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Investment principles

Learning outcomes

After studying this text the learner should / should be able to:

1. Distinguish the ultimate investments of the financial system and real economy and the investment vehicles which intermediate them and the investors.

2. Define the objective of investment.

3. Explain the investment environment and the research levels.

4. Demonstrate an understanding of, and the relationship between, risk and return.

5. Appreciate the existence of investment theories and the lessons drawn from them that are relevant to investments.

6. Describe the principle underlying the valuation of investments.

7. Explain the essence of portfolio management.

8. Describe asset class allocation of the course of the life-cycle.



Figure 1: investments

Thus far in this text on lifecycle investing, we have covered prudent lifestyle conduct (in order to reach your FSG as early as is possible), the financial system (from which three of the asset classes spring), the detail of the ultimate financial investments, real investments, and the investment vehicles (which have as assets the two aforementioned), the liabilities of which (PIs) are the main investment form for individuals. A summary of the above is provided in Figure 1.

A reminder of the asset classes, and the extent to which they are held directly or indirectly, is presented in Table 1, for the institutional investors (i.e. the investment vehicles - managed by fund managers) and the individual investors.

Financial assets:

Institutional investors:

Individual investors:


Held directly (with some exceptions):

- Ordinary shares

- Preference shares

Held in directly via CIs & CISs:

- As on left Held directly (HNWI)

- Ordinary shares


Held directly (with some exceptions):

- Government bonds

- State-owned enterprise (SOE) bonds

- Corporate bonds

- SPV bonds

- Foreign bonds

Held indirectly via CIs and CISs:

- As on left Held directly:

- Government bonds (retail bonds)

Held directly (with some exceptions):

- Treasury bills

- Commercial paper

- NCDs & NNCDs

Held in directly via Cis and CISs:

- As on left Held directly:


Hedge & private equity


Held directly

Not held

Real assets:

Institutional investors:

Individual investors:

Held directly:

- Commercial buildings Held indirectly:

- Mainly PUTs

Held in directly via CIs & CISs:

- As on left Held directly

- Own residential property

- PUTs


Held directly:

- Mainly precious metals Held indirectly:

- Commodity ETFs

Held directly:

- Precious metals (coins)

- Cattle (in some countries)

Other real assets

Not held

Held directly (by HNWI):

- Antique furniture

- Rare stamps and books

- Art, etc

Table 1: Asset classes of institutional investors & individual investors

This main section is concerned with the principles of investments. It is important to have a clear idea of the objective of investment and to differentiate it from speculation and gambling. It is essential to have an understanding of the context / environment of investments: the macroeconomy and its drivers, and the substance of the four levels of research. It is essential to be cognizant of the risk inherent in most investments and appreciate that there is a positive relationship between risk and return.

Because of the significance of investments to all individuals, many theories on and related to investments have been proffered. While not all are of pragmatic employ, many of them extrude useful practical lessons. An important principle is that financial and real asset markets discover prices which do not necessarily align with fair value (given the level of risk-free and other interest rates); thus, it is important to appreciate the principle underlying the valuation of investments. It is also important to understand the essence of portfolio management.

These issues are addressed under the following headings:

- Definition and objective of investment.

- Risk-free rate.

- Investment environment.

- Risk and return.

- Investment theory: practical lessons.

- Valuation of investments.

- Portfolio management.

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