Turgulova A.K., Intykbaeva S.Zh.

New Economic University named Turar Ryskulov Kazakhstan

Investment portfolio management during crisis

Contemporary financial markets are becoming more volatile. Increasing instability, unpredictable rallies and drops, chaotic quotation dynamics, as well as dependence on variable factors have become more frequent. Without competent management and application of advanced financial technologies, the investment portfolio loses its effectiveness and might become a subject to significant losses.

Implementation of investment portfolio management methods at the Kazakhstani enterprises is based on two prevailing methods - active and passive management.

Index fund strategy is one of the strategies of passive investment portfolio management. It is based on the assumption that the portfolio should reflect the dynamics of the selected index, which in turn portrays the condition of the equities market (or the key segments of the market). The security types and their weights are determined by the process, similar to the calculation of the index. The primary goal of investor is to replicate the market structure within the portfolio and modify it on a semi-annual to annual basis. This model is employed by the majority of Kazakhstani enterprises. Nevertheless, the equities market index strategy has a number of practical deficiencies.

First, indices are very inconsistent, as their components can change due to:

a) Reduction in the value of the concrete component; b) The appearance of new component; c) Bankruptcy of the company; d) Mergers and acquisitions.

The changes in monitoring process of the index fund for the passive portfolio imply corrections to reflect the current situation, which results in additional expenditures, since the restructuring of portfolio may require payment of the above-average commission fees. Another important factor to consider is the bid/ask spread. Hence, management of passive portfolio is not economically feasible in conditions of developing markets. Reinvestment of dividends as well as corrections which arise due to the changes related to the weights of component indices, require operation expenditures and payment of above-average commission fees due to insignificant investment amounts, as theoretically, each dividend must be divided for weighed distribution for each section within the index. This, in our opinion, is an important concept as the majority of the institutional investors in Kazakhstan assess the aggregate profit, i.e. the sum of capital and reinvested capital. Therefore, it is necessary to account for capital gains while changing the composition of the general index.

Secondly, replication of the index fund in its entirety is relatively complicated for domestic investors. Currently, there are several indices being calculated in Kazakhstan and their methodology for calculation, as well as the list of enterprises for inclusion in each index differ significantly. Therefore, the problem arises during the selection of the index fund that will adequately reflect the behavior of the market or its segments. Execution of the passive investment strategy in Kazakhstan is also complicated by the instability of the Kazakhstani equities market. In this case, replication of indexes, represented by the largest and most reliable companies will still remain a fairly risky investment. Furthermore, the domestic equities market is very dynamic, which makes the semi-annual/annual portfolio update insufficient. As a result, the main advantage of passive portfolio management, the low portfolio management costs, cannot be realized. Therefore, we assume that under the conditions of crisis, the market is more inclined towards using the index fund strategy as a method of active, rather than passive strategy.

Due to the above mentioned reasons, the need for constant update of portfolio increases expenditures and makes it impossible to replicate the behavior of the index precisely. Since index itself does not require such expenditures, as it is theoretically a construction, achievement of similar returns by means of passive portfolio becomes impossible.

The active management model assumes monitoring and immediate acquisition of instruments, which correspond to portfolio’s investment goals, as well as the quick change of the portfolio composition. The main task of the active management model lies in developing a proper forecast of the expected return on investment. Active model investors purchase securities with expectations of their rapid price appreciation. This method implies higher risk for investors, as they face the systematic risk (related to the market in general) and unsystematic risk (related to separate market component). In case of proper management of both risk components, the investor can achieve significant returns.

Regardless of the apparent advantages of the active management method, we believe that portfolio management in the case of the emerging market has its disadvantages. Firstly, it is impossible to understand the information about the fundamental factors, capable of influencing the market price of securities, in its entirety. Equities market is a sensitive system in regards to the external and internal factors. Therefore, understanding of the objective and subjective factors requires larger amounts of time and makes it impossible to study the entire volume of information under the conditions of highly dynamic environment. Secondly, the active method implies the absence of full-scale control over the systematic and unsystematic risks, which leads to an increase the risk of capital losses for portfolio. Therefore, the most suitable method for domestic enterprises will imply the combination of both, active and passive portfolio management methods.

The portfolio return is an important factor for consideration during the formation of the investment portfolio. The portfolio target return level determines the manager's choice of the investment method. Achievement of the return on portfolio equal to or greater than the return on index during the holding period constitutes the success of the investment policy, while portfolio return below index indicates that the portfolio formation was done incorrectly, since its price grew less than the market capitalization. The portfolio management style of the enterprises falls under the category of passive portfolio management, namely the index fund strategy, if the enterprise (investor) uses the highest risk methods, aimed at the achievement of highest returns. Such active management methods include operational buying and selling of securities to obtain capital gains from increases in securities’ quotations, investment in high-risk papers of little-known emitters or transactions with the use of margin. All of the mentioned methods are potentially profitable, but also risky. Due to the risk involved, many of those transactions are forbidden by law for the majority of institutional investors. In accordance with the Law of the Republic of Kazakhstan On Pension Provision (article 55), it is forbidden for pension funds to purchase securities with the use of margin; sign contracts for sale of securities, which do not belong to the non-governmental pension fund [1].

