Semester 1, 2017 CFP 4 Investment Strategies Assignment CFP 4 ASSIGNMENT SEMESTER 1, 2017 285_fpa_cfp4_asst_sem0117_v01-1_fa 4.1 CFP® 4 assignment Due date: 3.00 p.m. AEST Wednesday 10 May 2017 Last date for extension requests: Tuesday 9 May 2017 Mark allocation: Task 1—10 marks Task 2—Six questions worth a total of 90 marks This assignment is worth 100% of the total mark for CFP 4. The pass mark for this assignment is 70%. Word limit (article or report): Task 1—500 words maximum (excluding the text of the selected article or report) Task 2—5000 words maximum This assignment contains two (2) compulsory tasks. Task 1 involves writing a synopsis of an article or report on a selected topic area. It has been designed to target contemporary issues within the financial planning profession that are relevant to CFP 4. In order to complete this task successfully, you will need to conduct independent research on the selected topic. Task 2 is based on a number of case studies and the CFP 4 subject materials. You are required to answer six questions that have been designed to test your knowledge of investment strategies. In order to answer the questions successfully, you will need to consider the issues raised in the case studies and conduct your own research. A comprehensive list of resources can be found in the CFP Certification Program General Guidelines. It is expected that you will use current regulations and practice to inform your answers. You need to address all issues in this assignment within the word limit. To be able to write succinctly is an important skill for a financial planner. You must indicate the word length of your completed assignment. Assignments of excessive length will be penalised. A word count of up to 10% over the word limit will be accepted, but those assignments that fall outside of the acceptable range will have 10% of the total marks deducted. If your assignment significantly exceeds the word limit, it will only be assessed up to the 10% over the word limit. Note: Y ou must not exceed the word limit for either task (Task 1—500 words; Task 2—5000 words) even if you do not reach the word limit for one of those tasks. Refer to the 2017 Student Handbook for further information on penalties for exceeding word limits. Refer to the CFP Certification Program General Guidelines on how to present and submit your assignment. CFP 4 ASSIGNMENT SEMESTER 1, 2017 285_fpa_cfp4_asst_sem0117_v01-1_fa 4.2 Task 1 (10 marks) Research Part A Undertake research on one (1) of the following topic areas and obtain a recent article or report in this area. This may be a magazine article, online article, newspaper report, newsletter extract, relevant parts of a book and so on. The required readings for CFP 4 may not be used for this task. Select one (1) of the following for discussion: • the implications of geopolitical forces for portfolio management • portfolio management issues in an environment of low volatility, low growth or low inflation • the impact of investing in emerging markets in a diversified portfolio • the application of asset allocation to client portfolios through different life cycles • the expansion in socially responsible investments, issues involved in balancing returns to investors with ethical business operations, and principles for assessing what investments can be included in an ethical investment portfolio. Part B After sourcing your article and reading it thoroughly, write a brief synopsis. Your synopsis should cover: • a brief overview of the topic as it is addressed in the article • a critique of the major points presented and why you agree or disagree with them • an explanation of how the topic relates to contemporary financial planning practice. Your synopsis should be no more than 500 words, so write succinctly and use terms that a client would understand. Marks are allocated as follows: • 3 marks for the brief overview • 4 marks for the critique • 3 marks for relevance to contemporary financial planning practice. Note: Y ou must submit a copy of the selected article with your synopsis. Paste the text, a legible screenshot or a scanned image of the article into the last page(s) of your assignment submission template. If you have any difficulties, contact . Ensure that you provide details of the source of your selected article with your synopsis. (The text of the article or report is not included in the word limit for this task.) CFP 4 ASSIGNMENT SEMESTER 1, 2017 285_fpa_cfp4_asst_sem0117_v01-1_fa 4.3 Task 2 (90 marks) Question 1 (8 marks) Kate and Paul (aged in their late 40s) have come to see you for an initial meeting. They have a current financial planner, but they are questioning his ability to manage their growing investment portfolio as well as his ability to communicate with them about his firm’s investment philosophy and explain the reasoning behind changes he recommends to their portfolio. They have been saving some money to give to their only child (in two or three years time) to put towards a house