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INVESTMENT PROPOSAL Ms. Stephens

Imperium I t t

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Table of Contents CONTENTS...................................................................1 EXECUTIVE SUMMARY..................................................2 WELCOME....................................................................3 CLIENT INFORMATION...................................................4 MARKET OVERVIEW......................................................5 SELECTED ASSET OVERVIEW.......................................7 INVESTMENT

ASSET

1: 4.25%

INVESTMENT ASSET

2: M&G

INVESTMENT ASSET

3:

TREASURY GILT

2039..........................7

TRACKER FUND.......................................9

DOMINO’S PLC...............................................11

ASSET PORTFOLIO.....................................................13 RECOMMENDATION.....................................................14 SERVICE CHARGES AND BENEFITS.............................17 INVESTOR ADVICE DISCLAIMER...................................19 APPENDICES..............................................................20 REFERENCES.............................................................23

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Executive Summary According to the information provided by the client, she seems to be a low-risk investor with a long-horizon, seeking a large sum of money. We will meet these expectations by allocating assets based on Ms. Stephens’ needs and expectations. By using various concepts and theories, such as Capital Asset Pricing Model and Modern Portfolio Theory, we found the low-risk portfolio to be the most suitable for Ms. Stephens, with a monthly contribution of £800. This entails asset weightings of 33% in a Treasury Bond and 67% in an M&G Index Tracker Fund.

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Welcome Dear Ms. Stephens, On the behalf of Imperium Investments, a customised investment proposal has been created for you. This proposal outlines our recommendations for investment strategies and management of your account in accordance with your specific financial goals. Those objectives, which are outlined in this document, have been established in accordance with the profile information you have provided. Specifically, this investment proposal: • Establishes reasonable expectations, objectives, and guidelines for the investment of your portfolio. • Sets an investment structure detailing the expected initial allocation among asset classes. • Creates the framework for a well-diversified asset mix that we believe will produce long-term returns in accordance with your level of risk. Roles in the investment process are as stated: • Your role is to communicate your objectives, goals, and desired risk level by updating your investment profile when life changes occur. • We will provide oversight to the entire process and meet with you regularly. We have conducted thorough research to choose a professional money manager who will best support your goals. Thank you for reviewing this proposal. Please contact us if you have any questions about these recommendations, or your financial portfolio in general.

Sincerely, Imperium Investment representative

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In order to make a professional judgement of what assets and investments to make on Ms. Stephens’ behalf, as her investment managers, we must first evaluate her personal circumstances and needs. Only then can we produce an investment portfolio, where the asset allocation is aligned with her requirements. Name Age Lifestyle Financial position Time horizon Risk tolerance Investment objective Total investment Monthly contribution

Ms. Stephens 30 years old N/A N/A Longer horizon – 20 years old Low Income £250,000 £600-£800 (Figure 1 – Client information)

We have assumed that Ms. Stephens is not a professional investor and does not have any investment knowledge, so she is therefore a low risk investor. Ms. Stephens wants a long-term investment in order to buy a holiday home in 20 years’ time, therefore she cannot afford to lose money by taking risks within the portfolio and would like to see a steady increase in her return, so our recommended portfolio will reflect her circumstances and requirements. We do not have any information about Ms. Stephens’ financial position (assets and liabilities) or her lifestyle, thus it would be unprofessional to assume she is willing to take risk without this validation.

Market Overview Equities

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The FTSE All-Share is an index consisting of around 600 of the largest companies traded on the London Stock Exchange. The dividend yield shows the total annual dividend of all the companies divided by the current index value. If a share is above the current market average, then having a higher dividend yield can indicate the index is more profitable than its current stock prices. Thus indicating, the index is undervalued which could then lead to increase in the future price. When looking to invest in shares, it can be profitable to choose ones which are undervalued for this reason. Fa c t o r s A f f e c t i n g FT S E A l l - S h a r e Factor Affect Companies

A company’s positive or negative earnings surprise can have an effect on the price

Earning Report Interest Rates

of a stock and therefore the performance of the index. The relationship between interest rates and investment in equities is inverse.

