(Professor Name)
Portfolio Management Concepts
The concept of portfolio management is a lucrative sword as not only it offers not only returns but the investor also have to face risk associated with it. If the Investor is willing to earn higher return he has to associate higher return with higher risk. For an investor to diversify away the risk he can follow diversification rule. Under diversification, investor can include the assets which are not correlated to each other and thus by including these asset classes he can diversify away the risk. However, in terms of the risk there are two kinds of risk i.e Unsystematic Risk and Systematic Risk and an investor can diversify only unsystematic risk by following diversification rule including the asset classes that are not correlated with other and the risk left will be systematic risk, which is not possible to diversify even if the investor includes all the securities available in the investment universe.
Systematic Risk
For KMK Holdings, diversification is an important part of portfolio construction. Considering the market conditions which have grown highly risk on account of low interest rates and high volatility, the company in order to diversify away the risk will be using the asset allocation strategy by investing in Stocks, ADR’s and ETF in a rationale proportionate manner. The portfolio consists of 15 stocks, 3 ADR and 1 ETF, the net worth of portfolio at the time of writing was $103892.97 while the total borrowing power is $108931. The portfolio have earned a return of 3.89% on overall basis while on daily basis the return is 1.35%. However, the portfolio has not outperformed the S&P 500 benchmark as the benchmark return of 7.67% is not achieved by the portfolio.
Despite of poor performance of the portfolio in comparison to benchmark, the portfolio has still achieved a satisfactory diversification by investing in range of asset classes. Had the investor followed only 1 stock portfolio i.e Kaisser Stock, on daily basis the portfolio would have lost 263.58% in value. Thus, by investing in range of asset classes, the portfolio had achieved a satisfactory return as by including non-correlated asses in the portfolio it removed the unsystematic risk. However, in comparison to benchmark return, we can conclude that portfolio has still not achieved maximum diversification and it need to follow portfolios on efficient frontier that offers him maximum return with benchmark standard deviation of 0.72% on daily basis.
Answer 2)
Fundamental Characteristic relates to features that relate establishing intrinsic value of a company’ stock. For instance, in the given data for KMK Holdings, every asset classes have been provided with its basic fundamentals relating to its Market Capitalization , Dividend Yield, P/E Ratio and beta. It is based on these fundamentals that an investor decided about the proportion of asset class to be included in the portfolio. In other words, even before an investor think of looking over financial statements for indepth analysis of the company, he will be interested in looking over basic fundamentals of the company. If a company is having low dividend yield or high beta, an investor might straight-away refrain from investing in such particular stock. Similarly, if fundamentals of the company are in preference of the investor he might include the stock of the company in his portfolio and ultimately have the same impact on the performance characteristic. Thus, there is a strong relationship between fundamental characteristic and performance characteristic of a portfolio.
We can explain this relationship using example from the given data for KMK Investment Holdings. Here below is given the basic fundamental chart of different companies which the company is interested to include in the portfolio. If an investor who is risk averse and if given option of choosing 3 stocks for his small portfolio, might straight away reject the inclusion of Swift Transportation in his portfolio being a high beta stock and will endow his preference on Dollar Tree and Pepsico. Thus, since his portfolio includes low beta stock, his returns will also be low. Thus, in a clear view his selection being based on fundamentals will affect the performance characteristic.
Answer 3)
Behavior Analysis relates to the concept of Behavior Finance which is a branch of investment world that explain the stock prices anomalies because of psychological behavior of investors. In other words, behavior analysis reveals the pattern of how the market outcomes and an investors investment decisions are influenced by the prevailing market information structure and characteristic of market participants. It considers the psychological bases for percieved investor behavior that creates some degree of systematic mispricing of securities and may explain anomalies that tend to refute the efficient market hypothesis. Following are some bias related to behavior finance:
Overconfidence Bias:
With respect to growing companies, researchers have presented evidence that KMK Investments overconfidence in their earnings forecasts and their high estimated growth rate of earnings lead them to overemphasize the impact of good news and to underestimate the negative value implications of bad news. This may be the reason that the portfolio was not able to achieve benchmark returns.
Confirmation Bias:
This refers to the tendency for investors to seek out supporting information after making decisions and to avoid or ignore any other new information that could call the investment decision into question. This can also be extended to prior belief. For instance, an investor may believe that Dell is a good company and inclusion of the stock of Dell in the portfolio is a good decision even if Dell is not performing well at the time of portfolio construction.
Escalation Bias:
The tendency of investor that lead to investment through psychological sentiments can also be related to escalation bias. This refers to tendency of investor to committ more funds to a position that has gone down, often refered to as averaging(the purchase price)down. To the extent that investors undervalue information in opposition to the original purchase decision and overweight the importance of information indicating the original decision was a ‘’proper’’ one, they will tend to average down too often, escalating the size of their position.
Works Cited
Hsieh, William Fung and David. Performance Characteristics of Hedge Funds and Commodity Funds:. Research. Durham: Duke University, 2000. Web.
O'Connor. "Efficient Capital Markets." Institute, CFA. Equity Investments. Boston: Custom, 2011. 181-194. Print.
O'Connor. "Portfolio Concepts." Institute, CFA. Equity Investments. Boston: Custom, 2011. 23-56. Print.
