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Question 1: Investing in a specific company. 20% of the grade, Choose a company in a part of the world and domain where you feel at ease, and which has both shares on the stock market and also corporate bonds outstanding. Describe the company, consider the recent performance (e.g. five years) of the shares and the bond you have selected. That means that you have to research the price of the chosen bond and the share price five years ago and today.You should probably use Morningstar as your source but you are not obliged to.Had you invested 50/50 in the bond and the share, what would your average annual return over the last five years have been.Complete your answer with a reflection on how you found the exercise (easy/difficult, interesting/rather a chore). We are not looking for a particular view – only that you have one.
Solution
Answer 1: Investment in Company AT&T
This analysis is to consider returns from an investment in a specific company. Hence would entail a choice of a region, sector and eventually the company itself. Even though Asian markets are expected to generate higher returns, I have chosen the Americas as the same is relatively an average-risk – average-return profile suitable to my risk appetite. In addition, since my choice is to invest in a specific company my risk profile would be lower if I invest in a mature market rather than emerging markets. Hence I have chosen United States of America as the country within which I would select the company to invest. Within this geographic domain, I have chosen the communication sector for investment analysis purpose. This is because the communication sector is very dynamic and has to continuously respond to consumer preferences and choices. Within the geographic domain of USA and the communication services section, the company chosen is AT&T. The company has both corporate bonds and its equity shares listed in the market is AT&T Inc. AT&T is listed on the New York Stock Exchange under the ticker symbol “T” and is a Fortune 500 Company. (AT&T, n.d.). The company chosen by me is engaged in communication services across various countries and primarily based in USA. The company provides TV and wireless in addition to high-speed internet services to end consumers and other businesses across USA. It aims to be a premier integrated communications corporate. The company has been in business of communications since at least 1984. (AT&T, n.d.).
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I have analysed the returns from my investment in both the equity and bonds of AT&T. My analysis of the average returns from the investment has factored in the period of 5 years. Time value of money has been ignored for the overall computations of returns.
For this purpose, the share prices have been analysed for the price movement over the five year period. The Current price of AT&T as listed on NYSE is $37.56. The share price on the same day 5 years ago was $ 28.98. Further the company has been declaring dividends during this period. (Yahoo Finance, 2016).
Thus my total returns from the investment in equity shares of AT&T would include the capital appreciation in terms of increase in share price along. AT&T have been declaring dividends during this period and hence total of the dividends received during the same 5 year period have been added to my total returns from AT&T equity shares. I have not analysed the returns from the investment that would have been available had the dividends been re-invested. Further, taxation has been ignored in this case as I have assumed that good tax planning might effectively help me to nullify my long terms capital gain tax. Thus, with the given capital appreciation and dividend returns, the average annual returns from the investment in equity shares of AT&T would be 12.27% per annum. These have been summarised as below:
For investment in bonds, I have chosen AT&T Corporate Bond 6.55% with a maturity of 2039. The returns from investment in bonds comprise of the capital appreciation in the price of bond and the interest generated during the period of holding of such bond. The price of the bond five years earlier has been $124 and the current price is $116. (Morningstar, 2016). Hence I have suffered a loss in the value of the bond to the extent of $12 over the five year horizon. However, the coupon rate has been generating returns on the par value which is USD 1000 at the interest rate of 6.55% per annum. Hence, the investment in bond has generated a return of $327.50 in the form of interest over the period of Five years. I have excluded the impact of reinvestment of such interest form my returns computation. Further, to make the comparison at par, I have assumed the income tax rate of 28% on my total returns from the bonds. This is an arbitrary taxation rate considered for my analysis purpose. Post such computation of total returns after tax, the bond has generated an average annual return of 35%. These have been summarised as below:
If I choose to invest equally in the two investments of bonds and shares discussed above, my average annual returns would be the average of the returns of the two investments. In this case, the average returns would have been:
Average of (35% and 12%) = 23.5%.
I have not considered the risk of investment in USD as any appreciation in the USD currency rate vis-à-vis my home currency would impact my total returns.
Reflective analysis:
This analysis has helped me personally to understand the chart and indices of the listed entities. I had to research the stock prices and the returns generated from the same for the 5-year period in the form of historical data. Further, the returns from the bonds had to be analysed from the perspective of interest returns. This has helped me to understand that the returns from bonds is primarily the interest that is earned over the period. The movement in prices of the bonds is not the significant tool for investment decision as the price gets adjusted for the yields from the bond. The analysis of the share price has helped me to understand that the investment in equity for a longer-term generates positive returns. During 2016, there has been a substantial increase in the share price of equities for AT&T as per table below.
