FINM8016 Group 50Report1.docx
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FINM8016 Group 50Report1.docx
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FINM8016Group50Report1
portfoliocONSTRUCTIOn
FINM8016
Semester2-2018
Investment
Recommendationfor:
RobertWinston
&
AbigailKuzan
Group50–TutorialB
U6467803AdityaMakwanaU6467346GloriaPenayoU5221181NirintanaSoontornthamnitiU6147793QiyangZouU6448296RaviKumar
U6369514AlidaHuang
Tableofcontents
ExecutiveSummary
2
1.Introduction
3
2.Analysis
Quantitativeanalysis
3
2.1.1.DataSelection
3
2.1.2.BootstrapAnalysis
3
2.1.3.Optimization
4
2.2.Qualitativeanalysis
5
2.2.1.FundamentalRiskApproach
5
2.2.2.RelevantFundamentalRiskFactorstobeconsidered
5
2.2.3.Howeachassetclasscanbeusedtohedge
6
2.2.4.RestructuringAssetWeights
6
2.2.5.OtherConsiderations
8
2.2.6.FinalRecommendedWeights
8
Appendix1–OverviewofAssetClass
9
Appendix2–Investors’Information
10
Appendix3–Summ(Anon.,2018)aryofobjectivesandconstraintsresults
10
Appendix4–AbigailandRobert'sPortfolios-SummaryofAnalysis
11
Appendix5–Correlation
12
References
13
ExecutiveSummary
ThisreportaimstoprovideanoptimalportfolioanddetailsoftheassetallocationforAbigailKuzanandRobertWinston.Asclientswishtomodifytheirportfoliosaccordingtoindividualneeds,theanalysiswillprovidetwoseparatetailoredportfolios.However,theanalysismethodforbothclientsissimilar.Quantitativeanalysisusedinthisreportisbasedontheyearlybootstrapandoptimizationprocesswhichwillbeusedtomakequalitativeadjustmentsbasedoneveryassetclass’straitandfundamentalrisktheycarry.Reportwillalsotalkaboutalltheadvantagesanddisadvantagesforeachassetclassindetail.
(Anon.,2018)
Thefinalrecommendedweightsincludetheinvestmentinnewassetclassesthattheinitialportfoliodidconsider.Overall,theweightssatisfyeachclientobjectivesandconstraints,reducefundamentalriskandtakeintoaccountnatureofassets.Also,otherconsiderationssuchastransactioncostandmanagementfeeareincluded.However,investorsshouldbeawarethatmostofanalysiswasbasedonrealhistoricalnumberswhichtheexpectedreturnfrominvestmentmightnotbeachievedinthefuture.Wefurtherrecommendinvestorstoreviewtheirinvestmentportfolioregularly.
Allocationoftheclients’currentportfolioandrecommendweightsforthefinalportfoliosarepresentedinthefollowingpiecharts:
Introduction
ToprovidetailoredportfolioforAbigailandRobert,therecommendationsarebasedonquantitativeandqualitativeanalysis.Morespecificallythequantitativemethodinvolvesgenerationofyearlydatausingbootstrapfor4-and6-yearhorizons,whichcorrespondstotheinputsforoptimizertogetanoptimalportfolio.Astheobtainedweightsfromquantitativeanalysisarenotscreenedfromerrorsteam50usedqualitativeanalysistoprovideafinalrecommendationwhicharemorerealisticandachievableforthecoupleconsideringrisk’sperspectiveandotherconsiderations.Team50alsoconsideredfundamentalriskapproach(FRA)toensurethatthefinalrecommendationsareachievable.
