2015

Final Assessment
MONEY MANAGEMENT
STUDENT ID: 1212425

Table of Contents
Introduction .................................................................................................................................................. 2
Money: A Means to an End....................................................................................................................... 2
My Character and Lifestyle ....................................................................................................................... 2
The Plan................................................................................................................................................. 3
Why Should I Invest?............................................................................................................................. 3
Time Horizon and Risk Profile ................................................................................................................... 3
Investment Vehicles ...................................................................................................................................... 4
Mutual Funds ............................................................................................................................................ 4
Exchange Traded Funds (ETFs).................................................................................................................. 6
Replication Methods used by ETFs ....................................................................................................... 6
Mutual Funds or ETFs? .............................................................................................................................. 7
My Portfolio .................................................................................................................................................. 8
Portfolio Construction Method ................................................................................................................. 8
Equities Exposure Based on Geographical Location ................................................................................. 9
Risk Profile Matching .............................................................................................................................. 10
Analysis of the Individual Components in the Portfolio ......................................................................... 11
Vanguard S&P 500 ETF ........................................................................................................................ 11
iShares Morningstar Large-Cap ........................................................................................................... 12
Templeton Global Bond A Load Waived ............................................................................................. 13
iShares US Energy ETF ......................................................................................................................... 15
PowerShares QQQ ETF ........................................................................................................................ 16
American Funds New World R6 .......................................................................................................... 18
Conclusion ................................................................................................................................................... 19
Bibliography ................................................................................................................................................ 20

Introduction
Believe it or not, a huge portion of our lives is spent thinking about money, wish we had more of it and
wonder how we would spend it. We hear about financial sector in the news and watch it on television,
calculate our income and expenses on a regular basis or might even criticize our loved ones for spending
too much of it.
In essence we continually focus on MONEY 1.

Money: A Means to an End

Just because we spent so much time thinking about it, we shouldnt forget that money is just a tool to
help us reach our vision and our higher cause. It is essentially a means to an end, and not an end in
itself.
We have heard this a lot that Money cant buy happiness and it is somehow true as history showed us
that whom, who were always in pursuit of money, were ultimately disappointed. (James, 2013)
As Rousseau 2 says The Money you have can give you freedom, the money you pursue enslaves you (
Escape The City, 2013), the time that we spend in our lives to obtain money is what makes us regretful
in the end. However if we recognize that money could help us meet our needs and reach our higher
valued goals, then money becomes a contributor to our happiness.
In the end we should ask ourselves how much we are willing to pay to have money and how we are
going to spend it? (Josephson, 2014)

My Character and Lifestyle

I am in my early 30s, actually 31 to be exact, and I work as a teacher and manager of the company which
I co-founded 5 years ago, specializing in computer datacenter architecture and implementation.
Happiness of the people living around me, alongside my own happiness have always takes precedence
to money and I am always willing to work for less money as long as it brings me more happiness and
satisfaction. I do not care for a luxury home or a car but I do love the latest gadgets and technology.
Money has never been among my main concerns but I do understand the role of money as a tool which
enables me to reach my goals. Being able to maintain the flexibility to allocate my time to different jobs
is one goal which I always pursue.

Any item or verifiable record that could function as the medium of exchange, a unit of account and a store of
value is considered money. (Mankiw, 2012)
2
Jean-Jacques Rousseau, was a philosopher, composer and writer of the 18th century. His political philosophies
influenced French Revolution and the modern sociological and educational thoughts. (Bertram, 2010)
1

I love to learn about the lives of people in different settings, and I want to be able to understand their
feelings, hence the selection of teaching as my main job. I love to feel the people in their own life
context and I want to be able to learn different languages currently spoken around the world as the first
step toward this goal. Learning not enough languages has been among the few regrets in my life and I
am sure it will be in the future if I do not act on it now.
I usually spend a good amount of time on planning, and once I believe that the planning part is done
correctly, I try not to act on emotions in the process of plan execution.

The Plan
One of my major plans is to start traveling around the world for 3 years before I am 40 years old and I
plan to stay at least 6 months in the regions with cultural roots that has affected surrounding countries,
so I should be able to financially support myself during that time, maintaining my own lifestyle, and be
able to afford to suspend my jobs during that time. So it brings the idea of investing to forefront.

