Module 1: General Introduction and Key Concepts
1.1 Investment Management in a nutshell
Investment management is about managing risk!
The key to successful Investment Management is to constantly be aware of the underlying risks:
Country Risk
A country can be subject to a political problem at some point, and so the authorities, the government decides to shut the borders. And also there’s some restriction on captical movements.Market Risk
Currency Risk
Liquidity Risk
If you’re investing in what we call small caps, i.e., firms which have a small capitalization on the stock market. The problem is that their liquidity is less. And when everyone is rushing for the exit, everyone wants to sell, and nobody wants to buy. So these stocks get hurt badly.Inflation Risk
Shortfall Risk
Shortfall risk is the possibility that the performance of your portfolio does not allow you to reach the financial goal you set it up for.
Investment management is a two-step approach, whether you’re shooting for income or growth, all that defines your profile. And that goes into what we call your strategic asset allocation, the outcome will be that you need over a horizon of five to ten years, the optimal asset allocation is 10% cash, 40% fixed income, and 50% equities.
Once you have defined the strategic asset allocation, then you move on to the tactical asset allocation.
You should shoot for a strategic asset allocation for the long run but then adjust this asset allocation on a tactical basis.
Know youself in market
Decide whether you want to:
- Be a hunter: directly involved in the investment management process.
- Be a farmer: Delegate the investment decision and monitor the result.
Key takeaways when investing in bonds
- Beware of the limitation of benchmarking in the bond market
- Consider the fundamentals of the borrower you lend to
- The lower the starting yield, the lower the expected return
- Buy bonds if you expect a macroeconomic slowdown and conversely
Key takeaways when investing in equities
- Beware of the limitation of benchmarking in the equity market
- Strong GDP growth does not always imply higher equity returns
- Don’t chase past performance
- Look for truly active manager
1.2. Fundamentals
1.2.1 The role of financial markets
4 kinds of participants
- Firms: firms need to raise a lot of capical and will proceed with an initial public offering where investors would bring their savings to them. It’s called the primary market.
- Investors: not limited to specific persons, it also can be an org, a fund, and a portfolio. They allocate their savings to productive investment opportunities. and also can sell their shares between themselves. It’s called the secondary market.
- Government: it has a place to ensure market itegrity, to protect investors against abuse.
- Financial intermediates: all the chain of brokers, market makers, banks and institutions that make the interface between investors or between the investors and the firms.
2 kinds of markets
- Primary market: where the transfer of resources to productive investment oppotunities occur.
- Secondary market: allow investors to trade among themselves to buy and sell securities mainly for liquidity reasons and for portfolio reallocations.
functions
- Core function: a financial market serves to transfer resources, namely savings, from investors to firms, corporations, that need to make investments.
- Pooling of resources and subdivision of shares: pool money from a lot of shareholders, little investors, institutional investors to be able to raise such amounts in terms of billions of dollars of market capitalications.
- Transfer resources across time and across space.
- Help participants manage risks: One way of managing risks is to keep diversification, so you need diversified portfolio. The second way to manage risks is to use derivative products that allow you to insure your portfolio against a drop, for instance, S&P 500. The third way of managing risks is through securization.
- Provide information: every time you trade, that the buyer and seller meet, there’s going to be a transaction price. That price informs you on the value of a firm.
1.2.2 Basic concepts in finance
- Return: we should look at the past and not just focus on the last performance.
- Risk: the easiest way to take a tradeoff between reward and risk is to use the return-risk ratio. Take the reward divided by the volatility, divided by the risk, and pick the higher one to invest.
- Risk distribution: ~
1.2.2 Basic concepts in Investment Management
Descipline and planning are key
Defining your goals and your investment time frame
Growth assets: designed to provide most of their returns in the form of capital growth over time. Growth assets tend to have more volatile returns over the shorter term, but they have the potential to produce higher returns over the longer term.
Income assets: provide returns in the form of income and include cash investments, bonds and certain equities. Income assets tend to provide more stable, but lower returns.
Risks
- Country Risk: domestic events, such as political upheaval, financial troubles, or natural disasters
- Currency Risk: changes in currency exchange rate cause the value of an investment to decline
- Inflation Risk: inflation is a measure of the rate of increase in general prices for goods and services. The risk that inflation poses is that it can erode the value or purchasing power of your investments.
- Liquidity Risk: the chance that an investment may be difficult to buy or sell.
- Market Risk: investment returns will fluctuate across the market in which you are invested.
- Short Fall Risk: possibility that you portfolio will fail to meet your longer-term financial goals.
Recognize the importance of cost and tax
Type Description Initial charge This represents the charge the fund manager Exit Fee Fund management companies sometimes levy an exit fee and generally return the proceeds to the fund to cover the costs of setting the underlying securities. Annual Management Charge(AMC) The Annual Management Charge covers the fund manager’s ongoing costs of managing a fund Ongoing Charges Figure(OCF) Each share class of a Fund, or unit class in the case of FTSE Unit Trust Funds, has an Ongoing Charges Figure(OCF) which is based on projected expenses for a given period. The OFC covers administration, audit, depositary, legal, registration and regulartory expense incurred in respect of the Funds.
Understanding asset allocation
Asset ClassesEquities: also called stocks or shares, represent ownership in a company. This ownership gives you the right to share in that company’s future financial performance.
Bonds: a bond is a load made to the bond’s issuer, which could be a company, a government, or some other institution. Bonds can be useful in a portfolio as they provides income, typically paid twice a year. Bonds are issued for a set period and when that period expires(reaches its maturity), the issuer will repay the face value of the bond.
Property: for most people, their major investment in property will be owning their own home. For investors who want to increase their exposure to property, it is possible to diversify into commercial property, such as office space, retail outlets or industrial property. These funds earn returns from both rents on the property they own and the potential gains in the value of that property.
Cash Investments: includes cash holdings in bank or building society accounts, as well as investments in money market funds. Cash investment offer liquidity - the ability to withdraw cash easily while cash investment tend to be the least volatile of the major asset classes, historically they tend to provide the lowest returns.
Asset allocation simply means deciding how to spread your money across the different asset classes(including equities, bonds, properties and cash) and how much you want to hold in each.
Asset Class Key characteristics Potentially Suitable for Equities Potantial for captical growth, and may offer income through the payment of dividends. Medium-to-long-term investors(five years plus) Bonds Can provide a steady and reliable income stream with potential for capital growth and usually offers a higher interest rate, or yield, than cash. Short, medium or long-term investors Property Provides the benefits of diversification through access to properties in retail, office, industrial, tourism and infrastructure sectors. Medium-to-long-term investors(five years plus). Cash May be suitable for short-term needs, such as an impending down payment on a new home. Usually includes higher interest paying securities, as well as bank and building society accounts or term deposits (a cash deposit at a financial institution that has a fixed term) Short-term investors(up to three years) Looking after your investments over time
Keeping market movements into perspective, recognizing the potential impact of risk and regularly rebalancing your portfolio
1.2.3 Focus on the advantages private investors enjoy
- The ability to deal with illiquidity: private investor typically don’t have the same liquidity needs as professional investors.
- Private investors can also typically take a much longer term view than professional investor, who typically face daily mark to markets and career risk if they under perform for even a short period of time.
- Professional investors are usually tracking benchmark on US or European equity while private investors are inherently benchmark agnostic, so two areas in particular we focus on had been structurally overpriced. Then arbitrage can be made by selling overpriced insurance to markets which is full of individual investors.