(Source: Yahoo Finance, 2016)
The overall exercise has been interesting as it provided me with an opportunity to research a global MNC and learn to deal with the historical details available on the internet. This will help me to conduct my future research and will find practical application in my future job as a Financial Planner.
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Place Your OrderQuestion 2: An investment strategy based on funds. 65% of the grade, To answer this question you are to develop an investment strategy specifically for yourself, and as realistic as possible, and reflecting your view of macro-economics and its impact on financial markets. First analyse your own situation and risk profile (character, life-style, time horizon, objectives, etc) and your macro-economic view, then reflect them in a portfolio of mutual funds or ETFs using examples and providers chosen from David Costa’s book (but you can also use any mutual fund or ETF available in the Morningstar database). Before selecting the investment vehicles you will need to determine your asset allocation and justify it. Normally five to seven mutual funds and ETFs funds will suffice for diversification. Bring an element of timing into your investment plan. You are not obliged to one type over the other; make you choices and say why. That will require you to describe the funds. You should also wish to reflect your own view on likely global economic developments.
Answer 2: Current Situation:
My current situation is that I am a working professional and is unmarried. My current age is 25 years. I live alone. I have no dependents currently. My parents are financially independent and do not rely on me for their financing needs. I have an investment horizon ranging from 2 years to 30 years. These investment horizons are a direct result of my objective and financial goals in my life. I have identified three major financial objectives for me and these are spread across 2 years, 15 years and 30 years. Hence these objective can be broadly categorised into short term objective, medium term objective and long term objective.
My current lifestyle is expected to be that of an upper middle class. I do not intend to own any real estate and will continue to be on tenancy. This is crucial for me since this will afford me required flexibility in shifting jobs to a newer location in case of better job opportunities. Thus my ambitious financial goals is based on my expectations of an increased earnings owing to this flexibility in job hopping. My basic necessities would be to own a car for my commute and gradually another vehicle for my spouse and kids. These are not expected to be me major expenses and hence are not factored in my overall financial objectives. The financing of my short term objective would be from the inheritance from my parents who intend to provide me the required funds as a marriage gift. This funds are presently enough to cover my short term objective that is expected to be in 2 years’ time. My medium term and long term objective would be entirely out of my own earnings and investment strategy as may be devised.
My first objective is to arrange for sufficient funds for my marriage. I have an intention to be married in a 2 years’ time. I expect this wedding to be an international destination wedding and would prefer the save for the travel and stay costs for my friends and relatives as well. The marriage expenses would be entirely funded by me.
My second objective is to save for my extended family’s college education. I have planned to have one kid and would like to save for financing their education. I need to have the funds available to cover the cost of education of 1 student. These funds would be required in around 15 years of time.
My third objective is to save for my retirement. I intend to retire by the age 55. This gives me a roughly 30 year’s investment horizon to plan my investment. My retirement corpus is expected to cover a world tour with my spouse immediately on retirement. Further, it should cover my living expenses for the period of at least 35 years post my retirement. The important thing to note here is that I would not be engaged in any other jobs or work and hence would not have any sources of income other than my returns from the retirement corpus.
Macro-economic view:
The economic pattern of growth has been a reflection of “Look East”. The current growth drivers are focused in China and India. These two represents the largest consumer market in the world as these are the two most populous countries in the world. The best economic growth in the world has been in these two nations. The west and the Europe are witnessing a phase of meagre growth in comparison to emerging markets especially in Asia. However, even within Asia, the Chinese markets are reflecting a turmoil within their equity markets. (Hatheway, 2016). The European economies has been dealing with the influx of migration of people adding to the risk of terrorism in addition to slow down in economy and government spending. The situation is Middle East is also bad with the oil prices at an historic low levels leading to huge reduction in collection from sales of oil. Further geopolitical tensions emanating from Syria and other surrounding nations continue to challenge the expectations of any economic growth in this geographical region.
The emerging markets contribute to the 70% of the global growth and hence the significance of these (IMF, 2016). Of the total major economies, India is expected to provide the best performance. Hence I have chosen India as the overall geographical region wherein my funds and investments would be directed to garner better returns. Despite major studies backing India to witness a robust growth. At a micro level, the country is witnessing strong policy and economic decisions with the current being demonetisation of around 80% of its in use currency. This bold move is expected to wipe out the grey market and control inflation. The expected outcome would be an easing of interest rates leading to higher spending driving more consumption and eventually generating more demand. (Misra, 2016). Further, make in India Policy in India has garnered global interests with large corporations expected to set up manufacturing bases in India. This will boost the country employment and will eventually reduce the reliance on imports.
