Subject material for course Islamic Investment

1. ISLAMIC INVESTMENT
Mahyuddin Khalid
emkay@salam.uitm.edu.my
Investment Analysis and Portfolio Management

2. Chapter Outline
 Individual Investor Life Cycle
 The Portfolio Management Process
 The Need for Policy Statement
 Constructing the Policy Statement
 The Importance of Asset Allocation
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3. What is asset allocation?
Asset Allocation
•Process of deciding how to
distribute an investor’s
wealth among different
countries and asset classes
for investment purposes
Asset Class
•Group of securities that have
similar characteristics,
attributes, and risk/return
relationships
Not an isolated
choice, but
rather a
component of
the portfolio
management
process.
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4. Managing Risk
Since risk drives
expected return,
investing involves
managing risk
rather than
managing return.
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5. Risk Management Strategies
Risk
Avoidance
• Can avoid any real chances of loss
• Generally a poor strategy except for a
part of an overall portfolio
Risk
Anticipation
• Position part of your portfolio to protect
against anticipated risk factors
• For example, maintain a cash reserve
Risk Transfer
• Insurance and other investment vehicles
can allow for the transfer of risk, often at
a price, to another investor who is willing
to bear the risk
Risk
Reduction
• Effective diversification and asset
allocation strategies can reduce risk,
sometimes without sacrificing expected
return.
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6. Individual Investor Life Cycle
The individual
investors life
cycle can often
be described
using four
separate phases
or stages
Accumulation
Phase
Consolidation
Phase
Spending
Phase
Gifting Phase
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7. Phases of an Investor’s Life Cycle
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8. Accumulation Phase
Early to
middle
years of
careers
Attempting to satisfy
intermediate and
long-term goals
Net worth is usually
small, debt may be
heavy
Long-term investment
horizon means usually
willing to take
moderately high risks
in order to make
above-average
returns
8

9. Consolidation Phase
Past
career
midpoint
Have paid off
much of their
accumulated debt
Earnings now
exceed living
expenses, so the
balance can be
invested
Time horizon is
still long-term, so
moderately high
risk investments
are still attractive
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10. Spending Phase
Usually
begins at
retirement
Saving before,
prudent spending
now
Living expenses
covered by Social
Security and
retirement plans
Changing emphasis
toward preservation
of capital, but still
want investment
values to keep pace
with inflation
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11. Gifting Phase
Can be
concurrent
with
spending
phase
If resources allow,
individuals can now
use excess assets to
provide gifts to
other individuals or
organizations
Estate planning
becomes important,
especially tax
considerations
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12. The Portfolio Management Process
4 step process:
Construct a
policy statement
Study current
financial
conditions and
forecast future
trends
Construct a
portfolio
Monitor
needs and
conditions
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13. Portfolio Management Process
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14. The Portfolio Management Process
Specifies
investment
goals and
acceptable
risk levels
Should be
reviewed
periodically
The “road
map” that
guides all
investment
decisions
Policy
statement
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15. The Portfolio Management Process
Study current financial
and economic
conditions and
forecast future trends
Determine strategies
that should meet goals
within the expected
environment
Requires monitoring
and updates since
financial markets are
ever-changing
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16. The Portfolio Management Process
Allocate
available funds
to meet goals
while managing
risk
Given the
policy
statement and
the expected
conditions, go
about investing
Construct the
portfolio
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17. The Portfolio Management Process
Monitor and update
Revise policy
statement as
needed
Monitor
changing
financial and
economic
conditions
Evaluate
portfolio
performance
Modify
portfolio
investments
accordingly
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18. The Policy Statement
 Understand and articulate realistic investment objectives and
constraints
 Know yourself
 Know the risks and potential rewards from investments
 Learn about standards for evaluating portfolio performance
 Know how to judge average performance
 Adjust for risk
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19. The Policy Statement
 Don’t try to navigate without a map!
 Begins with:
 Profile analysis
 Investor’s current and future financial situations
 Important Inputs:
 Investment Objectives
 Investment Constraints
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20. Investment Objectives
Need to specify
return and risk
objectives
Need to
consider the
risk
tolerance of
the investor
Return goals
need to be
consistent
with risk
tolerance
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21. Investment Objectives
Capital
preservation
• Maintain purchasing power
• Minimize the risk of loss
Capital
appreciation
• Achieve portfolio growth through
capital gains
• Accept greater risk
Current
income
• Look to generate income rather than
capital gains
• May be preferred in “spending phase”
• Relatively low risk
Total return
• Combining income returns and
reinvestment with capital gains
• Moderate risk
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22. Investment Constraints
These factors may limit or at least impact the investment
choices
• How soon will the money be needed?Liquidity needs
• Influences liquidity needs and risk tolerance
• Longer investment horizons generally requires
less liquidity and more risk tolerance
Time horizon
• Limitations or penalties on withdrawals
• Fiduciary responsibilities
• Retirement regulations
Legal and
Regulatory
Factors
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23. Investment Constraints
• Unrealized capital gains: Reflect price appreciation
of currently held assets that have not yet been sold
• Realized capital gains: When the asset has been
sold at a profit
• Trade-off between taxes and diversification: Tax
consequences of selling company stock for
diversification purposes
Tax and
Zakat
Concerns
• Personal preferences such as socially conscious
investments could influence investment choice
• Perhaps the investor wishes to avoid types of
investments for ethical reasons
Unique
needs and
preferences
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24. Investment Education
The bottom line
If you do not plan for the future,
you will likely not be prepared for it.
Data indicates that many Malaysians have greatly under-invested for the future.
The type of information necessary to construct a good policy statement is neither
“common sense” or “common knowledge.”
Many investors fail to diversify. Many fail to plan completely.
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25. Asset Allocation Decisions
What asset
classes should
be
considered? What should
be the normal
weight for
each asset
class?
What are the
allowable
ranges for the
weights?
What specific
securities
should be
purchased?
Four decisions in an
investment strategy
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26. The Importance of Asset Allocation
The asset allocation decision (which
classes and at what weights) is very
important. Using fund data:
About 90% of
return variability
over time can be
explained by
asset allocation.
About 40% of the
differences
between returns
can be explained
by differences in
asset allocation.
Asset allocation
is thus the major
factor that
drives portfolio
risk and return.
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27. Risk/Return History and Asset Allocation
Looking at return data on various asset classes indicate
some important factors for investors
• Even apparent low-risk investments like T-bills can have
considerable reinvestment risk
Over long time horizons, stocks have always
outperformed low-risk investments.
• So the additional risk over shorter time horizons seems to all but
disappear over time.
The only way to maintain purchasing power, net of
taxes and inflation, is by investing in proper investment
instruments like common stock, unit trust etc.
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28. Asset Allocation and Cultural Differences
Differences in social, political, and tax environments
influence asset allocation.
For instance, 38% of pension fund assets of Kumpulan
Wang Amanah Pencen (KWAP) are invested in equities.
• 79% in equities in United Kingdom, where high average inflation
impacts this choice
• 8% in equities in Germany, where generous government pensions and
greater risk aversion seem to play a strong role
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29. Summary
In this
chapter
you have
learned
about:
Individual
Investor Life
Cycle
The Portfolio
Management
Process
The Importance
of Asset
Allocation
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30. Thank You30