Report on Portfolio Management for Investors - Free Essay Example

When investing in some securities, investors are expecting to receive returns, which will compensate the risks taken. Usually, investors form a portfolio, which involves a number of securities, and expect them to generate returns. However, by buying, for example, stocks of leading companies in flourishing industries is not a guarantee of high returns and the effectiveness of the portfolio. That is why investors should choose and apply the appropriate strategy of portfolio management. Today, there are two strategies, which can be implemented for effective portfolio management: the traditional approach based on a balance of the portfolio, its diversification (selecting of papers of well-known companies from different industries, which have a sufficient level of liquidity), and modern portfolio theory approach (constructing portfolios basing on the calculation of the correlation of investment instruments returns: negatively correlated investment may compensate for the failure of one instrument by increasing the profitability of others, while the maximum effect of diversification is achieved by combining a portfolio of negatively correlated investments). All investors, no matter how wealthy he/she is, aim to reach the specific goals, such as safety of the investments, their profitability/returns, and capital growth. The most reliable and secure securities are governm ent securities, which virtually eliminates the risk of the investor. More profitable securities are these of traded firms, but they have a high degree of risk. The most risky investments are stocks of young high-tech companies, but they may be most beneficial in terms of capital gains. Construction of the Portfolio As the major goal of portfolio is its diversification, only the right and wise portfolio structure can provide such diversification. So, constructing the portfolios structure is the essential step in portfolio management. If constructed well, the portfolio can bring significant returns. While being constructed poorly, it can lead to huge losses. The more aggressive an investment portfolio is, the higher the level of risk is and correspondingly higher possible returns are. Thus, the profitability of any investment is a kind of prize for that risk, which the investor takes. Due to the clients requirements of constructing the risky portfolio, the following promising industries have been analyzed: Consumer Goods, Basic materials, Technology, and Healthcare. The choice of industries is based on their influence on peoples lives and economy development. In these particular industries, the following sectors have been identified for further companies selection: services, biotechnology , sporting goods, gold, and communication equipment. According to Bodie (2009), when the economy on its contraction stage, it is advised to choose technology, financials, utilities, consumer durables, and health care sectors; when the economy on its expansion, it is advised to invest in materials, industrial, and energy (p.383). So, taking into account these recommendations, the sectors listed above have been chosen as targeted ones for investments. Asset Allocation Asset allocation is the essential part of the portfolio construction. There are two approaches of asset allocation: bottom-up and top-down. This particular portfolio was constructed using the top-down approach. Thus, the very first decision to be made is to choose between major asset classes, such as money market, bond market, and equity market. , in this case equity market is the most preferable class for allocation of assets. As far as the client is a wealthy person and aims to receive high returns by investing in high risk portfolio, the target securities to invest in are stocks. After deciding on assets class, it is necessary to identify the potential companies, in whose stocks investment will most likely be made. Stocks Selection After the targeted asset class has been identified, the following step is stocks selection. As far as the wealthy investor is interested in earning a high rate of return and is willing to take on substantial risk, therefore, high risk securities. Basing on this requirement and by analyzing historical prices performance for the past