Download draft1 140212

1. Introduction
Anglo American PLC (AAL) is a worldwide mining and exploration company with a portfolio
primarily in mining assets and natural resources operating in every continent. The Company
is a market leader in the platinum and diamond arena as well as owning shares in a number
of other mining and industrial businesses, namely Kumba iron Ore and Anglo Platinum which
together account for more than half of the Anglo's £40.2bn market cap.
2. Anglo American Beta and total risk
and return for 2011/12
Anglo’s beta of 1.64 (see appendix 1) shows that its stock’s increasing volatility in
comparison to the market and even the overall mining sector which has a beta of 1.33. With
a higher beta and thus greater risk you would assume greater relative returns according to
Market Portfolio Theory (MPT). However over this period Anglo’s returns have been less,
generating a -0.14 (%?) return and 0.02 risk which equates to a -7.57 gradient, weaker than
the market. However within the last 6 months the return has been 0.04 and 0.02 risk giving a
6 month gradient of 0.44 showing a strong turnaround and out pacing the FTSE 100 gradient
of 0.39.
However the Beta is based on historic information and thus is not always an accurate
indicator of future worth as it would not include future activities in Anglos peripheries such as
the nickel mining project in northern brazil due to go ahead in 2012 (ref), Therefore the Beta
may be acceptable for short term decision making concerning volatility and risk. However
when analyzing the risk for a long-term investor we should combine this with an in depth
analysis of a company’s fundamentals for a better overview.
(do we need more risk and return compare anglo gradient with gradient of mining sector?)
3. Anglo American shares compared
to 4.5% Treasury Gilt (2013)
The subsequent global economic collapse forced the Bank of England (BoE) to slash
interest rates and purchase £ of UK gilts through quantitative easing (QE) in an attempt to
revitalise the faltering economy. The UK’s persistence in never defaulting alongside taking
strong measures to devalue the currency and tackle its deficit, has led to it being considered
a safe haven among indebted EU states during the sovereign debt crisis. This has resulted
in foreign inflows into UK gilts by euro banks and international investors (proof), inflating
demand and thus escalating prices and shorting yields.
Which when compared to a gilt of which has a redemption yield of 1.96 and flat yield of 4.11(where can I mention flat?)
Gilts annual redemption yield of 1.96 is superior to last years equity data as Anglo held a 0.14 return. However over the last 6 months with a return of 0.04 it shows stronger return,
especially when combined with a 5year PEG ratio of 1.21(meaning). Therefore this allow
scope for growth which Gilts static returns will not, however they will be protected which will
be a benefit for the risk adverse investor.
This assessment is further justified by The Barclays Equity Gilts study (ref) which predicts
that equities will outperform government bonds over the next 10 years, providing an average
return of 6.3% in comparison to government bonds average returns of just 1.6%.
With further QE expected in early 2012(proof) and the emergence of Vickers reforms will
mean banks gathering increased gilt holdings to comply with more stringent loss absorbency
requirements (proof)it would be possible to make a short term gain by capitalising on these
artificially inflated prices especially considering the near maturity date of the gilt. However
(UK potentially loosing investment grade) as if the UK was to lose their trusted investment
grade it would result in higher coupons being demanded and lower prices(?)
Therefore there is still a level of risk around price volatility and selling short, as the annual
yield of 1.96 will insufficient in returning a comparative yield to that of an equity, as it will be
consumed by inflation equating to negative real returns therefore we would favor an index
linked gilt as a substitute.
(now maybe not needed considering the near expirey date of gilt 2013) and in the long term gilts are destined to fall
in price (proof) as the economy rewrites and interest rates increase to counter inflationary pressure.
4. The risk and return of our three
equity portfolio (2011/12)
Optimum combination in a our three share portfolio is where 65.57% is invested in Dev
London a Uk based real estate trust listed in the FTSE 250 and 34.43% in HMP a Chinese
based utility company listed on the New York stock exchange resulting in returns of 11.39 , a
risk of 1.43, thus a gradient of 7.91. The reason for excluding Anglo is that over the past
years data they have generated negative returns and thus would hinder the portfolios
gradient.