Why Should I Invest?

Definitely I want not only to able to retain the purchasing power of my money, for the days that I am
travelling, but also increase its value to be able to cover the expenses.
To keep the purchasing power of my money in 8-9 year time period, I should beat the consumer price
inflation 3 of the places which I intend to live in, and to increase the value of my money even further, I
should find the most relevant investment opportunities.
Based on the average CPI Inflation rates 4 of BRIC Countries, Euro zone and United Kingdom, my
investment needs to return at least 5.68% per annum, which translates to total of 64.41% for the period
of 9 years, just to keep up with the inflation.

Time Horizon and Risk Profile

Based on my plan I have a time horizon of 8-9 years for the investment.
As for the level of the risk, it is obvious that everyone wants to gain higher returns with lower risks but
there is always a trade-off between risk and return. (Costa, 2011) For higher return I should accept
higher risks.
If we divide the 3 year duration of the travel in which Ill stay in different countries to 6 equal portions and
assume that these regions have similar inflation rate to their surrounding countries, I need to sample 6 CPI
Inflation rate, and find the average.
4
All the rates are based on the latest published data in (Trading Economies, 2015).
3

With the level of return which I should expect from my investment in the mentioned time period I am
willing to accept high level of risk and major fluctuation in my capital without resorting to emotional
behaviors, So I dedicate around 70% percent of my capital to asset classes with relatively higher risks
like equities and around 30% to lower risk fixed-income assets like bonds and cash, and due to the
mentioned time horizon my risk profile would be categorized as Aggressive. (BCGE, 1996)

Investment Vehicles
Investment vehicles are products that are used by investors with the intention of having positive
returns. These vehicles range from certificates of deposit or bonds which are low risk, to stocks, options
and futures which carry higher level of risks but possibly higher returns. (Investopedia, 2015)
Investment in some of the mentioned vehicles, such as stocks, as an individual, would be a time
consuming task, as it needs continuous study of the market to keep track of them. It requires a fairly
high level of knowledge to decide what to buy and when to buy or sell but, even with a high degree of
skills an investor needs to diversify his portfolio to lower the risk which, in turn further complicates the
investment.
These prompted the need for introduction of new investment vehicles called investment funds.
Investment funds are collective investment schemes in which the investors capital are pooled together
to benefit from economies of scale, lower costs, increased diversification, which is usually impossible
with small amounts of money, and hiring of the professional managers who can further increase
efficiency and reduce the risks. It also enables the investors exposure to markets normally unavailable
to them as individual investors.
These investment funds can be actively managed by a team of professional managers who constantly
monitor and select the underlying assets, in the case of mutual funds, or can passively mimic a market
index to replicate its performance, in the case of index-funds or ETFs.

Mutual Funds
A mutual fund is an actively managed investment fund, and the term usually refers to the funds that are
regulated and sold to general public.
Investors purchase their share from the fund itself or through a broker, and cannot purchase the shares
from other investors on the secondary market such as stock markets. (U.S. Securities and Exchange
Commission, 2015)

The price that investors pay for each share of the fund is the funds net asset value (NAV) 5 per share plus
any fees that are charged upon the purchase, such as entry fee 6. This price is based on a forward pricing
mechanism as NAV is calculated usually in 24-hour intervals 7, and is not known exactly at any moment,
the investor will pay the quoted price plus or minus any deviation at the time of NAV recalculation.
The shares in these funds are redeemable which means that when the investor wants to sell his
shares, he sells back to the fund itself or the broker acting on behalf of the fund, at NAV minus any fees
such as redemption fee 8.
As most of these funds 9 are actively managed by professional fund managers, they charge a
management fee 10 while the management team ideally try to allocate the assets under management
(AUM) to the best possible investment opportunities.
A good mutual fund has:

High level of transparency regarding its fund managers, such as their names and their
backgrounds.
Clearly stipulated costs in the form of total expense ratio (TER 11) and not just the management
fees in term sheets.
Clear strategy regarding where the investors money is going to be invested with monthly
manager report.
A good track record 12
Regular, preferably daily, update on NAV calculation and performance.

