FOR KIZANGILA
putit_
topic_4_direct_invest_1401.pdf
Topic 4 – Direct Investments BAFI 1016 Personal Wealth Management
Introduction
• Direct investment occurs when investors make their own decisions where funds are ultimately placed
• Indirect investment involves investors placing their funds with fund managers
• It is important to appreciate the nature and structure of the relevant investment markets
Cash and Fixed-Interest Securities
• Deregulation of the Australian financial system in the early 1980s produced a highly competitive finance industry
• Process of deregulation was to free financial markets by removing many of the legal controls and regulations that restricted competition and stifled technological development
Cash and Fixed-Interest Securities
• Deregulation included: - floating of Australian dollar
- introduction of foreign banks
• Deregulation does not mean there is no regulation at all of the financial system
Cash and Fixed-Interest Securities
• Regulation is still applies via: – Reserve Bank of Australia (RBA) – systemic risk
– Australian Securities and Investment Commission (ASIC) – consumer protection
– Australian Prudential Regulatory Authority (APRA) – prudential supervision
• Rapid growth in development of debt markets occurred from mid 1980s providing greater access to domestic and commercial debt finance
Participants in the Fixed-Interest Markets continued
• These participants may take on roles as lenders, borrowers or both
• Financial services from a range of financial institutions are readily accessible via a range of retail and commercial outlets as well as online
The Nature of Markets and Products • Cash investments range from bank deposits to investments in cash management trusts (CMT) and the short term money market (STMM)
• These instruments are mainly issued by Federal and State governments, banks or blue chip companies
• Products may include deposits, CMT, bank bills and STMM instruments
• Cash is a short term investment with variable rates of return
The Nature of Markets and Products • Interest rate securities are usually for a longer period of time and at a set interest rate agreed for the term of the investment
• Products can include, government and corporate bonds, debentures and longer term deposits
• Characteristics – fixed terms with fixed or variable rates of interest paid
The Nature of Markets and Products
• All interest rates are based on the cash rate
• The cash rate is the interest rate paid on money lent between commercial banks overnight
• Real cash rate is the cash rate divided by the rate of inflation – Cash rate 4.75% – Inflation 2.7% – Eg. 1.0475 / 1.027 = Real cash rate of 1.996%
The Nature of Markets and Products continued
• The cash rate is managed by the RBA by manipulation of the money supply to inject or withdraw funds by buying or selling securities
• Margins added to compensate lenders for increased risk and increased time to maturity
Participants in the Fixed-Interest Markets
• Participants in the fixed-interest markets include: – authorised deposit-taking institutions (ADIs) and non-bank financial institutions (NBFIs)
– insurance companies – fund managers – private individuals – ordinary businesses – governments
The Nature of Markets and Products continued
• Fixed-interest investments can vary from immediate access to up to 20 years
• Two types of fixed-interest markets: – Money market (securities with terms of up to 1 year)
– Capital market (securities with terms greater than 1 year)
The Nature of Markets and Products continued
• Typically longer-dated securities offer a higher interest rate
• Changing monetary conditions affect the relationship between short and long-term rates
• Interest rates and maturity dates can be graphically illustrated via a yield curve
The Nature of Markets and Products continued
• Term deposits from one month to several years are available from ADI’s
• Commercial bills are usually of 90-180 days duration and are often provided by banks in return for a facilitation fee
• Corporate Bonds or Debentures are long- term securities that pay regular interest at fixed rates on their face value - they are usually secured over a group of assets owned by the issuer
• Unsecured Notes are riskier and offer higher interest rates to attract investors
The Nature of Markets and Products continued
• Government and semi-government bonds enjoy very good security ratings
• Fixed-interest securities are rated for risk with the lowest risk rated as AAA and the highest risk rated BBB
• Interest rates offered reflect the securities credit rating
Higher risk counterparties must offer investors greater compensation
Trading in Securities
• Securities are issued in the primary market and are subsequently traded in the secondary market
• Traded securities can be short or longer dated
• The existence of a secondary market for securities allows for investments to be sold prior to their maturity date
Trading in Securities continued
• Secondary markets: - give liquidity to financial markets - promote market confidence
- provide a price-setting mechanism
• Not all securities provide a secondary market for trading – these securities include:
- ADIs - savings accounts
- term deposits
Trading in Securities
• For short dated (non-coupon) paying securities the difference between the selling price and the face value represents the notional interest payment
Trading in Securities
Example • A security with a face value of $100,000 has 3 years to maturity and sells for $82,270.25
• What is the discount at which the bond is sold and the yield on the investment?
