Page 257 - DCOM504_SECURITY_ANALYSIS_AND_PORTFOLIO_MANAGEMENT

Security Analysis and Portfolio Management

Notes
Investing in Defensive Equities
David still had £2,200 of his 2008 ISA allowance with which to invest, so he decided to also
make an investment of some larger 'defensive' UK companies, with a fund in the UK
equity income sector. His IFA asked his opinion on investing outside the UK, explaining
that global markets have excellent potential for growth, although carry an extra level of
risk.
David decided that, because he felt that the outlook for the rest of the world was so
uncertain, he felt more comfortable investing in UK-based funds. He added: "I like the
idea of having part of my investment in big UK companies, the sort of firms that I can keep
an eye out for in the news and keep checking their progress."
David's IFA advised him that equity-based portfolio would be a good addition to his
bond-focused portfolio. If stockmarkets rallied, his equity fund would benefit from the
change in market sentiment. The IFA suggested that David should think about a UK
equity income fund, which would aim to pay a regular income by investing in defensive
UK companies.
David could always decide not to take the regular income from the investment, and keep
it 'rolled up' in the fund, and see his money grow that way.
Conclusion David's IFA was well aware of his investment objectives and his attitude to
risk before any investment was made. Given David's age and investment horizon, of
between five and ten years, the IFA felt that the majority of the portfolio should be
invested in low risk assets, although the equity holding offered some potential for future
growth.

David explained: "I'm pretty happy with my portfolio, and with the recession getting
worse this year, I wouldn't want to be invested in any other areas. This sort of portfolio
may not be 'racy' enough for younger investors, but I'm hopeful it will do what I want it
to and give me a decent nest egg in a few years time."
Questions
1. What big lesson do you derive from this case?
2. As an analyst, suggest difference that you could have build David's portfolio with.
3. After analysisng the above case, what do you think is the biggest responsibility of a
financial advisor when he is up to build a portfolio?

Source: www.moneysheets.co.uk

9.6 Risk Reduction in the Stock Portion of a Portfolio

Law of Large Numbers

Assume that all risk sources in a portfolio of securities are independent. As we add securities to
this portfolio, the exposure to any particular source of risk becomes small. According to the Law
of Large Numbers, the larger the sample size, the more likely it is that the sample mean will be
close to the population expected value. Risk reduction in the case of independent risk sources
can be thought of as the insurance principle, named for the idea that an insurance company
reduces its risk by writing many policies against many independent sources of risk.

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