Dynamic Hedge Fund Portfolio Construction - Myassignmenthelp.Com

Question: Discuss About The Dynamic Hedge Fund Portfolio Construction? Answer: Introducation Wesfarmers is the leading listed company in Australia that is focussed on the diverse operation for providing satisfactory returns to the shareholders. It is engaged in the production, retailing, coal mining, gas distribution and processing, distribution of safety and industrial products, manufacturing of fertilizers and chemicals and the investment business all over Australia, United Kingdom, New Zealand and various other countries. Wesfarmers operates 702 convenience outlets, 83 liquor stores, 89 hotels and 801 Coles supermarkets (Wesfarmers 2017). Governance structure Name of substantial ownership Holding more than 20% shares HSBC Custody Niminees (Australia) Limited is holding 21.25% of total shares of the company. Holding more than 5% shares J P Morgan Nominees Australia Limited is holding 12.29% shares and Citicorp Nominees Pty Limited is holding 5.77% shares of the company. Name of key personnel Chairman Michael Chaney AO Board members apart from Chairman and CEO, other board members are - Terry Bowen, Finance Director Jennifer Westacott, Director Vanessa Wallace, Director Wayne Osborn, Director Paul Bassat, Director Tony Howarth AO, director Diane Smith Gander, Director James Graham AM, Director CEO Richard Goyder AO Any of the key personnel of Wesfarmers does not hold more than 5% or more than 20% of the companys shares and therefore does not included in the list of substantial shareholders. Key ratios Return on assets (ROA) = (NPAT / Total Assets) Return on Equity (ROE) = (Net profit after tax / Ordinary equity) Debt ratio = Total liabilities / Total assets EBIT/TA * NPAT/EBIT * TA/OE = NPAT/OE EBIT/TA * NPAT/EBIT * TA/OE = 4,402/40,115 * 2,873/4,402 * 40,115/23,941 = 0.120 NPAT/OE = 2,873/23,941 = 0.120 Therefore, EBIT/TA * NPAT/EBIT * TA/OE = NPAT/OE phenomenon of the variable TA/OE TA stands for total assets and OE stands for ordinary equity or owners equity. TA/OE signifies the total assets of the company as compared to the equity of the company (Halili, Saleh and Zeitun 2015). It represents the companys insolvency risk and measures the shareholders exposures against the companys total asset. If the companys equity goes up the return on equity of the company will reduce. Reasons behind ROE being greater than ROA ROE and ROA both are the measure for measuring the return performance of the company. If the total asset of the company is higher than the shareholders equity, the ROE will be higher than ROA (He and Krishnamurthy 2013). Information from the website of ASX Movement graph of monthly stock for last 2 years Wesfarmers Limited All Ordinary Index Stock movement report From the above graphs of Wesfarmers stock and All Ords Index, it is recognized that both the stocks are upward moving. However, the stock of Wesfarmers is more fluctuating as against the stock of All Ords Index. Therefore, the stock of Wesfarmers is more volatile. Further, the correlation computed between 2 firms resulted as 0.862. Therefore, the stocks are uncorrelated. Recent announcement On 22nd December 2017, the company announced to sell Curragh coal mine for $ 700 million During July 2017 the company announced that it will phase out the single use plastic bags from all the stores For recognizing long-term relationship the company announced expanded partnership with WASO that will focus on international and regional touring During May 2017, the company announced appointments of 3 senior executives as transition part of the group leadership Stock field Beta of Wesfarmers is 1.02 Risk free rate = Rf = 4%, market risk premium = Rm = 6% Therefore, required rate of return of the companys share = R = Rf + ( Rm Rf ) R = 4% + 1.02* (6% 4%) = 6.04% Conservative investment Conservative investment is the investment approach where the value of investment is protected through investing in the lower risk associated and regular income paying stock. As the beta of the company is only 1.02 it is considered to be a stock with lower risk (Harris and Mazibas 2013). Further, the company is regular with regard to the payment of dividend. Therefore, stock of Wesfarmers can be considered as conservative investment. WACC Computation of WACC WACC = E/V * Re +D/V * Rd * (1-Tc), Where, E/V = Equity percentage in capital structure = 81% D/V = Debt percentage in capital structure = 19% Re = Cost of equity = 6.04% Rd = Rate of debt = 5.25% Tc = corporate tax rate = 30% Therefore, WACC = 81*6.04% + 19*5.25% (1-0.30) = 4.89 + 0.70 = 5.59% Implication of higher WACC on management evaluation The higher WACC indicates that the capital risk of the company is higher and the management shall raise the fund from lower cost sources. Further, the company shall find profitable project that is associated with lower risk (Zabarankin, Pavlikov and Uryasev 2014). Whether the fund is raised through equity or debt it raised in exchange of cost like interest risk or dividend or share of profit. Therefore, before raising additional fund the company shall take into consideration the WACC of the company and find out most appropriate source for the company. Optimal structure for debt Optimal capital structure Debt ratio Total liabilities / Total assets Year 2017 = 0.404 Year 2016 = 0.437 The ratio at which the value of the company is maximised is known as the optimum capital structure. The debt cost is considered as low as compared to cost of equity as the debt are deductible under tax and the equities are not deductible (Albul, Jaffee and Tchistyi 2015). Generally, 0.4 or lower than that is considered as appropriate debt structure if the pure risk aspect is considered. Looking into the debt ratio of the company, it is recognized that the debt ratio of the company for 2016 is 0.437 and for 2017 is 0.404. Therefore, the debt ratio of the company is ideal and stable. Gearing ratio For adjusting the gearing ratio the company reduced their borrowing from $ 5.671 million to $ 4,066 million from 2016 to 2017. Further, the company issued 2,378 shares for $ 93 million (Renneboog and Szilagyi 2015). However, the directors did not mention anything related to the adjustments in their report. Dividend policy The dividend policy of Wesfarmers considers the generation of free cash flow, availability of franking credits, generation of profit and assures to deliver the growing dividends over the time (Zhang 2014). Recommendation From the above analysis it is recommended that the stock of Wesfarmers shall be included in the portfolio of the client for investment. The reason behind this is that the beta of the company is 1.02 that states the stock of the company is exposed to lower risk. Further, the company is regular in paying dividend. Therefore, the stock can be considered as regular source of income. Therefore, it meets the preferred criteria of any investor and therefore shall be included in the portfolio of the client. Reference Albul, B., Jaffee, D.M. and Tchistyi, A., 2015. Contingent convertible bonds and capital structure decisions. Halili, E, Saleh, A and Zeitun, R., 2015. 'Governance and Long-Term Operating Performance of Family and Non-Family Firms in Australia', Studies in Economics and Finance, vol.32, no.4, pp.398-421. Harris, R.D. and Mazibas, M., 2013. Dynamic hedge fund portfolio construction: A semi-parametric approach.Journal of Banking Finance,37(1), pp.139-149. He, Z. and Krishnamurthy, A., 2013. Intermediary asset pricing.The American Economic Review,103(2), pp.732-770. Renneboog, L. and Szilagyi, P.G., 2015. How relevant is dividend policy under low shareholder protection?.Journal of International Financial Markets, Institutions and Money. Wesfarmers., 2017. Home - Wesfarmers. [online] Available at: https://wesfarmers.com.au/ [Accessed 18 Jan. 2018]. Zabarankin, M., Pavlikov, K. and Uryasev, S., 2014. Capital asset pricing model (CAPM) with drawdown measure.European Journal of Operational Research,234(2), pp.508-517. Zhang, Z., 2014. On a risk model with randomized dividend-decision times.Journal of Industrial Management Optimization,10(4), pp.1041-1058.