Further, the demographics is most favourable for India. This will continue to fuel the economy and hence a major factor in contributing to the improved economic performance in the Indian market. (IMF as cited in MBA Rendezvous, n.d.). The improved performance will be reflected in the equities market.
Hence from a macroeconomic point of view, India is expected to be reflect a better growth owing to current fiscal and policy decision making and favourable demographics that will have a long term impact.
Risk Profile and Asset Allocation:
My current objectives are based on assumption of my continuous contributions to the selected investment strategy. This would require me to be continuously engaged in a revenue generating avenue. My analysis would require me to be engaged in employment. Hence I would not be able to be actively engaged in live-tracking of my investment strategy. Direct investment in a company or equity markets is expected to be volatile and requires continuous attention and professional assistance. Investment in mutual funds provides the advantage of equity investment in many companies backed by a professional team actively involved to ensure that the best returns are generated for the investors in mutual funds. The cost of such dedicated professional team is spread across the mutual fund and hence the individual investor has to bear only a small percentage of the costs in terms of exit and entry loads. Exchange Traded Funds (ETF’s) are a better alternative to mutual funds as the costs of the dedicated professional team is reduced since the underlying investments are tracked on the basis of the indices and hence require a lesser team strength. (Costa, n.d.). Hence my investment vehicle would be a mix of mutual funds and equity funds.
Objective 1: Short-term
My short term objective as cited earlier is to ensure funding of my marriage in 2 years’ time. Since the funds requirement is immediately after a 2 year period, this has been classified as a short-term objective. In terms of financing, this does not require a strong investment recommendation since the required funds are readily available.
Since the funds would be invested it is important that the risk profile is suitable to the investment horizon to ensure that the capital protection is addressed. The asset allocation for this investment horizon would be to ensure that the capital is protected and minimal risk free returns are obtained. The risk profile of the current objective is very low since the returns expectations is also very low. The prime objective for the investment catering to this objective is not returns and hence risk would be eventually very low.
The investment vehicle to be considered for this objective would be those that efficiently generate at least the risk-free returns. Hence for the given investment horizon the expected asset allocation is expected to be at least 5 % in cash and 95 % in low risk low returns asset base. Such asset base provides a lower returns and have a very low probability of a capital loss. The equities are a tool for a longer term and hence excluded from the asset allocation of this objective. The 95 % of the available funds would be best invested in either a debt oriented funds or those funds that cater to the end objective of capital protection.
Thus the overall investment analysis of the short term objective can be summarised as below:
Objective 2: Medium term
My medium term objective is to ensure funding of my child’s college education. The funds are expected to be required in 15 years’ time. Thus the investment horizon for this objective is generate positive returns over a time frame of 15 years. This financial objective has been classified under medium term objective. The important difference for this financial goal is that the finding would be done for this goal on a monthly basis over the entire tenure of goal of 15 years. There is no dedicated lump sum funding available for this at present with me.
The cost of a good college education for me is an important goal in my life since my belief is that a good educational qualification is necessary to provide a head start in life. The cost of education is witnessing an increasing trend owing to inflation. Further, quality college education comes at a good price and often requires huge funding. My objective is to invest on a small amount of money every month in my investment vehicle as per my investment strategy so that the desired objectives are fulfilled. The 15 years’ time horizon gives me enough flexibility to include a high risk investment into my portfolio. Hence, equity will be a dominant part of my overall portfolio. However, since the returns are expected to be realised in the medium term of 15 years, a portion of my investment will be directed towards an index based fund and balanced fund. A small portion will be dedicated towards a debt fund to ensure capital protection and desired liquidity without compromising the overall effectiveness of the portfolio. Thus the asset allocation would reflect a tendency to ensure that the returns from the equity markets are harnessed with the desired capital protection on offer by the debt plans. The equity portion of the portfolio would be to ensure that the overall returns from the equity markets are available for my investments. The balance funds will provide the necessary support to my portfolio as these funds devote a major portion to equity at roughly around 60 % - 65 % and the balance portion to debt funds. The balance fund would be a medium risk tool of my investment strategy to support my investments in case of a sudden downward volatility in equity markets. The small portion dedicated to debt funds will offer me required liquidity in the case of any emergency requirement of funds. This will serve as a cushion to me existing investment in equity funds.
Thus the overall investment analysis of the medium term objective can be summarised as below:
Objective 3: Long term
My long term objective is to provide funding for my retirement. The funds are expected to be required in 30 years’ time. The retirement corpus shall be for a world tour with my spouse in addition to the monthly financing of the then cost of living for me and my spouse. This is the most critical of my financial goals as the retirement corpus will be the only source of money for my livelihood. Any error in the attainment of this objective would effectively render me with the lesser funds at that stage of life where my health might not enable me to be engaged in an active employment of entrepreneurial venture. This objective will receive my most funding. Any subsequent increase in disposal income would be directed towards this objective.
