PART1-Investment Policy Statement Purpose of Policy Statement The purpose of the Policy Statement is to create an agreement between XXXX, YYY, and ZZZ to collectively manage a mock $1,000,000 portfolio during the 2011 fall semester. It will define the investment objectives, strategies, and risks associated with this portfolio. Investment Objectives The objective of our team is to seek capital appreciation of portfolio in three months.
Moreover, given the little risk tolerance of the team, our nominal return should exceeds the rate of inflation over some period of the time through capital gains, and increase the purchase power of our group. The chosen benchmark to beat is the S&P index. Investment Strategies Our investment strategies are somewhere in between to maximize expected returns and to minimize risks. We use Market timing as one of our strategies to maximum our returns. The market timing strategy is to making buy or sell decisions of financial assets by attempting to predict future market price movements.
The prediction is based on an outlook of market or economic conditions resulting from technical or fundamental analysis. Also we another strategy is to analysis base on performance of a particular financial asset. The start-up fund was divided into six parts: 10% cash, 5% mutual funds, 55% stocks, 30% bonds, and may vary by+/-5%. Given the short time frame, liquidity is a concern and as such long-term speculative investments such as real estate, art and antiques, and collectibles will be avoided.
Only those investments than can be traded on a short-term notice will be used. Taxes and trading costs will not be considered since this is a simulation. Investment Risk On the grounds of strong risk aversion expressed within the team, risk bearing in excess of general market risk is not tolerated. Moreover, the team strives to mitigate the inevitable share of market risk as much as possible. As to the weight assigned to each stock that is central to risk control, there is a cap of 25% of the fund that is available to each stock.
No extra use of fund is allowed on single stock basis. PART2-Methodology 1. Well-Diversified & Best Risk-Return Trade-off Portfolios After we established the investment policy that specified our investment objectives, risk tolerance, allocation of different types of securities in details, we then sought for the best selections of securities. Generally, our first methodology was very simple but useful: maintain an appropriate level of portfolio diversification, and maximize the total return on our investment meanwhile limit the total risk.
According to this basic approach, firstly, we divided our bond investment into four portions equally in Treasury Bonds and different corporate bonds, which enjoyed good credits, rated above A, and operated stable and profitable in the long-run: |Table1 Bond Selections | | |Coupon Rate/Maturity |Rating | |T-Note |3. 75%/15-Feb-2013 |AAA | |MetLife Inc. |5. 000%/15-Jun-2015 |A | |Morgan Stanley |5. 250%/02-Feb-2012 |A | |Merck & Co Inc. |4. 000%/30-Jun-2015 |AA | Secondly, with respect to the reserved attitude for mutual funds, our team decided to only invest in two of them, taking up 5% of our whole portfolio value totally.
The following table provides summary information on these two funds: |Table2 Mutual Fund Selections | | |Blackrock Aggressive Prepared P (BCAPX) |Goldman Sachs Trust Equity Growth (GAPAX) | |Category |Large Blend |World Stock | |YTD Return |-3. 94% |-5. 30% | |Morningstar Overall Rating |??? ?? | |Beta |1. 01 |0. 96 | |Mean Annual Return |1. 02 |1. 00 | |R-squared |96. 63 |95. 10 | |Standard Deviation |20. 05 |22. 64 | |Sharp Ratio |0. 0 |0. 52 | |Treynor Ratio |10. 53 |10. 21 | |Source: www. yahoo. com/finance | |www. reuters. com/finance | |All information are based on 3 years performance of the mutual funds |
Finally, we would invest into two major kinds of stocks with different risk-return trade-offs. We would buy and hold value stocks from well-known, high-credited and strong firms with the attempt to diversify our portfolio and gain a stable growth. On the other hand, we would also choose some other growth stocks, which were generally characterized as higher-risky, non-US and more volatile, aiming at buying them low and selling them high to “speculate” or “gamble” the extraordinary gains in a relatively short period.
Due to the complex and crucial features for stock selection, we thereafter developed a comprehensive procedure particularly, called a blend of “Specific Analysis” and “Overall Analysis” by our own, to help us select our portfolio wisely. 2. Specific Fundamental Analysis When choosing the value stocks, we primarily applied the fundamental analysis including different kinds of analyses for sectors, firm’s specific potentials, cash flows, earnings, and dividends. This procedure had approximate four steps: To begin with, we would view the sector and firm’s overall ability because we were buying a business, not a stock.