Brexit

Higher interest rates result in increased debt and decreased profits. With the uncertainty of the Brexit and what it would mean for the UK, it has

Industry Factors

limited foreign investment. When specific industries decrease in investment, they drag the index lower, examples include; oil, mining and tobacco. (Figure 2 – Factors affecting FTSE All-Share)

These factors may produce irregularities within the FTSE All-Share, which can make our portfolio performance predictions slightly inaccurate. Therefore, it is important to keep these in mind when using the FTSE All-Share as an index comparison to the performance of assets. Gilt Bond A gilt is a bond is issued by the British Government. They are considered to be a low risk investment and have been dubbed with the tag ‘risk-free’. This means that its 20-year yield could be an accurate representation of the expected market inflation over time. The reason that The Gilt is considered risk free is because looking at recent trends, the Bank of England is unlikely to drastically change interest rates (Investopedia, 2018). This type of asset is suited to the investor for this reason, as she is a low-risk investor. I n t e r e s t R at e s

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An interest rate is the amount of money you pay for borrowing money. They are set by the Bank of England as a base rate (Bank of England, 2018). Interest rates have an inverse relationship, if the base rate increases then that will reduce the demand for equities and therefore lower the value. It normally rises in short increments over longer periods of time, which therefore means that there is very low vitality. Figure 3 shows the interest rate changes over the last 10 years (Bank of England, 2018). As you

Date

Interest Rate

can see, they have risen in recent

5th March 2009

0.50%

4th August 2016

0.25%

9th November 2017

0.50%

6th August 2018

0.75%

years which brings risk to portfolio values. Bonds can be protected from interest rate changes through cash matching, where the duration

of the bond is lower than time horizon of 20 years. By making the durations unequal, interest rate fluctuations will not decrease the price of the bond for reinvestment.

(Figure 3 – Interest Rates)

Selected Asset Overview Investment Asset 1: 4.25% Treasury Gilt 2039

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The UK government issues Gilt bonds with a maturity date and they are listed on the London Stock Exchange (LSE). Gilt bonds are used to fund debt issued by the Government. There are two different types of Government bonds. We’ve used conventional Gilt bonds in this portfolio as they are the simpler form of a Government bond. Until the maturity date, the Government has to pay the holder. Therefore, it is a guaranteed way of getting fixed income payment in cash, better known as a coupon, twice a year. The Gilt bond is redeemed for the original investment of £100 when the issue period is finished in 2039, until then it will yield 2.125% nominal interest on the price issued of £100 twice a year. Conventional Gilt bonds make up 75% of all the Gilt bonds that the HM Treasury issue. As opposed to the other 25% of Gilt bonds, made up by index-linked Gilt bonds. These bonds’ principal payments and coupons are adjusted in line with the UK’s RPI. A d v a n t a g e s a n d D i s a dv a n t a g e s Gilt bonds offer low-risk, predictable, steady return, due to the low probability of the UK Government defaulting its debt, fixed income and the risk mitigation. Gilt bonds decrease the overall risk profile as they increase the diversity of your portfolio due to the weak correlations. There is a particularly weak correlation between equities, thus there is with the M&G Index Tracker Fund, in addition to other asset classes.

