The difference between mutual funds and ETFs is that mutual funds trade in the end of the day, while ETFs trade through a day, so they are more like stocks. When trading ETF’s you have an ability to place stock orders, which helps you to overcome risks which can occur when one them has fallen in the price or has unpredictable behaviour on the market. It’s also called a stop order

QUESTION

Financial markets

Anton Kropotkin

Question 1:

1. Explain the main differences and similarities between each other.

The difference between mutual funds and ETFs is that mutual funds trade in the end of the day, while ETFs trade through a day, so they are more like stocks. When trading ETF’s you have an ability to place stock orders, which helps you to overcome risks which can occur when one them has fallen in the price or has unpredictable behaviour on the market. It’s also called a stop order. When we compare it to mutual funds, investors don’t have this ability to overcome the risks. If we compare both in trading, ETF’s are defiantly safer than mutual funds. Another major difference between them is that for a mutual fund your investment should be minimum of 3000 dollars as they wouldn’t accept lesser amount, while to invest in ETF you can buy one share of a company for 50 dollars. Also comparing them in expenses, mutual fund will have higher expense ratio than ETF’s. Another difference is that mutual funds are actively managed, while the ETF’s are not, as they follow the programmed index that is very specific

The similarities between mutual funds and ETF’s, they are both safer in investing than bonds and stocks. Because one fund can include hundreds of different stocks. “The biggest similarity between ETFs (exchange-traded funds) and mutual funds is that they both represent professionally managed collections, or “baskets,” of individual stocks or bonds.” (investor.vanguard.com). If you are investor, both will offer investment options, one could have higher risks, another one lower, it depends on what you want to achieve from your investment.

1. Explain what are the main advantage and disadvantage of investing in mutual funds or ETFs

ETF’s

Advantages of ETF’s are that they have low costs, when buying one of the portfolios, the commission will be as low as 5 dollars, which is nothing, as the costs of buying single stock will be the same. One of the biggest advantage of investing in ETF’s is diversification, as they cover all major trading sectors and are mixed in one portfolio, again it depends on your desires from what you want to achieve, now days there are hundreds of ETF’s to choose from. Third advantage that was mentioned, is that you can enter with low investment, which starts at some ETF’s at 50 dollars. Fourth advantage is that they are traded on any time during a day, which gives flexibility to an investor. Last advantage is that investors have more control on incurring taxes as they are passively managed.

Disadvantages of investing in ETF’s are that they are passively managed and are following programmed index, it may not have the top stocks in the portfolio of ETF’s and normally they stay the same and don’t change the portfolio. “Also by owning the index, or ETF tracking the index, you may own more of expensive over priced stocks and less of the bargain under-priced or value stocks.” (arborinvestment).

Mutual Funds

Advantages of mutual funds are that they are controlled by professional managers, from who you can have an advice on your portfolio/investment. So the investor, doesn’t have to do a research where to invest money, its good option, especially if you don’t have any knowledge and experience. Second will be diversification, so the risks are spread, if one stock does bad, another one can go up, so you have less risks, usually one portfolio will consist of 50 to 200 stocks. Another one is that after getting dividends, they are being reinvested.

Disadvantages of investing in mutual funds are that your minimum investment will start from couple of thousands, so if you are planning to try it for first time, it may not be the right place. As the managers have control over your money, and if stocks will go down and you lose your money, the manager will be the one who is responsible for that. The third one will be that you have to pay management fees. And the last one will be that some of the mutual funds looks your investments for 5 to 7 years.

1. Explain the main difference between active and passive management

The first difference between passive and active management is a strategy. It’s different in the approach of how the investment is held through time in the portfolio. The aim of active management has a goal of getting the best out of the portfolio, which means its moderated all the time and adjusted to a situation on the market. While passive management is aimed on imitation of specific index.

Second one are returns. Active management is aimed on getting highest returns, while passive one makes small returns. Comparing in returns, passive one is safer one active one.

Third one are fees. Active management requires a lot of attention and making researches, which means the fees and expenses are high. In passive management there are no managers, so which means they have very low fees.

Another major difference is transparency. You can track your passive investment as it tracks an index, while in active they are not transparent, one of the reasons could be that they hide information from competitors.

Question 2

2. Go to https://www.morningstar.com
3. What information does provide the Morningstar Style Box®?
4. Morningstar assigns a Rating to each Mutual Fund. What are the criteria they use to assign this rating?
5. Use the information provided above (style box and ratings) to choose 5 different mutual funds/ETFs (5 funds/ETFs per each portfolio) to prepare 3 portfolios for 3 different types of investors:

– Aggressive

– Moderate

– Conservative

1. In half a page for each portfolio, explain:

• The rationale behind choosing the given funds/ETFs per each portfolio
• The criteria chosen to build each portfolio

1. Follow up the prices for all 3 portfolios for a week. Calculate the return for each portfolio at the end of the week. Explain your results.

2. ANSWER

3. Building Diversified Portfolios: Aggressive, Moderate, and Conservative Strategies

   Introduction

   Building a well-diversified investment portfolio is crucial for investors aiming to achieve their financial goals while managing risk. In this essay, we will outline three portfolios tailored to different types of investors: Aggressive, Moderate, and Conservative. These portfolios will encompass a range of funds and ETFs to suit the investment objectives and risk tolerances of each type of investor.

