5.

0 Recommended Asset allocation

Based on the investors profile it is suggested to go with a relatively aggressive

portfolio. Given the goal that James has to purchase his own property, this will be one of

the suggested investment vehicles. Besides this a relatively high proportion of investment

will be allocated to equity. Some of this is suggested to be invested in equities outside

Indonesia, given the high volatility of the Indonesian equity market, this might give more

stable results to James. It needs to be observed though that investing outside Indonesia

introduces a currency risk.

It is recommended to have a reasonable proportion of the investment allocated to

bonds, there are two reasons for this; firstly the bond yield in Indonesia are high, and the

returns are close to the targeted returns that James is looking for. Thus adding a

reasonable portion of bonds to the portfolio helps James reducing risk in his portfolio,

this will reduce returns but not below his actual target. Secondly, as the country is

becoming more and more stable politically and economically, one might anticipate

interest rates to come down somewhat in the mid long term. Being invested in medium to

long duration bonds can then create the additional benefit of capital gains.

In summary the recommended portfolio of assets looks as follows;

Asset Class Allocation

Local Equity 30.0%
Local Fixed Income 25.0%
Property 20.0%
Foreign Equity 15.0%
Cash/deposits 10.0%
Total 100.0%
5.1 Local Equity

The 30% allocation of the inherited capital to local equity represents an equivalent

amount of 60k James needs to consider a number of issues when investing this money;

1. Diversification

When investing in equity it is important to obtain enough diversification in his

portfolio; in terms of different stocks as well as over different industries.

Diversification is best obtained by investing in equities whose performance is not

closely correlated. Diversification therefore is found by spreading over different

industries for example. In order to achieve this with a limited budget it would be

recommended to make use of the services of a fund manager.

2. Management and analysis

Optimizing equity performance requires the investor to set out an investment

strategy and execute strategy this consistently. This requires the investor to

continuously follow movements in the market as well requires him to have the

technical skills to analyze and make decision. Since James does not have time nor

the technical knowledge and skills to define a trading strategy and continuously

monitor the market in order to execute this trading strategy, again the use of the

services of a professional fund manager seems to make sense.

The cost of using a professional fund manager in Indonesia is 200 to 250 Bps.

Alternatively James could manage his own portfolio but would still be facing some

trading cost. The one issue that James will obtain for the price of 200 Bps is that he will

not have to define his own trading strategy and/or execute is consistently. Also since he
does not have any technical skills or tools to monitor and make investment decisions, he’s

more likely to make a higher return on his investment despite the cost he has to pay for

the service.

The benchmark for the equity performance will be the performance of the Jakarta

Composite Index. The goal should be to outperform this index. Most fund managers will

publically announce their benchmark for fund they offer, and therefore it should be

possible for James’ to indentify a fund that has the same benchmark as he has for himself.

Local Fixed Income

The local fixed income market is primarily a government bond market, although in

more recent years the number of corporate bonds of quality has increased quite

significantly. The lot size for investing one bond is 100k This means that James is unable

to diversify his portfolio without again using the services of a professional fund manager.

The cost of using a professional fund manager in the fixed income section in Indonesia

is 125 to 175 Bps. Alternatively James could manage his own portfolio but would still be

facing some trading cost. An additional benefit is that the capital gains as well as the

coupon payments on fixed income held in a mutual fund are free of tax in Indonesia,

whereas in case of direct holding they would be subject to 15% final tax. This alone will

make it more attractive for James to use a fund manager, rather then invest direct.

The benchmark for the fixed income performance will be the HSBC fixed income index

for Indonesia. The goal should be to outperform this index. Most fund managers will

publically announce their benchmark for fund they offer, and therefore it should be

possible for James’ to indentify a fund that has the same benchmark as he has for himself
Property

20% of the current allocation of fund will be directed towards James’ new property. This

20% will be in the form of down payment and through monthly installments the

proportion of fund allocated to his property will increase.

Foreign Equity

The foreign equity proportion will again be subjected to the same limitation as we saw

on the local equity funds; this again means that the use of a fund manager would make

sense, as James time sand expertise are not sufficient to manage his own portfolio with

optimal results.

The cost of using a professional fund international equity fund manager is around 200

Bps. Alternatively James could manage his own portfolio but would still be facing some

trading cost. The one issue that James will obtain for the price of 200 Bps is that he will

not have to define his own trading strategy and/or execute is consistently. Also since he

does not have any technical skills or tools to monitor and make investment decisions, he’s

more likely to make a higher return on his investment despite the cost he has to pay for

the service.

The benchmark for the equity performance will be the performance of an international

index. The goal should be to outperform this index.

Cash
 Some of James money will be kept absolutely liquid and will function as a first buffer

against unexpected cost. Since James is not able to safe much from his current monthly

income liquidity is important as borrowing against credit card or other personal loan

arrangement are likely more expensive than the income lost because of allocating to cash

rather than another asset class.

Rebalancing the portfolio

James will have to rebalance his portfolio on regular bases. In this process he will need

to asses how his personal situation has changed and how this might impact his risk

appetite and therefore how it might impact his investment strategy. Secondly he will need

to take into account how the balance between the different sectors in his investment

portfolio have changed; if one or the other has show a significantly different performance

then the other he might want to rebalance between the different assets classes and bring

things back in line with the original (or the adjusted) strategy. Initially this process would

take place once a year, but this frequency might be adjusted later on.