Financial Management 5

Investment and Portfolio Management

How to be an effective investment and portfolio manager?

1. Effective managers consistently assess and balance risk across their portfolios,
employing strategies such as asset allocation and diversification
2. Staying informed about market trends, economic indicators, and global events is
essential.
3. Quantitative analysis skills, or proficiency in financial modeling, statistical analysis, and
performance metrics allows managers to evaluate investment opportunities objectively
and measure portfolio performance accurately.
4. Effective communication
5. Discipline and emotional control
6. Ethical conduct

Investment is the employment of funds on assets with the aim of earning income or capital
appreciation Investment has two attributes namely time and risk.

For a layman, investment means some monetary commitment.

To the economist, investment is the net addition made to the nation’s capital stock that consists
of goods and services that are used in the production process.

Financial investment is the allocation of money of assets that are expected to yield some gain
over a period of time.

The financial and economic meanings are related to each other because the savings of the
individual flow into the capital market as financial investments, to be used in economic
investment. Even though they are related to each other, we are concerned only about the
financial investment made on securities.

Thus, investment may be defined as “a commitment of funds made in the expectation of some
positive rate of return”. Expectation of return is an essential element of investment. Since the
return is expected to be realized in future, there is a possibility that the return actually realized
is lower than the return expected to be realized. This possibility of variation in the actual return
is known as investment risk. Thus, every investment involves return and risk.

What is the objective of investment and portfolio management?

The primary objective of investment and portfolio management is to maximize returns while
minimizing risk for investors.

What is the importance of investment and portfolio management to the economy?

Investment and portfolio management play a crucial role in the modern economy, serving as key
drivers of economic growth, financial stability, and wealth creation.

The importance of investment and portfolio management in the economy cannot be overstated.
Firstly, it facilitates the efficient allocation of capital.

Moreover, investment and portfolio management play a vital role in risk management. By
diversifying investments across various asset classes, industries, and geographic regions,
portfolio managers help mitigate the impact of market volatility on individual and institutional
wealth.

Another significant aspect is the role of investment management in retirement planning and
social welfare.

Furthermore, investment and portfolio management contribute to market liquidity.

Lastly, the field of investment and portfolio management drives financial innovation.

In conclusion, investment and portfolio management are integral to the health and growth of
the modern economy.

What are the key risks to be considered in portfolio management?

The key risk that investors and portfolio managers must grapple with is market risk, also known
as systematic risk.

PRELIMINARY PERIOD
1.1 - Nature of Investment
Understanding the Nature of Investment: A Financial Perspective

The nature of investment can be characterized by several key aspects:

1. Risk and Return: Every investment carries a degree of risk, which is generally
proportional to its potential return. Higher-risk investments often offer the possibility of
greater rewards, while lower-risk options typically yield more modest returns.
Understanding this relationship is crucial for making informed investment decisions.
The risk of an investment depends on the following factors.
1. The longer the maturity period, the larger is the risk.
2. The lower the credit worthiness of the borrower, the higher is the risk.
3. The risk varies with the nature of investment. Investments in ownership securities
like equity shares carry higher risk compared to investments in debt instruments like
debentures and bonds.
 Risk and return of an investment are related. Normally, the higher the risk, the higher is
the return.
2. Time Horizon
3. Liquidity
4. Diversification
5. Asset Classes
6. Market Efficiency
7. Psychological Factors
8. Economic Influences
Importance of Studying Investments
Understanding investments is a crucial skill for university students preparing to navigate
the complex world of personal finance. By studying investments, you gain valuable
insights into how to grow your wealth over time, manage financial risks, and make
informed decisions about your money.
Objectives of Investment
The objectives of an investor can be stated as:
➢➢ Maximisation of return.
➢➢ Minimization of risk
➢➢ Hedge against inflation.

 Financial and Economic Meaning of Investment

Per the dictionary, investment is the action or process of investing money for profit or
material result.

Investment as define in economics is the purchase of goods that are not consumed
today but are used in the future to create wealth

While investment in Finance is a monetary asset purchased with the idea that the asset
will provide income in the future or will later be sold at a higher price for a profit.

So there are 3 types of investments:

1. Cash
2. Fixed Income
3. Equities
What can be considered as Cash?
- The bills and coins in your pockets
- Current Accounts, Savings Accounts
- Time Deposit
 - Special Deposit Accounts
What are Fixed Income?
- A fixed-income security is an instrument that allows governments, companies, and other
types of issuers to borrow money from investors.
- Entities, Businesses and Governments are able to finance their projects.
- Creditors/Investors are rewarded by coupon interest on money lent.
- Riskier projects will require much more compensation than less risky ones.

Characteristics of Fixed Income Securities

• Bondholders have no ownership rights;
• Fixed income securities take precedence over payment to shareholders upon
bankruptcy;
• Fixed income securities are, in theory, less risky than common shares.
To understand the terms use in Investment and Portfolio Management, please take note of the
following:
• Issuer – entity who is offering bonds for sale to investors (e.g. government entities and
corporations)
• Term – period of time during which the debt instrument is outstanding.
• Maturity – the date on which a debt becomes due for payment
• Principal – amount to be repaid to the investor at maturity
• Coupon – periodic interest payment made to the bondholder during the life of the bond
Why Invest in bonds?
- Income payments
- Slow and steady predictable (though the return is slow, yet the returns are steady and
predictable)
How to earn bonds?
- Through bond coupons
- Through trading of bonds
What are Equities:
• Equities/Stocks - Security that represents shares of ownership in a corporation
• Allows for ownership of a portion of the company without taking possession
 • Owners of shares of a publicly listed company are considered stockholders or
shareholders
• Participate in the company’s growth and future profits / loss
• Allows stockholders vote on corporate issues
What is the Stock Market?
 Venue where stocks are bought and sold
 Place where people can invest in publicly listed companies through accredited trading
participants
 Philippine Stock Exchange is the only operating exchange in the Philippines

