An analysis of a portfolio of investments aimed at producing gains over the short-term.
This essay will firstly introduce the aim and structure of the portfolio. This will be followed by assessing each investment of the portfolio, discussing the rationale behind each investment and analysing and evaluating each one on its performance over a two month period. Finally, improvements will be considered that would make the portfolio an even better investment.
The investment in this portfolio is based on short-term speculation. The main purpose is to generate income over a short-term period rather than a long-term plan. Regarding investment styles, this portfolio is based on value and growth stocks. The main aim is to increase income generation in a short-term period, so the investments made are mainly in stocks expected to increase in a short-term speculation, or their value is expected to increase in the next few years. The portfolio is actively managed as for short-term income generation it is necessary to outperform the market to get better results.
The main reason for the selection of the short term speculation investments was that the investments were to be assessed after a two month period, and also the life cycle hypothesis theory suggests that even the more long term investors also tend to generate income quicker if an opportunity is seen (Carroll, 1997). This also brings the theory of psychology of investment decisions into play. Considering the psychology, as the project focused on assessing a two-month period, the aim became to increase the investment in the next two months. Although in a real situation other important factors such as risk, rate of returns etc will be much more important factors.
Overall the portfolio contains seven investments. This covers equity in three companies, two major indices investments, one fund and one ETF. The investments in the portfolio totalled approximately one million pounds (£992,529). The major part of the investment went to indices £45,6979 or 46.04%. This was followed by £30,8750 or 31.10%, which was invested in equity. Lastly £147,400 (14%) went towards ETF and £79,400, or 8%, in funds. Looking at the structure of the portfolio, this is more focused towards short-term speculation. As the portfolio of investments were to be assessed after two months, the investments made focused to increase the investment on a short-term basis rather than considering the long-term retirement savings. Although in a real life situation the portfolio selection should have been made from a long-term perspective, rather than focusing on the short-term speculation.
First of all the, stock in companies will be considered. A total of three investments in stock were made. As mentioned before the total investment in stock was around 31%. This was divided between three different companies from three different industries. There was no real strategy regarding industries when the initial selection was made. But looking at risk of investments and how to diversify portfolio risk, it is important to invest in different industries rather that one industry (Redhead, 2008). By investing in different industries the market risk could be reduced. Gerald Krefetz, in his book How to Reduce Investing Risk, says that market risk can be reduced through proper diversification. Most investors make the mistake of buying only two or three securities. Economists have calculated that a portfolio comprising of shares from 12 to 15 different companies from different industries will eliminate 91 per cent of all unsystematic risk. If all the investments are in the same industry and that particular industry is affected by uncontrollable factors the investor will be taking a loss in all his investments. Coming back to the portfolio equity investments, the three companies in which investments were made were Virgin Media INC, Vodafone group PLC and ITV PLC. There was an overall gain in all three stocks. The value of the share increased over the two-month period and thus gave a better return. But as mentioned by Redhead, investing in stock is always risky but gives high returns as well.
Assessing each of the stock, Virgin Media INC increased by a total of 12.07%. Since the investment was made Virgin Media INC has been on a rise compared with its rivals. Market leaders British Sky Broadcasting Group PLC have been constant over the two month period (Yahoo finance). The initial investment was made due to the increase in Virgin Media Inc share prices trend at that time. But looking at the overall industry in the current quarter, the industry growth has been negative by 51% (yahoo finance). Despite the decrease in the overall industry Virgin Media have had a positive growth, thus there has been increase in value of investment as well. Even over the next five years growth prediction an increase is expected in Virgin Media stock, so this is a good investment from the long-term perspective. The industry in the future is expected to gain growth, which according to Appelbaum in his article Measures of Risk Aversion and Comparative Statistics of Industry Equilibrium, it is safer for an investor to invest in an industry with a positive growth rate as compared to an industry with negative growth rate.