Due to bonds’ outcome being predictable and steady in addition to them paying fixed interest rates, equity investments are considered less secure in comparison. Although, because bonds are low risk they have low returns. Therefore, they are not ideal for investors that want high returns. Individual bond portfolios often have unsystematic risk that investors do not receive extra compensation for (Lazaroff, 2016). Investors cannot benefit from global diversification using individual bonds. Government bonds are beneficial because they do not have holding costs or accumulate any stamp duties. Although, they incur disposal costs to brokers, along with a given commission interest rate. R i s k a n d Re t u r n s

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As shown in the Gilt bond sheet calculation summary factsheet (Appendix D), the asset class is a government bond, issued by the HM treasury, with a low risk profile and an expected return of 4.25%. The 4.25% Treasury Stock 2039 clean price increased in December 2018 up to 138.94, from December 2013 being 111.84. Overall this demonstrates a consistent improvement. Over the past 5 years, the historic return has accumulated to 4.84%. The yield to maturity is 1.96% which is the real expected return, providing the bond is held until its maturity in 2039. The annualised risk is 10.11% for the 4.25% bond. Therefore, bonds fit more appropriately with the low-risk requirements of the investor. Unlike Domino’s shares, they offer low returns but they have low risk as well.

INVESTMENT ASSET 2: M&G TRACKER FUND C o l l e c t i v e s : I n d ex t r a c k e r f u n d s

The M&G index tracker fund is designed to track the FTSE All-

9 Equities

Share Index, which represents a broad spread of UK company shares. The fund typically has around 550 holdings, representing nearly all of the companies in the FTSE All-Share Index and matches closely the weighting that each stock represents in the index (M&G, 2018). The index tracker fund is designed to offer exposure to an entire index at a low cost and at a lower risk, which

Tracks

FTSE All-Share

Risk Profile

Moderate

Year to date performance (11/12/2017 – 10/12/2018) Largest Companies

-10.27%

is why the fund is an essential part of the portfolios that we have proposed, as it will allow you to gain returns without huge reductions due to costs. Tracker funds typically buy the individual

Largest Industries

securities in the index they seek to replicate, so the transaction costs involve paying only for a single fund instead of paying each

Royal Dutch Shell A/B HSBC British American Tobacco Oil & Gas Producers Banks Pharmaceutical s & Biotech.

equity individually. Therefore, by having the tracker fund, the portfolio can be diversified with a lower leverage, without having to do it with direct equities. (Figure 4 – Tracker Fund factsheet) A d v a n t a g e s a n d D i s a dv a n t a g e s One of the advantages that is mentioned above is low costs in fees,

you will be paying one payment for all 550 shares rather than paying for the stamp duty and other fees such as broker fees for each individual share which would deplete your returns. Another very important advantage that the tracker fund offers is diversification, which helps minimise risk and over exposure to a particular stock or sector. However, a disadvantage to the tracker fund is it being an opaque investment because the assets behind the index fund are frequently changing and as an investor it is harder to determine exactly what you own compared to an individual share, and past performances cannot guarantee future performances. Additionally, the tracker fund holds more risk to it than bonds, although it does generate a higher return.

M&G Index tracker fund (prices) 160 140 120 Price

100

R i s k a nd R e t u r n s There are no significant spikes or falls in prices, which means that price volatility is not high. If current trends continue, this fund

80 60 40 20 0

NT CO UK |

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is expected to offer a nominal return of 8.11% annually, with real returns of 7.2%. The M&G Index Tracker Fund has a volatility of 13.6%, making its risk profile moderate. Due to the high levels of both firm and industry diversification this asset is only subject to systematic risk, purely macroeconomic factors.

(Figure 5 – M&G Index Tracker Fund prices over 5years)

INVESTMENT ASSET 3: DOMINO’S PLC E q u i t y I nve s t m e n t Equity investment is when investors gain shares of a company by investing in common stock. The investor only recovers their money when they sell their shares or when assets of the firm are liquidated. Profits from the investment can be from dividends or capital gains (Investment UK, 2010).

