Investment management.docx

**Investment management** **Unit 1** **Concept of investment management** **Introduction** An investment management is a sacrifice of current money or other resources for future benefits. Numerous avenues of investment are available today. We can deposit money in a bank account or purchase a lon...

**Investment management** **Unit 1** **Concept of investment management** **Introduction** An investment management is a sacrifice of current money or other resources for future benefits. Numerous avenues of investment are available today. We can deposit money in a bank account or purchase a long term government bond or invest in the equity shares of a company or contribute to a provident fund account or buy a stock option or acquire a plot of land or invest in some other form. **Meaning of investment** Investment is the employment of funds on assets with an aim of earning income or growth in value or capital appreciation. In other words, investment is the sacrifice of certain present value for uncertain future reward. It involves commitment of resources which have been saved or put away from current consumption in the hope that some benefits will accrue in future. Investment may be defined as a "commitment of funds made in the expectation of some positive rate of return". The return is expected to be realized in future. **Investment management** Investment management refers to the handling of financial assets and other investments by professionals for clients. Clients of investment managers can be either individual or institutional investors. Investment management services include asset allocation, financial statement analysis, stock selection, monitoring of existing investments and portfolio strategy and implementation. Investment management may also include financial planning and advising services, not only overseeing a client's portfolio but coordinating it with other assets and life goals. **Investment as per finance** Investment is the commitment of a person's funds to derive future income in the terms of interest, dividend, premium, pension benefits or appreciation in the value of their capital. Purchasing of shares, debentures, post office savings certificates. Insurance policies are all investments in financial sense such as investments. Generate financial assets. In other words, financial investment is the allocation of money to assets that are expected to yield some gains over a period of time. It is an exchange of financial such as stocks and bonds for money. **Investment v/s Economics** Investment means the net additions to the economy nation's capital stock which consists of goods and services that are used in the production of other goods and services. Investment in this sense implies the formation of new and productive capital in the form of new constructions, plant and machinery, inventories, etc. such investments generate physical assets. **Objectives of investment** Investment objectives are related to what the client wants to achieve with the investments portfolios. Generally, the objectives are concerned with risk and return, which are interdependent, as the risk that you are willing to take, will determine your returns. The following are the objectives **Primary objectives** a. Maximizing the return b. Minimizing the risk **Secondary objectives** a. Increasing wealth b. Hedging against inflation c. Tax savings **Maximizing the return** Investment decisions are based upon the expected return from them. The rate of return is total income of investor receives during the holding period. Investors always expect a good rate of return from their investments. Returns expected from securities consist of two parts. They are **Current income** The dividend or the interest accrued from the given security reflects as the current income or current yield of the security. **Capital formation** The difference between the selling price and purchasing price of the security is called capital appreciation. Returns from particular securities depend on the expectations held by the investors. Generally, longer is the holding period of the investment; higher is the expectation of the investors. If it is a stock, the investor gets the dividend as well as the capital appreciation as returns. Market return of the stock indicates the price appreciation for the particular stock. **Minimizing the risk** Risk means possibility of incurring loss in financial transaction. It arises from the possibility of variation in returns from investment. In other words, when the actual return is less than expected return is called risk. Investment risk is an important as measuring its expected rate of return because minimizing risk and maximizing the rate of return are interrelated objectives in investment management. **Increasing wealth** Some individuals consume first and save the remaining. However, some individual called rich save first and consume the remainder. They save to multiply the wealth rather than to provide for future consumption. Thus reward for making the investment comes in the form of increased wealth through capital appreciation of the investment. **Hedging against inflation** If the return of any security is lesser than the inflation, then loss is incurred in real terms. It is preferred that investment should provide a protection against inflation. So the rate of return should ensure a cover against inflation to protect against a rise in prices or fall in the purchasing value of money. Growth stocks would appreciate in their values overtime and provide protection against inflation. **Tax savings** Income generated by common shareholders is considered capital gains and is taxed differently. Taxes on capital gains are significantly lower than taxes on interest income or ordinary income like salary. If your primary objective is tax saving, registered plans such as national pension schemes and tax free savings accounts are the best bet. However, there are also effective ways to earn good returns along with saving taxes like investing in tax saving mutual funds or life insurance policy. **Features of investment programme** **Safety of principal** Safety means protection against loss. The investor should carefully