Asset management : Assignment 2
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Problem 1
The equity market has trended upward. Your equity exposure, which was $600,000 of a total
portfolio of $1,000,000 has increased by 20%. Your overall portfolio, which contains equity,
debt and some cash is now valued at $1,150,000. You have to determine if it is time to rebalance
your portfolio and follow a new investment strategy.
1) Assuming a steadily rising market, the best strategy is :
A. Buy and Hold
B. Constant Mix
C. CPPI
2) Determine the preferred dynamic rebalancing strategy if the market is expected to be highly
volatile but more or less flat.
A. Buy and Hold
B. Constant Mix
C. CPPI
3) Which of the following statements about CPPI strategies is the least correct :
A. CPPI strategies represent the purchase of portfolio insurance because they will buy stocks as
they rise and sell them as they fall
B. CPPI strategies offer good upside potential because they increase exposure to risky assets as
the market rises
C. Due to the concave nature of CPPI strategies, they offer good downside protection
4) You had determined to systematically rebalance annually to maintain a corridor of +/- 5%
for equity. Given the constraint, you should :
A. reallocate an additional $50,000 to equity
B. reallocate the entire $120,000 to debt and cash
C. make no adjustments
5)Which of the following would generally suggest a narrower tolerance band ?
A. Assets in the portfolio tend to be illiquid
B. Highly volatile assets
C. Correlated portfolio assets
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Problem 2 : Style Analysis
You want to compare 2 equity fund managers who try to outperform the S&P 500. The
following table gives the monthly returns of Fund manager 1 and the benchmark over one year
:
1
2
3
4
5
6
7
8
9
10
11
12
Benchmark return FM 1 return
2.0%
3.0%
1.0%
3.0%
0.5%
-2.0%
-1.0%
-2.0%
-0.5%
0.0%
1.0%
3.0%
1.0%
0.0%
0.5%
-0.5%
-0.5%
2.5%
2.0%
1.5%
0.5%
2.5%
0.5%
-1.0%
1.Calculate the Tracking-error and information ratio of Fund Manager 1. Annualized tracking
error is obtained by using the square root of time rule.
Fund Manager 2 has delivered a 9% return for a 2% Tracking error.
Compare and analyse the returns of the 2 Fund managers. What is their investment style ?
2. A style analysis performed over the last 5 years gives the following results when Fund
managers monthly returns are regressed on equities and bond returns :
alpha
FM 1
FM 2
US bonds
-0.10%
0.10%
0.3
0.05
S&P 500
0.7
0.95
The R2 are respectively 60% and 88%
Please comment the results. Which strategy is followed by Fund Manager 1 ?
What could explain the lower R2 for Fund Manager 1 ?
3. Over the last 5 years, the cumulative performance of equity and bond indexes have been
respectively 28% and 15%.
Calculate the cumulative performance of Fund Managers 1 and 2 based on the results of
question 2. It is reminded that the results of question 2 are based on monthly returns.
What is the proportion of cumulative performance explained by strategic allocation for each
Fund Manager ? Comment the results
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Problem 3 : Core-satellite
Core-satellite investing combines a core portfolio and a satellite portfolio. The core portfolio
objective is to meet an investor’s long-term goals. It is invested in traditional asset classes and
generally passively managed. The satellite portfolio is actively managed and can be invested in
less traditional asset classes.
An investor uses a core-satellite approach to allocate funds amongst equity managers. The
equity manager’s active risk (Tracking error), active return, and allocations are shown as
follows :
Passive Index
Enhanced Indexing
Active manager X
Active manager Y
Active manager Z
Expected active
return
0%
1.7%
1.9%
3.3%
3.9%
Expected Tracking
error
0%
2.5%
3%
5.5%
7.2%
Allocations
15%
45%
25%
10%
5%
Describe the investor’s core and satellite.
Calculate the investor’s active return , tracking error and information ratio given the above
allocations. Assume that the correlations between the equity managers’ active returns are zero.
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