Investments & Risk Management
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Table of Contents
Section A: Investment Profile, Strategy, and Investment ……………………………………………………… 3
Investor risk profile……………………………………………………………………………………………………… 3
Passive Portfolio …………………………………………………………………………………………………………. 3
Investment Strategy ………………………………………………………………………………………. 3
Performance of Passive Stock Portfolio …………………………………………………………………………. 5
Market Outlook…………………………………………………………………………………………………………… 5
Section B: Active Portfolio and Rebalancing ……………………………………………………………………… 6
Active Portfolio…………………………………………………………………………………………………………… 6
Investment Strategy ………………………………………………………………………………………. 7
Rebalancing………………………………………………………………………………………………….. 8
Section C: Absolute and Risk-adjusted return…………………………………………………………………… 12
Passive Portfolio ……………………………………………………………………………………………………….. 13
Active Portfolio…………………………………………………………………………………………………………. 15
VaR …………………………………………………………………………………………………………………………. 17
References……………………………………………………………………………………………………………………. 18
Appendix……………………………………………………………………………………………………………………… 21
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Section A:
Investment Profile, Strategy, and Investment:
This section would pave insight to risk profile, investor strategy and outlook for market. The client is mid
aged government employee, Mr. Akbar Ali who opted for passive investment for last five years and now
tend to actively invest in a portfolio over 10 weeks.
Investor risk profile
Every person has a risk profile from low risk, moderate risk, and high-risk profile. This risk profiling affects
the asset selection and investment strategy. Financial and psychological attitude toward level of risk
tolerance determines the risk profile of a Person (Bortoli et al., 2019). The risk tolerance test can be
performed online and test for Mr. Akbar Ali concluded that he is a moderate risk taker. Results are disclosed
in the appendix A (Investright, 2022).
Passive Portfolio
Under Passive Strategy, investor tend to hold stock to benefit in a long run through increase in prices. In
passive strategy, investor does not need frequent buying and selling. The stock is held over particular time
period (Padyšák, 2020). Under this strategy, stock has been contained by the investor to maximize their
profit from dividends and capital gains. In management of passive portfolio, diversification strategy is used
that enables the investor to see through a variety of investment in different industries within the portfolio
(Bama, 2020). Use of diversification effectively can enable an investor to overcome the risk of being
affected by bad performance of one asset or industry which is referred to unsystematic risk (unsystematic
risk only affect particular segment of markets) (Vakulchyk & Protasova, 2017).
Investment Strategy
Passive portfolio for the client was established before five years in Feb 2017. The client invested
1,000,000 GBP at the London Stock Exchange. As all the passive investment is made in the
London Stock Exchange, portfolio is exposed to systematic risk. In order to restrict the
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investment’s vulnerability to market risk (Systematic risk), investments have been made in equities
with betas lower than 1.0, taking the investor’s risk profile (moderate risk profile) into account
(Scholtz, 2014). All stocks are bought within FTSE 250 index (screening criteria in appendix B).
Shares of FTSE 250 listed companies are bought as investor has opted for value investing strategy.
The stocks were selected under value investing strategy. 10 Stocks with lowest P/E ratio was
selected for investment. Value investing is a passive strategy that requires the significant time
period to grow to actual values (Damodaran, 2012).
Figure 1 Passive Portfolio (Bloomberg, 2022)
A portion of investment has been allocated for each company of five different industries to mitigate
the unsystematic risk. 5 stocks shall be invested in Real Estate, 2 in industries, 1 in financials and
consumers discretionary and 1 is not classified. The construction of passive portfolio is disclosed
in appendix C. Risk profile of the investor was the primary factor for decision of investment in
equity stock. Investor is of moderate level of risk profile; therefore, we have selected the LSE
market. Due to low profitability on fixed income instruments (Wang, 2017), investor refused to
invest rather he wanted to invest in stock market to exponentially benefit from rise in the portfolio.
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Performance of Passive Stock Portfolio
Figure 2 Performance of Passive Portfolio
The passive portfolio was discharged on Feb 1, 2022, after five years. The performance of
passive portfolio has shown that portfolio has failed to be lived up to expectations as stocks did
not appreciate as expected under the value investing as it has produced loss over the holding. The
portfolio has depreciated from 819,000 GBP from 1 million GBP invested.
Market Outlook:

Figure 3 Market outlook data Source: (Trading Economics, 2021)
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Figure 4 Expected Return Source: Bloomberg (2022)
Bloomberg has estimated that there is positive return expected from the FTSE 100 at 0.86%.