The next stock in the portfolio is Vodafone Group PLC. This showed a total rise of 10.66% over the period of two months. There were peaks and troughs in the share price, with the value peaking in mid November but then showing falls till December. The major reason for the investment was that Vodafone Group PLC is the market leader in the wireless communication industry and the price was expected to rise in the coming period. As the initial investment was made from a short-term perspective these factors were taken into consideration and thus an investment was made. But looking at the expected analysis, the growth of Vodafone is decreasing each year and the total growth in the next five years is only expected to be 0.83%. This is possibly due to the rising competition in the industry. To evaluate the investment from a long-term perspective a more cautious approach shall be taken and future growth shall be taken into account.
The final stock investment was in the TV-broadcasting industry through ITV PLC. During the time of investment ITV was suggested as one of the better investments for the upcoming period. This is reflected in its performance as well. A total constant rise in the share price until December, and a total rise of 7.3% has been achieved. In future further growth is expected in the industry and for ITV PLC. A total growth of 44% per annum is expected (yahoo finance). This investment can be considered a good long-term investment due to the potential in the growth in both the industry and the company itself.
Mutual Funds and ETFs
Coming to the funds, there were two investments made. One was a mutual fund while the other was exchange traded fund (ETF). As both have different characteristics, the investments will be evaluated separately.
Looking at the mutual fund the investment was made in a unit trust, and totalled around £80,000, which is only equal to around 8% of the total investment. Investing in funds has many advantages, such as instant diversification and continuous professional management (Lee McGowan, 2006). Despite these factors the reason for the relatively low investment was that the portfolio‘s purpose was short-term income generation, and experts believe that investing in funds is not suitable for short-term investments. This is because the gains from the investment in unit trusts are not realised straight away. At best one could sell the units held once its price increases.
However, the upward movement in price, being dependent on the movement of the market, is usually much slower than the market’s movement (Taylor, 2007). Considering this, a smaller sum of money was invested to fullfil investment plans. Over the two month period the total increase was just 1.40%. Compared to equities the increase is not as much, but this was expected, as it is a much risk diversified investment.
Despite the diversification experts do believe that mutual fund investment is also subject to market risk, as unit trusts invest in marketable securities (lee McGowan, 2006). Comparing the investment in HSBC with other options available, financial times analyses show that HSBC has been improving since late 2008 and is expected to further improve in the coming years, and therefore it is considered a better and safer investment. Had the portfolio aim been a long-term investment more money would have been put into this particular investment or other funds available, but as the portfolio aim was towards short-term speculation, fund investment is only limited to 8% of the total investment.
An investment in an Exchange Traded Fund was made as well. The investment was around £150,000, which is 15% of the total investment. The reason for more investment in an ETF than funds was that ETFs are traded like stocks (Smith, 2010). So there can be a rapid increase in value compared to a mutual fund. Along with that, there are no professional maintenance fees and investment could be made in any sectors (Smith, 2010).
ETFs are also instantly diversified, although there is a strong argument that this diversification can reduce potential profits (Lee McGowan, 2006). Due to this, a smaller investment was made compared to those made in equity in companies. Another reason was that at times one does not know what items the investment is going towards when investing in ETFs compared with stocks. Experts believe that one of the cardinal rules of investing is to understand what you’re investing in.
Despite that ETFs were a good option and a total of £150,000 was invested in Ishare Citgroup Global Government Bond ETF. At the end of the two month period a total loss of 4.75% was suffered. One major flaw was that the whole investment was made in one ETF, and so there were no alternatives where the money could have come back from somewhere else. The major reason for the investment was the ETF’s performance in the past three quarters. But there was a sudden decrease in the final quarter of the year 2010. Although increases in the value of ETFs are expected, the growth is expected to be so slow (Financial times) that it clashes with the initial aim of the portfolio, which is based on short-term speculation rather than a long-term retirement saving plan.
Stock Market or Indices
Finally the major part of the investment went towards two stock markets, FTSEALLSHARE and FTS Euro first 300. Around 45% of the total investment was invested into the stock markets. The main reason for this was that markets are more diversified compared with stocks in different companies. Investing in various sectors and industries makes the portfolio much more diversified (Redhead, 2008). Along with that stock markets can give instant increases in the investment, which was considered as the main aim of the whole portfolio. Experts believe that stock markets generally provide solid returns (Siegel, 2004). For example, the historical annual real return on US stocks is close to seven per cent, which is a very attractive return (yahoo finance).