On a global scale economic changes or shifts do not occur for the individual enterprises - emitters, but for the industrial groups (for example, as a result of the appearance of new technologies or change in market conditions). Supply and demand for the stocks may change depending on the group composition. These groups may be formed based on different factors: the scale of emitters, the level of capitalization, etc. However, it is more efficient for the enterprise that represents a specific industry to classify its shares on the market on the basis of its industry.

It is important for enterprises to control the tendencies that occur within the industry. The market acts as a barometer of the country’s entire economic system. Main reason being the fact that the most liquid capital and monetary instruments are traded on the exchange. Regardless of the fundamental factors, the industry-level events may impact the share prices of the emitters in the industry. For example, an increase in the prices of oil on the global market result in higher prices for the shares of oil companies in the short-term. Besides, the capital flows may start flowing into or out of the market, or fluctuate within the market between the industrial groups. Therefore, it is important for the investor to monitor the capital flows within the market, in order to forecast the future conditions of the industry, to which his enterprise belongs. This process is also effective in the absence of possibility of investing capital on the market, as it allows to gain the understanding of the industry dynamics.

In the process of managing the most liquid instruments of the investment portfolio there is the need for control of capital flows between industries. This problem creates the need for the industry indicator - index, which can control the structural changes of the fund capital. Currently, the absence of such indicator negatively affects the regional investors, which face the information deficiencies.

Regional equities market mainly consists of regional companies’ stocks. The available information only allows for monitoring of the factual dynamics of the market and quotations of specific securities. Emitters often act as owners of free capital. On the basis of the Board of Directors decision the enterprise executes the buyback of its own shares that belong to second or third liquidity groups (for example, Kazakhtelecom JSC and Kazatomprom JSC bought back 100% of their outstanding preferred shares). High level of correlation between securities of emitters from same industry allows building of forecasts for less liquid shares. However, the current voting power of the capital owner during the decision making process in regards to purchase/sale price is not sufficient. The procedure of second-class share valuation is entirely delegated to professional market participants, or sometimes, investment consultants. Both of them may have a subjective influence on the valuation price. The industry of the emitter is never chosen as the main factor for valuation, which can help characterize the security from industry investment rating perspective, as it is always a specific security - industry representative. Therefore, the main aim of the consultant is to support the choice of a particular industry representative. Under conditions of highly dynamic market on short-term basis, the task is complicated by the large quantity of contradictory information, capable of radically changing the investment attitude of market participants.

All of it means that more detailed control over the market requires monitoring not only global (between markets) and small (between emitters) capital flows, but also medium ones (between industries). To solve this issue, a synthesized instrument, which allows the execution of real-time technical control over capital flows between markets, is necessary.

One of the most efficient instruments for use in the process of portfolio management on the Kazakhstani market may be the RCBK index (index of the Kazakhstan equities market). However, the use of general equities indexes is efficient only for large enterprise-investors, which have sufficient amounts of free capital. The basing of portfolios of such volume (which are usually sufficiently diversified) on index brings moderate, but stable returns. Small and medium investors, whose portfolio usually consists of one to three most liquid emitters, use this metric in decision making. Index changes essentially bear informative nature for them, since securities quotations’ dynamics may differ from index in short-term.

Analysis shows that presently the control is implemented only for capital flows between markets and specific emitters, which allows for monitoring of the integrated capital moves, which include strategic and speculative capital. Monitoring of the capital flows between individual emitters allows distinguishing the speculative capital from the rest to one degree or another. However, the capital flows between industries enable the efficient control of large investors’ strategic capital.

Management of the cross-branch capital flows solves the following key issues:

Firstly, it allows the financial management team to assess the attractiveness of investing capital into key economic sectors of the national economy. Secondly, it helps obtain the complete control over the capital flows within the equities market. Thirdly, it allows for usage of a more detailed approach to the formation of strategic investment portfolio, taking into account the attractiveness of branch sectors.

While the equities index indicates the increase or the decline of the overall activity, cross-branch capital flows, expressed by one index or another, show the internal structure of capital on the market, as well as investor preferences. With this indicator, the enterprise financial manager may obtain additional confirmatory signals in the process of portfolio management. Besides, it creates the possibility to forecast cross-branch capital flows, which increases the probability of making more optimal investment decision. This approach allows large enterprises to secure their investments with additional insurance. Using different methods of hedging, investor can focus on specific shares of concrete industry representatives without taking additional risk. In absence of the chaotic dispersion of capital, the portfolio return becomes easier to forecast, while the capital becomes liquid and manageable.

In order to assess the attractiveness of the securities group, related on the basis of industry, the index that allows the aggregation of quotations of separate shares is necessary.

In order to be aggregated, this index must: - be representative of all securities within the industry; - be computed from data that is publicly available.

