Assignment
Portfolio Theory and Management Group Assignment I. General Instructions 1. This assignment has a maximum group size of 3 students. Students will form groups in MyUni for the course and submit the assignment through the group. Students who wish to complete the assignment individually must contact the course coordinator (
[email protected]) to seek approval. 2. The due date for the assignment is Sunday, the 17th October (11:59pm). Each additional working day (does not include Saturday, Sunday, or public holidays) incurs a 3-mark penalty which will be deducted from the total mark for the assignment. Late assignments must be submitted by the 25th of October (11:59pm) after which no assignments will be accepted. 3. Index data for US, Developed and Emerging markets is provided in the Assignment module and is adequate to complete the assignment. The data is provided from Q1 1994 to Q2 2021 (note that some data series does not start from Q1, 1995). Column labels/headers provide index details. Bonds’ data is provided in quarterly yields (in % returns) while Equities, Real Estate, Gold prices and CPI indexes are in quarterly values. Teams must ensure that all asset returns must be converted to real returns prior to commencement of the assignment. Teams must also ensure that the returns for all assets remain in quarterly return format. 4. Students should familiarize themselves with the communication skills guide as well as the Academic Integrity Policy (attached in the Assignment Module). Plagiarism in assignment from any source will be investigated by the Academic Integrity Committee and will be detected through the Turnitin report for similarity checks. 5. This assignment is worth 30 marks and is also weighted 30% of the total course assessment. A maximum word count for each section is provided. Teams are required to provide a word count for each section to show that the word limit has not been exceeded. mailto:
[email protected] II. Assignment Brief Farmers Union Foundation (FUF) is a not-for-profit foundation to support the tertiary educational needs of the families in the rural communities. The foundation is currently worth $125m and raises 2% (in real terms) contributions annually during its fund-raising events. The foundation has previously drawn 5% of the asset value (of Q4 of the previous year) to support its operational needs. The foundation’s strategic asset allocation (SAA) is benchmarked to the traditional growth allocation of 40:60 [Defense:Growth]. The Foundation committee has made several points based on a recent article on CNBC https://www.cnbc.com/2021/09/02/traditional-60/40-portfolio-has-actually-reached-its-expiration- date.html?&qsearchterm=60/40 1. “A benchmark of 20:80, instead of the current 40:60, may be more suited for the future. We understand that this will increase the volatility of the portfolio but will also deliver higher returns. Are we able to get a sense of the impact on the portfolio in terms of the (i) spend drawdown, and (ii) spend variability in real terms?” 2. “To-date, we have only invested in US equities and Investment Grade bonds (Government t and Corporate). It is time to expand the investment universe to include not only below investment grade bonds but also bonds and equities from other markets, as well as Real Estate. We have been thinking about adding either Gold or Cryptocurrencies to the portfolio as a hedge for inflation. Since the jury is still out on the latter, we will stick with Gold for the time being.” 3. “Historical average returns are poor estimates of future returns. We would like to use Reverse Optimisation and/or James Stein Estimates to generate a set of CMAs to help create the Strategic Asset Allocations for the Foundation.” 4. “Since the MV framework has issues in real world implementation, we would like to see two other competing SAAs based on (i) Risk Allocation, and (ii) 3 Bucket portfolio construction methodology.” The BoD has further stated that the portfolio manager will NOT use derivatives, short positions, or leverage. Cash will not be held by the fund unless it is a residual amount (from sale of assets or remaining yields from equities or bonds). The FUF’s Board of Directors have invited proposals for the future direction SEF fund’s investment needs from reputable investment https://www.cnbc.com/2021/09/02/traditional-60/40-portfolio-has-actually-reached-its-expiration-date.html?&qsearchterm=60/40 https://www.cnbc.com/2021/09/02/traditional-60/40-portfolio-has-actually-reached-its-expiration-date.html?&qsearchterm=60/40 companies. Invited investment proposal should be submitted by the 17th of October, 2021 and must cover the following 5 sections: a) Establish Investment Return Objectives b) Explain importance of each Assets/Sub-Assets in the SAA c) Create Capital Market Assumptions (CMAs) of returns for each Asset/Sub-asset d) Create competing Strategic Asset Allocations (SAA) e) Test competing asset allocations against each other and Recommend the most suitable SAA to the FUF’s BoD. Each section is further elaborated below. In the event of any clarifications, investment teams can also post question, and respond to other teams’ questions, in the thread “Assignment Q&A” on the discussion board. III. Specific Requirements 1. Benchmark and Spend: 15% (= 7.5% + 7.5%) of the assignment mark (maximum 400 words) The FUF’s Board of Director’s (BoD’s) investment objectives will drive the Benchmark for the portfolio. The