Equity Portfolio Management: 100M Euro Investment Analysis

Introduction

As a fund manager, I am often charged with investing relatively large sums of money for specific periods of time, with specific goals and objectives for those investments. On February 4th, I was charged with investing €100,000,000 for a period ending on April 14th. The investment objective was to provide a return higher than what could be received in the money market. Money market rates during the investment period fluctuated between 2.57% and 2.98%, with an average daily yield of 2.62% according to the Crane 100 Money Fund Index. Therefore, the target return on this portfolio should be at least higher than the money market rate, and any losses should be limited and explainable in detail.

To achieve a higher rate of return, more risk would have to be assumed, and the volatility of the stock market in general — as well as specific stock and industry risks — would have to be examined and contemplated. Since it is the fund manager's personal philosophy to seek substantially higher returns than what can be achieved by investing in the relative safety of a money market account, the portfolio would be designed accordingly.

An additional factor to consider when investing over such a short period of time is the time factor itself. Stocks are known for their enhanced volatility, and a two-month time frame does not allow for a recovery period when stocks take an inevitable dip.

Executive Summary: The equities market can be so volatile during a two-month time frame that the entire market can fall substantially, and with so little time to recover, the objective of beating the money market is a relatively difficult task. For this particular portfolio, the market risk is very high, the industry risk is high, and the specific stock risk is relatively low.

Investment Strategy

The desired objectives, return on equity, and risk assumption levels of the investor should all be considered when investing funds on an investor's behalf. A sense of responsibility toward the investor and their capital should be diligently maintained by the manager of such funds. Acquiring the necessary information concerning the investor should be accomplished beforehand, and both parties should have an equal understanding of the investment objectives and the risks the manager will assume in order to achieve those objectives.

It is the manager's job to determine what investment philosophies and strategies to use to meet those objectives, and it is the investor's responsibility to ensure that the manager is fully informed of what those objectives are. If either party is uncertain about the specific goals and methods of the investments, action should be taken to rectify that uncertainty.

In this specific portfolio, the investment strategy is understood to be an equity portfolio that is particularly vulnerable to market risk due to the relatively short duration of the investment. Other risks assumed by the manager include industry risk and company risk. Many of the equities selected carry relatively high volatility, but the stock market itself presents the greatest overall risk due to worldwide uncertainties such as wildly fluctuating (and increasingly high) oil prices, mortgage difficulties, and recession fears.

An asset allocation approach will be used by the manager while investing these funds. The strategy seeks to maintain 20% liquidity and an 80% equity investment model. Because the return being sought exceeds currently available money market rates, this allocation provides the opportunity to reach that objective. Fifteen percent of the overall portfolio will be invested in Chinese stocks, with an additional 10% invested in two Irish banks. The remaining equities will be divided between U.S. companies trading on the S&P 500 and companies trading on NASDAQ. A maximum of €5,000,000 will be invested in each individual equity.

Since two months is a short investment period, few if any trades will be made regardless of whether investments are up or down. It is the manager's philosophy that such trades would cost the investor more than the potential benefit.

Stock Selection and Rationale

It is expected that the Chinese stocks will provide the most volatility. The fund manager's view — consistent with that of other experts — is that returns on those stocks will be modest due to that volatility. Fernald and Rogers wrote: "We attribute low Chinese expected returns to the limited alternative investments available in China" (2002, p. 417). There are also two separate classes of equities issued in the Chinese markets: one class for foreign investors and another for domestic investors. The foreign shares are the ones that will be purchased for this portfolio, even though domestic stocks average a 4% higher yearly return.

The following investments were chosen based on a variety of considerations. Primarily, each stock was evaluated for its potential return, the company's track record of yearly returns, profitability, industry position, products or services provided, shares outstanding, and any projected dividends.

The three Chinese stocks selected were Sinopec, COSCO, and China Unicom. All three companies are leaders in their respective industries: COSCO is a diversified shipping company, China Unicom is a national communications and media firm, and Sinopec is a leading petroleum and chemical company.

The two investments in Ireland were both banks: the Bank of Ireland and Allied Irish Bank. Both institutions are highly rated and perceived as sound investments. The Bank of Ireland was chartered in the late 1700s and is known for its stability; its shares offer a current dividend yield of just under 5%. Allied Irish Bank offers a return on average equity of over 20% per year.

The remaining 11 equity investments were divided between U.S. small-cap and large-cap companies. The small-cap companies included Computer Science, Unisys, Check Point Software, AES Corp., Amarin Corp., Avon Products, and Dell Computer. The large-cap companies included General Motors Corp., Coca-Cola Co., Apple Inc., and Google Inc.

Many of these firms carry relatively high betas but also offer opportunities to achieve above-average rates of return. Most of the stocks were purchased at prices well off of their recent highs, with a few exceptions.

Mid-Period Adjustment — Amarin: The only adjustment made to the portfolio during the investment period was the sale of Amarin. It was purchased at €2.48 per share with an initial investment of €5,000,000. Within one month, the stock had gained substantially and was consequently sold for €6,370,967, generating a profit of €1,370,967 — approximately 28% in one month. The profit and initial investment were swept into the money market fund to remain there until the end of the investment period. No additional changes were made to the portfolio.