Assignment: Strategic Asset Allocation
Your investment team is hired to manage a large define contribution superannuation fund in Australia. The fund provides eligible employees with a convenient way to save on a regular and long-term basis for retirement. The fund offers investors with four investment options - growth, balanced, conservative and cash. Below are the details of these investment options:
Growth - Around 85% (range ± 10%) in growth assets, and the rest in defensive assets. Aim for high returns over the long run. This investment option results in high volatility with negative returns expected 4-6 years out of 20.
Balanced - Around 65%(range ± 10%) ingrowth assets, and the rest in defensive assets. Aim for reasonable returns but less than the growth fund to reduce risk of losses in bad years. This investment option results in medium volatility with negative returns expected 3-5 years out of 20.
Conservative - Around 40% (range ± 10%) ingrowth assets, and the rest in defensive assets. Aim to reduce risk of losses over the long run. This investment option results in low volatility with negative returns expected 0 years out of 20.
Cash - 100% in deposits with Australian or foreign deposit-taking institutions. This investment option results in very low volatility with negative returns expected 0 years out of 20.
The investment guidelines are based upon an investment horizon of greater than ten years. Accordingly, the decision on asset allocation will reflect the long-term investment risk/return objectives for each investment option. Since the investment is long-term, the influence of financial crisis and business cycle is supposed to be less important. Short-term liquidity requirements are anticipated to be non-existent. The client recognizes that some risk must be assumed in order to achieve the investment objectives of the plans. The client also states that the portfolios should be monitored and reviewed yearly.
Asset class guidelines:
The client has specified six asset classes for investment: (1) Australian equities; (2) Australian Real Estate; (3) US large equities; (4) Australian government bonds; (5) US government bonds; and (6) Australian short-term money market instruments. Interest-generating investments, such as bonds and short-term money market instruments, have historically provided little opportunity for real long-term capital growth due to their susceptibility to inflation. Equity investments, on the other hand, have significantly higher expected returns but have the disadvantage of much greater variability of returns.
Individual Client
Gloria, aged 40, is a single mother with two kids living in Melbourne. She is a service manager at XYZ Company and earns an annual salary of $65,000 before tax. Her salary is expected to grow at 2% annually (in nominal terms). Following the Australian superannuation rule, her company pays 9.5% of each employee's regular income (before tax) to their nominated superannuation fund, at the same time as the company pays their staff wages. She has accumulated $80,000 in her superannuation. She is passive in investment and thinks that term deposit is an ideal investment solution. During your discussion with the Gloria, she tells you:
• My personal contribution to the superannuation is 0%. I can increase my contribution to the super but I don't think there are any benefits doing so;
• On average, my living expense is about 3,000 a month (based on the most recent year figures);
• I receive income on a monthly basis;
• I always choose the ‘cash' option in my superannuation as this is the safest;
• I have no debts and own a property worth $700,000 at the current market value;
• I don't have any financial assets;
• My elder child will go to high school in 5 years;
• I don't expect to retire before age 65;
• I think it's important to have an emergency fund to cover at least 3 to 6 months' worth of living expenses;
• I don't know how much is required for my retirement.
For simplicity, ignore how employer contribution is taxed and assume Gloria's salary and all capital gains and investment income are taxed at 30% and no tax-sheltering strategies are available.
Required Information:
Part 1: Strategy Asset Allocation (SAA)
For this part, assume all investments are at benchmark. Do not take into consideration the impact of any active investments. For simplicity, do not consider taxes and transaction costs on any income generated.
1. Analyse the performance of each asset class and examine the relationships among them. Discuss the role each asset class plays in an investment portfolio.
2. Usearithmeticmeans as the expected returns for the asset classes going forward (and any other relevant historical statistics), come up with four appropriate SAA portfolios (growth, balanced, conservative and cash). Discuss your asset allocation decisions in detail.
3. Apply the asset allocation to the provided historical data and calculate the performance of your portfolios. Comment on the performance and discuss how the portfolios meet their investment objectives. You must at least provide the following to accompany your analysis:
a. Average portfolio returns ("arithmetic" for both monthly and yearly) and Sharpe ratios over the sample period;
b. Average returns (yearly) of trailing 3 and 5 years at the end of every year;
c. Graph and compare the performance of your portfolios over time;
d. Standard deviation (both monthly and yearly) of your portfolios over the sample period;
e. Probability of a negative return in any one year over the sample period.
4. Your team charges management fees (excluding transaction costs) for each investment options. Typically, fees are highest on those assets that are relatively costly to manage, such as foreign market asset, and lowest on cash-based funds. Assume the average fees across similar types and size of funds are about 1% per annum for the growth, 0.8% for the balanced, 0.6% for the conservative, and 0.1% for the cash. Discuss how management fees affect the overall performance of the funds.
5. A sale pitch on why investors should go with your portfolios? How do these portfolios benefit them, and why they are better than alternatives?
Part 2: Individual Investor
For this part, your need to create an Investment Policy Statement for Gloria and recommend an investment portfolio (choose one portfolio from the four SAA portfolios you have created in Part 1 above) that satisfies her needs.
1. Formulate the risk and return objectives.
2. Formulate the following investment constraints:
a. Time horizon;
b. Liquidity requirement;
c. Legal and regulatory factors;`
d. Unique needs and preferences.
3. Based on the investment objectives you have identified, recommend an appropriate investment portfolio (based on the four portfolios you have created in Part 1 above) for Gloria. Suggest investment strategies to help Gloria better achieve her goals.
Attachment:- Data.rar