benchmark must achieve a) Annual drawdown, or Spend, of 5% of the (previous year’s) fund value (in real terms) per annum, and b) Provide annual real growth of 1% of the portfolio. Annual contribution of 2% and Portfolio management fee of 0.75% must also be accounted for in the return objectives. FUF’s committee has requested that the investment objectives must be established using only the U.S. Aggregate Bond index (to represent defensive investments) and the MSCI USA Equity index (to represent growth investments) which are provided in the Excel file “PTMIII assignment 2-2021.xlsx”). CPI data is also provided in the same file to ensure that all returns data used is in real terms and NOT in nominal terms. Investment proposals will ONLY use real return data from Q2, 1994 to Q1, 2020 to decide on a defense:growth Benchmark that will achieve both return objectives of the FUF fund. Once the Benchmark has been decided upon, invited proposal will test if the Spend should be based on the last year’s fund value OR the average of the last 3 years of fund value. Invited teams must consider the variability of Spend, average Spend and the impact on fund’s value. Investment proposals will ONLY use returns data from Q2, 1994 to Q1, 2020 and the Benchmark to structure a Spend that will have lower variability and lower impact on the fund’s value over the testing period (Q2, 1994 to Q1, 2020). 2. Role of Asset/Sub-Asset in SAA: 20% of the assignment mark (maximum 1000 words) The assets for FUF’s SAA are restricted to Equities (US, EM and EAFE), RE (Developed and EM), Bonds (US Government, US Investment Grade, US High Yield, US Agencies and EM Aggregate) and Gold. The index values or returns are provided in the Excel file “PTMIII Assignment 2-2021.xlsx”. Prospective portfolio managers should note that one data series does starts in Q1, 1995. Investment proposals will first provide a discussion of each asset/sub-asset with a focus on the allocation (industry sector for equities; credit quality and duration for bonds; developed and emerging markets for real estate) and the diversification benefits for investing in each asset/sub-asset. The discussion on each asset will be further enhanced by summary statistics of risk measures (Volatility, Maximum Drawdown and VaR @ 90%) and average returns. Invited proposals should note that data used and any calculations to generate risk and return measures must be placed in the Appendix and not in the main body of the proposal. Only a table of risk and return measures should be provided in the main body of the report. A correlation matrix of all assets against each other must also be provided. 3. Generate Capital Market Assumptions (CMAs): 15% (=5% + 5% + 5%) of the assignment mark (maximum 100 words) Invited proposal will create CMAs (returns only) using (i) historical average (from section 2 above), (ii) James Stein estimates, and (iii) Reverse Optimisation. Teams will ONLY use returns data from Q2, 1994 to Q1, 2020 for the estimates. Teams will then decide (with a one sentence justification) upon the most reasonable return CMA for each asset/sub-asset. 4. Create 3 Strategic Asset Allocations (SAAs): 25% of the assignment mark (maximum 600 words): The SEF’s BoD would like to evaluate three different SAA, using three different portfolio construction techniques. Each asset allocations will be constructed using (i) quarterly real returns, (ii) data from Q2 1994 to Q1 2010 [do not use data up to Q2 2021], and CMA return estimate (based on section 3 above). Investment team will decide and justify an appropriate level of tracking error (against the Benchmark). Allocations to each asset must be whole numbers (for example a 9.5% allocation to US should be changed to either 9% or 10%), and allocation to each asset class – Bonds, Equities Real Estate and Gold- must be in multiples of 5% (for example a 24% allocation to equities must be changed to 25%). These allocations adjustments may be programmed OR can be adjusted manually. I. An optimised Mean-Variance SAA: MV Optimised SAA will be created using Excel Solver (or any optimisation program). Basic constraints will include: a) No leverage or short selling b) Required return based on the return objective established in Section 1 above. c) Ensure a defense:growth bias as established in Section 1 above. d) Constrain/Minimize risk measures: (i) tracking error (against the Benchmark), (ii) VaR @ 90%, and (iii) Volatility. Additional constraints, as deemed appropriate based on the asset/sub-asset class discussion in section 2 above, can be added with justification. II. A Risk-Allocated Portfolio: A risk-allocated SAA will be created using Excel Solver (or any optimisation program). Investment proposals have freedom to allocate risk (marginal contribution) as deemed appropriate based on the asset/sub-asset class discussion in section 2 above. Constraints used in Risk Allocated SAA may not be the same as for the MV Optimized SAA. III. 3 Bucket Allocation: An SAA based on allocations across three buckets: Safe Bucket, Market-Risk bucket, and a Risky Bucket. Allocation within, and across buckets, can be based on a single methodology, a combination of methodologies, and/or subjectively. Allocation of asset classes/sub-asset classes to each bucket must be justified by the inherent nature of the investment (qualitative and quantitative) from section 2 and 3 above. Constraints for this methodology may not be the same as for the MV