Portfolio Construction and Analysis

Investment Portfolio

Jonathan Max Burkett

Capella University

Investment Portfolio

As an investor, I would like to invest in a stock portfolio comprising of 3 stocks from cyclical industry and 3 stocks from non-cyclical industry. My objective is to earn reasonable gains in exchange for lower stress levels and adequate free time. As such, I would like to buy stocks from established firms and hold the portfolio investment for 5 years. With this in mind, the 6 stocks that will be in this investment portfolio are Toyota Motors Corporation, Ford Motors Company, Fiat Chrysler Automobiles, Novartis AG, and Pfizer Incorporation as well as Eli Lilly and Company. Whereas the first three stocks are from a cyclical industry, the remaining three stocks are from a non-cyclical industry.

For this portfolio, I intend to use the index investor style by passively investing in funds that do not only follow indices, but also receive an average rate of return. According to Tang & Xiong (2012) index investing style became popular in the bull market during 1980 to 2000. This kind of investment strategy does well in the bull markets but poorly in the bear markets. It produces fair rates of return and less expense. The authors assert that index investing strategy is appropriate for investors who lack the knowledge and the desire to invest their time and energy into individual investment opportunities.

All investments involve risk taking. This investment portfolio is subject to macroeconomic, political and industrial events that may affect the return of the portfolio. Regarding macro-economic factors, Elton et al. (2009) indicate that various issues such as gross domestic product, interest rates and inflation as well as taxation policy may affect an investment portfolio. Interest risk may arise if the United States Federal Reserve attempts to manage the country’s economy. Central banks decision to increase or reduce the amount of money circulating in an economy can lead to a rise or a fall in interest rates. Changes in interest rates can affect the value of income generating assets like stocks, bonds and real estate. As most investments have long time horizon, they are prone to inflation risk. Political events such as Brexit may also affect an investment portfolio. Regarding industrial events, changes in production techniques and new innovations may affect the performance of an organization, thereby affecting its stock price either positively or negatively.

The initial holding consists of Ford Motors, Toyota Motors, Fiat Chrysler, Novartis AG, and Pfizer Incorporation as well as Eli Lilly and Company. Out of the $100,000 available for investment, I intend to invest $30,000 in Eli Lilly and Company’s stock, $ 25,000 in Novartis AG’s stock, $20,000 in Pfizer Incorporation’s stock, $10,000 in Fiat Chrysler’s stock, $10,000 in Ford Motors’ stock and $5,000 in Toyota Motors’ stock. This decision is made on the company’s closing stock prices as of January 17, 2019. Eli Lily and Company’s stock price closed at $119.16, Novartis AG stock closed at $88.63, and Pfizer Incorporation’s stock closed at $42.47. Concerning the automobile industry, Fiat Chryslers stock closed at 14.54 euro on the Milan stock exchange whereas Ford Motor’s stock closed at $8.36. Toyota Motors’ stock price closed at 6,816 Japanese Yen on Tokyo Stock Exchange. The other factors that I put into consideration include: class of investment assets, the prevailing industrial events, the country of origin, and short-term as well as long-term investment objectives.

Market Value of the Portfolio

Weights of stock

Expected rate of return = WA x ErA + WB x ERB +-------WN x ErN

= (0.3) (10%) + 0.25(10%) + 0.2(10%) +0.1(5%) + 0.1(5%) + 0.05(3%)

=3%+2.5%+2%+0.5%+0.5%+0.15%

= 8.65%

Benchmarking is very important in investment decision. Elton et al. (2009) define a benchmark as an alternative to an investment portfolio against which investors can measure a portfolio’s performance. Comparing an investment portfolio’s returns against a benchmark may help in tracking errors. By tracking errors, an investor can get an insight of how tight or volatile the portfolio in question is relative to the benchmark. As such, benchmarks help in measuring returns, risks and determining whether or not the added return adequately compensates the risks involved. For this portfolio, I will use the Standard and Poor 500 index (S&P 500) benchmark. The Standard and Poor 500 Index is one of the most commonly used benchmarks by investors.

This portfolio investment is prone to two significant risks-sector risks and political risks. Regarding sector risks, the automobile industry has recently witnessed various scandals that have led to car recalls, and this may affect the stock prices of Toyota, Fiat Chrysler and Ford Motors. For instance, Price (2018) indicates that Toyota had to recall more than 1 million vehicles in 2018 because of airbag defects, which may not only affect the company’s profitability but also stock prices. With regards to political event, Brexit may adversely affect not only the European business and finance environment, but also the United States economy. Breinlich et al. (2018) indicate that the legal framework plus the regulatory standards in the United Kingdom financial market are very strong, providing excellent projections to investors. Also, changes in regulations and laws in the United States, Japan and/ or Italy may negatively affect the stock prices of the portfolio investment. The portfolio may also be affected by a market risk like the financial crisis of 2008 which resulted in market values, including stock prices, of even profitable organizations decreasing significantly. This investment is appropriate for investors whose objective is to earn reasonable gains in exchange for lower stress levels and adequate free time

References