There is greater risk by investing solely in one company as you are reliant on their sole performance for
returns, unable to be offset losses by gains in another. Thus by investing in three different markets given weak
or negative correlations, it is possible to reduce the isocratic risk of the portfolio according to MPT, alongside
international diversification also reducing the market risk, this is proven from the gradient of D London of 6.57,
which when combined with HMR rose to 7.91 even though HMR has a lower gradient of 4.83. This is due to the
weak correlation between them of 0.06.
By diversifying sectors, markets and geographical regions it will reduce exposure to economic shocks and
lower the overall risk of the investment.(replace with quote)build into paragraph above
(What does it look like if we included it in our portfolio?)We believe that all portfolios should hold an element of
fixed interest, with most clients holding upwards of 25% in this asset class."- gilts included?
5. Critical appraisal of the theoretical
models used to evaluate our
investment.
Our data is contrary to Solnik’s views that “an internationally well-diversified portfolio would be one-tenth as risky as a
typical security and half as risky as a well-diversified portfolio of U.S. stocks” Bruno solnik 1974 http://ben1208.free.fr/nouveaux%20m%E9moires/autre/f0510089a.pdf
as the negative returns in all stock markets over the last year have meant that the FTSE 100 is completely favored, if
combined with investments in the other stock exchanges it would receive a lower gradient. However this would not
normally be the case as exchange diversity would traditionally lower systemic risk.
Although through MPT we have been able to increase the gradient of our portfolio by diversifying away risk, the assumption
that the investors would be able to borrow unlimited amounts of capital at the risk free rate is unfounded as ……
( what is the implications of not borrowing at the risk free rate? What is the average cost of borrowing in reality? What does this do to the CAPM line and what
does this mean for our investment? Good or bad?)
due to the drying up of credit globally during the crisis. And different rates will apply depending on the quality of investor’s creditworthiness. The
ideal perfect market is also tainted as the size of the deal and market imperfections such as asymmetry of information are ever-present which was
demonstrated in the vast investments in highly rated risky investments leading up to the financial crisis.
Although MPT assumes the investors’ objective is to maximize the utility of wealth, the emergence of a more ethical conscience
of investors or the need for stable income and security overriding wealth may contradict this. This could be an issue
concerning the mining investment as The environmental impact of mining will result in a loss of biodiversity,
and contamination of soil, groundwater and surface water by chemicals from mining processes.
The CAPM model builds on this defining a relationship between risk and expected return. EXPAND Thus it falls short on similar assumptions
and how the ‘rational investor’ which the assumption state could now be skued by the volatile climate at which they operate.
APT further discusses the CAPM model in terms of economic factors effecting the relationship between risk and expected
return believing markets to be perfectly competitive, however the recent Glencore-Xstrata merger “ has sparked criticism
by potentially allowing Glencore Xstrata to control the prices of commodities through its control of the
entire supply chain.” And thus will be price setters eroding the ideal of perfect competition. Alongside limiting entry as
companies will need to gain scale to compete.
Fama and French’s three factor model KEEP IT SHORT!
Does the theory seem too short?
6. Future prospects of Anglo
American and our Portfolio
Anglo benefits from strong geographical and product diversification as well as being dual
listed in the UK, South Africa, Switzerland, Botswana and Nambia. Their reduces translation
and economic exposure will reduce volatility and maintain sales and brand awareness while
allow for a efficient sourcing raw material.
Demonstrated by their product range growing in worth:
“Anglo have reported their third quarter production of iron ore, metallurgical coal, thermal
coal and diamonds above expectations” (weak)
In order to add greater context to the Beta analysis we have centered our finical analysis
around the current worth of Anglo but more importantly how the market values their stock.