As fees can reduce investment returns considerably, they are an important factor which investors should
consider when buying a share in mutual funds.

Net asset value of an investment fund is the funds total assets minus its total liabilities but the term NAV is
usually used instead of NAV per Share.
6
Sales Load or Sales Charge terms are sometimes used instead of Entry Fee.
7
Each fund has an authorized administrator to perform regular NAV calculation and registration of relevant
transactions. (Costa, 2011)
8
Deferred Sales Load or Exit Fee are alternate terms which are sometimes used instead of Redemption Fee.
9
There are passively managed mutual funds which track an index.
10
These fees are calculated as a percentage of investors assets and not their profits.
11
TER is calculated by dividing the total fund costs (management fees, trading fees, legal fees, auditor fees and
other operational expenses) by funds total assets. (Investopedia, 2015)
12
Although stellar past performance is not a guarantee for the future returns, it is all we have for now. (Costa,
2011)
5

Exchange Traded Funds (ETFs)

An Exchange traded fund is an investment fund, in which the shares are traded on stock exchanges.
Most ETFs are passively managed as they track an underlying index.
Much like an index-based mutual fund, ETFs are designed to track the performance of an index which
they are trying to replicate but with different tradability level.
ETFs do not sell individual shares directly to investors and they only issue shares in large blocks which
are called Creation Units 13 to market makers 14 which then, can split these units and sell individual
shares to investors on secondary markets such as stock exchange. (U.S. Securities and Exchange
Commission, 2015) These market makers are in charge of providing liquidity, but these added liquidity
comes at a price, because of the costs that market maker should incur in providing these liquidity while
it should take some additional risks 15 to provide constant tradability of an individual share. Because of
this, ETFs are not traded at NAV and carry a slight premium.
This premium is in the form of Bid-Ask Spread. The bid is a price that buyer is willing to pay for an ETF
share while ask is the price at which the seller is willing to sell. If you are a seller you receive the lower
price (bid) and if you are a buyer, you have to pay the higher price (Ask) and the difference which is
called Bid-Ask Spread or simply Spread is the compensation to market maker. (Morningstar, 2015)

Replication Methods used by ETFs

As most ETFs are passive investment instruments which are designed to mimic the performance of a
benchmark index, the easiest way for the ETFs to accomplish this is through physical replication or full
replication. In this method ETF manager or operator simply purchases the underlying assets of the index,
be it a stock, commodity or a bond relative to their corresponding weight in benchmark index. This
method can result in tracking error 16 when the index components change or transaction costs are
accounted for. (Costa, 2011)
Another method is sampling, in which the manager tries to achieve the same performance of index by
holding just a part of the components of the index. This method reduces the trading costs as now only
the fraction of securities are hold and traded. It also reduces the tracking error.

For Example a creation unit could consist 50000 shares of an ETF.

Generally a broker that accepts the risk of holding shares of an ETF to facilitate the tradability is called market
maker.
15
Providing liquidity to an ETF shares which tracks a foreign index but is traded on a local stock market while that
foreign stock market is closed, is an example in which market maker should undertake additional risks.
16
Because FTFs can lend securities to hedge funds or other institutions and receive a fee in return, the tracking
errors are not always necessarily negative. (Morningstar, 2015)
13
14

There is also another popular method of index tracking called synthetic replication in which the
manager instead enters a swap agreement with an investment bank which agrees to pay the index
return in exchange for a fee and any returns on collateral held in ETF portfolio. (Morningstar, 2015)
Since there is no actual trading of security in synthetic method, this method eliminated the tracking
error but comes at the cost of counterparty credit risk. ETFs attempt to minimize this risk by holding
collaterals which are higher in value than the ETFs assets.

Mutual Funds or ETFs?