Trading in Securities
Solution • Discount on face value
= 17,729.75/100,000 = 17.73% • Yield on investment • = 3√(100,000/82,270.25)-1 = 6.72%
Trading in securities
• Coupon securities pay a coupon or interest rate on a predetermined basis
• When the security is sold the price at which is traded is a function of the interest rate environment and the perceived risk of the security
• The price of a bond is calculated using the formula for the present value of both a future value and of an annuity
Accessing Fixed-Interest Markets
• ADIs offer current, savings, cash management and term accounts
• Finance companies offer debentures and unsecured notes direct to the public
• Professional bond dealers trade semi-government and government notes and bonds via telephone
Matching Investors to Products
• Fixed-interest investments held to maturity appeal to more risk-averse people because: – There are guaranteed interest payments at a given level
– The level of capital remains fixed which means there is a lower risk of loss
Inverse relationship between movements in interest rates and the price of a bond
• Traded fixed-interest investments fluctuate in value based on movements in the general level of interest rates:
- when market interest rates fall underlying capital values rise
- when market interest rates rise underlying capital values fall
Shares (Equities)
• Shares have historically offered higher long term returns than other asset classes
• Shares can offer both a regular income via dividends and strong capital growth
• Australian shares can offer the added tax benefit of dividend imputation
Participants in the Equities Market
• Participants in the equities market include: – Listed corporations – Investors – Brokers – full service and discount – Hedgers – Speculators – Arbitrageurs
Nature of the Equities Market
• Bulk of trading occurs on stock exchanges, with the Australian Stock Exchange (ASX) having a virtual monopoly in Australia
• Listed companies are divided into industrial (80%) and resource sectors
• Listed companies in addition to complying with Corporations Act must also follow ASX Listing Rules
Nature of the Equities Market
• Market prices are determined by interaction of supply and demand
• Value of Australian shares are particularly influenced by: – Economic fundamentals – Company profitability and outlook, quality of management – Government policy – International capital flows – International demand for Australian products
(especially commodities) – Australian dollar fluctuations – US sharemarket price movements – International economic and political events
Nature of the Equities Market
• There are various types of shares of which ordinary shares are the most common
• Shares offer investors an investment with limited liability
- liability limited to paid up value of shares
Analysis of Share Prices
Analysis of Share Prices - Singapore
Analysis of Share Prices - Singapore
Analysis of Share Prices
• Methods of share price analysis: – Fundamental analysis uses objective measures to analyse a company’s current financial position
– Technical analysis is concerned with how recent market perception of the worth of an investment is translated into market prices
Analysis of Share Prices
• Fundamental analysis can involve many measures and should at least include a consideration of: – liquidity – capital structure – profitability – market valuation – risk analysis
Analysis of Share Prices continued
• Technical analysis is often referred to as charting: – plots historical share prices on graphs to identify past patterns and trends that are expected to be reproduced in the future
• Technical analysis is not generally supported by empirical research
Diversification
• Total risk = systematic or market risk plus non- systematic or company specific risk
• We cannot diversify market risk but we can diversify company specific risk by holding a shares in multiple companies – by the time we have purchased 10 – 30 companies we have reduced our non-systematic risk to very low levels
Diversification
Accessing the share market
• Stock Exchange Automated Trading system (SEATS) system
• A client instructs a broker to buy or sell shares at ‘market’ (best available price) or at ‘limit’ (at a particular price or better)
• The SEATS system will match orders (subject to share availability) and execute trades
• Share ownership transfers on Clearing House Electronic Settlement System (CHESS)
• Funds pass from buying to selling brokers through CHESS
• Settlement is T+3
CAPM
• The Capital Asset Pricing Model (CAPM) attempts to establish a relationship between systematic risk and return
• CAPM uses beta as a measure of risk of a share relative to the total market risk
• The CAPM model holds that the expected return of a security or a portfolio equals the rate on a risk-free security plus a risk premium - if the expected return does not meet or exceed the required return, the investment should not be made
CAPM Formula
• CAPM gives the following relationship between return and risk:
Ri = Rf + βi (Rm – Rf)
where:
Ri = expected or required return on share I Rf = risk-free rate βi = the beta of share i (Rm – Rf) = the risk premium
Basic valuation models
• Gordon dividend discount model • Price to earnings ratio (PE) • PE (Growth) PEG
Gordon dividend discount model
• In theory, the value of a stock is worth the total future cash flows expected to be generated by the firm, discounted by an appropriate risk-adjusted rate
• The model holds that dividends are the cash flows that are returned to the shareholder
• So in order to value a company using the model you calculate the value of dividend payments that you think the share will pay in the future
Gordon dividend discount model
Formula: V0 = DPS1
(r – g)
Where:
V0 = estimated value now
DPS = expected dividend per share next period
r = required rate of return
g = growth
PER
• PER gives an indication of how the market is pricing the company’s shares by relating the EPS to the current market price of the shares.
