Investment Strategy and Portfolio Management (Research Paper Sample)

INVESTMENT STRATEGY AND PORTFOLIO MANAGEMENT
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Executive Summary
Kaplan is a charitable fund established in 2007 to provide an investment vehicle for investors seeking to finance some educational objectives. The aim of the fund is to grow members’ contributions through investment in securities. Investors in Kaplan are yet to start making withdrawals from the fund but are due to begin in June 2012. This report looks at current issues in the investment environment in the UK, Europe, and the rest of the world which have an impact on Kaplan’s operations. It also examines strategic asset allocation and investment strategies that Kaplan should employ to achieve its goals. In addition, the report recommends areas in which the fund’s management should actively manage investments and those areas in which passive management would be the better option.
Overview of the Investment Environment
In recent years, the global fund sector has continued to register robust growth in many countries with developed financial markets. Collective investment schemes are becoming the most preferred investment vehicles for investors because of their obvious advantages including diversification, professional management of investments, liquidity and investment advice for investors and superior returns (Roll, 2008). Indeed, as by the end of 2011, the global investment fund industry was worth US $11.7 trillion which translates to 17 percent of primary securities holdings around the world. However, recent events in international financial markets and the prevailing global economic conditions have made the investment environment increasingly uncertain and more difficult to predict for fund investors. Since most investors are risk averse, this situation has impacted negatively on the flow of funds to investment schemes. On the other hand, the number of fund investors liquidating their shares is on the rise (Rhodes, 2005).
Although the global recession of 2007 looks like a thing of the past, its effects on investor confidence and investment activity still hang around. In fact, the world seems to be still stuck in the recession and the few signs of complete recovery evident are shrouded in uncertainty and the risk of falling back into an even deeper recession (Remolona, Kleiman and Gruenstein, 2009). Many major economies including the U.S., European economies and economies of the emerging markets such as China, Singapore, India and Brazil continue to post high rates of unemployment and low activity in major economic sectors including housing, manufacturing, financial and the service sector (Quigley and Sinquefield, 2011). The European debt crisis affecting Greece, Spain and Italy has also had a substantial effect on investment in the Euro zone and around the globe. The full impact of this crisis is yet to become full-blown as a result of the efforts of the European Union members to avert the worst of the crisis. Both the global economic slowdown and the European debt crisis have had an impact on fund investments by reducing financial markets activity in general, not only in the Euro zone but around the globe, including the UK.
Issues Facing Fund Investments in the UK
There are several key issues affecting the investment fund sector in the UK. These include: laws and regulations, competition from the banking sector, level of education, wealth of the population, the age of the investment fund industry, security trading costs and the GDP of countries forming the UK.
Laws and regulations
Recent legislations by the UK government aimed at protecting fund investors have been a boon to the investment fund industry in this region. These laws raised investor confidence in fund investment by increasing disclosure requirements, making fund managers more responsible and accountable for fund assets, reducing conflict of interests between funds managers and investors. The effect of these laws has been to increase the level of investment inflows into these schemes.
Competition
The fund industry in the UK and elsewhere in the world faces stiff competition from the banking sector since banks offer substitute products to fund investors. A concentrated banking industry, as in the UK, offers more competition to the fund sector than a less concentrated one since the former is allowed by regulation to offer products offered by investment funds. Studies show that growth of the funds sector is higher in those countries where investment funds face lower competition from the banking industry than in those countries where competition is higher (Shukla and Trzcinka, 2006). Thus, a concentrated banking sector is one of the reasons why the fund industry has taken a long time to develop in the UK as opposed to its rate of growth in other countries like the US.
Level of Education and Wealth of the UK population
The level of education and wealth of a country’s population are positively related to growth in investment funds industry (Volkman and Wohar, 2010). Thus countries whose population is more educated and well-off (e.g. the U.S.) tend to have higher rates of growth for the funds sector than those with lower levels of education and wealth. The effect of education on investment funds growth is based on the fact that education is important in understanding investments and also in gaining financial literacy. The degree of wealth on the other hand determines the amount of disposable incomes that individuals are willing to commit to investment in securities. The UK population has been experiencing gradual rise in both the levels of wealth and education and this trend is expected to continue into the foreseeable future. As a result, the funds sector in the UK also experienced constant growth in the past. The momentum of this growth is expected to be maintained into the near future.
Age of the Investment Funds Industry
As past studies have indicated, the age of the investment funds industry is positively related to the level of development of this sector (Warther, 2005). Consequently, countries where investment funds were introduced early have a more sophisticated funds sector compared to countries where investment funds were introduced recently (Rolls, 2004). In fact, since the US was the first country to introduce investment funds, age of the funds sector is one of the reasons the US funds industry is more developed than that of the UK (Sharpe, 2007). Thus, the UK industry is relatively young but it is expected to expand over the years.
Security Trading Costs
The transaction costs incurred in the exchange of securities also affect the rate of growth as well as development of investment funds. The level of securities trading costs depends on the efficiency of the financial markets in which transactions are taking place (Treynor and Mazuy, 2006). More efficient financial markets have lower transaction costs making buying and selling of securities more attractive. In contrast, the less efficient financial markets have high transaction costs. This situation is unfavorable to investors since it increases the liquidity risk of holding securities. Investors have always preferred to hold those securities which can be easily converted into cash without significant loss of value (Sirri and Tufano, 2003). The UK financial market is relatively efficient and, as a result, its trading costs are substantially low. Therefore, it provides a favorable environment for growth of investment funds. Moreover, the advent of internet technology in security trading has significantly reduced trading costs enabling financial markets to offer more liquidity to investors.
The GDP of Countries forming the UK
Countries forming the UK, namely England, Scotland, Wales and Northern Ireland have seen modest but constant economic growth in the past few decades. Over the years, the economies of these countries have proved to be stable and this has had a great impact on the investor confidence. Also, the per capita incomes of the UK population have been rising gradually over the years and more people have now taken to investing in securities than the case was in the past. Stability in these economies has been a boon to the funds industry and it is one of the factors predicted to drive growth in this sector in the future.
Asset Allocation
Asset allocation refers to the allotment of investment funds among different asset classes such as equities, bonds, cash and the adjustment of the amounts in different asset classes over time to take advantage of price variations (Zheng, 2009). There exist two forms of asset allocations, namely strategic asset allocation and tactical asset allocation (Wermers, 2009).
Strategic Asset Allocation
Strategic Asset Allocation entails selecting the fund’s investment policy regarding the asset classes to invest (Company, 2006). It is a long-term policy which determines the fund’s long-run returns and the variability in those returns. Several factors are considered as setting a fund’s long-term investment policy. These include: the objective of the fund’s portfolio, the risk-tolerance level of the fund’s investors and the time horizon of the selected investments. Strategic asset allocation is the major determinant of the fund’s long-run return.
Tactical Asset Allocation
Tactical Asset Allocation involves the adjustment of amounts allotted to each asset class in a fund’s portfolio to take advantage of market inefficiencies or movements (Merton and Henriksson, 2006). Some of the techniques used in tactical asset allocation include market forecasts, market timing and financial models (Leger, 2007).
Overview of Kaplan
Kaplan is a charitable fund that was formed to advance educational goals. The aim of the fund is to help its members to grow their funds by investing in securities so t...