Introduction

Investment choices include exposure to the major and alternative asset classes

Investment in major asset classes can be either direct or indirect through a managed fund

In order to build a portfolio the investor must have appreciation of risk and return attributes

Risk and return trade-offs are inherent in all investment analysis

two form of investment:

1. direct investment : Occurs when investors make their own decisions about where their funds are
ultimately placed, be it in fixed-interest deposit accounts, shares, property or some other form of
asset

2. indirect investment : Occurs when investors place their funds with funds managers who use
vehicles unit trusts and master funds to consolidate the funds of many investors and then invest the
pooled funds according to their own stated investment strategies

L1. General attributes of investors

Investors are classified into various groups based on their tolerance to risk, their preference for
income versus capital growth and their investment timeframe

Defensive investors are more risk averse and are focused on preserving capital

Aggressive investors have more tolerance towards risk and focus on capital growth

Financial planners use these classifications to determine the appropriate asset mix for their clients
(see table 4.1)

General classification of investor (benjamin 1949) :

1. defensive investor : Focused on conversing capital, their main emphasis is on avoiding any serious
mistakes or losses, and also on freedom, effort, annoyance and the need for making frequent
decisions

2. enterprising / aggresive investor : is characterised not by speculation, but by their willingness to

devote time and care to the selection of sound and attractive investments even though they may not
be fully trained experts in the field

L2. Broad investment classes

The main investment choices are:

- cash investment : aim to provide income, liquidity and stable returns

Provide income, liquidity and stable returns

Low risk, Low return and Short-term

Can include savings accounts, money-market securities and cash management

Can be adversely affected by tax and inflation

Return is low and investment term is short

Cash investments can include savings accounts, money market securities and cash-management
trusts

- fixed Interest : are investment that are agreed for a certain period of time at a known interest rate.

the main types : 1) term deposits - issued by banks, 2) debentures - issued by corp, 3) govern and
semi govern - issued by govern to fund or help pay for major public project, 4) corp bond or notes -
issued by large public companies to fund business expansion

Fixed term, Low risk

Issued by institutions (bank, corporation), large-public companies to fund business expansion and
government and semi government authorities

Fixed term (e.g. term deposit, debenture or government or corporate bond)

Fixed interest rate with interest paid on a regular basis (a bond) or factored into the final payment
and offered as a discount security (a bank bill)

Issued by institutions and government and semi government authorities

Longer investment horizon than cash

Low risk — corporate bonds are riskier than government bonds

Fixed interest continued

Generally secured apart from unsecured notes which are riskier

Hybrid instruments — instruments that have some characteristics of debt and equity (e.g. a
convertible note is debt but may be converted to a share at a future date)

Can have a stabilising effect upon a portfolio

Credit risk can be an issue — more so with corporate bonds

- property : an investment into the asset class that covers real estate in its many forms

Riskier than bonds but lower risk than shares

Direct property consist of rental properties; residential, commercial, industrial or rural

Indirect property investment includes listed property trusts and unlisted property trusts

- shares : an investmet holding in a company

High risk, High return,Long-term

Returns can be both capital growth and dividends

L3. The Risk and Return Relationship

the key determinants of the price of an asset are risk associated with the asset and the returns that
the asset is expected to generate. consequently, all financial decisions must be evaluated in terms of
expected risk and expected return.

- Inflation-adjusted rates of return : the real rate of return allows for the effects of inflation. inflation
causes investors to lose purchasing power when they sell their assets in the future and wish to buy
with the proceeds.
- Definitions of Risk :

The chance of loss of capital - A negative real return

The chance of loss of purchasing power - Will returns be greater or less than the inflation rate?

The variability of returns - In finance we use standard deviation as the measure of risk (i.e. the
variability of returns around an expected mean)

For a portfolio of shares, we must consider the risk and returns of the whole portfolio rather than just
the return of the individual shares in the portfolio

The expected return for a portfolio is the weighted average return of the individual shares in the
portfolio

L4. How can diversification reduce risk?

Risk of share can be measured by the standard deviation. standard deviation is a measure of riskiness
of an investment. when a portfolio of shares is held rather than shares in one company only, we have
to consider the risk and returns of the portfolio as a whole

L5. General investment strategies

Diversification — ‘don’t put all your eggs in one basket’

Risk is reduced if the determinants of risk and return among the assets are related to different
phenomena

Diversification raises the question as to how an investment portfolio should be allocated

Investors must have allocation decisions based on their risk–return profile

Gibson (2000) argued that holding four asset classes in a portfolio (multiple-asset class investing)
would reduce the risk of the portfolio and increase its average return

This happens because the four asset classes are not strongly related to each other

As one asset class performs well the others are less likely to perform as well and as the better
performing asset class reverses its performance the other asset classes tend to perform better

The performances tend to counteract each other which provides for a better long term average
return and lower level of risk of such a portfolio

L6. Investor behaviour

The traditional view is that markets are efficient and that investors are rational — Efficient Market
Theory

This view is challenged by advocates of Behavioural Finance Theory who argue that people sometimes
display irrational behaviour

Some irrational behaviour observed:

Loss aversion — prospect theory: investors dislike losses a lot more than they like equal gains

Herding — people tend to follow crowd behaviour

Overconfidence — many investors mistakenly believe they can beat the market resulting in
overtrading and more losses

Biased judgements — ‘house prices never go down’

?? Investment scams Common factors among all scams include:

Product Disclosure Statement is not provided

High returns are promised

A password or bank account details are required

Investments are often based overseas or hidden

Ponzi schemes — the most simple yet effective of scams where money from new investors is used to
pay dividends to the older investors

If it seems to good to be true it probably is!

Recent ASIC research shows internet scamming is on the rise…is there really a pot of gold at the end
of the rainbow?

L7. Information sources for investment choices

Economic fundamentals

Industry characteristics and reports

Company background, prospects, annual reports

Current market prices

Government reports, ASIC website

Analyst reports

Using the internet as a search engine

Chapter 5 : Direct Investment - fixed interest and shares

a master fund : Another form of managed fund where an administration manager receives funds from
an investor and then invests that money into a number of other funds so that only one item reporting
to investor is carried out by the administration manager, that is, the administration manager provides
investors with a consolidated report of all the different fund managers in which monies are invested
for that investor.

L1. Fixed-Interest Market

- the nature

The essential features are :

The interest rate,

The face value (the principal) is fixed

Interest is payable at the start, during or the end of period

- the participant

Authorised deposit-taking institutions

Bank and non-bank financial institutions

Insurance company and funds managers

Private individuals

Trading companies

Governments

Some of these paticipants come to the market as lenders, borrowers and some as both

L2. Shares Market

- the nature :

Trading occurs on stock exchanges. In Indonesia, the IDX (Indonesia Stock Exchange has a virtual
monopoly on the trading of listed shares.

- the participants:

Listed corporations

Investors

Broker who facilitate the trading

L3. The Influence on Share Prices

analysis of share prices:

Rational decision making usually dictates the following factors may be of some consequence :

Interest rate levels

Inflation

Taxation

Theoretical price levels

Earning and dividens

Quality of management

Company reports and announcements

Profit reports

Government policy

Economic expectations

methods of analysis
- Liquidity : often measured by current ratio, ratio of current assets to current liabilities

- Capital structure : measured by the debt-equity ratio or proprietorship ratio which is the proportion
of shareholders funds to total assets

- profitability : measured by after tax earning to shareholder funds

- market valuation : a company number if ordinary shares on issue multiplied by the market price per
share

-risk analysis : two components; market or systematic risk and unsystematic risk

L4. The Capital Asset Pricing Model (CAPM)

Attemps to establish the relationship between systematic risk and return.

This model says that the expected return on a share is equal to the risk-free rate (the rate offered by a
government security) plus the amount of risk (beta) multiplied by the price of risk (the risk premium)

L5. Basic Valuation Model

????

L6.

Ethical Investment

Ethical investors interested in putting their funds to work in companies they approve of are rather
limited in the scope of activities and number of investees.