deposit, and they are putting money away for a two-month aroundthe-world trip when they turn 60 years of age. (a) Explain to Kate and Paul in language they will understand how your firm ascertains a client’s risk profile and how regularly this is reviewed. Applying what you have learned in this course, are there any changes you would like to make to your firm’s process? (2 marks) (b) In your own words, explain to Kate and Paul what asset allocation is, why it is important and how you determine a client’s asset allocation. (2 marks) (c) Explain to Kate and Paul about the enhancements to the traditional portfolio construction process and how these enhancements will benefit them. (2 marks) (d) Kate and Paul ask you whether a client’s asset allocation will ever change. List two (2) changes in Kate and Paul’s circumstances that would cause you to re-evaluate their asset allocation. (2 marks) CFP 4 ASSIGNMENT SEMESTER 1, 2017 285_fpa_cfp4_asst_sem0117_v01-1_fa 4.4 Question 2 (16 marks) (a) A set-and-forget investment strategy was criticised during the global financial crisis (GFC) when traditional investment principles broke down. As a result, some investment professionals now argue for a more active approach to managing client portfolios to reduce the impact of drawdowns from similar events in future. Explain in your own words the differences between the two active methods of asset allocation—dynamic asset allocation (DAA) and tactical asset allocation (TAA)—and any limitations they may provide. In your response, justify if you prefer either method and why. (3 marks) (b) When investing offshore, currency fluctuations can have a positive or negative impact on an investor’s returns. Assume AUD 400,000 was invested equally across four countries/regions. Using the information below, calculate the value of the portfolio in three years time in Australian dollars and provide the overall currency impact for the three-year period. Show all calculations. Currency rates—AUD 1 vs. base currency Year 1 Year 3 Japanese yen 78.00 98.00 United States dollar 1.02 0.82 Euro 0.81 0.66 Portfolio Allocation/value— year 1 Three-year total return (unhedged) Australian shares AUD 100,000 27% Japanese shares AUD 100,000 75% United States shares AUD 100,000 48% European shares AUD 100,000 36% Total AUD 400,000 (5 marks) (c) An insurance company investment/education bond and a retail managed fund are two options for clients wishing to save for a child’s future education expenses. Based on the following scenario, calculate and comment on which portfolio is projected to provide the better outcome in terms of net proceeds for the child in 11 years time, when the investment is closed to pay for university fees. Scenario • Client’s (parent) marginal tax rate is 32.5% (ignore Medicare levy in workings). • Education/insurance bond investment option and retail managed fund projected returns are 8% per annum (4% for total income and capital gains on assets held for less than 12 months, and 4% for capital gains on assets held for more than 12 months). CFP 4 ASSIGNMENT SEMESTER 1, 2017 285_fpa_cfp4_asst_sem0117_v01-1_fa 4.5 • Annual turnover of the fund each financial year is 30%. (Half of this turnover is for income/capital gains held for less than 12 months, and half is for realised capital gains where the underlying assets were held for more than 12 months.) • Initial investment is $10,000, with additional contributions of $1000 after 12 months (start of year 2) and each year thereafter. • Both portfolios are fully withdrawn on the second day on year 12. Ignore any capital income/growth for these two additional days. Show all figures to zero decimal places. Complete the following templates as part of your response: Insurance bond (year) Contribution Return on investment (ROI) Tax Balance at end of year (EOY) 1 2 3 4 5 6 7 8 9 10 11 Retail managed fund (year) Contribution ROI ≤12 months ROI >12 months Tax Balance EOY 1 2 3 4 5 6 7 8 9 10 11 (8 marks) CFP 4 ASSIGNMENT SEMESTER 1, 2017 285_fpa_cfp4_asst_sem0117_v01-1_fa 4.6 Question 3 (18 marks) This Case study relates to both Question 3 and Question 4. Albert (aged 63 years) and Tina (aged 61 years) have come to you for financial guidance on how they should invest their retirement capital to achieve their retirement goals. They have recently inherited $750,000 from Tina’s mum’s estate. Given that they are debt-free empty-nesters, they can afford to contribute this money into super and build their retirement capital. Albert subscribes to a number of investment newsletters and has a keen interest in investments but by his own admission is not an expert and wishes to receive professional advice. After receiving the inheritance, Albert and Tina set up a self-managed superannuation fund, consolidated their existing super accounts and contributed the inheritance into the self-managed superannuation fund. This was done on the advice of their accountant. Their self-managed superannuation fund has the following investments: Cash $900,000 Vanguard Australian Fixed Interest Index Fund (VAF) $50,000 Vanguard Australian Shares Index Fund (VAS) $75,000 Vanguard MSCI Australian Small Companies Index ETF (VSO) $30,000 Both Albert and Tina are wary of investment costs and have therefore taken the approach of investing through low-cost exchange-traded funds (ETFs). They have the following goals: • retire in two years time, when Albert turns 65 • have a retirement income of $50,000 per annum • develop a portfolio that is well diversified and will provide income and growth over the long term • have the ability to be nimble and take advantage of cyclical opportunities by quickly moving in and out of various markets depending on prevailing conditions. They would like to implement this based on advice from the various investment magazines and newsletters they subscribe to. The various sources of information they are receiving have left them confused, and they wish to receive personal advice from you to initially construct their portfolio. They have read a lot about the current ‘low-return environment’ that we are likely to be in for some time and about some of the alternative investments and strategies that can be utilised to achieve good returns in the future. CFP 4 ASSIGNMENT SEMESTER 1, 2017 285_fpa_cfp4_asst_sem0117_v01-1_fa 4.7 After a detailed discussion of investment concepts and the completion of a risk profile questionnaire, Albert and Tina both come out as ‘aggressive’ investors. According to your licensee guidelines, a suitable portfolio for an aggressive risk profile has the following asset allocations: Australian shares 38% International shares 37% Australian fixed interest 5% International fixed interest 5% Cash 5% Property 10% Total 100% According to your licensee guidelines, for investors with an aggressive risk profile, you can direct a portion of their portfolio from growth assets (shares and property) to alternative assets and strategies based on client need and risk profile. The following ETFs, alternative investments, managed funds and cash funds are available on your licensee’s approved product list for you to recommend: • Vanguard Australian Fixed Interest Index Fund (VAF) • Vanguard International Fixed Interest Index Fund (VIF) • Vanguard Australian Shares Index Fund (VAS) • Vanguard MSCI Australian Small Companies Index ETF (VSO) • Vanguard Australian Property Securities Index Fund (VAP) • Vanguard International Shares Index Fund (VGS) • the full suite of BetaShares ETFs—available at • Magellan Infrastructure Fund (unhedged) • Aspect Diversified Futures Fund—Class A • Bennelong Kardinia Absolute Return Fund • Macquarie Cash Management Trust (CMT) • Platinum International Fund • PIMCO Diversified Fixed Interest Fund. (a) Taking into consideration the three Vanguard ETFs the clients currently invest in, identify and discuss four (4) concerns that you would raise with them in relation to their current self-managed superannuation fund portfolio. (4 marks) (b) Tina asks whether they should invest in the BetaShares Gold Bullion ETF (QAU). Given their circumstances, goals and the current economic climate, advise them on whether an investment in gold is appropriate or not and why. In your discussion, outline one (1) advantage and one (1) disadvantage of this asset class. (3 marks) CFP 4 ASSIGNMENT SEMESTER 1, 2017 285_fpa_cfp4_asst_sem0117_v01-1_fa 4.8 (c) Given the clients’ circumstances, what percentage of their portfolio (if any) would you allocate to alternative assets, and why? (2 marks) (d) After researching the alternatives on your licensee’s approved product list, you decide that an allocation to alternative investments is appropriate and settle on a shortlist of the following options that can form the alternative asset allocation for Albert and Tina’s self-managed superannuation fund: i. Magellan Infrastructure Fund (unhedged) ii. Aspect Diversified Futures Fund—Class A iii. Bennelong Kardinia Absolute Return Fund. Explain to Albert and Tina in simple terms the benefits to their portfolio of adding each of the funds, and discuss two (2) risks for each strategy that they need to be aware of. (9 marks—3 marks for discussion of each option) CFP 4 ASSIGNMENT SEMESTER 1, 2017 285_fpa_cfp4_asst_sem0117_v01-1_fa 4.9 Question 4 (21 marks) Albert and Tina have been reading with interest that an increased number of exchangetraded funds (ETFs) in Australia now use strategies other than the traditional market cap weighted indexing approach to invest money. They are keen to utilise some of these in their portfolio. Albert is also keen to explore options within the self-managed superannuation fund to gain geared exposure to Australian shares. He has read about geared share funds and ETFs that are available but is particularly interested in how warrants can also be used for this purpose. a) Albert has read about a unique ETF called the Australian Dividend Harvester Fund (HVST) that invests money in a different way to traditional ETFs. Explain to Albert how