Section B
Active Portfolio and Rebalancing
The passive portfolio was closed on Feb 1, 2022, at 819,000 GBP. The capital was invested in
active portfolio in an attempt to beat the market index (FTSE 100). Now the investor wanted to
invest in active portfolio where frequent management of portfolio is done to earn profit on
regular basis. Investor priority for dividends has been shifted from retaining profits. Dividends
were more appeAkbar Aling in term of high returns. It seemed feasible to the investor to go for
current dividends.
Active Portfolio
The active portfolio is significantly different from the passive portfolio as it does not encompass
the regular buying and selling. The distinctive feature of the active portfolio is selling the
unprofitable stock or low profit stock and rebalancing with a better investment. The active
portfolio is used by investors to generate higher return than the market. It involves higher cost
than passive portfolio (Allaj, 2011).
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Investment Strategy
New active portfolios were created once a passive portfolio was liquidated. Investing in both fixed
income securities such as corporate bonds and equities was performed. Eighty percent of the funds
were allocated to stocks, while the remaining twenty percent were allocated to corporate bonds.
On the basis of momentum strategy, stocks were selected. Momentum strategy enable the investor
to select the stock which are already in great momentum and expected to provide higher return
than market (Zhao et al., 2018).
Figure 5 Active Portfolio
The active portfolio was constructed on March 1, 2022. The stocks are selected on basis of
momentum strategy. Best performing equities over past three months were selected (HL, 2022).
80% of capital was placed in four equities and 20% placed in SPDR BBG Sterling high yield bond
fund.
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The bond is investment grade under moody ratings as disclosed in appendix d. Investment grade
bonds have a better credit rating and a lower chance of default as the bonds are less risky and pay
a set amount of return (Singh & Mathur, 2013).
Rebalancing
Rebalancing is practice of removing undesired or security which is expected to provide loss
where adding the investment which is expected to provide higher returns than market
Rebalancing.
1st Rebalancing
The outcome of portfolio was evaluated at the end of 3rd week of investment. CAPM Model is
utilized to measure the expected return and perform the rebalancing. It comprehends the cost of
equity and measures the association between systematic risk and expected return (Fernandez,
2014).
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Figure 6 SML (Fernandez, 2014)
Security Market Line (SML) has been shown above in the Figure 5. Overvalued stocks are those
that are below the SML, while undervalued stocks are those that are above the SML. It’s a good
idea to get rid of overvalued stocks since they’re now providing a lesser return (Fernandez, 2014).
CAPM return is measured at Bloomberg via EQRP function as shown in below table.

CAPM model has estimated the expected returns and these expected returns are compared with
the actual return over the years. The portfolio returns as of March 22, 2022, are disclosed in the
appendix e. Two stocks are found as undervalued and two are found as overvalued. AZN
overvalued stocks would be rebalanced with another stock on the basis of momentum strategy with
stocks that are performing higher returns over the past two months. AZN is rebalanced as it has
generated profits while BAE is also overvalued, and it has generated profits (as selected on the
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basis of momentum investing) we are expecting the stocks to provide positive return. AZN is
rebalanced with GSK Plc. Over the past six months, it has generated return of 29% (HL, 2022).
2nd Rebalancing
2nd rebalancing is performed at the end of six week. This time rebalancing has been performed
on the basis of the dividend discount model. The dividend discount model (DDM) was
introduced by Gordon in 1962. The dividend discount model states that there is dividend would
grow at constant rate for infinite period. The market price or intrinsic of investment can be found
by discounting all the future dividends payments (Ferguson, 1998). The DDM model for given
securities are taken from Bloomberg (2022). The DDM model is widely used to estimated
whether investment is undervalued or overvalued. The DDM models are provided in table 1.

Table 1 DDM Model (Bloomberg, 2022)
Table1 states that three stocks are overvalued as per DDM model and only one stock is
undervalued performed. As the investment are bought under the momentum investing,
overvalued stocks are expected in portfolio. Now, performance of stocks would be evaluated as
of April 12, 2022. The performance of stock is attached below.
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Figure 7 Stock Performance till April 12, 2022 (Bloomberg, 2022)
Above figure has demonstrates that all stocks have very strong positive return. Even AZN has
produced profit, but rebalanced GSK has provided higher return which has encouraged portfolio
manager to rebalance the overvalued stock with lowest total return YTD. Hence, we have opted
to rebalance BAE system with Shell Plc which is expected to overcome bearish trend and pick up
the momentum.
3rd Balancing
The 3rd balancing is performed on the basis of relative equity valuation metrics. These tools are
also used to find the fundamental value of the investment and can help investor in determining
the undervalued or overvalued stocks. This rebalancing was performed at the end of eight week.
Earnings multiplier (P/E ratio) was used to compare the price of stocks with earnings to compare
the overvalued or undervalued stocks (Viebig et al., 2008).