Actively managed funds and passive ones, each have advantages or disadvantages compared to the
other. Advocates of active investing tout the ability of smart fund managers to beat the market and
produce a higher Information Ratio 17 and higher alpha 18, while the advocates of passive investing
question the ability of most active managers to add value to the investment in the long term and the
high fees charged for their underperformance.
There are some debate surrounding the more tax efficiency of ETFs (Gastineau, 2011), but in short they
are both subject to capital gain tax when the investor sells his shares.
While ETFs are generally more transparent (all the holdings are listed), more liquid, more diverse, with
higher level of flexibility and are more cost effect compared to mutual funds, a highly skilled and
professional manager can add Intelligent advantage (Costa, 2011) to mutual funds.

It is a ratio of portfolio returns above the return of the benchmark index to the volatility of those returns. The
information ratio measures the ability of the manager to generate excess returns compared to a benchmark index,
it is also shows the consistency of the manager. (Investopedia, 2015)
18
In simple definition alpha is known to represent the value that the fund manager adds to a portfolio.
(Investopedia, 2015)
17

My Portfolio 19

Portfolio Construction Method

The portfolio is constructed loosely 20 based on core-satellite model in which the core of the investment
is invested through low-cost investment vehicles such as index-funds or ETFs and the satellite or
supporting portion is invested through more specialized vehicles and actively managed funds with focus
on the markets difficult to reach with higher costs. (Costa, 2011)

As my country of residences currency is linked to U.S. Dollar, it is logical to go with that currency investing in
vehicles with underlying assets denominated in USD, but as for the vehicles with underlying assets in other
currencies I tried to select vehicles which are USD currency hedged.
20
I said loosely because the fixed-income portion of the portfolio is allocated only to an actively managed fund.
19

Equities Exposure Based on Geographical Location

Analysis of the total underlying assets in portfolio clearly shows the exposure level to equities in
different geographical locations.

Risk Profile Matching

By simply looking at the holdings in the portfolio, someone might think that it matches the Dynamic
risk profile (30% allocated to a bond fund) but upon deeper inspection of what makes the underlying
assets 21, it becomes clear that it matches my stated Aggressive risk profile.

21

Around 49.23% of Templeton Global Funds assets is kept as cash. (Morningstar, 2015)

10

Analysis of the Individual Components in the Portfolio

Here I try to analyze each holding in the portfolio and indicate my selection criteria.

Vanguard S&P 500 ETF

Ticker: VOO
Tracking Index: S&P 500
Role in Portfolio: Core
Weight in Portfolio: 20%
Total Assets: 30.91 Billion USD
Net Expense Ratio 22: 0.05%
Sharpe Ratio 23: 1.79
Website: www.vanguard.com
The Vanguard S&P 500 ETF seeks to track the Standard & Poors 500 capitalization-based index, which is
dominated by the stocks of large U.S. companies. So by buying this ETF I am exposing myself to stocks of
the 500 biggest U.S companies. Although the rationale behind this index weighting means that an
investors buy the stocks of a company when it has already grown and sells it when it falls out of the
index favor, it is worth noting that these large-cap companies are mostly the bellwether of U.S and
global stock market, so it is logical to assume if this market falls considerably, the global market is likely
to fall.
As an index tracking ETF, using the full-replication method without any leverage, it is highly transparent.
As a fund with assets invested in equities it has higher risks than funds with bonds as their underlying
assets but offers higher potential returns. (Vanguard, 2015)
Compared to SPDR S&P 500 ETS (SPY) which is one the most popular ETFs in the world with total
assets around 182.62 billion USD and the net expense ratio of 0.09% tracking the same index, this fund
offers the same performance with lower net expense ratio of 0.05% 24, hence the selection of this
vehicle.

The percentage of investors asset deducted each fiscal year for fund expenses is called Expense Ratio. It
should be noted that transaction fees, sales load and brokerage costs are not included in this ratio. (Morningstar,
2015)
23
The Sharpe Ratio is the measure to calculate the risk-adjusted return of a funds portfolio (Investopedia, 2015)
by dividing the funds annualized excess returns over the risk-free rate (such as U.S. treasury bills rate) by its
annual standard deviation. (Morningstar, 2015) The higher the Sharpe Ratio, the better its risk-adjusted
performance.
24
This is the lowest expense ratio among all funds tracking S&P 500 index. (Morningstar, 2015)
22