review the economic and industrial trends before choosing the types of investment. Errors are avoidable and therefore to ensure safety of principal the investor should consider diversification of assets. Proper diversification involves mixing investment commitments by the industry, geographically, by the management by financial type and by maturities. The proper combination of these factors would reduce losses. **Liquidity** Investor requires minimum liquidity in this investment to meet emergencies. An investment is liquid asset if it can be converted to be cash without delay at full market value in any quantity. Liquidity will be ensured if the investors buy a proportion of readily saleable securities out of his portfolio. So investor keeps a small portion of cash fixed deposits and units which can be immediately saleable. **Income stability** While investing, the investor must consider stability of monetary income. Regularity of income at a consistent rate is necessary in any investment pattern. Not only stability, it is also important to see that income is adequate after taxes. **Appreciation or capital growth** The investor should forecast which securities will possibly appreciate a purchase of property at the right time will lead to appreciation in time growth stock will also appreciate over time. **Purchasing power stability** Investor should consider purchasing power stability of future funds. Because an investment involves the commitment of current funds with the objective of receiving greater amounts of future funds. For maintaining purchasing power stability, investor should carefully study the following factors: - The degree of price level inflations they expect. - The possibilities of gain and loss in the investment available to them. - The limitations imposed by personal and family consideration **Legal and freedom from care** All investment should be approved by law. Law relating to minors estates, trusts, shares and insurance be studied. To identify the legal securities and investments in such securities will also help the investor in avoiding problems. **Tangibility** Investors prefer to keep a part of wealth invested in tangible properties like building, machinery and land. It may however, be considered that tangible property does not yield an income apart from the direct satisfaction of possession. Because intangible securities have many times lost their value due to price level inflation or social collapse. **Investment process** The investment process involves a series of activities leading to the purchase of securities or other investment alternatives. The investment process can be divided into five stages or steps as mentioned below: 1. **Framing of investment policy** The government or the investor before proceeding into investment formulates the policy for the systematic functioning. The essential ingredients of the policy are the investible funds, objectives and the knowledge about the investment alternatives. - **Investible funds** The entire investment procedure revolves around the availability of investment funds. The funds may be generated through savings or from borrowings. If the funds are borrowed, the investor has to be extra careful in the selection of investment alternatives. The returns should be higher than the interest he pays. Mutual funds invest their owner's money in securities. - **Objectives** The objectives are framed on the premises of the required rate of return, need for regularity of income, risk perception and the need for liquidity. The risk takers objective is to earn high rate of return in the form of capital appreciation, whereas the primary objectives of the risk averse is the safety of the principal. - **Knowledge** The knowledge about the investment alternatives and markets plays a key role in the policy formulation. The investment alternatives range from security to real assets. The risk and return associated with investment alternatives differ from each other. Investment in equity is high yielding but has more than the fixed income securities. The tax sheltered schemes offer tax benefits to the investors. 2. **Investment analysis** The investor should be aware of stock market structure and the functions of the brokers. The mode of operation varies among BSE, NSE and OTCOEI. Brokerage charges are also different. The knowledge about the stock exchanges enables him to trade the stock intelligently. After formulating the investment policy, the securities to be bought have to be scrutinized through the market, industry and company analysis. - **Market analysis** The stock market mirrors the general economic scenario. The growth in gross domestic product and inflation are reflected in the stock prices. The recession in the economy results in a bear market. The stock prices may be fluctuating in the short run but in the long run they move in trends i.e. either upwards or downwards. The investor can fix his entry and exit points through technical analysis. - **Industry analysis** The industries that contribute to the output of the major segments of the economy vary in their growth rates and their overall contribution to economy activity. Some industries grow faster than the GDP and are expected to continue in their growth. - **Company analysis** The purpose of company analysis is to help the investor to make better decisions. The company's earnings, profitability, operating efficiency, capital structure and management have to be screened. These factors have direct bearing on the stock prices and the return of the investors. Appreciation of the stock value is a function of the performance of the company. Company with high product market share is able to create wealth to the investors in the form of capital appreciation. 3. **Valuation** The valuation helps the investors to determine the return and risk expected from an investment in the common stock. - **Intrinsic value** The intrinsic value of the share is measured through the book value of the share and the price earnings ratio. Simple discounting models also can be adopted to value the shares. The stock market analysts have developed many advances models to value the shares. The real worth of the share is compared with the market price and then the investment decisions are made. - **Future value** The future value of the securities could be estimated by using a simple statistical technique like trend analysis. The analysis of the historical behavior of the price enables the investor to predict the future value. 