HVST invests money and how this method differs from Vanguard Australian Shares Index Fund (VAS), which he and Tina already own. Your response should compare the investment approaches of HVST and VAS and also outline two (2) risks associated with HVST that aren’t applicable to VAS. Justify whether this would be a suitable investment given the clients’ goals. (3 marks) b) Explain to Albert and Tina how they can use ETFs to gain tactical exposure to different asset classes or markets, and provide two (2) examples of ETFs in the Australian market that can be used for this type of strategy (refer to Case study approved product list). (2 marks) c) Albert asks you to clarify how a self-funding instalment warrant (SFI) differs from a normal warrant and whether this type of investment would be suitable for their portfolio. To assist in your response, use a simple cashflow table of the interest and dividend payments for the following hypothetical SFI: • XYZ shares currently trading at $18.50 per share. • XYZ self-funding instalment loan amount is $9.75 per share. • The forecast dividend for XYZ shares over the next two years is $0.75 per annum per share, which is payable six-monthly ($0.375 every six months) and is 100% franked. • The interest rate on the loan amount is 6.25% per annum. Use the following table in your response: Cash flow Loan balance Issue date Dividend 1 Dividend 2 Year 1 Interest Dividend 1 Dividend 2 Year 2 Interest (3 marks) CFP 4 ASSIGNMENT SEMESTER 1, 2017 285_fpa_cfp4_asst_sem0117_v01-1_fa 4.10 d) Albert and Tina’s portfolio holds 1065 VAS shares, currently valued at $70.42 per share. They are concerned that over the next six months, the price of VAS shares may fall. They are considering purchasing a put warrant with the following features to protect their portfolio: • purchase price—$2.50 • exercise price—$71.00 • expiry date—six months • conversion ratio—1 for 1. Demonstrate to Albert and Tina the impact on their portfolio if: i. VAS share price rose to $74 at expiry. ii. VAS share price fell to $66 at expiry—assume the warrant is valued at $5 at expiry if this happens. Use calculations to support your response and advise them on whether it is a good strategy to use this put warrant to hedge against a price fall. (4 marks) e) You decide on a core and satellite approach to constructing Albert and Tina’s portfolio. Based on their asset allocation (as per their aggressive risk profile as previously stated) and your view on the appropriate allocation to alternative assets, construct a suitable portfolio that you believe will help them to achieve their goals. Choose from the investments available within your licensee’s approved product list as provided in the Case study. Your response should address the following: i. the asset allocation of Albert and Tina’s portfolio after the implementation of your recommendations ii. the amount invested in each investment iii. why you have chosen to include the recommended investments in the portfolio, and how they help to achieve the clients’ goals iv. why the clients are better off as a result of implementing your recommendations. The benefits should be linked back to the client objectives. For recommended asset allocation and investment manager weightings, present the numerical component of your response using the table below: Asset class Target strategic asset allocation (SAA) (%) Recommended allocation (%)— core vs. satellite Recommended investment manager ($)—core vs. satellite Cash Australian fixed interest International fixed interest Property Alternative assets Australian shares International shares Total (9 marks) CFP 4 ASSIGNMENT SEMESTER 1, 2017 285_fpa_cfp4_asst_sem0117_v01-1_fa 4.11 Question 5 (15 marks) This information relates to both Question 5 and Question 6. Your financial planning practice provides investment management services, including direct investment in ASX-listed securities. For clients who have an allocation to Australian shares, you construct investment portfolios using a model portfolio (which you replicate for clients on an individual basis). You are considering adding an extra holding to your model investment portfolio and have identified two securities that meet your investment criteria. One is a company that operates in the property sector. The other is a company that operates in the finance sector. To assist with your decision, you plan to conduct some additional analysis. You begin with a consideration of the historical returns of these securities and a commonly used market index. You have also calculated the average return over the relevant period (for data, refer to the following table and an Excel spreadsheet will be available to refer to in your online resources kit). Note: for calculations please refer to your CFP 4—Investment Strategies unit material for the relevant formulae. Date Market Property Finance 31-Dec-15 -0.82% -13.05% 1.77% 31-Dec-14 0.66% 47.22% 2.41% 31-Dec-13 14.76% 20.04% 25.08% 31-Dec-12 13.46% 29.61% 30.20% 31-Dec-11 -15.18% -17.03% -9.95% 31-Dec-10 -0.73% -13.02% -12.21% 31-Dec-09 33.43% 42.64% 49.09% 31-Dec-08 -43.01% -58.38% -39.22% 31-Dec-07 13.76% -6.18% 15.18% 31-Dec-06 19.87% 27.35% 6.55% 31-Dec-05 16.18% 9.28% 16.73% 31-Dec-04 22.60% 31.84% 21.89% 31-Dec-03 11.11% 3.40% 16.29% 31-Dec-02 -11.44% -25.52% -12.73% 31-Dec-01 6.51% -22.04% 19.41% 31-Dec-00 1.48% -21.56% 25.57% 31-Dec-99 15.27% -3.00% -3.78% 31-Dec-98 4.55% 46.67% 11.25% 31-Dec-97 7.27% 22.95% 37.09% CFP 4 ASSIGNMENT SEMESTER 1, 2017 285_fpa_cfp4_asst_sem0117_v01-1_fa 4.12 Date Market Property Finance 31-Dec-96 9.88% 25.13% 20.13% 31-Dec-95 15.69% 22.18% 37.33% 31-Dec-94 -12.15% -10.14% -6.26% 31-Dec-93 35.50% 20.82% 43.34% 31-Dec-92 -6.63% -18.78% -29.77% 31-Dec-91 29.04% 23.42% 38.86% 31-Dec-90 -22.43% 13.64% -38.52% 31-Dec-89 10.93% 27.93% 2.27% 31-Dec-88 12.77% 6.00% 38.17% 31-Dec-87 -10.48% 3.77% 1.43% 31-Dec-86 46.76% 84.67% 7.96% 31-Dec-85 38.25% 13.86% 29.53% 31-Dec-84 -6.35% 14.84% -3.47% 31-Dec-83 59.72% 76.28% 45.25% 31-Dec-82 -18.49% -14.42% -12.33% 31-Dec-81 -16.54% 1.27% -0.66% 31-Dec-80 42.70% 45.52% 8.63% 31-Dec-79 36.57% 13.10% -0.44% 31-Dec-78 13.59% 11.44% 21.82% 31-Dec-77 10.61% 30.67% 10.89% 31-Dec-76 -2.64% -22.41% -17.96% 31-Dec-75 48.46% 93.33% 59.04% Average 10.35% 13.74% 11.12% Source: Based on data from IRESS, https://www.iress.com/au/, accessed February 2017. (a) In light of the information in the table, calculate the variance and standard deviation of returns for the market, property security and finance security (correct to two (2) decimal places). Compare your results with consideration to the average return of each security and the index. Note: F or the sake of consistency, please use the methodology outlined in your course materials. Please note that this methodology is appropriate for a data set that represents all available observations in an entire population (rather than just a sample). (3 marks) CFP 4 ASSIGNMENT SEMESTER 1, 2017 285_fpa_cfp4_asst_sem0117_v01-1_fa 4.13 (b) Explain how standard deviation can be used to help inform investors about the range of investment returns attributable to an asset (assuming asset returns are normally distributed). Refer to ‘confidence levels’ in your answer and provide an example of the range of returns you’d expect at different confidence levels. (3 marks) (c) Calculate the covariance of the property stock with the market and the covariance of the finance stock with the market. Show your workings and provide a description of the methodology used to calculate covariance. (2 marks) (d) Calculate the correlation coefficient of each security with the market (correct to two (2) decimal places). That is, calculate the correlation coefficient of the property stock with the market and the correlation coefficient of the finance stock with the market. Based on your findings, draw some basic conclusions as to the potential benefit of adding either of the stocks into the portfolio. (2 marks) (e) Based on your findings in the above questions, provide a value for β (the beta coefficient in the capital asset pricing model) for each asset. Show your workings. What do the calculated values for β tell you about the expected returns of these securities? (3 marks) (f) β is often described as a measure of ‘systematic risk’. Explain the concept in your own words. (2 marks) CFP 4 ASSIGNMENT SEMESTER 1, 2017 285_fpa_cfp4_asst_sem0117_v01-1_fa 4.14 Question 6 (12 marks) Further to Question 5, you repeat the exercise by extending the return data to include another nine years. Your updated analysis reveals: • The beta for the property security in Question 5 is 1.21. • The beta for the finance security in Question 5 is 0.82. • A reasonable estimate of the long-term expected return for the Australian Share Market is 8.85% with a standard deviation of 21.88%. (a) The capital asset pricing model relies on the idea of a ‘market or equity risk premium’. Explain this concept in your own words, including how investment professionals would determine these values. (3 marks) (b) Assuming the 10-year government bond (spot) rate is 2.81%, use the updated analysis at Question 6 to calculate the expected return of the property and finance securities under the capital asset pricing model. Show your workings. (3 marks) (c) Based on your findings in Questions 5 and 6, which of the two securities will you add to the model investment portfolio? Explain your reasoning in detail. How would you adjust your approach if your medium-term outlook for investment returns were low or even negative? (2 marks) (d) Explain how the capital asset pricing model is still relevant to modern financial planning practice for businesses that do not recommend direct equities. Provide a clear and concise justification for your response. (2 marks) (e) The capital asset pricing model is based on modern portfolio theory. Outline some limitations of the capital asset pricing model that, if the model was followed absolutely, would lead to adverse results. (2 marks) End of assignment