Asset Class: Equities - Rights and Privileges

1. Common Stocks
• Units of ownership of a public corporation
• May also be referred to as “ordinary shares”
• Have no fixed yields attached to them
• Participation in profits, control of ownership and management of a company
2. Preferred Stocks
• A class of capital stock that pays dividends at a specified rate and has preference over
common stock in the payment of dividends and the liquidation of assets
• Does not ordinarily carry voting rights

Cost Averaging
 technique of buying a fixed amount of investment on a regular schedule regardless of
price.
 Lessens the risk of investing a large single investment at the wrong time
 More shares – when prices are low
 Less shares – when prices are high
 NAVPU = net asset value per unit

When and where you can Invest?

Fixed Income:
- During issuances (primary market)
- At the secondary market
Equities:
- During Initial Pub Offer (IPO) Primary Market
- At the secondary market

 Investment and Speculation

Investment and speculation are two distinct approaches to wealth management, each
with its own set of characteristics and risks. Investment typically involves a careful
analysis of an asset's fundamental value and potential for long-term growth, while
speculation often focuses on short-term price fluctuations and market sentiment.

 Speculation refers to the act of conducting a financial transaction that has substantial
risk of losing value but also holds the expectation of a significant gain
 Without the prospect of substantial gains, there would be little motivation to engage in
speculation.
 Consider whether speculation depends on the nature of the asset, expected duration of
the holding period and/or amount of applied leverage.

Speculation therefore is conducting a financial transaction that could yield a significant

loss or gain. Since we cannot predict the trading,
 How Does Speculation Work?

Speculators can provide market liquidity and narrow the bid-ask spread, enabling
producers to hedge price risk efficiently. Speculative short-selling may also keep rampant
bullishness in check and prevent the formation of asset price bubbles through betting
against successful outcomes.

Several factors have contributed to the growth of speculative trading:

1. Technology advancements
2. Lower costs
3. Greater access to information
4. The popularity of new asset classes

In conclusion, speculation involves trading high-risk assets with the potential for
substantial rewards, but it requires a solid understanding of market dynamics, effective
risk management strategies, and emotional discipline.

Investment Vs Speculation
Investment and speculation are two terms which are closely related. Both involve
purchase of assets like shares and securities. Traditionally, investment is distinguished
from speculation with respect to three factors, viz. (1) risk, (2) capital gain and (3) time
period.

 Investment, Savings and Gambling

Three primary options stand out: investing, saving, and gambling.

Investing involves allocating funds into assets like stocks, bonds, or real estate with the
expectation of generating returns over time, albeit with some level of risk.
Savings, on the other hand, represent the safest option, typically involving placing
money in low-risk accounts like savings accounts or certificates of deposit, which offer
modest but guaranteed returns.
Gambling, in contrast, is the riskiest choice, where money is wagered on uncertain
outcomes with the potential for significant losses or gains.
opposite of investment.

Types of Investors
Investors may be individuals and institutions. Individual investors operate alongside
institutional investors in the investment arena.
 Institutional investors, on the other hand, are the organizations with surplus funds who
engage in investment activities.

What Are the 3 Types of Investors in a Business?

The three types of investors in a business are pre-investors, passive investors, and active
investors.

Investment Avenues
There are a large number of investment avenues for savers. Some of them are
marketable and liquid while others are non marketable. Some of them are highly risky
while some others are almost riskless. The investor has to choose proper avenues from
among them depending on his preferences, needs and ability to assume risk.
The investment avenues can be broadly categorized under the following heads:
1. Corporate securities
2. Deposits in banks and non-banking companies
3. UTI and other mutual fund schemes
4. Life insurance polices
5. Provident fund schemes
6. Government and semi-government securities.

 Investment Process
The investment process typically consists of five key stages:
1. Setting Investment Objectives
2. Asset Allocation
3. Security Selection
4. Portfolio Construction
5. Monitoring and Rebalancing

 Features of Good Investment

What are the Key Characteristics of a Good Investment?
A good investment exhibits several key characteristics that help assess its potential for
generating returns and minimizing risks. Here are some fundamental traits that define a
promising investment:
1. Positive Expected Return
2. Manageable Risk
3. Liquidity.
4. Stability and Consistency
5. Transparency and Information Accessibility
6. Alignment with Goals and Strategy
7. Tax Efficiency.
8. Quality Management or Governance
 9. Scalability and Growth Potential
10. Cost-Effectiveness
11. Environmental, Social, and Governance (ESG) Factors
12. Adaptability to Market Conditions

 Risk of Investing
There are several types of risk that investors should be aware of:
1. Market Risk
2. Specific Risk
3. Inflation Risk
4. Liquidity Risk
Portfolio managers use various tools and metrics to assess and manage risk. These include:
1. Standard Deviation: Measures the volatility of an investment's returns.
2. Beta: Compares an investment's volatility to that of the overall market.
3. Sharpe Ratio: Evaluates risk-adjusted performance by comparing excess return to
standard deviation.

In conclusion, understanding risk is fundamental to successful investing and portfolio

management. By comprehending the various types of risk, implementing diversification
strategies, and utilizing risk assessment tools, investors can make more informed
decisions aligned with their financial goals. As Arthur Zeikel's work suggests, effective
risk management is not about avoiding risk entirely, but rather about balancing risk and
return to optimize investment outcomes.