• P/E Ratio = market price / EPS
• The P/E ratio calculates the number of years based on current earnings that it would take for a share to pay for itself.
• An abnormally high or low P/E ratio relative to similar companies will indicate that the company is either over or under-priced by the market.
PEG
• The PEG Ratio uses the P/E Ratio of a company and compares it with the company’s annual growth rate (g)
• PEG = P/E divided by g
• Low values indicate the company is undervalued on the market
Accessing the Share Market continued
• Investors have their holdings substantiated by an electronic transfer and settlement system such as CHESS
• The ASX trades only by linked computers without a trading floor
Matching Investors to Products
• Investors in shares are: – Less risk-averse than those favouring property
– Single-sector. Single country – Much less risk-averse than those favouring fixed interest products
• The wide range of shares allows accommodation of various risk profiles
Growth vs Value strategies…
• Growth investments with high P/E’s and related low yields have potential for high future growth should be purchased now so as to enjoy now to enjoy future gains
• Value – if an share is apparently underpriced ie low P/E and relatively high dividend yield – it may be a good buy
Alternative Investments
• Includes investments in: – infrastructure – property development trusts – residential property trusts – private equity – hedge funds
Other Asset Markets
• Other markets: – precious metals – Collectibles – viaticals
Other Asset Markets continued • Ethical investments are often referred to as: – green investments – socially responsible investments (SRI)
• Seeks to allow for integration of investment objectives with personal values and social concern
• Investments options are often restricted by limited range of suitable investments and access to relevant information
Investment Strategies
• Diversification strategies reduce risk • Investors need to decide between ‘growth’ and ‘value’ investments
• Issues that need to be considered include: – price to earnings (P/E) ratio – yield – buying with ‘growth’ in mind – buying with ‘value’ in mind – portfolio performance
Property Investments
• Property investment is a wide asset class • Investment in buildings and/or land • Investment in property offers a choice of forms and types
• Purpose of investing both income and capital growth
Qualities and Characteristics of Property
• Main characteristics include: – Solid form of investment – Land is scarce – Generally illiquid form of investment – Returns comprise both income and capital – Entry and exit costs may be high – Management and maintenance costs can be expensive – High level of gearing possible – Taxation advantages – Prices less volatile – Property market cycles do not necessarily coincide with the share market - can offer diversification
Direct and Indirect Investment in Property Direct Ownership: • Estimated 70% of property under direct ownership
• Registered on title of property Indirect Ownership: • Increasing proportion of property held by managed funds – property trusts (both listed and unlisted); mortgage funds, syndicates; mixed funds; etc.
Residential Property
• Rise in capital value since early 2000s • Rise in value partly due to study of land economics – scarcity; infrastructure; and availability of finance
• Effect of negative gearing and immigration policies
• Trend to inner-city apartment living • Encouragement for higher density housing
Total Debt Ratio
• Introduced in 2013 to cool the Singapore Property Market
• Has resulted in the gradual softening of property prices
Commercial Property
• Largely the domain of institutional investors – large capital required
• Wide range of real estate- CBD, suburban strips, industrial, farming, tourism
• Higher yields than residential property • Income security depends on length and quality of lease
• Investment risk – tenant may cease trading or not renew lease
Benefits of Investing in a Property Fund
Provides investors with opportunity to diversify property investment by:
• location • size • sector- office, industrial, shops, hotels, etc. Trust undertakes on-going management and maintenance
Summary
• Direct investment occurs when investors make their own decisions
• Investments may be made in three main asset classes or a niche market
• Different markets have different characteristics and have provided varying returns over time
• Diversification is an overriding risk management investment strategy
• Individuals can also invest directly into property