Due to these reasons the major part of the investment went towards stock market. Coming to the performance of the investments, both the markets have provided gains. There was a 3.32% increase in FTSEALLSHARE and a 5% increase in Euro First 300. The economic condition of the euro currency also became a significant factor in increases in a market. By using GBP rather than EUROS, less money acquired more shares in the market. Future growth is also expected in both the markets. Despite this experts believe that a sudden collapse in the market can lead to huge losses. The economic collapse in 2008 was a clear example of this. As the economic recession still continues there is a certain risk, which could lead to decreases in the value of the market. However, with proper diversification these risks could be reduced.
Comparing the FTSE-ALL Share and Euro First 300 with other alternative options available, these two indices cover various sectors. For example, the FTSE-100 is mainly dominated by just four sectors (Redhead, 2008) where as the FTSE-ALL Share and Euro First 300 consists of companies from many sectors. As mentioned before, investing in more sectors can help to further diversify the investment. A second important point for analysing the stock markets is market capitalisation. The FTSE 100 and the FTSE 250 represent 80% and 16 % respectively in the total market capitalisation of the UK market. Comparing this with the FTSE ALL Share, this covers the 98% of the total market capitalisation of the UK market. Statistics like these can further reduce risk, as it shows the investment is wide spread in different shares from various industries and sectors, thus it diversifies the portfolio.
To conclude the investments have yielded good results. The main aim of income generation has been fulfilled and an increase of income can be seen in the final figure over the two months period. The current investment structure helps to increase the income, but despite that there are areas where improvements can be made and further improve the portfolio returns and reduce risk. With further diversification more of this risk could be eliminated. So the main improvements will consider reducing risk or diversifying the portfolio.
Considering the stocks, for further diversification different sectors should be considered. Currently the stocks are from different industries but come under the same sector. Experts such as Rob Bennett believe that widening the investment to different sectors can further diversify and thus minimise risk. Current stocks are growth stocks and some value stocks should be considered as a sudden increase in the underpriced/value stock share price can lead to income generation, which is the fundamental aim of the portfolio.
Investment within funds and ETFs could be improved as well. The characteristics of mutual funds are not fully suitable for achieving the aim of the investment, so minimum investment was dedicated towards these. But ETFs can increase income generation in the short-term. With more diversification, that is, investing in more than one ETF, risk can be further eliminated . Better research on ETFs could have lead to better performance.
Finally currency risks should be considered, as one of the investments was made in foreign currency index and there is a risk of getting a heavy loss or profit (Arnott, 2009), and this has to be monitored. During the current period it came as a profit, but this could easily have been the reverse. Investment in more indices could lead to further diversification.
To conclude on the portfolio it can be said that over the past two months the initial aims of the portfolio seemed to have been achieved. However, there are significant areas where the compilation of investments could be improved. Along with that more diversification techniques could help in making the investment safer. Comparing this portfolio with other similar portfolios, it has the wide sectors and industry investments, which improves diversification. Along with that significant returns are being achieved. The expected growth rate of the investments also show that these investments could be a good for a longer period of time, although further diversification and some major changes in the aims will have to be made to do so.
Applebaum, E. (2009), Measuring of risk aversion and comparative statics of industry equilibrium. Available at:
http://www.jstor.org/pss/1813369 (Accessed on2 2-12-2010)
Bennett, R. (2008), Passion savings. (1st Edition) Available at
http://www.passionsaving.com/passion-saving-book.html (Accessed on 20-12-2010)
Krefetz.G, (2007), How to reduce investment risks. (2nd edition), London: Financial Times
McGowan, L. (2006), Mutual funds pros and cons. Available at
http://mutualfunds.about.com/od/mutualfundbasics/a/disadvmf.htm?mr=952 (Accessed on 18-12-2010)
Redhead. K, (2008), Personal Finance and Investment. (2nd edition).London: Routledge
Taylor, A (2007), Mutual funds weighing the positives and negatives. Available at
http://www.financialplanning2u.com/retirement/weighing-the-pros-and-cons-of-investing-in-unit-trusts.htm (Accessed on 18-12-2010)