4. **Portfolio construction** A portfolio is a combination of securities. The portfolio is constructed in such a manner to meet the investor goals and objectives. The investor should decide how best to reach the goals with the securities available. The investor tries to attain maximum return with minimum risk. Towards this end he diversifies his portfolio and allocates funds among the securities. - **Diversification** The main objective of diversification is the reduction of risk in loss of capital and income. A diversified portfolio is comparatively less risky than holding a single portfolio. There are several ways to diversify the portfolio. - **Debt and equity diversification** Debt instruments provide assured return with limited capital appreciation. Common stocks provide income and capital gain but the flavor of uncertainty. Both debt instruments and equity are combined to complement each other. - **Industry diversification** Industries growth and their reaction to government policies differ from other. Banking industry share may provide regular return but with limited capital appreciation. The information technology stock yields high return and capital appreciation but their growth potential after year 2002 is not predictable. Thus, industry diversification is needed and it reduces risk. - **Company diversification** Securities from different companies are purchased to reduce risk. Technical analysis suggests the investors to buy securities based on the price movement. Fundamental analysts suggest the selection of financially sound and investor friendly companies. - **Selection** Based on the diversification level, industries and company analyze the securities have to be selected. Funds are allocated for the selected securities. 5. **Portfolio evaluation** The portfolio has to be managed efficiently. The efficient management calls for evaluation of the portfolio. The process consists of portfolio appraisal and revision. - **Appraisal** The return and risk performance of the security vary from time to time. The variability in returns of the securities is measured and compared. The developments in economy, industry and relevant companies from which the stocks are bought have to appraise. The appraisal warns the loss and steps can be taken to avoid such losses. - **Revision** Revision depends on the results of the appraisal. The low yielding securities with high risk are replaced with high yielding securities with low risk factor. To keep the return at a particular level necessitates the investor to revise the components of the portfolio periodically. **Factors to be considered in investment decisions** **Return on investment** Return on investment is the benefit that the investor gains after deducting the cost of the investment. It can be in the form of interest, dividends or capital appreciation. The return on investment should be expressed as the net after-tax income assets. After-tax return should be higher than the inflation rate. There is usually a direct link between risk and return on investment. **Risk** Risk refers to the possibility of losing money due to unforeseen circumstances. The higher the potential return, the higher the potential risk of losing money. For example, investing in shares has a higher risk than investing in a fixed deposit, but also promises higher returns. **Investment Period / Investment Term** Investment period is the duration (length of time) of the investment, which can influence return on investment. The investment can be short, medium or long term. Long-term investments must be held for more than a year, while short-term investment held for one year or less. Long-term investments generally yield higher returns than short-term investments. The investment period depends on the personal needs of the investor. **Liquidity** Cash is considered a liquid asset because it can be easily accessed and used almost anything. Liquidity, therefore, refers to how quickly and easily an investment converted to cash. In case of emergencies, there should be an amount of capital allocated to a can be easily converted to cash. A savings account Is more hood then property because it is easier to convert to cash, while property takes time to sell. Many shares on the stock market are considered fairly liquid because they can be easily sold to other traders in the market **Taxation / Tax Implication** Tax is a compulsory fee that citizens must pay to the government. Different investments have different tax rates. The investor must consider income tax implications in order, to secure a high net after-tax return. A good investment must produce a good after-tax Income **Inflation Rate** Inflation is the continuous rise in the prices of general goods arid services, which leads to a decrease in the value of money. The inflation rate is a percentage that is calculated annually to measure the rise of the average price of goods and services in the economy In South Africa, the inflation rate has been around 4% for the past few years. A good investment should, therefore, generate an interest of 6% or more in order to beat inflation and produce visible returns. 1. When the inflation rate rises, the purchasing power of consumers decreases. 