Desperate Global University (DGU) Endowment fund has requested Major Asset Management (MAM) to help create an Investment Policy Statement (IPS). The current portfolio management team will use this document to manage the endowment assets.
MAM has created the first part of the IPS (Investment Objectives and Constraints) and has asked for your team’s help to prepare the second part of the IPS: Strategic and Tactical Asset Allocation, and Spending and Rebalancing Policy.
IPS Part 1: Investment Objectives and Constraints
Investment Objectives: Endowment assets must be invested in a well-diversified moderate growth biased portfolio. The endowment committee understands that a growth biased portfolio will be more sensitive to market events. A well-considered strategic and tactical asset allocation, along with an appropriate spending and rebalancing policy should be able to successfully navigate through adverse market conditions. The fund will be benchmarked to a 40:60 (Australian Bonds: Australian Equities) portfolio of indexes and must aim to achieve at least the returns of the benchmark, after portfolio management costs, without taking any additional risk in terms of volatility AND maximum drawdown.
Successful portfolio management teams should be able to outperform the benchmark by 0.50% per annum after costs.
Investment Constraints: The endowment restrictsthe portfolio management to directly engage in short selling, leveraging, derivatives or currencies, or individual securities. Portfolio managers will direct all assets to mutual funds (for all equity, real estate and investment grade bonds), gold spot ETF, and Fund of Hedge Funds. The endowment must generate cashflows that part based on last year-end fund value,and part based on a fixed dollar value. Expected cashflows from the fund is approximately $500,000 per annum (in today’s dollar terms or inflation adjusted). The endowment committee has stipulated that the fund cannot invest more than 40% in global equities, global bonds, Global Hedge funds and Global REITs (in total) and no more than 10% in Gold. Portfolio management will cost 0.75% (of fund value) per annum.
IPS Part 2: Strategic and Tactical Asset Allocation
MAM has requested your help in creating a Strategic and Tactical Asset Allocation for DGU Endowment fund. You need to analyse the investment objectives and constraints and the capital markets to complete this task. You have been provided with monthly returns for 8 assets that starts from the January 1996 till January 2022. You have also been provided with Australian annual inflation over the same period.
Report Format and Requirements: The report must be written in a professional format as it will be presented to the endowment committee. The endowment committee members have basic finance background. The report should have the following sections:
- Introduction (Maximum 100 words – No marks):
Introduce the objective and scope of the task and provide a recommended Strategic and Tactical Asset Allocation.
Asset SAA Policy Weights Minimum Maximum
2. Appropriate Spending Policy (Maximum 500 words – 10% marks):
The appropriate spending policy will balance fund drawdown and variability of cashflow from the fund. As mentioned in the Investment Constraints, part of the spend will be based on a percentage of end-of-year fund value and part based on a fixed dollar amount. Teams will test various values of gamma (25%, 50% and 75%) on the benchmark and choose the optimum Spend policy.
Teams will create a 40:60 (Bonds:Equities) benchmark using only Australian Bonds and Australian equities January 1997 to December 2011. Spend will be generate in January of each year and will not consider the yields from the two assets in the analysis. Spend on 1st January 1997 is assumed to be $500,000 and Fund value on that day after the spend is $10 million. Teams must ensure that Spend is considered on an inflation adjusted basis.
- Asset Class Characteristics (Maximum 1000 words – 20% marks)
DGU Endowment committee has established that the assets/indexes that must be used in creating this portfolio are: Australia Bonds and Equities, Global Bonds and Global Equities ex Aus, Global Fund of Hedge Funds, Gold and Global REITs. However, the committee has asked you to use a only of one Alternative Investment
The report will first introduce each asset (including the three AIs) with a summary description of the asset and the role each asset plays in achieving the investment objectives. Teams will research each asset to understand (i) Yields (as a percentage) from each asset, (ii) the role the asset will play in the portfolio, and (iii) Economic conditions when each asset will have above normal drawdowns. The report will use a table with these details as follows:
Summary Description Role the asset plays in the portfolio Economic Condition in which the asset performs the best/worst Yields %
Each asset/index will be further examined by a discussion on the summary statistics of risk measures (Volatility and Maximum Downside), returns and correlation over the period January 1997 to December 2011.
Teams will then choose ONE alternative investment (Global Fund of Hedge Fund, Global REITs or Gold) that best enhances the SAA to achieve investment objectives.
- Dollar and Risk Strategic Asset Allocations (Maximum 1000 words – 20% marks) DGU would like to evaluate two different SAAs. Each asset allocations will be constructed using (i) monthly returns, and (ii) January 1997 to December 2011. Allocations must be whole numbers (for example a 9.5% allocation to bonds should be changed to either 9% or 10%),and allocation to each bond and equity asset class must be in multiples of 5% (for example a 4% allocation to equities must be changed to 5%). Allocations adjustments may be programmed OR can be adjusted manually. A minimum allocation of 5% must also be ensured.
i.An optimised Mean-Variance SAA: MV Optimised SAA will be created using Excel Solver (or any optimisation program).
Solver objective will be to either minimise an appropriate risk measure (not used in the constraint) or maximise an appropriate performance ratio.
Solver constraints will include:
(i)No leverage or short selling
(ii)Minimum/Maximum allocation specified above.
(iii)Required return specified above.
(iv)Ensure a defense:growth bias specified above.
(v)Teams must use at least one of the assets: Global Fund of Hedge Funds, Global REITs and Gold.
Teams will ensure the allocation preferences mentioned in Investment Constraints above.
However, teams have freedom to add additional constraints as deemed appropriate based on the asset characteristics and discussion in section 3 above to achieve investment objectives.
Teams will explain the process of creating this SAA (for example any additional constraints used) without discussing the operation of the Excel Solver. Equal dollar allocation between any two or more assets will not be considered an acceptable solution.
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/index discussion in section 3 above and demonstrate that the investment objectives will be met. Allocation constraints specified above (in Investment constraints) will be indicative allocation to risk (or Marginal Contribution to Risk) instead of dollar allocation. However, a minimum allocation of 5% in each asset must be ensured. Teams will explain the process of creating this SAA (for example the MCR proportions used). Equal risk allocation between any two or more assets will not be considered an acceptable solution.
Teams will compare the two SAAs qualitatively and quantitatively against the 40:60 benchmark in a single table. Quantitative comparison will compare average and active return, volatility, tracking error and Maximum Drawdown. Qualitative comparison will explain the relative performance and riskiness of the SAAs based on (the discussion on assets) in section 2 above.
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