels,
resorts, and serviced apartments. Key factors driving these investments are a young, growing population, remittances
from Overseas Filipino Workers (OFWs), foreign investments encouraged by liberalized ownership laws, and robust
tourism growth. However, investors must navigate challenges such as regulatory changes, potential market
saturation, and economic downturns that could impact property values.

Real Estate Investment Trusts (REITs)

Real Estate Investment Trusts (REITs) offer an alternative way to invest in the real estate market. REITs are
companies that own, operate, or finance income-producing real estate, structured to provide regular income streams
to investors. They offer benefits such as liquidity, diversification, regular income, and professional management.
The REIT market in the Philippines has gained momentum since the REIT law was revised in 2020, with key players
including Ayala Land, DoubleDragon, and Megaworld focusing on office spaces, malls, logistics, and other
commercial properties. When considering REIT investments, factors such as dividend yields, growth potential,
management quality, and overall market conditions should be evaluated to make informed decisions.

Overview of Alternative Investments: Commodities, Hedge Funds,

Private Equity
Alternative investments, encompassing commodities, hedge funds, and private equity, provide diversification
beyond traditional asset classes. Commodities, such as metals, energy, and agricultural products, can be invested in
directly or through futures contracts and commodity-focused funds. They offer advantages like diversification and
an inflation hedge, but come with risks such as price volatility and geopolitical factors. Hedge funds, which employ
various strategies like long/short equity, market neutral, arbitrage, and global macro, aim for active returns and offer
flexibility. However, they are associated with high fees, lack of transparency, and liquidity constraints. Private equity
involves investments in private companies or buyouts of public companies, often leading to their delisting. It
includes venture capital for early-stage companies, buyouts for established companies, and growth equity for
expansion. While private equity has the potential for high returns and active management benefits, it poses risks like
illiquidity, high minimum investment requirements, and business operational challenges.
 Topic 8: Risk and Return Analysis

Measuring risk and return is fundamental to evaluating investment performance. Return represents the gain or loss
on an investment over a specified period, expressed as a percentage of the initial cost. It comprises income from
dividends or interest and capital gains from the appreciation in the investment's value. Total return is calculated by
dividing the sum of the ending price, beginning price, and income by the beginning price. To facilitate comparisons
across different periods, annualized return adjusts this measure for the investment's duration. Risk, on the other hand,
refers to the uncertainty surrounding the investment's return. It can be categorized into systematic risk, which affects
the entire market and cannot be diversified away, and unsystematic risk, specific to a company or industry, which
can be mitigated through diversification. Variance and standard deviation measure the dispersion of returns around
the mean, while beta gauges an asset's sensitivity to market returns.

Portfolio risk and diversification are key concepts in managing investments. Portfolio risk considers the combined
risk of all assets in a portfolio, taking into account their individual risks and interactions. Diversification spreads
investments across various assets to reduce unsystematic risk, as poor performance in some assets can be offset by
better performance in others. The expected return of a portfolio is the weighted average of the expected returns of
its constituent assets. Portfolio variance and standard deviation measure the overall risk, incorporating the
covariances between all pairs of assets in the portfolio. These measures help investors understand the total risk and
potential return of their diversified portfolios.

The efficient frontier and modern portfolio theory (MPT) provide a framework for constructing optimal portfolios.
The efficient frontier represents a set of portfolios that offer the highest expected return for a given level of risk or
the lowest risk for a given return. Investors plot all possible portfolios on a risk-return graph, with the efficient
frontier forming the upper boundary. MPT, developed by Harry Markowitz, assumes that investors are rational and
risk-averse, markets are efficient, and returns are normally distributed. It emphasizes diversification to reduce risk
by combining assets with low or negative correlations. The risk-return tradeoff principle states that higher risk must
be compensated with higher returns. The capital market line (CML) illustrates the risk-return profile of optimal
portfolios combining the risk-free asset and the market portfolio, with its formula showing the expected return of a
portfolio based on its risk. The security market line (SML), derived from the Capital Asset Pricing Model (CAPM),
and graphically represents the relationship between expected return and beta, highlighting the tradeoff between
market risk and return.

In summary, understanding risk and return is crucial for investment evaluation. Diversification helps mitigate
unsystematic risk, while portfolio risk measurement aids in managing total risk. The efficient frontier and MPT
provide tools for constructing portfolios that optimize the balance between risk and return, guiding investors in
making informed decisions.