2. A good investment should have a return on investment that is higher than the inflation rate. 3. Some investments such as property and shares are positively impacted by inflation. Their value can increase as inflation rises. **Volatility / Fluctuations on Investment Markets** Volatility is a rise and fall of market prices. If a market goes through frequent swings or fluctuations, it is seen as highly volatile. Low volatility means that the investment, market or economy is stable. Before making an investment, the investor should consider the fluctuations in national and international economic trends. The level of volatility will have an impact on the amount of returns that the investment yields. Market volatility is usually associated with investment risk. **Investment Planning Factors** When planning investments, you should consider the safest possible investment opportunities. Although some investments offer low returns, they can be safer than those that offer higher gains. Explore opportunities that have a history of good returns. To minimize risk, you should divide investments between the different investment options. The method of calculating interest should also be considered. **Speculation** Speculation is a financial term that refers to the act of purchasing an asset that has a substantial risk of losing value but also holds the hope of gaining value in the near future. An investor who's into speculative trading purchases an asset in an attempt to gain profit from small fluctuations in the market. **Types of speculation** **Option dealings** Option dealing is an arrangement of the right to buy or sell a specific number of securities within a prescribed time at a price determined earlier. Option dealing is a highly risky transaction in securities as their prices change very frequently and very heavily. Option dealing can be further classified into call, put and call option dealings. **Margin Trading** In margin trading, the client opens an account with the broker by depositing a certain amount of securities or cash. The client purchases securities with the funds that he borrowed from the broker and then the price difference is credited or debited to or from the client's account. **Blank transfer** This is a transfer method in which securities are transferred without mentioning the name of the transferee. With this process shares can be transferred any number of times and finally the transferee who wanted the shares can get them registered under his/her name saving stamp duty that is charged during transfers. **Arbitrage** In arbitrage, speculators earn profit out of the differences in prices of a security in two different markets. This process is known to level the pricing of that security in those two markets. It is highly specialized speculative activity that requires skills. **Wash sales** Wash sales are used to create artificial demand in the market which will lead to rise in prices. This is done by selling securities and then buying the same securities at a higher price. Wash sales sometimes also called fictitious transactions as the only purpose of these transactions is to jack up the prices. **Money market** **Meaning** Money market refers to the market where money and highly liquid marketable securities are bought and sold having a maturity period of one or less than one year. The money market constitutes a very important segment of the Indian financial system **Instruments used in money market** **Treasury bills** Treasury bills are short term instruments issued by the Reserve Bank of India on behalf the government to tide over short term liquidity shortfalls. This instrument is used by the government to raise short term funds to bridge seasonal or temporary gaps between its receipt and expenditure. **Commercial papers** A commercial papers is an unsecured short term instrument issued by the large banks and corporations in the form of promisor note, negotiable and transferable by endorsement and delivery with a fixed maturity period to meet short term financial requirement. **Certificate of deposit** It is another term of short term time deposit. The receipt issued for 3 to 6 months at rate of interest different from its normal time deposit rate through issue of CDs **Discount house** Discount houses are special institutions for rediscounting the bills of exchange. They usually deal in three kinds of bills a. The domestic bills b. The foreign bills c. The government treasury bills The discount houses borrow huge funds short period from commercial banks and RBI and re-invest them in discounting bills. **Acceptance houses** Acceptance houses are institutions which specialize in accepting bills of exchange. Generally they are merchant bankers. **Repurchase agreement** Repo is a market instrument, which enables collateralized short term borrowing and lending through sale or purchase operations in debt instruments. Under repo transaction, a holder of securities sells them to an investor with an agreement to repurchase at a predetermined date and rate. **Capital market** It is the place where the medium term and long term financial needs of business and other undertakings are met by financial institutions which supply medium and long term resources to borrowers. **Instruments of capital market** **Debt instruments** A debt instrument is used by either companies or governments to generate funds for capital intensive projects. It can be obtained either through the primary or secondary market. The relationship in this form of instrument ownership is that of a borrower creditor and thus, does not necessarily imply ownership in the business of the borrower. **Equities** This instrument is used by the companies only and can also be obtained either in the primary market or the secondary market. Investment in this form of business translates to ownership of the business as the contract stands in perpetuity unless sold to another investor in secondary market. The investor therefore possesses certain rights and privileges in the company. **Preference shares** This instrument is issued by corporate bodies and the investors rank second on the scale of preference when a company goes under liquidation. The instrument possesses the characteristics of equity in the sense that when the authorized share capital and paid up capital are being calculated. **Derivatives** These are instruments that derive from other securities, which are referred to as underlying assets. The price, riskiness and function of the derivative depend on the underlying assets since whatever affects the underlying asset must affect the derivative. **Mutual fund** Mutual fund is an investment vehicle that is made up of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market instruments and similar assets. Mutual funds are operated by money managers, who invest fund's capital and attempt to produce capital gains and income for the fund's investors.