Question

QUESTION TWO Investment Environment & Management Process Floro is a young energetic lady aged 23, she is in excellent health, she lives a simple but active lifestyle, and currently childless. Through her boyfriend’s advice who is a Finance guru, she has developed interest in investment related activities and has interest in investing K70, 000 resources given to her upon her graduation from Mulungushi University as a present from her boyfriend. She doesn’t want her boyfriend to know about these plans and decides to seek for advice from you as an investment scholar. She is currently unemployed but is actively looking for full-time employment which is promising to come by any moment. She is also looking forward to starting a family in the near future. Currently, the following assets are available for use in building an appropriate portfolio: a. What comprehensive Investment policy statement would you formulate for Floro? It should be inclusive of important Objectives and constraints. b. Given the information, what long term asset allocation (Minimum Three Assets) would you provide for the investment Policy statement and what assumptions are you putting in place to justify its usage.

Answer 1

The purpose of Investment Policy Statement is to establish a clear understanding between Investor and Advisor as to the investment goals and objectives and management policies applicable to the Investor’s investment. This Investment Policy includes but not limited to:

1. Establishes the Investor’s expectations, objectives, and guidelines for the investment of the Portfolio
2. Creates the framework for a well-diversified asset mix that can be expected to generate acceptable long term returns at a level of risk suitable to the Investor, including: - describing an appropriate risk posture for the investment of the Investor’s Portfolio, specifying the target asset allocation policy, establishing investment guidelines regarding permissible securities and diversification of assets, specifying the criteria for evaluating the performance of the Portfolio’s assets
3. Defines the responsibilities of the Investor and the Advisor
4. Encourages effective communication between the investment manager and the Investor comprehensive investment policy.

Objectives of Investment Policy Statement

1. Long-term growth and capital preservation
2. Risk profile: Conservative
3. Time horizon: Greater than 30 years
4. Short-term liquidity needs: Settling down in near future. (Assume 20% of 70,000)
5. Long-term rate of return expectation: 8% (based upon historical rates of return)

Investment Policy Constraints

1. Liquidity : Liquidity is also a necessity in the event of a situation beyond your control. for example - What if you get sick and you can’t get to work for three months?, Where will you get the money to support yourself in the event your employer declares a redundancy or shutdown of operations? How will you sustain yourself while looking for a new job in the next six months or one year?
2. Time Horizon : Floro with 23 years of age have long investment horizon say 40 years to remain invested and generate wealth for her retirement, she can also recover losses if any in this long horizon.
3. Tax Concerns : High the income, higher the taxes, Floro should also`o consider her investment such that she doesn't end up paying higher taxes just for earning more returns. She should choose investment which support federal tax exemptions as well.
4. Legal : Contracts and legal issues. Floro if choose to invest in a mutual fund should check for legal guidelines. for example you might consider is there a lock-out period? What are all the hidden fees? If this is bought with your pension fund, what are the conditions for contribution or withdrawal

Long Term assets allocations and assumptions.

Generally, long term investment performance is determined by historical asset performance. Equity assets offer higher return along with greater volatility. Fixed assets on the contrary yield lower return, lower correlation with equities and less risk. Diversification across asset geography and size is recommended to Floro.

Based on the Floro's conservative risk profile, the portfolio asset should be as follows.

1. Emerging Equities (up to 40%) - To gain growth momentum, equity is highly volatile and give necessary boost to generate wealth.
2. Real Estate (up to 30%) - To earn steady revenue either by leasing it out or by using for own residing, thereby saving in living cost.
3. International Debt (up to 10%) - Helps in generating wealth when domestic market isn't performing well.