Research Paper Week 5

5.0 Recommended Asset allocation Based on the investors profile it is suggested to go with a relatively aggressive portfolio. Given the goal that James has to purchase his own property, this will be one of the suggested investment vehicles. Besides this a relatively high proportion of investment will be allocated to equity. Some of this is suggested to be invested in equities outside Indonesia, given the high volatility of the Indonesian equity market, this might give more stable results to James. It needs to be observed though that investing outside Indonesia introduces a currency risk. It is recommended to have a reasonable proportion of the investment allocated to bonds, there are two reasons for this; firstly the bond yield in Indonesia are high, and the returns are close to the targeted returns that James is looking for. Thus adding a reasonable portion of bonds to the portfolio helps James reducing risk in his portfolio, this will reduce returns but not below his actual target. Secondly, as the country is becoming more and more stable politically and economically, one might anticipate interest rates to come down somewhat in the mid long term. Being invested in medium to long duration bonds can then create the additional benefit of capital gains. In summary the recommended portfolio of assets looks as follows;

Asset Class Local Equity Local Fixed Income Property Foreign Equity Cash/deposits Total

Allocation 30.0% 25.0% 20.0% 15.0% 10.0% 100.0%

5.1 Local Equity The 30% allocation of the inherited capital to local equity represents an equivalent amount of 60k James needs to consider a number of issues when investing this money; 1. Diversification When investing in equity it is important to obtain enough diversification in his portfolio; in terms of different stocks as well as over different industries. Diversification is best obtained by investing in equities whose performance is not closely correlated. Diversification therefore is found by spreading over different industries for example. In order to achieve this with a limited budget it would be recommended to make use of the services of a fund manager. 2. Management and analysis Optimizing equity performance requires the investor to set out an investment strategy and execute strategy this consistently. This requires the investor to continuously follow movements in the market as well requires him to have the technical skills to analyze and make decision. Since James does not have time nor the technical knowledge and skills to define a trading strategy and continuously monitor the market in order to execute this trading strategy, again the use of the services of a professional fund manager seems to make sense.

The cost of using a professional fund manager in Indonesia is 200 to 250 Bps. Alternatively James could manage his own portfolio but would still be facing some trading cost. The one issue that James will obtain for the price of 200 Bps is that he will not have to define his own trading strategy and/or execute is consistently. Also since he

does not have any technical skills or tools to monitor and make investment decisions, he’s more likely to make a higher return on his investment despite the cost he has to pay for the service. The benchmark for the equity performance will be the performance of the Jakarta Composite Index. The goal should be to outperform this index. Most fund managers will publically announce their benchmark for fund they offer, and therefore it should be possible for James’ to indentify a fund that has the same benchmark as he has for himself.

Local Fixed Income The local fixed income market is primarily a government bond market, although in more recent years the number of corporate bonds of quality has increased quite significantly. The lot size for investing one bond is 100k This means that James is unable to diversify his portfolio without again using the services of a professional fund manager. The cost of using a professional fund manager in the fixed income section in Indonesia is 125 to 175 Bps. Alternatively James could manage his own portfolio but would still be facing some trading cost. An additional benefit is that the capital gains as well as the coupon payments on fixed income held in a mutual fund are free of tax in Indonesia, whereas in case of direct holding they would be subject to 15% final tax. This alone will make it more attractive for James to use a fund manager, rather then invest direct. The benchmark for the fixed income performance will be the HSBC fixed income index for Indonesia. The goal should be to outperform this index. Most fund managers will publically announce their benchmark for fund they offer, and therefore it should be possible for James’ to indentify a fund that has the same benchmark as he has for himself

Property 20% of the current allocation of fund will be directed towards James’ new property. This 20% will be in the form of down payment and through monthly installments the proportion of fund allocated to his property will increase.

Foreign Equity The foreign equity proportion will again be subjected to the same limitation as we saw on the local equity funds; this again means that the use of a fund manager would make sense, as James time sand expertise are not sufficient to manage his own portfolio with optimal results. The cost of using a professional fund international equity fund manager is around 200 Bps. Alternatively James could manage his own portfolio but would still be facing some trading cost. The one issue that James will obtain for the price of 200 Bps is that he will not have to define his own trading strategy and/or execute is consistently. Also since he does not have any technical skills or tools to monitor and make investment decisions, he’s more likely to make a higher return on his investment despite the cost he has to pay for the service. The benchmark for the equity performance will be the performance of an international index. The goal should be to outperform this index.

Cash

Some of James money will be kept absolutely liquid and will function as a first buffer against unexpected cost. Since James is not able to safe much from his current monthly income liquidity is important as borrowing against credit card or other personal loan arrangement are likely more expensive than the income lost because of allocating to cash rather than another asset class.

Rebalancing the portfolio James will have to rebalance his portfolio on regular bases. In this process he will need to asses how his personal situation has changed and how this might impact his risk appetite and therefore how it might impact his investment strategy. Secondly he will need to take into account how the balance between the different sectors in his investment portfolio have changed; if one or the other has show a significantly different performance then the other he might want to rebalance between the different assets classes and bring things back in line with the original (or the adjusted) strategy. Initially this process would take place once a year, but this frequency might be adjusted later on.