FIN 408 Hybrid Funds

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FIN 408 - Hybrid Funds

• Hybrid Funds
• Invest in both stocks and bonds,
• May also invest in convertible bonds and
  preferred stocks,
• Generally less risky than the stock funds may
  provide better return than the bond funds
• The level of risk depends on the mix of stocks
  and bonds,
• Appropriate for conservative investors.

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Hybrid Funds

• Three types of Hybrid Funds

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Asset Allocation

• Asset Allocation Purpose is to put assets
  together in such a way as to maximize return at a
  level of risk consistent with investors
  objectives.
• Process involves 4 key elements
• 1) Investors need to determine the assets that
  are eligible for the portfolio.
• 2) Necessary to determine E(R) for these eligible
  assets over a holding period.

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Asset Allocation

• 3) Once returns have been estimated and risk
  accessed, optimization technique is used.
• 4) Choose portfolio from efficient frontier,
  provides maximum return, minimal risk.

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Approaches to Asset Allocation

• Three approaches to Asset allocation
• Fixed Weight Fixed percentage of the portfolio
  to each asset category 3 to 5 in total. Fixed
  does not mean equal weight.
• Common Stock 30
• Bonds 50
• Foreign Securities 15
• Short term Securities 5

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Approaches to Asset Allocation

• Allocation does not change over time, may be
  adjusted after a major market move to keep the
  desired fixed allocation

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Asset Allocation

• Flexible Weight - also known as strategic asset
  allocation Weight changes on the basis of market
  analysis. Favorable domestic inflation forecast
  compared to foreign may result in revised
  allocation.
• Common Stock 30 to 45
• Bonds 50 to 40
• Foreign Securities 15 to 10
• Short term Securities 5 to 5

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Asset Allocation

• Weights are changed to capture greater returns
  in changing market.
• Tactical Asset Allocation Form of market timing
  that uses stock index futures and bond futures to
  change a portfolios asset allocation.
• Stocks are forecasted to be less attractive than
  bonds, sell stock index futures and buy bond
  futures.

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Asset Allocation

• Bonds are forecasted to be less attractive than
  stocks, buy stock index futures and sell bond
  futures.
• Requires sophisticated technique, large
  portfolio, quantitative modeling.
• Appropriate for large institutional investors.

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Balanced Fund

• Balanced fund Preservation of capital is the
  main objective
• Each fund sets its own fixed allocation
  percentage and discloses them in the investment
  objective,
• Traditional balanced fund allocation
• 60 stock 40 bond bond
• Other allocations scheme may be 555 stock 35
  bond and 10 cash equivalent.
• Rarely the leading performers not the worst
  performer.

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Convertible Securities Fund

• Invests in corporate bonds and preferred stocks
  that can be converted into common stocks
• The majority of the bond and preferred stock are
  investment grade securities
• Small percentage may be invested in
  nonconvertible corporate bonds, U. S. government
  securities, foreign securities, and common
  stocks,
• Fund is not well known or popular difficult to
  understand how the underlying instruments work.