two years, ratios in comparison with industry and SP 500, and also taking into account analysts rating, and coefficients of correlation, the portfolio with following companies has been constructed: Aviat Networks, Inc. (AVNW), Codexis, Inc. (CDXS), Claude Resources, Inc. (CGR), DreamWorks Animation SKG Inc. (DWA), and Johnson Outdoors Inc. (JOUT). These companies are not listed in the SP 500 market index. According to analysis of past prices performance (Appendix 4), all stocks, except DWA, have been performing well with the increasing trend, while DWA experienced a decrease in stock price. During the two-year period, DWA reached its min. price of $27 .08 and max. price of $44; CDXSs min. price was $7.11 and max. price was $14.45; JOUTs min. price was $8.96 and max. price was $15.22; CGRs min. price was $0.92 and max. price was $2.3; AVNWs minimum price was $3.46 and maximum price was $7.87. Analysts stocks ratings also were taken into account in order to evaluate and forecast the future stocks performance. According to Zacks Investment Research (2011), DreamWorks Animation Skg Incorporated, a mid-cap growth company in the consumer services sector, is expected to significantly outperform the market over the next six months with average risk; Claude Resources Inc., a micro-cap growth company in the basic industries sector, is expected to underperform the market over the next six months with very high risk; Johnson Outdoors Inc., a small-cap value company in the consumer services sector, is expected to match the market over the next six months with above average risk. The major condition for creation a well-diversified portfo lio is choosing negatively correlated stocks. For revealing stocks, which will provide portfolio diversification, the correlation analysis was conducted. The results of this analysis are presented in the Appendix 2. According to this matrix, DWA is negatively correlated with both JOUT (-0.42) and CGR (-0.36). JOUT is also negatively correlated with AVNW (-0.42) and CGR is negatively correlated with AVNW (-0.16). The negative correlation means that a failure of one investment will be compensated by a rise of another. Correlation analysis has also revealed that coefficient of correlation of DWA and AVNW is 0.86, meaning that if DWA stock price rises, AVNW stock goes down, and vice versa. Regarding the results of analyses described above, the portfolio was structured the following way: AVNW 19%, CDXS 2.23%, CGR 9%, DWA 12.19%, JOUT 58.26%. Companies Overview Aviat Networks, Inc.  [1]  is a leader in wireless transmission solutions. The company applies innovation and IP networking expertise toward building a carrier class foundation for future mobile and fixed broadband networks. With more than 750,000 systems installed around the world, Aviat Networks has built a reputation as a leader in offering best-of-breed solutions including LTE-ready microwave backhaul and a complete portfolio of service and support options to public and private telecommunications operators worldwide. With a global reach and local presence in more than 46 countries, Aviat Networks works by the side of its customers allowing them quickly and cost effectively seize new market and service opportunities. Aviat Networks listed on NASDAQ (AVNW). Codexis, Inc.  [2]  develops industrial biocatalysts, enzymes, and microbes for energy, pharmaceutical, and environmental industries. The company focuses on conversion of renewable resources into transportation fuel s and pharmaceuticals. It offers development of technologies for air and water treatment and chemical manufacturing. The companys products include biocatalyst panels, custom biocatalysts, enzymes, active pharmaceutical ingredients and intermediates, and human cytochrome biocatalysts. Codexis is listed on NASDAQ (CDXS). Claude Resources, Inc.  [3]  acquires, explores, and develops precious metal properties, as well as produces and markets minerals in Canada. The company principally focuses on gold. Its primary mineral properties are located in northern Saskatchewan and northwestern Ontario. The company owns the Seabee Mine, a producing gold mine located at Laonil Lake, Saskatchewan; and Madsen properties located in the Red Lake Mining District of northwestern Ontario. It also holds interests in a portfolio of exploration properties that are located in the provinces of Saskatchewan, Manitoba, and Ontario. Claude Resources is listed on NYSE (CGR). DreamWorks Animation SKG, In c.  [4]  engages in the development, production, and exploitation of animated feature films and characters worldwide. It provides animated feature films and characters for the theatrical, home entertainment, television, and merchandising and licensing markets. The company has strategic alliances with McDonalds, Hewlett-Packard, Intel, and Samsung. DreamWorks Animation SKG, Inc. is listed on NASDAQ (DWA). Johnson Outdoors, Inc.  [5]  , together with its subsidiaries, engages in the design, manufacture, and marketing of outdoor recreation products worldwide. Its Marine Electronics segment provides battery-powered fishing motors for trolling or primary propulsion; sonar and GPS equipment for navigation; downriggers for controlled-depth fishing; and marine autopilot systems for large boats. It offers its products through outdoor specialty retailers, retail store chains, marine distributors, international distributors, and original equipment manufacturers. PORTFOLIO EVALUATION For proper portfolio evaluation, it has been monitored during a three-week period. For its assessment such tools as CBOE and RiskGrades were applied. CBOE.com provided a possibility of virtual trading and monitoring the portfolio performance during three weeks from January 31, 2011 to February 18, 2011. Also, with the help of CBOE.com it was possible to buy/sell the chosen stocks and watch how the portfolio could have changed. Another tool, RiskGrades, provided evaluation of risks associated with stocks and portfolio itself. It also helped to make Risk vs. Return analysis, Sector analysis and Risk ranking. Portfolio Performance As mentioned above, the portfolio has been monitored for three weeks. On the January 30, 2011 the following stocks were bought at amount and a price respectively: 20 shares of AVNW, $5.09 per share 5 shares of CDXS, $9.18 per share 85 shares of CGR, $1.98 per share 5 shares of DWA, $28.4 per share 90 shares of JOUT, $15.19 per share As it was an experimental portfolio, such insignificant amount of shares was purchased. The initial portfolio value totaled $1,896.00. During the three-week period the stocks were performing comparatively well and positive; the average change in AVNW price was 0.46%, CDXS 0.12%, CGR 0.13%, DWA 0.44%, JOUT 0.28%. Along with positive average changes in stock prices, the SP-500 market index changed by 0.31%. On February 7, 2011, I have sold 20 shares of CGR @ $2.58 and 70 shares of JOUT @ $15.59 due to constant down falling behavior; moreover, selling of these stocks could help improve portfolio performance and minimize losses. Aft er selling these stocks, the portfolio value also decreased, amounted to $758. From the sales proceeds, I have purchased 80 shares of JOUT @ $15.66 and sold another 10 shares of CGR @ $2.58. As a result of these transactions, the ending value of portfolio was $1,979. Therefore, during three-week period the portfolio gained $68. Risk and Return Analysis Risk and return are the major issues, which the investor is always mainly concerned about. For risk and return evaluation the Risk Grades tool was applied. So, according to RiskGrades.com, the riskiest stock in the portfolio is the stock of Claude Resources, Inc. (CGR), it has a risk rank of 64%, which means that 36% of the tickers in U.S. markets are riskier than CGR (RiskRanking, n.d.). The next, less risky stock is that of Aviat Networks, Inc. (AVNW) having risk rank of 55%. The stocks of DWA, JOUT and CDXS have the risk rank of 30%, 37% and 47% respectively. The portfolio has the total risk rank of 29%, which implies that 71% of the stocks in SP-500 are riskier than the portfolio. According to RiskGrades, the portfolio is 1.81 times as volatile as the SP SP 500 Index. Basing on Return Analysis, the average expected return of the portfolio is 47%. In the short-term perspective, JOUT will generate the highest return in the portfolio (24%), and the lowest return will be that o f DWA (-11%). In the long-term perspective, CDXS will not generate any return, whereas the CGR will generate the highest return (136.6%). But DWA will continue to generate negative return (-39.5%). All in all, the average return in the long-term perspective is going to be 24.38%. Sector Analysis Sector Analysis focuses on how much value movement of the portfolio is explained through average value movement of each sector in your market. Portfolios weights are compared to risk contribution in each sector against markets benchmark index (Sector Analysis, n.d.). So, taking the Risk Grades as a basis for this analysis, it can be concluded that: Financials is the most overweight sector compared to the benchmark. Health Care is the most underweight sector compared to the benchmark. Materials is the most overexposed sector to risk compared to the benchmark. Industrials is the most underexposed sector to risk compared to the benchmark. According to Sector Analysis, the portfolio specific risk (86.4%) is twice as higher than the specific risk of SP-500 (43.5%). Although, the investor wants to invest in high risk portfolio, the fact that the portfolio specific risk is higher than that of SP-500 can be omitted. However, the diversification benefit of 14.5% can minimize the specific risk of the portfolio. RECOMMENDATIONS The primary purpose of this report was to research, analyze the market and construct the portfolio for a high net-worth client, who aims to invest in a high risky portfolio. After conducting the research of literature, industries and sectors, colleting historical prices of some stocks, and making careful financial analysis of key ratios and correlation analysis, and also after monitoring the trial portfolio for three weeks, the following conclusions and recommendations can be made. First of all, the chosen industries and companies are performing quite well for this time and are at high demand. Although, stocks of Codexis, Inc. have been underperforming, and causing significant losses. Also DreamWorks Animation SKG, Inc. stocks have not been generating positive returns; moreover, its return will continue to decrease in the long-term perspective. So, in case the investor will keep the current trial portfolio, I would advise to replace the stocks of DWA and CDXS with other stocks. Des pite the fact the CGR stocks the riskiest ones in the portfolio; they will bring the highest return to the investor. So, it is advised to keep them. In addition, it is advised to include such stocks as JOUT and CGR in the new future portfolio, as these stocks have been performing well and are most likely to generate high returns in the long-term perspective, moreover these companies stocks have the high risk rank. But, by including the AVNW stocks in the new portfolio, which are negatively correlated to both JOUT and CGR, an investor will compensate potential losses. REFERENCES Bodie, Kane, Marcus. (2009). Essentials of investments (8th ed.). McGraw Hill Primis. CBOE trading system. (2011). Retrieved from https://www.cboe.com/ MSN Money. (2011). Key Ratios. Retrieved March 20, 2011 from https://investing.money.msn.com/investments/ Morningstar. (2011). Financials. Retrieved March 20, 2011 from https://financials.morningstar.com/ratios/r.html?t=AVNW Risk grade system. (2011). Retrieved from https://riskgrades.com/ APPENDIX 1 Company Ticker Sector DreamWorks Animation SKG Inc. DWA Services Codexis Inc. CDXS Biotechnology Johnson Outdoors Inc. JOUT Sporting goods Claude Resources, Inc. CGR Gold Aviat Networks, Inc. AVNW Communication Equipment APPENDIX 2 DWA CDXS JOUT CGR AVNW DWA 1 0.65 -0.42 -0.36 0.86 CDXS  1 0.34 0.15 0.66 JOUT   1 0.46 -0.42 CGR    1 -0.16 AVNW     1 APPENDIX 3 Ratio Company Industry SP 500 DWA P/E Ratio 13.3 13.7 20.3 Price/Book Value 1.76 11.59 3.59 Leverage Ratio 1.4 2.1 2.3 Current Ratio 2.63 1 1.4 ROE 14.2 -62.6 22.4 ROA 10.8 -26.6 8 CDXS P/E Ratio NA 14 20.3 Price/Book Value 3.56 5.64 3.59 Leverage Ratio 1.32 1.7 2.3 Current Ratio 3.35 4 1.4 ROE -12.01% 1.7 22.4 ROA -3.71% -2.38 8 CGR P/E Ratio 231 40.4 20.3 Price/Book Value 2.73 3.31 3.59 Leverage Ratio 2 1.5 2.3 Current Ratio 2.3 5.2 1.4 ROE 1.6 3.2 22.4 ROA 0.7 -22.8 8 JOUT P/E Ratio 15.4 13.7 20.3 Price/Book Value 1.2 2.88 3.59 Leverage Ratio 2 2 2.3 Current Ratio 2 2.6 1.4 ROE 8 15.9 22.4 ROA 4 8.3 8 AVNW P/E Ratio NA 26.3 20.3 Price/Book Value 1.36 3.12 3.59 Leverage Ratio 2 2.7 2.3 Current Ratio 1.88 2.6 1.4 ROE -48.9 13.4 22.4 ROA -29.2 6.3 8 APPENDIX 4