I'd like to get done the calculations for the porfolio returns, benchmark selection, andPerformance measurement part of this assingment. All of this can be found on the 10 th page. All the data is given on the assingment on prior pages (4-9)
NORTHERN ALBERTA INSTITUTE OF TECHNOLOGY JR Shaw School of Business Edmonton, Alberta Investment Policy Statement - Justin Trudeau Prepared by: Nimra Rehman, Zia Rehman, Jesus, Aroma Students Business Administration for partial credit in Advanced Portfolio Theory FNCE4471 (O01) Prepared for: Mr. Asim Yaqub, Instructor Advanced Portfolio Theory November 22, 2021 Contents I. The case (1 page max) 3 II. Investment policy statement (2 pages max) 4 III. Strategic asset allocation (2 pages max) 6 IV. Performance measurement and attribution (4 pages max) 7 V. Risk analysis (1 pages max) 8 The Case The investment policy statement (IPS) serves as a strategic guide to the planning and implementation of an investment program. When implemented successfully, the IPS anticipates issues related to governance of the investment program, planning for appropriate asset allocation, implementing an investment program with internal and/or external managers, monitoring the results, risk management, and appropriate reporting. (CFA Institute, 2010) Justin Trudeau born on December 25, 1971 is Canada’s 23rd Prime Minister. Justin grew up with the profound influence of his father, Pierre Elliott Trudeau, and his mother, Margaret Trudeau. He was raised speaking both French and English and has family roots in both Eastern and Western Canada. (Canada, n.d.) Investor: Justin Trudeau Investor’s age: 49 Profession: Politician, Teacher, Critic Wife: unemployed age: 46 taking care of their children Children: 3 Job: Trudeau is the Prime Minister of Canada Salary: $357,800 a year. Net Worth: $10 million Inheritance: $1.2 million Assets: Primary residence valued at $600,000 2018 Honda Pilot valued at $25,000 Life insurance policy on himself ($1,000,000 value) RSP through work ($80,000) Well-diversified Portfolio: $1,500,000 Current Expenses: Home+car maintenance expenses: $20,000 per year Living expenses (groceries, clothes etc.): $40,000 per year Vacation Fees: $15,000 in Hawaii per year Charity Donation: $200,000 on Boundless School (for children) Tax Rate: 30% (in both capital and dividend gains) Inflation Rate: 2% Spending Rate: 3.0% Expected Age to Retire: 65 (16 years left) Investment Policy Statement Return objective/Investment performance objective: Trudeau shared his financial goals to be as follows, he would like to leave a legacy behind for his three children, have a retirement that sustains his current lifestyle, and would like to continue to travel. Taking all those objectives into account, the investment advisor has suggested a long-term growth portfolio. The financial plan developed for Trudeau indicates a required real growth rate of 12 percent to satisfy his future obligations and allow him to meet his objectives in the next 20 years. Required annual income after tax Justin’s annual salary $167,400 Less: taxes (30%) -$50,220 Living expenses -$40,000 Home and Car maintenance -$20,000 Vacation Expense -$15,000 Net annual cash flow $42,180 Inheritance 500,000 Well-Diversified Portfolio 1,500,000 Subtotal 2,000,000 Less one-time needs: Charitable Donation (200,000) Total 1,800,000 Return objective: Meet living expenses for Justin’s Wife; provide $200,000 on Boundless School (for children) Justin’s portfolio must generate real, before-tax return of: N = 16, PV = $1.8m, PMT = $0, FV = $2.5m, I= x+2 , X=4.49%, total= 6.49% The required, nominal before-tax return that will maintain the real value of the portfolio is i = 6.49% + 3.0%= 9.49% Risk tolerance = High: Trudeau is a highly experienced investor, so he understands the very nature of risk and the uncertainty about the future—specifically, uncertainty as to future investment returns. Trudeau seeks to generate investment returns that are proportional to the risks assumed in his Family Trust portfolios. Trudeau would benefit from an investment strategy that balances the need to build the Family Trust assets with the risks associated with that strategy. Based on a Risk Assessment interview with Trudeau, the investment advisor understands that an absolute loss in any 12-month period of more than 44 percent is intolerable. At that threshold, therefore, policies and procedures to minimize risk of further loss should be implemented by the investment advisor. Liquidity requirements/short term liquidity needs = none: With an annual income of $357,800 and an investment account of $1,500,000, Trudeau has a high cash flow, reducing his immediate short-term liquidity needs. Time horizon = 20 years: Trudeau is currently 49 years old and is at the peak of his political career. Trudeau does not plan on resigning anytime in the near future. Trudeau wishes to retire late at the age of 65. Trudeau's current time horizon is greater than 5 years. Tax considerations: As a high-net-worth client, tax considerations are important for Trudeau to evaluate. Being in the high-income tax bracket, the investment policy will invest for appreciation in the taxable individual accounts and invest for dividend and interest income in the individual retirement accounts. In addition, the investment adviser shall consider tax-loss harvesting of existing high-basis holdings as transactions in similar industries or sectors are considered. Strategic Asset Allocation