Answer

1. Case Study on Investment Portfolio Construction

   Introduction

   Our stockbroking company has held a reputation of delivering quality and reliable services in regard to offering our groups of high net-worth clients with reliable investment information. As a result, this report is directed at a client who has presented conditions on the financial thresholds to be met while making an investment option. The client wants ongoing advice on how to invest $2,000,000 from an employment based superannuation account. In the light of this information, this report presents investment options to be considered by our clients in constructing a preferred portfolio. These portfolio include; purchasing shares, investing in listed investment companies, investing in SPI, put options and index calls, and cash investments if desirable (Guerard et al 2015). Investment decisions are to be guided by investment philosophies and strategies which will enable the identification of asset classes consistent with the requirements of the client.

   1. Investing in Equity Shares, ETPs and LICs

   When analyzing financial markets, a share refers to a unit of account or ownership of a given company. It represents the stock of the company given out to potential investors as a way of raising capital. Listed investment trusts (LITs) and listed investment companies (LICs) refer to well established investment vehicles that enable investors to access diversified portfolio of shares across listed companies while exchange-traded funds (ETFs) refers to marketable securities that track commodities, bonds and indexes as well as baskets of assets including index fund (Rae 2015; Petajisto 2017). It is unlike a mutual fund since it trades like common stocks on stock market.

   The philosophies to consider when investing into these asset classes include understanding their structure such as taxation, and how franked dividends are treated, asset exposure whereby in the case of Australia, it is prudent to avoid investing in mining industries because of the high exposure to risks, net tanging assets (NTA), costs in terms of management expense ratio (MER), closed-end, transparency, regularity of savings, volatility, and liquidity (Giamouridis & Vrontos 2017).

   The client has a high level of risk tolerance. This correlates with the investment philosophy where high risks attract high returns. The client is equally willing to invest in LICs, EFTs and shares across the international and Australian financial markets. Other considerations include the need to create a portfolio focused on capital growth and less concerned with tax effectiveness or receipt of ongoing income. Other requirements include a cap on minimum investments in shares which should be restricted at 50% of the total amount to be invested.

   Investment in shares will account for $1,000,000 which represents half of the total amount to be invested. This investment has to be hedged through either maintenance of futures contract settlement accounts or purchasing an index options. These is also a 10% provision for investing into short sales equity shares. 10% of the $2,000,000 to be invested equals $200,000. This amount can be invested into a maximum of 9 companies or less considering on the suitability of their share offers. On the other hand, the companies have not put a cap on minimum purchase parcel size or investment amount. These investments are excluded from associated brokerage costs. The most lucrative shares to purchase are listed as follows.

    

   Equity Shares – Purchases	Price	Number	Cost
   Caltex Australia Ltd	$31.26	3,200	$100,032
   Commonwealth Bank of Australia	$82.81	1,200	$99,372
   Cochlear Ltd	$153.14	800	$122,512
   CSL Ltd	$133.32	1,100	$146,652
   Domino’s Pizza Enterprises Ltd	$51.45	2500	$128,625
   Flight Centre Travel Group Ltd	$44.93	2,500	$112,325
   Macquarie Group Ltd	$87.79	1,000	$87,790
   Magellan Financial Group Ltd	$27.00	4,000	$108,000
   REA Group Ltd	$63.35	1,500	$95,025
   Total			$1,000,333

    

   1. Short Selling

   Another group of portfolio includes investing in short sales equity shares. This process is known as short selling and it involves the sale of security that is not initially owned by the person selling it. The seller might consider borrowing security whose price might decline (Chow et al 2016). This will enable the borrower to make a profit after the security is bought back when the prices decline. This is the reason the cost for short selling is shown as a negative. The procedure for making this investment entails borrowing stock against the two identified firms based on the listed price. The second step is selling the borrowed shares immediately, after which you wait for the prices of the stocks to fall and rebuy them at a lower price. The investor then returns the shares to the brokering firm and pockets the difference as a profit. This will represent $200,000 which is 10% of the total investment. This investment is short lived and thus, deserves minimal investment in order to curb emerging risks and associated uncertainties in the stock markets.

   In relation to short selling, DeFusco et al (2015) note that it is required that the clients hold sufficient funds or cash in CMT to enable them repurchase the shares at the end of the investment period. Therefore, the amount shown in the table below is not invested but held in CMT in anticipation for a short selling opportunity. As much as this amount remains in the firms accounts, it is important to note that it is effectively reduced from the cash flows.

