3.

0 Investor profile
The first step to determine the investment allocation for James is to better understand

his investor’s profile. The investors profile will help to determine what asset allocation

would best fit with James. In order to determine James profile we asked the following

questions;

3.1 What are James Investment Goals?

We have seen in the previous chapter that James’ primary investment objectives are to

own a property and to retire early. At the same time he would like to have some cash

available to travel and enjoy life

3.2 How much time does James have to achieve these goals?

Time is an important factor in determining the investor’s profile. Over longer periods

expected results of riskier investments will become less volatile than they are over shorter

periods. This is the reason why a person with a long term investment horizon can invest

in more risky investments than somebody who wants to achieve his goals in a shorter

time frame.

James main objective is early retirement and he currently plans to early retire at age 60.

This means that he has 30 year to achieve this goal; this long time horizon would justify

an aggressive investment portfolio.

3.3 How much can James afford to invest regularly?

This is another important question to ask as it will determine how much his James

assets need to grow to achieve his objectives. James is currently unable to save any of his

monthly income, and given his indicated wish to travel on regular bases, it is assumed in

the assessment that only the current inheritance will be invested.

3.4 How much do James assets need to grow to achieve his objective?

It is important to understand the answer to this question as well, as this will determine

the annual return that James would need to achieve to obtain his goals; of course the asset

mix that James would choose should lead to an expected annual return that is sufficient

for James to obtain his goals. We have seen in the previous chapter that in order for James

to obtain his financial goal of early retirement he will need to make an annual return of

9%.

3. 5 How much Risk is James willing to take?

Finally we asked the question how much risk James is willing to take? Depending on

the portfolio that James would choose, and the mix of assets in this portfolio, there is a

risk that in the end James does not achieve his investment objective due to variations of

actual investment income as compared to expected investment income. The level of risk

that James is willing to take depends on what would happen in case he would not achieve

his objective. In this case that would mean that he could not retire early but would have to

work on until 65, or more likely (since he might under achieve his goals but only to a

certain extend) until 61 or 62; so although there is some risk in this, it does not present a
major risk that can not be found any solution for; therefore the conclusion is that James is

not risk averse.

4.0 The Indonesian market

Indonesia has in the last 10 year transformed itself; it is currently lead by its first

directly elected president Susilo Bambang Yudhoyono and the days of autocratic rule are

long over. Along with the political reform has come a more resilient economy; the

government forecast s GDP growth to be at around 7% per annum driven by increasing

investments and strong consumer consumption. Inflation has been curbed in recent years

and has come down in the single digits. Foreign direct investment reached 10 billion in

2007 a rise of 73.2% over the year before that (BKPM, 2008). I recent years the

Indonesian floated several international Government bonds successfully, these were for

nearly 50% taken up by US investors, with European and Asian investors taken up the

remainder. Recent recession has of course slowed down the economy and its outlook, but

overall the long term outlook remains positive.

The key financial indicators of the economy are as follows;

2006 2007 2008

GDP growth* 5.0% 5.6% 3.6%
JSEX growth ** 55.4% 52.1% -50.6%
10-year government bond yields ** 11.8% 10.5% 12.1%
IDR Exchange rate to 1 US$ * 9,124 9,340 11,030
Risk free interest rate * 9.5% 7.5% 9.3%
Inflation * 6.6% 6.6% 11.1%
Growth in Total Consumption * 3.9% 4.9% 5.9%

* Source: Bank of Indonesia annual report 2008

** Source: Yahoo Finance

4.1 Indonesian Stock market.

 The Indonesian Stock market’s performance has been highly fluctuative in recent years.

After the booming years of 2006 and 2007, the market dropped significantly in 2008 as

the world went into recession. Thus far in 2009 it has seen remarkable recovery though.

Graph 4.1; Historical Performance of Jakarta Composite Index

4.2 Return analysis

4.2.1 Calculation of annual return

For this calculation the annual rate of return was calculated using the following

formula;

EMV − BMV + I
r=
BMV
Thus the following result is obtained:

Table 4.1 Annual return of the Jakarta Composite Index

Closing Annual
Year Value Return
2008 1,355.41 -50.6%
2007 2,745.83 52.1%
2006 1,805.52 55.3%
2005 1,162.64 16.2%
2004 1,000.23 44.6%
2003 691.90

Source; Yahoo finance

4.2.2 Arithmetic Mean

The arithmetic mean is obtained through the following equation:

1 T 1
ARM =  ∑ ri =  (r1 + r2 + ... + rT )
 T  t =1 T  (University of Liverpool 2009)

Where;

T is number of periods and , r is the rate of return of each period

Thus we have:

ARM= (1/5)* ( 44.6 + 16.2 + 55.3 + 52.1 + -50.6) =

ARM=23.5%
4.2.3 Standard Deviation

The standard deviation is equal to the square root of the variance. With the variance

being equal to:

 1 
σ 2 = VAR =  ∑ (rt − r ) 2  (University of Liverpool 2009)
 T −1 

With:

T the size of the population sample, which is 5

rt equal to the rate of return for the period t

r equal to the arithmetic average of the sample

Thus we have

VAR=19.6%

Thus the Standard Deviation is 44.2%

4.3 Indonesian Bond Market

The Indonesian bond market has fluctuated quite a bit as well. The yields on 10 year

bonds for example in recent years has varied from as low as 9% to as high at 19%. The

graph below gives some indication of the fluctuation in recent years;

Graph 4.2 Indonesian 10-year government bond yield

Source; Bloomberg
4.4 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%