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Gobeil's Strategic Financial Planning Study Aid - Investment Planning - Question 10 of 20

Posted by David Gobeil on

 This question originally was looking at shorting shares to benefit from a decline in a market segment and was somewhat confusing. it also referred to Potash Corporation and Agrium, which have now merged as Nutrien. I have rewritten the question as purchasing an interest in the market segment and updated information on the corporations involved.

Michael seeks to reduce potential volatility by including income-generating investments in his portfolio and accepting moderate growth of principal. He is willing to tolerate short-term price fluctuations and has a long-range investment time horizon. Michael is a balance-oriented investor. Michael's strategic asset allocation includes 40% to 60% fixed income and 60% to 40% equities. Michael does not intend to change his strategic asset allocation.

Currently, Michael's portfolio has a fair market value of $800,000 and his asset allocation includes 10% cash, 45% bonds and 45% equities.

Michael believes that the common shares of corporations in the fertilizer industry, particularly potash and phosphate, are going to increase significantly in value. He wants to add exposure of about $50,000 to the sector.

Shares of the iShares S&P/TSX Capped Materials Index Fund seeks to provide long-term capital growth by replicating the performance of the S&P®/TSX® Capped Materials Index, which consists primarily of common shares of corporations in the Canadian mining sector, with the shares from the Canadian fertilizer sector comprising about 15%.

Shares of the iShares S&P/TSX 60 Index Fund (XIU-T) seek to provide long-term capital growth by replicating the performance of the S&P®/TSX® 60 Index through investments in the constituent issuers of such index. The Index is comprised of 60 of the largest by market capitalization and most liquid securities listed on the TSX with the shares from the Canadian fertilizer sector comprising about 8%.

The Mosaic Company is one of the world's leading crop nutrition companies with a focus on potash and phosphate, two of three most vital nutrients. Mosaic is one of the world's largest producers of finished phosphate products.

Nutrien is the world's largest fertilizer producer by capacity. Nutrien produces the three main crop nutrients--nitrogen, potash, and phosphate--although the company's main focus is potash, where it is the global leader in installed capacity with roughly 20% share. The company is also the largest agricultural retailer in the United States, selling fertilizers, crop chemicals, and seed directly to farm customers. Seventy percent of Nutrien's sales are as an agricultural retailer.

What would you advise your client to buy?

(A)              Shares of the iShares S&P/TSX Capped Materials Index Fund

(B)              Shares of the iShares S&P/TSX 60 Index Fund

(C)              Shares of Mosaic Company

(D)              Shares of Nutrien

(Concepts)  If an investor wants to gain exposure to a particular segment of the market, there are usually many ways to do so. However, each alternative investment may include other market segments than the market segment being sought. So, the investor needs to determine the components of each alternative.

For example, if an investor wants more exposure to the cell phone market, an exchange traded fund (ETF) might have shares of Rogers, BCE Inc, and Telus. But if these 3 companies comprise only 20% of the holdings of the ETF, the investor would be paying for much that is not exposure to the cell phone market. If the investor wants the cell phone market, Rogers is primarily cell phones, but BCE also has huge holdings in land lines and broadcasting. Rogers is a purer cell phone play/investment.

Answer is (C). 

(Choice A) The iShares S&P/TSX Capped Materials Index Fund consists primarily of common shares of corporations in the Canadian mining sector, with the shares from the Canadian fertilizer sector comprising about 15%.

So, these shares would give Michael very limited exposure of only 15% to the Canadian fertilizer sector.

(Choice B) Shares of the iShares S&P/TSX 60 Index Fund (XIU-T) seek to provide long-term capital growth by replicating the performance of the S&P®/TSX® 60 Index through investments in the constituent issuers of such index. The Index is comprised of 60 of the largest by market capitalization and most liquid securities listed on the TSX with the shares from the Canadian fertilizer sector comprising about 8%.

So, these shares would give Michael very limited exposure of only 8% to the Canadian fertilizer sector.

(Choice C) The Mosaic Company is one of the world's leading crop nutrition companies with a focus on potash and phosphate, two of three most vital nutrients. Mosaic is one of the world's largest producers of finished phosphate products.

So, these shares would give Michael exposure to the fertilizer sector, Mosaic is a pure play on fertilizer, particularly potash and phosphate.

(Choice D) Nutrien is the world's largest fertilizer producer by capacity. Nutrien produces the three main crop nutrients--nitrogen, potash, and phosphate--although the company's main focus is potash, where it is the global leader in installed capacity with roughly 20% share. The company is also the largest agricultural retailer in the United States, selling fertilizers, crop chemicals, and seed directly to farm customers. Seventy percent of Nutrien's sales are as an agricultural retailer.

So, these shares would give Michael exposure to the fertilizer sector, but 70% of Nutrien's sales are as an agricultural retailer.

(Choice C is correct.) Michael believes that the common shares of corporations in the fertilizer industry are going to decrease significantly in value.

Shares of the iShares S&P/TSX Capped Materials Index Fund or shares of the iShares S&P/TSX 60 Index Fund would give Michael very limited additional exposure to the fertilizer sector.

Mosaic Company is a pure play on fertilizer.

Shares of Nutrien would give Michael exposure to the fertilizer sector, but 70% of Nutrien's sales are as an agricultural retailer.

So, Michael should look for the purest play on (investment in) fertilizer and buy shares of Mosaic Company.

 


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