The investment horizon for this objective is the highest at 30 years. Hence this financial objective has been classified under long term objective. Since the investment will be for a longer time horizon of 30 years, my investment strategy would be to invest all the sums into an equity oriented mutual fund. The investment horizon allows for a high risk profile. This also provides the investment to generate the highest returns at par with the risk it carries. Hence 90% of the total investment would be in the highest risk category of equity funds. Around 8% of the total investment would be directed towards balanced funds and balance 2% in debt oriented funds. This being the most crucial of all objective, my investment strategy would be revisited in the time frame of 5-6 years. If the performance is reasonable within the range of the overall objective, the investments would be continued in the similar ratio. However, during the last 5-6 years of the 30 years horizon, the investment portfolio would be tracked on an annual basis. Since the timing of the financial goal is now within less than 5 years, the equity funds would be diverted towards a relatively lesser risk of debt funds. This approach is similar to that accorded to the short term objective of capital protection. In this case, it would be to ensure that the returns earned over the majority of the investment life is not lost to any sudden volatility.
Thus the overall investment analysis of the long term objective can be summarised as below:
Selection of funds
The risk profile and asset allocation discussed in the earlier section requires investment in mutual funds with major investment in equity, debts funds and balanced funds. We are analysing the various mutual funds based on their performance of at least an 8 year horizon. This is because, I believe that the 8 year period is a sufficient time frame to factor in the cyclical trends in the equity performance. Since I have chosen India to be the preferred market for investment, the selection of the best performing funds in each category is as below: (Morningstar, 2016)
Equity Funds:
ICICI Pru Midcap Gr – INF109K01AN2: This fund invests in 95 % equity
L&T Midcap Gr – INF917K01254: This fund invests 95 % in equity
Debt Funds:
HDFC Gilt Funds Long Term Plan: This fund invest 100 % in AAA rating bonds
ICICI Pru Long Term Gilt Fund: This fund invest 100 % in AAA rating bonds
Balanced funds:
Birla Sun Life Balanced Advantage Fund: This fund invest 52 % in equity
ICIC Pru Balanced Fund: This fund invests 72 % in Equity, 20 % in Debts and Balance in cash
(Morning Star, 2016) (Money Control, 2016)
The choices of above funds have been based on their performance history. These are the leaders in terms of YTD annualised performances in their respective categories. Since the existence of the funds have been over the period long enough to sustain cyclical trends, the funds have been shortlisted over other funds.
In total my investments would be restricted to these total six fund as this would give me the required diversification in terms of asset allocation and fund houses as well. However, my investment strategy would be revisited on a periodic basis to ensure that performance is on track asper expectations and overall financial goals.
Expected Global Economic Developments
The world is increasingly becoming smaller in term of impact of global events. The latest events in terms of Brexit, Trump’s Election as President of USA and smaller events such as demonetisation will have a significant impact in the long term over the globe. The world economies would be affected. Europe’s regional growth would be affected by the expected depreciation of the EURO against other major global currencies. This is due to the impact of Brexit which will require Europe to pump in additional stimulus to ensure that the desired levels of growth and economic recovery is maintained for the Euro Zone.
The election of Trump as the President of United States is expected to impact the outsourcing of the US manufacturing and other service bases to other emerging economies. The Trump administration is expected to discourage outsourcing of jobs and investments unless it directly provides employment opportunities in the United States. This reverse globalisation could severely dent the economies of China, Mexico, Vietnam and other southern Asian nations whose economies have been fuelled by the existence of the manufacturing bases of US corporations. Further, restraint of the US armed forces from being commissioned to Middle East might negatively impact the containment of the ISIS and may lead to unexpected global consequences.
Apart from these the bold fiscal moves within certain countries like India with demonetisation of 86% of used currency (Misra, 2016) could place the Indian economy on the long term growth trajectory. However, there are other pockets of economic spurt expected with the development of Western region of China. With the commissioning of the CPEC corridor, the western China, which is highly underdeveloped, will witness huge investments as it is the starting point of the CPEC corridor that connect western landlocked China to the Indian Ocean, Central Asia and also India. This new phase of investments could once again feed the Chinese Growth which at present is witnessing a phase of consolidation.
These expected global developments to the extent of Chinese growth and Trump’s election as the new president is expected to have a positive impact on the Indian Economy and hence the latter being the foremost choice of investment to achieve my financial goals and objectives.