One of the key deteriorates of their expectations would be the company’s earnings, current
and future. Inflated earnings would increase the probability of a higher dividend and also
lead to a higher stock price.
With their total net margin increasing to 23.4% in 2010 from 11.63% in 2009 we have seen a
recent growth trend, matched by a reduction in their debt levels increasing their stability and
security in a volatile market. Demonstrated by their debt to equity ratio being reduced from
54.8% to (2010) 39.3%. Earning growth alongside increased cash flow adaptability and thus
a stronger current ratio from 1.5 to 1.8 2010 increasing Anglo’s ability to pay off long term
obligations.
return on equity in 2010 is now 22.32% rising from 2009 10.3%) Having increased from the
previous year we can see improved efficiency in the mangers allocation of shareholders’
funds in generating revenues.their increased stability and earnings trajectory alongside
positive PEG ratios of 1.21. Demonstrated that with a current PE of 9.5 Anglo may be a
reasonably prices growth share in a sector with a PE of 20.93 and high market expectations.
It may also rise significantly given the potencial take over by glaxco
however in order to reduce the risk from this volatile sector and improve the risk return
efficiency we would combine it within a portfolio.
(give excuse for why anglo data is poor for 2011” - The data presented is marred by an
especially difficult 2011 period in the mining sector)
Ideally “a portfolio of 20 to 30 stocks diversifies away unsystematic risk”. Richard A. Brealey
and Stewart C. Myers, authors of "Principles of Corporate Finance -- Sixth Edition
However in a portfolio of three we have chosen D London and HMP.
D london because as a trust they . The MMR will reduce mortgage supply through more
stringent assessment criteria this could restrict the amount of commercial property bought
and thus increase the renting population which would benefit D London’s income. However
the reduced demand for property and reduction in commercial prices could reduce the value
of their asset base. which will be somewhat countered by further QE will boost demand for
property and thus their prices as confidence grows and investors rebalance their portfolios in
search of higher yields. If QE is unsuccessful in inspiring growth and just inspires inflation
then there will be a shift into Anglo commodities as (QUOTE)
This is an ideal counterpart to Anglo given the housing market and Anglo’s product portfolio
are negatively correlated.(need figure data and graph)
HMP being dual listed will benefit from the same advantages as Anglo. With all of their
operations based in china thy can benefit from the growing economy and population. China
government is investing heavily in utilities (need quote), utilities is a necessity hence a low
beta of 0.4 and thus used to anchor our portfolio. As “When the economy is slow, regulated,
traditional companies that provide essential services act to stabilize an investment portfolio”
http://www.istockanalyst.com/article/viewarticle/articleid/4508318
However China’s potential fall into recession by 2015, which being the largest importer of
commodities could “reduce commodity prices as much as 70 percent” Smead Capital
Management Inc. which would impact the portfolios share in Anglo. Fortunately we believe
this will not impact HNP as past performances from utility companies during a financial crisis
have proved to be resilient, as shown by British Gas share’s stability during the financial
crisis of 2007 in the UK. (appendix)
The newly formed Glencore Xstrata International plc would benefit from far greater leverage
resulting in monopolistic tendencies concerning price. (link to quote) threatening the
competitiveness of Anglo in this sector.
7. Conclusion
Therefore in conclusion, gilts currently do not represent good value, this will mean if held as
an investment their value is destined to decrease and thus the investment will need to be
held to maturity gaining a extremely low redemption yield of 1.92 %, which will be eaten up
by inflation.
Contrary to the CAPM’s results, we would invest in Anglo, this is due to CAPM’s inability to
consider the future growth prospects such as the P/E ratio of % and share price
increasing due to potencial bid. However given the volatility of the sector, namely china’s
potential fall commodity demand due to their recession alongside the heightened competition
by the Glencore and Xstrata merger. We would advise reducing the unsystematic risk by
diversifying into a portfolio as this would increase our risk-return gradient detailed by MPT
and proven through our statistics.
2100current wc