11

iShares Morningstar Large-Cap

Ticker: JKD
Tracking Index: Morningstar Large Core IndexSM
Role in Portfolio: Core (Complimentary)
Weight in Portfolio: 20%
Total Assets: 721.2 Million USD
Net Expense Ratio: 0.20%
Sharpe Ratio: 1.88
Website: www.ishares.com
This ETF also seeks to track an index composed of large-capitalization U.S equites, and given the
presence of VOO in portfolio, looks somehow redundant but the underlying index has a different
approach than S&P 500 index by which it measures the performance of stocks issued by large-cap U.S.
companies which have shown average growth and value characteristics according to Morningstar
proprietary index methodology. (Morningstar, 2015)
Being an ETF, it is very transparent in posting all of the underlying holdings and its relatively low 0.20%
net expense ratio compared to category average of 0.36% makes it an attractive holding.
It has 99.92% of its assets in underlying index securities and 0.08% in cash.
It has demonstrated lower risks compared to VOO and historically shows over 90% return over the 9
years 25 of investment period so I select this as a complimentary core holding in my portfolio.

25

It should be reiterated that past performance is not an indicator of the possible future performance

12

Templeton Global Bond A Load 26 Waived

Ticker: TPINX.lw
Role in Portfolio: Fixed-Income Portion (Bonds)
Weight in Portfolio: 30%
Total Assets: 68.6 Billion USD
Net Expense Ratio: 0.89%
Sharpe Ratio: 0.60
Level-Load (12b-1 fee) Ratio 27: 0.25%
Website: www.franklintempleton.com
Since bond indices are notably dull as bonds are highly subject to swings in interest rates, and
macroeconomic situation has a great effect on them (Costa, 2011), I would rather invest in an actively
managed fund for this portion of my portfolio.
Franklin Templeton fund family has high transparency with proper disclosure on asset allocation, top
holdings and fund managers.
Management is very active in finding opportunities to invest in global bond market and the Alpha of
4.84 over 5-year period is a testament to managers ability to do that. Dr. Michael Hasenstab as the chief
investment officer prefers emerging markets government bonds so over half of the funds underlying
assets are exposed to currencies other than USD but has been carefully hedged against USD.
Currently 49.23% of the funds underlying assets is kept in cash and 49.90% in bonds with average BB
credit ratings.
The risk is above average compared to its category while the returns are higher.

Any commission of sales charge is called Load. There are two flavors of loads, a front-end load which charges
the investor upon the purchase of the fund or a bank-end load which is charged upon the redemption. There is
also another type of load which is called Level-Load or 12b-1 by which the investor is charged annually as long
as it holds the fund. A fund with a level-load no more than 0.25% can call itself a no-load fund in market in market
literature. (Investopedia, 2015)
27
This is included in net expense ratio mentioned above.
26

13

In the following diagram you can see the growth of 10,000 USD investment in this fund vs category and
an index tracking the same category.

Net expense ratio of 0.89% which is expected to reach 0.90% is higher than ETFs but for an actively
managed fund with global exposure is attractively low.

14

iShares US Energy ETF

Ticker: IYE
Tracking Index: Customized index composed of U.S. equities in the energy sector.
Role in Portfolio: Satellite
Weight in Portfolio: 10%
Total Assets: 2.15 Billion USD
Net Expense Ratio: 0.43%
Website: www.ishares.com

Through this ETF I am seeking to achieve broad exposure to U.S energy sector 28. With 34% of underlying
assets invested in integrated oil and gas firms, 31% in exploration and production firms, 17% in
equipment and services companies, 7% in pipelines, 7% in refiners and 7% in drillers, this ETF offers
diverse exposure to various industries that comprise the energy sector. (Morningstar, 2015)
Over 90% of the fund underlying assets are invested in companies which possess an Economic Moat 29,
or sustainable advantage. (Morningstar, 2015)
This ETF net expense ratio of 0.43% is considered high for an ETF but, compared to its category average
of 0.48%, combined with its lower risk it should still be considered as a viable investment vehicle.