Question 3: How will you use your nestegg? 15% of the grade, 500 words Assume that you have built up funds from the portfolio in Question 2. How might you use such a nestegg in your retirement?
Answer 3: Use of Nest egg
The utilisation of the nest egg is very crucial as it should be in line with the assumptions that were made at the initial investment stage. In absence of this, the desired nest egg might fall short to meet the required objectives. The Nest egg will be made available at the stage of life with no alternative source of income. Hence its capital preservation is of utmost importance. Any decision leading to capital loss will erode the corpus.
The first step of action in dealing with the nest egg would be to invest in liquid funds. These funds have the dual advantage of being highly liquid and generating risk free returns. These returns are generally more than the inflation rate as the liquid funds invest in safe and secure government papers. Thus the investment would secure the corpus and would enable it to generate returns to beat the current inflation. The corpus would be used for funding the expenses as and when required with the balance generating returns at the rate beating inflation. Thus there would not be any deterioration of the corpus in real terms or in terms of its purchasing power. This requires a constant monitoring of the investment portfolio. The shift of the portfolio from the equity to liquid funds should be after some signs of corrections in the equity markets which is affecting the overall returns. However, I would not be suggesting this as the retirement stage is expected to be worry free and this tracking of costs might affect my health with severe consequences. I would prefer a peace of mind and though with my nest egg secured in safer funds.
Further, a portion of the investments would be help in cash to meet the urgent needs. I would be need to ensure that the budget is in place in terms of expected plans so that the withdrawals from the corpus could be planned. At this stage of my life, the biggest risk to the nest egg would be any health complications that I might enter inti given my old age. Thus a robust health insurance should be in place to cover me and my spouse for any medical uncertainties. This will save my nest egg from any exigencies.
I would assign a portion of the corpus to an annuity plan. The lump sum investment would be made which will be used to generate annuity to cover at least 85 % - 90 % of my living expenses every month. This might take up a larger chunk of my nest egg. But the remainder would be surplus which could be used as a buffer to cover for any unexpected expenditures. (Invest0pedia, n.d.)
My investment strategy in dealing with the nest egg would revolve around:
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- Purchasing of annuity to cover my monthly expenses
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- Purchase of a health plan
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- Change in portfolio from equity to liquid funds which would offer capital protection
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- Devising a budget that should ensure that would insulate my nest egg from the unexpected
References:
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AT&T (n.d.) AT&T Company Profile, Retrieved from: http://www.att.com/gen/investor-relations?pid=5711 on November 18, 2016
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David Costa (n.d.) Funds. FM Answers, [Online], Retrieved from: http://funds.fm/fund-answers on November 19, 2016
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Dr. Frank Hatheway (2016) A Macroeconomic View of the markets, [Online], Retrieved from: http://news.cqg.com/events/2016/01/macroeconomic-view-markets on November 19, 2016
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International Monetary Fund (2016) Subdues Demand Diminished Prospect, [Online], Retrieved from: http://www.imf.org/external/pubs/ft/weo/2016/update/01/ on November 19, 2016
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Investopedia (n.d.) Immediate Payment Annuity, [Online], Retrieved from: http://www.investopedia.com/terms/i/immediatepaymentannuity.asp on November 19, 2016
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MBA Rendezvous (n.d.) Demographic Dividend – Advantage India, [Online], Retrieved from: http://www.mbarendezvous.com/general-awareness/demographic-dividend-advantage-india/ on November 19, 2016
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Moneycontrol.Com (2016) Performance Tracker, Retrieved from: http://www.moneycontrol.com/mutual-funds/performance-tracker/returns/balanced.html on November 19, 2016
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Morningstar.com (2016) AT&T 6.55% | Maturity:2039, Retrieved from: http://quicktake.morningstar.com/StockNet/Bondsquote.aspx?cid=0C00000AGU&bid=d3121cf19442c73e4312b9a7fa287e77&bname=At%26T+6.55%25+%7c+Maturity%3a2039&ticker=T&country=USA&clientid=dotcom on November 19, 2016
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Morningstar.in (2016) Fund Quickrank, Retrieved from: http://www.morningstar.in/tools/mutual-funds-ytd-top-performers.aspx on November 19, 2016
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Udit Misra (2016) Stats Guru: India’s black economy and impact of demonetisation, [Online], Retrieved from: http://www.business-standard.com/article/economy-policy/statsguru-india-s-black-economy-and-impact-of-demonetisation-116111400034_1.html on November 19, 2016
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Yahoo Finance (2016) Historical Data, Retrieved from: https://finance.yahoo.com/quote/T/history?period1=1321641000&period2=1479493800&interval=1mo&filter=history&frequency=1mo on November 19, 2016
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