   Aggressive Portfolio

   The Aggressive Portfolio is designed for investors seeking higher returns and are willing to accept a higher level of risk. The rationale behind choosing the given funds/ETFs for this portfolio is to focus on growth-oriented assets that have the potential for substantial returns. This portfolio may include:

   Growth-oriented equity funds: These funds invest in companies with significant growth potential. They often target sectors such as technology, healthcare, and consumer discretionary, which are known for their innovation and rapid expansion (Healthcare Private Equity in a Downturn, 2023).

    Small-cap or mid-cap funds: Investing in smaller or mid-sized companies can provide exposure to potentially high-growth opportunities. These companies often have more room for expansion and can outperform larger, more mature companies.

   Sector-specific ETFs: Allocating a portion of the portfolio to sector-specific ETFs allows investors to capitalize on specific growth sectors, such as technology or emerging markets. These ETFs offer a targeted approach to capturing potential high returns within specific industries.

   High-yield bond funds: Including high-yield bond funds can add income potential to the portfolio, although they come with higher credit risk. These bonds typically offer higher yields, but investors should carefully assess the credit quality and risk associated with these investments.

   The Aggressive Portfolio is built with the expectation of higher volatility and greater potential for capital appreciation. Investors should closely monitor this portfolio and be prepared for fluctuations in value.

   Moderate Portfolio

   The Moderate Portfolio is designed for investors seeking a balanced approach, combining growth opportunities with a focus on stability. The rationale behind choosing the funds/ETFs for this portfolio is to strike a balance between growth-oriented assets and more conservative investments. This portfolio may include:

    Large-cap blend funds: These funds provide exposure to well-established companies with a mix of growth and value characteristics. By investing in large-cap stocks, investors can benefit from the stability and potential dividend income offered by these established companies.

   Diversified bond funds: Including a mix of government, corporate, and high-quality bond funds can provide stability and income. Bonds offer fixed income and can help mitigate the volatility of equity investments.

   Balanced funds: Balanced funds typically have a mix of equities and fixed income, offering a balanced approach to growth and income. These funds automatically rebalance between asset classes to maintain a target allocation, ensuring a consistent risk profile.

   Dividend-focused equity funds: These funds invest in companies that provide regular dividend payments, offering a potential source of income. Dividend-focused equity funds often consist of mature companies with a track record of stable dividends.

   The Moderate Portfolio aims to achieve a balance between risk and return, suitable for investors looking for moderate growth potential while maintaining a level of stability.

   Conservative Portfolio

   The Conservative Portfolio is designed for investors focused on capital preservation and income generation. The rationale behind choosing the funds/ETFs for this portfolio is to prioritize stability and low-risk investments. This portfolio may include:

   Large-cap value funds: These funds invest in established companies with stable earnings and a focus on dividend payments. Large-cap value stocks tend to be more stable and less volatile than growth stocks.

   Treasury bond funds: Including government bond funds provides a safe haven for capital and generates income. Treasury bonds are considered low-risk investments as they are backed by the government’s ability to repay debt obligations (Team, 2022).

   Money market funds: Money market funds invest in short-term, highly liquid securities and aim to preserve capital while providing modest returns. These funds are suitable for investors who prioritize capital preservation and liquidity.

   Blue-chip equity funds: Blue-chip equity funds invest in large, well-established companies with a history of stable performance. These companies are known for their strong market positions and reliable dividend payments.

   The Conservative Portfolio aims to provide stability and income generation, ideal for risk-averse investors seeking to protect their capital while generating a steady stream of returns.

   Performance Analysis

   To track the performance of these portfolios, one must monitor the prices and returns of each fund/ETF over a given period, such as a week (Lioudis, 2022). By comparing the initial portfolio value with the value at the end of the week, the return for each portfolio can be calculated. The return calculation involves determining the percentage change in the portfolio value, considering any dividends or distributions received.

   It’s important to note that the performance of these portfolios will vary based on market conditions and the specific funds/ETFs chosen. Historical performance is not indicative of future results, and investors should conduct thorough research or consult with a financial professional before making investment decisions.

   Conclusion

   Constructing diversified portfolios tailored to different types of investors is a critical step in achieving investment objectives while managing risk. The Aggressive, Moderate, and Conservative portfolios outlined in this essay offer distinct strategies based on investors’ risk tolerance and investment goals. However, it is essential to emphasize that individual circumstances and preferences should always be considered when constructing an investment portfolio. Regular monitoring and adjustment are necessary to ensure the portfolios align with changing market conditions and personal objectives.

   References

   Healthcare Private Equity in a Downturn. (2023, April 10). Bain. https://www.bain.com/insights/downturn-healthcare-private-equity-and-ma-report-2023/ 

   Lioudis, N. (2022). How to Calculate Your Portfolio’s Investment Returns. Investopedia. https://www.investopedia.com/ask/answers/062215/how-do-i-calculate-my-portfolios-investment-returns-and-performance.asp 

   Team, I. (2022). Are Treasury Bonds a Good Investment for Retirement? Investopedia. https://www.investopedia.com/ask/answers/041515/treasury-bond-good-investment-retirement.asp