I had decided to allocate this portion of portfolio to commodities, but due to recent abnormal high volatility level
of commodities market I was inclined to invest in companies with high correlation to this market instead.
29
By Morningstar definition, a company that has an economic moat has the ability to its competitors at bay.
Network effect, high level of intangible assets, cost advantage, high switching costs for customers and efficient
scale are some of the attributes that can give companies economic moat. (Morningstar, 2015)
28

15

PowerShares QQQ ETF

Ticker: QQQ
Tracking Index: Nasdaq-100 Index
Role in Portfolio: Satellite
Weight in Portfolio: 10%
Total Assets: 38.60 Billion USD
Net Expense Ratio: 0.20%
Sharpe Ratio: 1.46
Website: www.invesco.com
In recent years, enterprise and SMBs alike, are adopting a new computing model called Cloud
Computing. Just like a fund, that capitals are pooled together to benefit from economies of scale, in
cloud computing, computing resources 30 are pooled together to achieve economies of scale, on-demand
self-service, rapid provisioning and service measuring. (NIST, 2011)
Global spending in public cloud services is expected to surpass $210 Billion in 2016 (Gartner, 2013),
while Infrastructure as a service, as one of the cloud computing models, will be the fastest growing area
companies like Intel, Cisco, IBM, Apple, Samsung, Microsoft, EMC, VMware, Oracle, Amazon and Citrix
are very well positioned to benefit from this trend.
For this reason I tried to allocate a portion of my portfolio to a specialized ETF in cloud computing.
Currently there is only one such ETF, with SKYY Ticker offered by First Trust, tracking a customized index
called ISE Cloud Computing (Morningstar, 2015). With the net expense ratio of 0.60% and total assets of
428.52 Million USD, the mentioned ETF has a relatively high fee and the index does not even fully cover
my intended target companies so I decided to opt for PowerShares QQQ ETF as a lower cost alternative
covering the most of the mentioned companies through Nasdaq-100 technology index.
With its above average risk vs its category, an investor should expect high returns and this ETF delivers.

In Infrastructure as a Service IaaS cloud computing model, these computing resources are categorized as
Compute (Processing Power and RAM), Storage and Network Bandwidth which will be abstracted from
hardware subsystem and the allocated to clients.

30

16

With historical cumulative returns of over 190% this ETF is well suited to my high risk profile and the
following chart (Morningstar, 2015) shows the historical 10 year period growth of $10,000 investment in
this ETF compared to its benchmark.

17

American Funds New World R6

Ticker: RNWGX
Role in Portfolio: Satellite
Weight in Portfolio: 10%
Total Assets: 23.7 Billion USD
Net Expense Ratio: 0.65%
Sharpe Ratio: 0.54
Website: www.americanfunds.com
This funds unique underlying asset allocation method, combined with its presence in global equities
market, makes this fund an attractive satellite investment vehicle for the investors who seek higher
exposure to international equities market.

Asset Allocation RNWGX

10% 0% 12%
10%

68%
Cash

US Stock

Non US Stock

Bond

Other

The fund net expense ratio of 0.65%, compared to 1.56% ratio of the category average (Morningstar,
2015) is very reasonable for an actively managed fund with such high exposure to international equites
market. It is very transparent in posting the managers profiles, strategy and top holdings in the fund,
and its return level vs its associated risk, makes it even more attractive to be included in any portfolio.

18

Conclusion
Today an individual investor is presented with a myriad of investment vehicles and investment
companies that promise high returns on the capital, and unless the investment objectives, time horizon
and level of risks that can be tolerated, is properly identified, the odds are that the investment is likely
to fail to meet the expectations of the investor.
To avoid such scenario, it is crucial that, after properly identifying the investment time horizon and risk
profile, the investor conducts and in-depth research into the available vehicles to evaluate whether
these vehicles had lived up to their promises in the past and have clear strategy in their asset allocation
policies.
Once selected, it is important to note that having too many vehicles in the portfolio can actually lower
the performance of the portfolio so it is a good practice to keep the portfolio simple but yet well
diversified.
It is also worth noting that keeping track of the investment is very important and while over-trading and
emotional behavior are considered to have detrimental effects on the performance of the portfolio,
sometimes rebalancing of the assets is needed to maintain the consistency with the initial allocation.
(Costa, 2011)

Finally every investor should know that if he, himself doesnt care about his money no one else will.

19

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