    

   Short Selling	Price	Number	Cost
   AGL Energy Ltd	$25.00	4,000	$(100,000)
   ASX Ltd	$52.74	2,000	$(105,480)
   Total			$(205,480)

    

   1. ETPs and LICs

   As requested by the client, the maximum investment to be made towards ETPs and LICs has to be 35% of the total amount allocated by the client of $2,000,000.

   = 35% of 2000,000 equals $700,000.

   It is further noted that the minimum investment into ETPs and LICs is 0. The principles for selecting the firms to invest into is guided by the effectiveness of the listed securities of these firms just like it is the case with shares. Another restriction is that when investing into these two asset classes, the maximum investment to be made in one company should not be more than 10% of the total investment. In this case, 10% of 2,000,000 which is $200,000.

   Additionally, it is required that the asset classes have exposure to the US market. The most strategic plan towards achieving this is by investing into short and long term positions. It is also prudent to avoid investment into resources sector thus having a minimum exposure of $0. As a result of these considerations, $700,000 will be invested into the listed investment companies (LICs) and exchange-traded funds (ETFs) as shown in the table below.

    

   LICs	Price	Number	Cost
   WAM Capital Limited	$2.43	32,000	$77,760
   WAM Active Limited	$1.56	50,000	$78,000
   Platinum Capital Limited	$1.72	50,000	$86,000
   ETPs
   Betashares S&P 500	$17.78	8,000	$142,240
   Vanguard MSCI International Shares	$61.53	3,000	$184,590
   SPDR World Ex Australia	$26.21	5,000	$131,050
   Total			$699,640

    

   1. Hedged Position for ASX Equity Investments

   Hedging is the act of assuming an investment position where an investor is strategically positioned to offset potential gains or losses that are likely to occur during the investment period. It is important for our clients to hedge their investment because it evens substantial losses or gains that could be made or suffered by the investor (Harris & Mazibas 2013). In the case of our investor, they have to hedge their investment risks by investing in strategic instruments that will potentially offset risks in case of adverse price movement. The first process to hedging for our investors is investing into several portfolio and asset classes. Second, the investors have to invest in different securities that have a negative correlation. For instance,

   The philosophy governing investments into hedged funds makes provision for the inclusion of short sales since short sells represent a negative correlation to the equity shares (Jiao et al 2016). This is evident in the computations below. Other facts to note is that hedging has to consider SPI futures contract which represent the level of speculations in market index. The Australian Stock Exchange (ASX) as at December 2017 on SPI 200 contract will be at a higher value than the current trading value estimated at 5,663. This will be lower than the ASX 200 value computed at 10/7/2017. This value was established to be 5,724.40.

   Other things to consider in this computation is that the client considers opening a settlement account with $20,000 per SPI 200. This implies that purchasing 4 futures contract will expose the investor to an estimated investment value of ($25 * 5663 * 4). Likewise, it will attract a margin investment amounting to $80,000.

   Futures contract value = $25 × 5,663 = $141,575

   Net equity share exposure = $1,000,333 – $205,480 = $794,853

   50% hedge of exposure requires buying 4 futures contract

   Invest in settlement account = 4 × $20,000 = $80,000

   The total amount to invest in the hedged funds will be $80,000

   This computation assumes that the option will be sold and its position closed out by the end of the stated investment period.

    

   1. Investment in Cash Management Trust

   Investments in AMP cash management trusts (CMT) requires a minimum investment of $0 and a maximum investment of 20%. 20% of the available $2,000,000 is $400,000. As an investor, this amount can be allocated into percentages for liquid investments, cash investments and the remainder can be invested in options or shares.

   The maximum amount of cash for investing into the cash management trust has to be a minimum of $0 and a maximum of $400,000. Therefore, the balance of the cash remaining after the previous allotments into equity shares, LICs and ETPs as well as hedged positions for ASX. Cash holdings will be as follows:

   Cash holding      = {($2,000,000 – ($1,000,333 + $699,640)}

                                   = $ 2,000,000 – $ 1,699,973

                                   = $ 300,027

   Conclusion

   As supported by the table and computations, it is recommended that our client invests in the identified asset classes in order to construct a superior and properly hedged investment portfolio. The computations are based on an understanding of market dynamics across the international markets as supported by investment philosophies and strategies suggested by the client. Purchasing equity shares, short selling, LICs and ETPs and hedging in ASX equity, as well as making cash investments in the amounts identified will guarantee optimal returns for the client.