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Figure 8 P/E ratio of Portfolio (Bloomberg, 2022)
As higher P/E ratio is unattractive, we have opted to rebalance the stock, GSK which has
exhibited highest P/E ratio at 17.58 times It is rebalanced with another momentum stock on May
3, 2022, with Standard Chartered plc which has provided return of 13.52% over last month. This
portfolio will be held until May 17, 2022. The active portfolio will be disposed over 10 weeks.
Section C
Absolute and Risk-adjusted return:
This section would examine the absolute and risk adjusted performance of the absolute and risk
adjusted return.
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Passive Portfolio
Figure 9 Passive Portfolio over five years
Figure 8 has stated that Passive portfolio has suffered bearish trend till 2019 where value stocks
have posted adverse performance. At the start of 2019, portfolio has started to increase in value,
and it has continued till 2022. It has led the portfolio to post absolute return of 52% which has
outperformed the market where market index (FTSE 250) has performed lower return at 37%
making passive portfolio to accomplish objective by outperforming market.
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Figure 10 Risk adjusted Return of Portfolio
The standard deviation is measure of risk that project the deviation from mean points. Higher
standard deviation is implying for higher risk (Sedgwick, 2019). The portfolio has posted slightly
higher standard deviation than portfolio which makes the portfolio riskier. Portfolio has also
posted slightly higher downside risk. Tracking error indicates the size of difference between
portfolio return and market benchmark (Evans & van Vuuren, 2019) (FTSE 250). The tracking
error has indicated that portfolio size at 12.28. Sharpe ratio, Jensen Alpha, Information ratio and
Treynor ratio can be used to measure the risk adjusted performance.
1. Sharpe ration comprehends the risk excessive of risk-free rate over standard deviation. It
measures return relevant to standard deviation. As portfolio has posted slightly higher
Sharpe ratio than the market, it has produced better risk (Sharpe, 1994).
2. Jensen Alpha is recorded for 3.97 times implying for abnormal risk adjusted return
(Breloer & Scholz, 2014).
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3. Treynor ratio is also positive which implies that stock has produced higher return over
risk free rate relative to volatility (Hubner, 2003).
Active Portfolio
Figure 11 Active Portfolio Absolute Return
The active portfolio has produced absolute return of the 6.36% which is significantly higher than
market where the FTSE 250 index has produced loss of the -1.38%. Figure 10 has also shown
that portfolio has significantly dominated the market return as indicated by green period.
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Figure 12 Portfolio Performance
Figure 11 has shown that portfolio has outperformed the market index as market has suffered
loss where portfolio produced return of 6.36%. The portfolio has posted slightly higher standard
deviation than portfolio which makes the portfolio riskier. Portfolio has also posted slightly
higher downside risk. Tracking error indicates the size of difference between portfolio return and
market benchmark (Evans & van Vuuren, 2019) (FTSE 250). The tracking error has indicated
that portfolio size at 28.73 implying for bigger disparity between actual return and benchmark.
Sharpe ratio, Jensen Alpha, Information ratio and Treynor ratio can be used to measure the risk
adjusted performance.
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1. Sharpe ration comprehends the risk excessive of risk-free rate over standard deviation. It
measures return relevant to standard deviation (Sharpe, 1994). As portfolio has posted
slightly higher Sharpe ratio than the market, it has produced better risk. The negative sign
implies for loss over the period.
2. Jensen Alpha is recorded for 37.97 times implying for extra ordinary high abnormal risk
adjusted return (Breloer & Scholz, 2014).
3. Treynor ratio is also positive which implies that stock has produced higher return over
risk free rate relative to volatility (Hubner, 2003).
VaR
The VaR metric is used to assess a portfolio’s market risk. It includes the portfolio’s risk
exposure, as well as market risk specifically. This is the worst-case situation, in which the
investor suffers the most loss (Kenton, 2019). VaR is determined using a 1-day interval and a 95
percent confidence interval (CI). The portfolio earned a return of 21,010 GBP, according to the
VaR (Para). Appendix f has further information.
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References
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Fernandez, P. (2014). CAPM: An Absurd Model. SSRN Electronic Journal.
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HL. (2022). FTSE 100: Performance. Hargreaves Lansdown; Hargreaves Lansdown.
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Trading Economics. (2022). United Kingdom – Economic Indicators. Tradingeconomics.com.
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Appendix
Appendix A: Risk Profile

Appendix B-Equity Screening
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Appendix C: Passive Portfolio
Appendix D: Bond Screening
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Appendix 5: Portfolio Return
Appendix E:
Composition of Active Portfolio
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Appendix F: