Preservation Of Capital

From CEOpedia | Management online

Preservation of capital is an investment strategy generally designed for people with a short investment horizon or because of their financial situation who do not accept the risks associated with the equity market. The strategy is most appropriate for those who value, above all, investment security and greater stability of profits, even at the price of lower rates of return in the long term. This strategy belongs to the conservative category. Preservation of capital meets the needs of investors who want to multiply capital, but are interested in a constant, albeit low, income. They are characterized by low risk acceptance, so they choose instruments that will allow them to sell their securities at any time and return on invested funds (S.L. Schaus, Y. Gao 2017, pp. 127-130).

Investment objective and portfolio composition

The investment objective is to protect against the risk of inflation and to preserve the real value of the portfolio. of the invested capital. The objective is to achieve a comparable rate of return. with interest on deposits. The portfolio ensures high liquidity of deposits. Objective financial indicator: 100% WIBID_1Y. The funds will be invested in bills, Treasury bonds and bonds guaranteed by the Treasury. Countries, on deposits as well as in investment funds whose policies investment is limited to these types of deposits.

Scope of investment by asset class
Assets Participation in the Portfolio
Treasury bonds and bills 0-100% Assets
Deposits 0-100% Assets

In the case of investments in investment funds, exposure to a particular asset class with appropriate restrictions shall be calculated taking into account the fund's investment policy, e.g. in the case of bond funds, limits on bonds as an asset class apply. Investments in investment funds may represent the total exposure in the asset class (J. Bonza, N. Gómez, 2010, pp.73-75).

Characteristics and assumptions

The strategy of preservation of capital assumes that the investor should divide his money between bonds and stocks, with the investor never holding less than 25% and more than 75% in stocks, and more than 75% and less than 25% in bonds. It is best to divide it equally, half of the money into bonds and half into shares, and the reason to change this proportion should be the change in the level of prices on the stock market. Along with a prolonged bess squeeze, the investor should slowly increase the share of shares in the portfolio and vice versa, when price levels become dangerously high, it is recommended to reduce the share of shares to the level below 50% of the portfolio (M. Baskin, et al., 2019, pp. 45-49 ).

Capital preservation as a conservative strategy

The conservative strategy states that fixed capital (equity and long-term borrowed capital) finances not only fixed assets but also part of current assets. A conservative strategy is the opposite of an aggressive strategy of financing activities . It results in a positive net working capital. In this case, the financial risk is low, as the share of short-term financing is low. Because of the large share of long-term capital in the financing of the company, financing costs are high and the return on equity is low. A conservative strategy is a safe strategy, strengthening the company's balance of payments and financial stability, but at the same time a high level of fixed capital leads to higher financial costs. A company with a moderate strategy finances fixed assets from fixed capital and all current assets from short-term sources (R. H. AlHalaseh, Alali A., 2009, pp. 86-88) .

Determinants of the choice of capital preservation strategy

The four initial, analysed factors determining the company's financial strategies are ( H. Abdul-Hadi,2018, 133-134) :

As a result of the analysis, we obtain two "collective" factors describing the situation of the company, for which a financial strategy will be formulated. These are:

  • economic added value (EVA), resulting from the comparison of return on invested capital (ROIC) and weighted average cost of capital (WACC),
  • excess or deficit of capital in self-financing sales growth resulting from the comparison of sales growth (AS/5) and sustainable growth (g).

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Author: Dawid Misiura