Generally, corporates in prosperous industries and growing stages would likely take our prior consideration. An important indicator to show whether a corporate has potential ability was the historical prices of its stock. Therefore, a long-run descend stock price usually implied the decline of the firm, which largely against our favor. Then we needed more fundamental analysis for a firm’s earning ability in depth, such as earning per share that shows how well earning support its shareholders’ benefits and the P/E ratio that indicates how investors expect its future earning power.
General speaking, we preferred earning growth at least 7% annually and P/E ratios at the lowest 10% of all equity securities when selecting the growth stocks. After viewing a firm’s possible return, we next looked into another important factor-the risks along with the firm. Basically we would like to know the firm’s Beta that measures how much the systematic risk affects the firm’s stock and the leverage ratio that discloses its financial stability and stress. Thus we were looking for firms having low Beta and D/E ratio of no more than 1.
Finally, we would use the discounted cash flow model to find out the reasonable market value for the firm’s stock and to see whether it is incorrectly undervalued by the market. The following table provided the summary of our holding-oriented equity securities: |Table3 Stock Selections | | | |Google Inc. (GOOG) | |New Oriental Education & Technology Group Inc. EDU) | 3. Overall Performance Analysis After well knowing the firms and their stocks we chosen from the comprehensive selection procedure, we took one more step to mix then together and see how much our portfolio’s overall proposition fits our objectives and expectations. We decided to combine all equity securities, bonds and mutual funds, which we would like to hold for a relatively long time span and calculate the overall expected rate of return and risk using Capital Asset Pricing Model (CAPM). 4.
Tracking and Monitoring Process While the efficient market hypothesis (EMH) claimed that the stock prices were reflecting all relevant news and information and always showing the inherent value of the company, valuing a stock was just a vain attempt. Our team members, however, were more inclined to believe that the EMH was honestly set up in the academic wonderland. Thus, beside the stock valuation analysis addressed above, we also made the agreement that paying attention to both whole market and firm specific news on daily basis and making appropriate adjustments according to the news in time.
In addition, we would keep tracking and recording our portfolio’s overall performance and rating on a week basis meanwhile monitoring the growth stock’s specific performance on daily basis because day-time monitoring and trading could enable us to avoid the big loss due to the high volatility of them and grab the best time to gain the extraordinary profits. PART3-Microanalysis of the Market During this stock simulation, our group has learned that it’s quite instrumental to analyze and, if possible, follow the market trend for the sake of wise investment.
Hence, microanalysis of the market is equally, and sometimes more important as the number analysis. Since the stock simulation only lasted for three months, out group mainly did the short-term analysis. Depending on our analysis, world’s financial market has become more volatile and unpredictable for the short run, primarily because the global economy grows sluggishly and involves more risky events. Several reasons are illustrated as follows. The euro zone debt crisis is the number one big headache. The debt problem in Europe has become persistent and pervasive. Greece experienced the most serious situation.
Simply, Greece has borrowed much more money than they can pay back. Italy is in better financial shape, but still risky since investors continued demand high interest rate of its bond. Other countries, such as Spain and even France, the second largest euro zone economy, have also been under pressure as investors question the creditworthiness of every euro zone government. Consequently, the global stocks, especially European and American Stocks have caught the euro zone flu. Investors have become super sensitive about each piece of information associated with the term, euro zone.
Our group has recorded that the Dow Jones Industry Average index fluctuated mostly following the euro zone policy changes. It soared rapidly when European Union announced the Greek rescue plan and plumped immediately when the Greek government announced the Greek referendum the next day. “Markets always want short, sharp, simple solutions. ” said Bob Janjuah, fixed income analyst at Nomura Securities (‘The eurozone…’, 2011). ” In addition, the future of U. S. economy is ambiguous. U. S. has been through a tough time since the subprime mortgage crisis. Analysts share different point of views about whether U.
S. is experiencing a recovery or recession. First, the macroeconomic data tells an unclear story. The growth rate of real GDP (As illustrated by the figure below) in the third quarter is 2. 0%, higher than the previous two quarters. While compared to the previous year, we can see the U. S. economy has slowed down. Though the U. S. economy has jumped out of the mire in 2008, it remains unstable. While we focusing on the recent year data, we can see no big signal of an up-coming boom or bust. As showed below, the unemployment rate has remained above 9 percent.