Asset classes and ETF proxies Generally, investment performance is determined by asset performance. Stocks with higher volatility would return higher rates. Fixed income assets return lower rates with less risk. Diversification between risky and non-risky assets should be maintained to generate optimal returns. Based on the client's risk profile, the asset classes should be: 1. Money Market 2. Canadian Bonds 3. International Bonds 4. Canadian Equities 5. Real Estate Exchange traded funds trade on stock exchanges and have a value that is similar to the total value of the assets they contain. This means that the value of an exchange traded fund can change throughout the day. The risk level of an exchange traded fund depends on the assets it contains. If it contains high-risk assets, like some stocks, then the risk level will be high. (Financial Consumer Agency of Canada, 2021) Appropriate optimization approach Optimization has several drawbacks as an approach to indexation. First, even the best risk models are likely to be imperfectly specified. That is, it is virtually impossible to create a risk model that exactly captures the risk associated with a given stock, if only because risks change over time and risk models are based on historical data. Furthermore, the optimization procedure seeks to maximally exploit any risk differences among securities, even if they just reflect sampling error (this is the problem known as overfitting the data). Even in the absence of index changes and dividend flows, optimization requires periodic trading to keep the risk characteristics of the portfolio lined up with those of the index being tracked. As a result of these limitations, the predicted tracking risk of an optimization-based portfolio will typically understate the actual tracking risk. That said, indexers have found that the results of an optimization approach frequently compare well with those of a stratified sampling approach, particularly when replication is attempted using relatively few securities. With either stratified sampling or optimization, the indexer may fully replicate (purchase in index-weight proportions) the largest stocks and create an optimized/sampled portfolio for the rest. (Maginn, 2007) Mean-variance optimization results CAPM Asset class E(r) σ Correlation A B C D E 1 Money Market 12% 20% 1 2 Canadian Bonds 10% 17% 0.68 1 3 International Bonds 9.5% 15% 0.5 0.35 1 4 Canadian Equities 9% 13% 0.5 0.35 0.15 1 5 Real Estate 8.5% 11% 0.5 0.35 0.15 0.1 1 Corner Portfolio Asset class E(r) σ Sharpe Ratio Portfolio Weight A B C D E 1 Money Market 11% 20% 0.425 100% 0.00% 0.00% 0.00% 0.00% 2 Canadian Bonds 10% 17% 0.441 65 45 0.00% 0.00 0.00 3 International Bonds 9.5% 15% 0.467 15 20 20 35 10 4 Canadian Equities 9% 13% 0.500 20 15 10 45 10 5 Real Estate 8.5% 13% 0.462 10 15 15 25 35 9.27 = 9.5w + 9 (1-w) 9.27 = 9.5w + 9 - 9w 0.27 = 0.5w w = 0.540 Weights of the Assets on Combined Portfolio Money Market = 0.540 (0.15) + 0.460 (0.20) = 17.3% Canadian Bonds = 0.540 (0.20) + 0.460 (0.15) = 17.7% International Bonds = 0.540 (0.20) + 0.460 (0.10) = 15.4% Canadian Equities = 0.540 (0.35) + 0.460 (0.45) = 39.6% Real Estate = 0.540 (0.10) + 0.460 (0.10) = 10% Justin Trudeau requires a 9.27% return over the span of 16 years to achieve his children's needs and retirement goals, the recommended allocation is 54% Allocation 3 and 46% Allocation 4. Specifically, these combinations will meet the required return of Trudeau’s portfolio. It also has the highest combination of expected Sharpe ratios among the portfolio. Performance Measurement and Attribution (4 pages max) Portfolio returns Prepare the monthly returns for the period for the asset classes that constitute your portfolio. Benchmark selection Select and justify the selection of an appropriate benchmark. Prepare the returns on the benchmark portfolio for the same period. (You might want to run the style analysis first and use it as a guide for the selection of the benchmark asset classes and their weights.) Performance measurement Calculate the appropriate performance measures. Select the ones you deem necessary and sufficient to justify the performance appraisal. Evaluate and explain the proportion of systematic vs. idiosyncratic risk in your portfolio, compared to the benchmark. Performance attribution Apply analysis to separate the timing, selection and interaction component of the returns. Discuss briefly their meaning for your portfolio. Risk Analysis (1 page max) Downside measures Calculate the downside risk measures covered in class to both the portfolio and benchmark monthly returns and discuss the results. VaR analysis Calculate both the analytical and historical VaR of your portfolio at 5% confidence level. If the two values differ, briefly explain why. References CFA Institute. (2010, May). Elements of an Investment Policy Statement for Individual Investors. Retrieved from cfainstitute.org: https://www.cfainstitute.org/-/media/documents/article/position-paper/investment-policy-statement-individual-investors.ashx Canada. (n.d.). The Right Honourable Justin Trudeau, Prime Minister of Canada. Retrieved from pm.gc.ca: https://pm.gc.ca/en/about Maginn, J. L. (2007). Managing investment portfolios: A dynamic process. Hoboken, N.J: John Wiley & Sons. Financial Consumer Agency of Canada. (2021). The Basics of Investing. Retrieved from: https://www.canada.ca/en/financial-consumer-agency/services/savings-investments/investing-basics.html