In its content any index is a mathematical expectation. It must be the center of gravity for that sample, for which it was calculated. In this case the condition for selection will be the belonging of emitter to one industry or another. Therefore, this index should be named the free industrial index.

The realization of this possibility is connected with the construction of an indicator on the basis of the objective data about the activity of professional participants and proper methodology for their processing. The most convenient and publicly available data for evaluation of business activity of professional market participants includes the volume of transactions within specific market segments during the specific period of time and with a specific security. The methodology for processing of this data should offer the possibility of obtaining comparable valuations to make judgement about the direction and intensity of market activity changes. In general, the changes of investment attractiveness of a specific security can be assessed by comparing the trading volume of this security with base instrument or with the previous trading value. Such approach to market valuation, hypothetically, will allow the manager to determine the degree of investors’ interest in a specific security.

For computation of the industry index (quasi-index) for separate emitter’s security, the following methodology is offered:

Where: Int - the instantaneous value of purposeful index (quasi-index) for securities n at the moment of time t; In_t–1 - the previous value of the index (quasi-index) at the moment of time t - 1; Vnt - the daily trading volume with security, at t; Vnt-1 - the previous daily trading volume with security, at t - 1.

Let’s assume that the previous value of the emitter’s shares index at t - 1 equals 102; daily trading volume - 10; the previous daily trading volume - 16 [4]. Consequently, the current value of the index for emitters’ shares at the moment of sale equals 7.98.

The proposed methodology for index calculation will make it possible to analyze its current values, while also taking into account the previous results. Values obtained with this methodology will act as individual indexes in relation to separate types of securities.

Creation of a synthesized industry index requires the weighting of quasi-indexes. The coefficients, which can be used as qualitative characteristic of the securities’ attractiveness, should be used as the weights.

As a rule, transactions with securities are done for the purpose of generating income. This is possible only in the case of existing price spread, which allows the investor to overlap the transaction expenses in case of taking certain actions. An increase in the difference between the local levels of maximum and minimum price of security speaks about an increase in trading activity of participants with this particular security and possibility of obtaining high income from trades with this security. However, one should keep in mind that similar price spread may mean different things for different securities. The relativity of the securities’ spread to its overall price is important. This allows evaluating the return from capital, invested in security. The higher level of return constitutes a higher security rating. Using the initial data, the maximum profitability from the transactions with security may act as the rating of the asset. Therefore, this indicator characterizes the attractiveness of security and serves as weights for the quasi-indexes, which were calculated for it. In the formalized form, the maximum level of profitability can be represented as the maximum day spread divided by the minimum price of day. In this case the ideal scenario is taken into consideration, when investor acquires the security at the lowest price, and sells it at the highest price.

On the basis of the above-mentioned conclusions we offer the following formula for calculation of general industry index IB.

Rn = ([N]n - Ln)/Ln, where: IBxt - industry index during the separate time interval t for the branch X; IBxt-1 - previous value of industry index at the moment of time t for the branch X; Vnt - the trading volume with security at the time t; Vnt-1 - previous trading volume with security the time t - 1; Rn - the highest daily profitability of the security n; [N]n - maximal daily price; Ln - minimal daily price;

ΣRn - sum of all levels of maximum profitability values of security n for the time interval t.

The recurrent (sequential) methodology for calculation of summarized industrial index allows controlling changes in the index, while taking the previous values into account, which increases the correlation of its discrete variables.

It should be noted that the methodology for calculation of summarized branch index lacks the leveling coefficient, which makes it possible to smooth the rapid changes of its values that occur as a result of changes in the listing. Such changes in the lists of securities, which form industry blocks, are of high importance for the manager. Exclusion of securities from the general listing indicates a decline in the business activity in this market sector or the corporate actions of the emitter. While the general equities market index is aimed at leveling the changes in the listing, the industry index, on the contrary, must track and accentuate them.

An increase in the values of industry index implies an increase in the trading volume within the respective industry, which is a consequence of increased investor demand for the whole industry, or its separate components. A decline of the industry index constitutes the overall decline of the equities market (confirmed by declining equities market index) or the outflow of capital to another industry (confirmed by increasing index of another industry).

The summarized industry index reflects the degree of investors' business interest in the emitters' shares taking their industry accessory into account. With its computation the investor weights the relative coefficients, instead of the absolute coefficients, while involved in decision making process. These relative coefficients characterize the degree of change within concrete market parameters, such as investor activity and the maximum return on invested capital.

Literature

1. Law of the Republic of Kazakhstan On Pension Provision № 369, 2011.

2. Securities market of Kazakhstan. 2011, January.

3. Dodonov V. Yu. Portfolio management in the developing equities markets – Almaty, 2010.

4. Formation of the investment portfolio // Kazakhstani securities market. – 2009, № 1. – C. 52.

5. Mischenko A.V., Popov A.A. Approaches to the optimization of the investment portfolio // Management in Russia and overseas. – 2012, №2. – С. 103–109.

6. Kazakhstan Stock Exchange website – www.kase.kz.