New jobs are created, but not sufficient. Average Hourly Earnings remains the same. CPI and PPI both declined on October, primarily due to the decline of energy price. In addition, the 2011 U. S. fiscal policy remains neutral. The market is unlikely to get further stimulus. Also we can forecast an increase in the rate of fiscal tightening at the federal level over the next period of time. Overall, U. S. economy still remains unsustainable and U. S. financial market is highly sensitive, which can be immediately shocked by each piece of up-coming information, whether positive or negative. Table4 United States – Monthly Data | |Data Series | | |Our Value |Rank |S&P500 |Comparison with peers | | | | | |Google |Kraft |BRK-B |BP | |09/13/2011 |529. 2 |34. 23 |68. 85 |36. 45 | |09/20/2011 |546. 63 |34. 52 |69. 72 |38. 77 | |09/27/2011 |539. 34 |34. 93 |72. 07 |37. 94 | |10/4/2011 |501. 90 |32. 86 |73. 17 |35. 42 | |10/11/2011 |543. 8 |34. 40 |73. 41 |38. 36 | |10/18/2011 |590. 51 |35. 24 |75. 07 |41. 11 | |10/25/2011 |583. 16 |34. 93 |75. 74 |43. 52 | |11/1/2011 |578. 65 |34. 56 |75. 52 |42. 72 | |11/8/2011 |612. 4 |35. 48 |78. 16 |44. 70 | |11/15/2011 |616. 56 |35. 48 |75. 93 |43. 70 | |11/18/2011 |594. 88 |34. 77 |75. 37 |42. 48 | |Total Return |12. 34% |1. 58% |9. 47% |16. 54% | Source: www. google. com/finance
From the table and graph above, we could clearly see that the best performer in our portfolio was BP with a 16. 54% total return, while the worst one was Kraft with a total return of 1. 58% during the holding period. Among all of the four holding-oriented securities, the only one underperformed than the benchmark, namely S&P500, was Kraft. All other three stocks had much better return than the S&P500 of 3. 64%. Overall, these observe actually proved that our selection approach for holding-oriented stocks was successful. PART5-Conclusion What we did successfully:
Generally speaking, the first class we learned from this three-month stock simulation is how to select stocks and establish a portfolio wisely and systematically. From initially setting up the investment policy, we explored how to select and allocate the individual securities, how to diversify our portfolio to minimize the risks, and how to find the best return-risk trade-off for our portfolio. Through this procedure, we really needed to use all financial knowledge we have learned before, including fundamental analysis, ratio analysis, technical analysis, free cash flow analysis and so on.
Another significant difference is that we did pay a lot attention to follow macroeconomic and financial news, as well as particular news about our securities. It brought us more quickly and sensitive observe ability to what happened all over the world than before. In addition, we did well on diversifying our portfolio and minimize the systematic risks. Since we established an investment policy in details that we strictly implemented, we had everything under control and didn’t expose to any extraordinary risks out of our expectation.
What we would improve in the future: Unfortunately, we did beat the benchmark performance finally, although we once did well and ranked better during the trading period. Firstly, we had to admit that sometimes we have delayed trading and tracking our portfolio, resulting in great losses on some particular stocks. Besides, we had limited experience on daytime trading and using on-time information, so we sometimes encounter unexpected results. For example, we sold Apple’s stocks immediately after we got the news about its CEO, Steven Jobs’s death.
However, as we all know, the Apple’s price wasn’t affected a lot in the next trading date. In the way that was expected, unlike our holding-oriented stocks, our gambling-oriented stocks general performances were typically unsatisfied. Therefore, we concluded that wisely selecting stocks according to the macroeconomics and fundamental analysis and then holding them for a relatively long period would be the best way to gain profit from security market.
Interestingly, we also found that people might not that know themselves on risk tolerance. Whatever from our investment policy or our trading strategy and results, our portfolio is somewhat risk-averse, so we well diversified our investment and always holding a relatively high level of bonds and mutual funds, as well as some excess cash. Interesting finding is that, however, our group members got all high-risk-tolerance ranking in the survey that we finished on class. Appendix1 Ratio Calculation Spreadsheet pic] Appendix2 Class Ratings [pic] References “The eurozone debt crisis just won’t quit”, retrospect from: http://finance. yahoo. com/news/eurozone-debt-crisis-just-wont-211300837. html “StanChart warns on China’s local-government debt”, retrospect from: http://www. marketwatch. com/story/stanchart-warns-on-chinas-local-government-debt-2011-09-20 Data, retrospect from www. yahoo. com/finance Data, retrospect from www. reuters. com/finance Data, retrospect from www. google. com/finance