Question

You are hired as a fund manager in the Stockiest91 Fund Management Company where your job is to manage the accounts of high net worth clients and usually clients net worth is more than 10 million therefore high due diligence is required in construction of portfolio. You have interviewed the client to know her financial health and jot down some points:-

• Current age is 45 years
• Source of income is passive, currently employed in an organization since 10 years and no plan for startup new business due to fear of failure.
• The objective of the client to save 2.5 million in next 5 years along with finance her children fees till next 3 years more and each year cost around 35,000, in addition to that client also planned a leisure trip which required around 2 million in next 7 years, at last, clients want to preserve its capital by the rate of inflation to eliminate the risk of losing purchasing power parity where expected inflation rate would be at 7.5%.
• Current portfolio worth 10 million in which sector allocation mainly to Cements 25%, Steels 20%, Fertilizer 30% and Foods sector 25%.

Mutual funds industry is offering an equity return for a 1-year basis 18% whereas expected rate of inflation in the economy as per analyst consensus around 7.5% however equity market offering 25% return for a year.

Sector	Expected Return	Beta
Cements	20%	1.80
Steels	18%	1.50
Banks	30%	2.50
Technology	27%	2.30
Fertilizer	15%	1.15
Foods	22%	1.90

After conducting your analysis you come to the point current portfolio allocation is not optimal to the clients objective therefore you have re-allocate the portfolio into different sectors as per your analysis. You believe that Banks/Automobile/Technology sector seems much lucrative at the moment and will produce a good return in the future which likely to help in achieving the client needs & aspirational goals.

Instructions:

Prepare the complete portfolio management report (at least 450 words) in which you mentioned the working of required return which meets the objective completely and construct the portfolio based on your market analysis. In addition to that, first define the investor behavior as per Markowitz portfolio theory and rest of the working will be based on investor’s willingness & ability to take risk.

This is the complete information. need answer on urgent basis.

Answer 1

Portfolio Management Report

Return Objective: Return objective can be futher divided into required return (on the basis of primary goals) and desired return (for secondary goals)

Required Return
a. 2.5m in next 5 years (500k per year)
b. 35,000 per year for next 3 years

Desired Return = 286k

Total required return is 821k per year

Required Return = 821k/10m = 8.21%
Nominal Return required = 8.21% + 7.5% = 15.71%

Risk: Risk capacity of an investor is divided into ability and willingness to take risk.
Ability - Client is 45years old with a passive income source. Client has significant liquidity needs over short term and medium term. Client also requires inflation protection on her portfolio. Hence ability to tolerate risk is moderate.
Willingness - Client willingness is low as she has a fear of failure. Her portfolio has exposure to low beta stocks.
Hence overall portfolio risk should be low.

Current Investible assets of 10m invested as below
Cement: 2.5m
Steel: 2m
Fertilizer: 3m
Food: 2.5m

Return generated as shown below:
Cement: 2.5m * 1.2 = 3m
Steel: 2m * 1.18 = 2.36m
Fertilizer: 3m * 1.15 = 3.45m
Food: 2.5m * 1.22 = 3.05m

Total Value = 11.86m
Actual Return on portfolio = (11.86-10/10)*100 = 18.60%

Current portfolio generates return which is above the required rate of return for the client. Hence optimal to client objective.

Re-allocation of portfolio to Bank/Automobile/Technology sector will increase the portfolio risk unnecessarily (higher beta of these stocks compared to Cement/Steel/Fertilizer/Food) and expose the client to higher risk which is against the clients risk appetite