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Finance - Investments Sub-forum: Non-Actuarial Personal Finance/Investing

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  #1  
Old 11-03-2009, 01:11 PM
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Cheezy Cheezy is offline
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Default Portfolio Analysis

So I'm doing a portfolio analysis for the insurance company I work for. The cash flows are fairly simple but I'm having problems deciding what to do for returns on our stock holdings. Basically we purchase/sell stocks which aren’t hard to deal with in determining returns. I'm having problems on what rate to use for reinvestment of dividends. We don't reinvest directly back into the stock that pays dividends but instead it goes into a cash holding account which is used for other purposes. I have three options for the rate to use for reinvestment of dividends to calculate a return on stock holdings.

1) Basic return on our Cash holding account. Basically assume that the money from dividends stays in this account through the period of analysis which isn't that bad because we are only doing an 18 month analysis.

2) Use the overall portfolio return as a reinvestment return. This would assume that the cash would be reinvested proportionally to our holdings in fixed income, money market, stocks and cash. I have issues with this because it is not what actually happens.

3) Use the rate of return for our fixed income holdings. This assumes that cash is mainly used to buy bonds and as such dividends are used similarly. This is close to what actually happens but we may have a cash balance in our cash account for several months depending on market conditions.

What say you fellow actuarial people? What would you do?
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Last edited by Cheezy; 11-03-2009 at 01:16 PM..
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  #2  
Old 11-06-2009, 02:19 PM
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you might be a DB if you didn't help me out at all OPers!
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  #3  
Old 01-08-2010, 12:53 AM
mek42 mek42 is offline
 
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I'm still studying for the P and my business education pretty much consists of first year accounting sequence. In other words, I don't have any experience or training, so filter what I write accordingly.

On the other hand, I am planning to start a small non-profit scholarship type fund this year, so this question is important for me to figure out.

Once dividend interest is received, it goes into the cash holding account. Since that is where the cash goes and once it is there it is indistinguishable from the rest of the cash in the cash holding account, I think that using the return on the cash holding account is the most appropriate rate of return for dividends as a reinvestment. After all, the dividends are being used to invest in cash via the holding account.
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  #4  
Old 01-08-2010, 08:51 AM
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A key question is this. How far into the future are you projecting?

If only a short period, then #1 looks right. For a longer period, #3. Both reflect your actual reinvestment strategy, but for different time frames. I wouldn't consider #2 unless your company actually did plan to purchase more stock.

JMO, of course.
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Old 01-08-2010, 09:59 AM
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Quote:
Originally Posted by Cheezy View Post
So I'm doing a portfolio analysis for the insurance company I work for. The cash flows are fairly simple but I'm having problems deciding what to do for returns on our stock holdings. Basically we purchase/sell stocks which aren’t hard to deal with in determining returns. I'm having problems on what rate to use for reinvestment of dividends. We don't reinvest directly back into the stock that pays dividends but instead it goes into a cash holding account which is used for other purposes. I have three options for the rate to use for reinvestment of dividends to calculate a return on stock holdings.

1) Basic return on our Cash holding account. Basically assume that the money from dividends stays in this account through the period of analysis which isn't that bad because we are only doing an 18 month analysis.

2) Use the overall portfolio return as a reinvestment return. This would assume that the cash would be reinvested proportionally to our holdings in fixed income, money market, stocks and cash. I have issues with this because it is not what actually happens.

3) Use the rate of return for our fixed income holdings. This assumes that cash is mainly used to buy bonds and as such dividends are used similarly. This is close to what actually happens but we may have a cash balance in our cash account for several months depending on market conditions.

What say you fellow actuarial people? What would you do?
Is this backward or forward-looking? Are you assuming a return on the stock portion of the portfolio, or calculating past performance? If you're assuming a return, then it doesn't matter how you treat the cash - that error will be infintesimal compared to the error of predicting market performance.

You should treat the cash from dividends as part of the equity investment until the next rebalancing period (at which point you invest the proceeds of the dividends into fixed income). It will lower the overall equity return, and that is the correct approach. In GIPS performance reporting standards, and the performance reporting standards at our firm we always show the total return including the temporary cash balance resulting from dividend payments. Since they client can't avoid having it, it can't be ignored.

But it seems like you are an actuary and not a financial analyst, and are indeed projecting into the future (which boggles my mind...) Assume quarterly rebalancing in which 4.0% of the equity (or whatever the dividend yield is) is moved to fixed income. That feels clean & consistent to me.

However, the most important point you didn't tell us: what is the purpose of this analysis?
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