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Ordinary shares, also known as common stock, are an equity investment instrument. The investor earns money in the form of dividends by holding shares in the company. Generally, they are considered riskier ventures as dividend payments are not guaranteed and the investor has minimal decision-making power. Ordinary shares can be public or private. Private equity shares are not publicly traded, giving the company control over investors. However, companies like Domino’s offer public equity shares, whereby shares are listed on stock exchanges, for example the London Stock Exchange, and anyone can buy them (Investopedia, 2019). Company Profile Domino’s Pizza Group PLC is a UK-based master franchise name for the international fast-food company, Domino’s Pizza. Their first store opened in Luton in 1985 and they have now grown to approximately 1,100 stores across the UK, Ireland and Switzerland, amongst other countries. A d v a n t a g e s a n d D i s a dv a n t a g e s A fundamental analysis was carried out, which suggested overall that Domino’s is overvalued in the market. Their Price-Earnings Ratio was £1,154.44x, compared to the market average of the FTSE 350 being only £12.0x, suggesting that Domino’s could be a high-risk. However, it must be considered that the Earnings Per Share figure that is required in this part of the fundamental analysis is subjective and does not reflect risk. Also, the Price-to-Book was £1.60x, suggesting that the market is willing to pay more than the equity per share because the value is more than £1. However, this calculation excludes internally generated intangible assets, which must be considered in Domino’s case, due to the large amounts of staff. The Dividend Yield is 0.04% which is considered low, with the market average of the FTSE 350 being 4.1%, indicating again that shares are overvalued. The Dividend Per Share figure that

(Figure 6– Share price of

is required is objective, making it more reliable. Companies

Domino’s Pizza Group PLC over

with low or zero dividend yields suit capital growth investors,

the last 5 years)

thus going against your income requirements. R i s k s a n d Re t u r n s At the beginning of the 5-year period, on 10th December 2013, the close price of Domino’s shares was £159.33. They peaked over the period on 29th July 2016 at £396. It then decreased

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again to £237 by the end of the 5 years, on 10th December 2018, making a year-to-date performance of -25.94%. Therefore, the share price is very volatile and has not been performing well recently. As opposed to fundamental analysis, technical analysis was also calculated. The historic return for Domino’s is 11.87% and the real expected return (calculated using CAPM) is 5.764%. The annualised risk is 28.1%, which is higher than the historic return, thus indicating a high-risk spread.

Asset Portfolio C o r r e l at i o n C o e f f ic i e n t A correlation coefficient is a statistical measure that calculates the strength of the relationship between the relative movements of two variables. A positive correlation is when one variable increases or decreases and the other moves in the same direction. Whereas a negative correlation is when one variable increases or

ρ Shares

Fund

+1.000 +0.466

+1.000

+0.800

+0.647

Bonds

+1.000

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decreases and the other moves in the opposite direction. The correlation coefficients of the portfolio we have chosen are shown in Figure 7. (Figure 7 – Correlation Coefficient between asset classes) As we have decided that our client is a low-risk investor, we would advise them to invest in classes with a lower correlation coefficient. This is because when an asset starts to generate negative returns, assets with a higher correlation coefficient would become negative as well, and therefore could be of higher risk.

Shares

Beta Values 0.68

B e t a Va l u e s : A beta value measures the level of systematic risk

Funds

1.00

relative to the systematic risk of the whole market

Bonds

0.40

portfolio. In Figure 8, we can see the value of each asset.

(Figure 8 – Asset Beta Values) M o d e r n Po r t f o li o T h e o r y As we have recommended to exclude Dominos PLC shares from your portfolio, a two-asset portfolio will be advised to follow. According to Harry Markowitz (1952), an investment portfolio should contain at least two constituents, which can include units in equity and government bonds. From the information provided we can presume that you are a rational investor and the Modern Portfolio best suits you to achieve your expected returns.

Recommendation After

evaluating

your

personal

2 Asset porfolio information and considering your (M& G Track er fund , 4.25% Treasury gilt)

Return (Erp)

financial needs that you have provided

8.00% 7.00% 6.00% 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% % 00 7.

00 8.

%

00 9.

%

0 .0 10

%

0 .0 11

Risk (σp)

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%

0 .0 12

%

0 .0 13

%