1.Analysis
2.1.QuantitativeAnalysis
2.1.1.DataSelection
Asthemainquantitativeanalysisfocusonbootstrap,wheretheunderlyingassumptionsincludethattherandomvariablesareindependentandidenticallydistributed.Thedatasetselectedincludesyearlydatatoavoidhigherserialcorrelationproblemthatnormallyoccursinquarterlydata.TheyearlydatasetfromDecember1991toDecember2017(27datapoints)waschosentocalculateyearlyreturn,whichisusedforbothclients.Thisperiodwasconsideredaccordingtotheavailabilityofthedata,asthehistoricaldataofsomeassetclassesarenotavailableinearlierperiods.Theinclusionoftheseperiodscouldoverestimateorunderestimateriskbecausetheoptimizerwilltreatthelackingvalueaszero.
2.1.2.BootstrapAnalysis
Thebootstrapmethodisahelpfulapproachwhichgenerateextendeddatabyrandomlydrawingmoreobservationsfrompastwhenitisassumedthatfutureoutcomewillbehighlycorrelatedwiththepast.Thebenefitofthismethodoverhistorical-basedhypotheticalrollingisusingyearlydataforbootstrapreducesserialcorrelationproblemasrollingoutcomemethodisusedwhenwepredictthatthefuturewilloccuratthesamedistributionasthepast,sousingquarterlydataisbetterrepresentativeasitdoesnotunderestimatestatisticalreliabilitybutitleadstoserialcorrelationproblemandourquarterlydataneedtobackfilling.So,bootstrapmethodismoreappropriatedinthiscase,asayearlydatasetwasselected.
Afterthemeanadjustmentoftheyearlyreturnswithexpectedreturnassumptionforeachassetclasses,wasconductedabootstraptoobtain10,000randomdrawsasthesamplesizeofyearlydatareturns(26datapoints)isquitesmallandapplythedrawstoamplifiesthedatasettogetexpectedportfolioreturnsaccordioningtotheinvestmenthorizonofeachinvestor(fouryearsforAbigailandsixyearsforRobert).
2.1.3.Optimization
Consideringtheconstraintsoftheclients,theoptimalportfoliohasbeengeneratedusingoptimization(solver).Theweightsoftheportfoliosatisfytheclientsconstraintsarepresentedintable1.Although,Mean-Varianceoptimizationisaneasytooltoallocateweightsbasedonconstraints,thepotentialshortcomingisitcouldcausetheissueoferrormaximizationwhichcanleadtoinfeasibleassetallocations.Toovercomethispotentialerror,theoutcomewillbeadjustedinthequalitativeanalysissectionforfinalrecommendation.
Table1–ObjectivesandConstraints
Clients
AbigailKuzan
RobertWinston
InvestmentHorizon
Four-yearoutcome.
Six-yearoutcome.
Compoundnominalreturn
Atleast6.5%p.a.overthenextfouryears.
Highestvaluepossibleinsixyears’time.
Volatility
Standarddeviationnotexceed8%p.a.basedonyearlyreturnsandreducedasfaraspossible.
Probabilityofshortfall
Notlosingmoney:
limitchanceofportfoliodeclininginvaluetonomorethan6%.
Limitchanceofportfoliovalueinsixyearsbeing12%lessthanmighthaveobtainedfromacomparisongroupoffundstonomorethan10%.
Relativeperformance(Portfoliovsretailfund)
Trackingerror(portfolioversuspeer)isnogreaterthan1.5%p.a.basedonyearlyreturns.
▪Trackingerror(theportfolioversuspeer)isnogreaterthan2%p.a.basedonyearlyreturns.
▪Performsbetterthanthecomparisongroupoverthenextsix-yearsbyatleast1%p.a.
Illiquidassets
(maintainflexibility)
Maximumof15%.
Maximumof30%.
Others
Atleastone-thirdtobeinvestedwithinFixedIncome(includesAFI,WFI,ILBandAC).
Atleast60%stayinvestedinliquidAustralianassets(includesAE,AFI,ILBandAC)tomaintainfondnessforAustralian.
Shorting
Dislikesgearing,sonoshortsalesarepermitted.
Dislikesgearing,sonoshortsalesarepermitted.
Table2–RecommendedPortfoliobasedonOptimization
Table2showsthecurrentweightsofpeer’sbenchmarkandtheinitialexistingportfoliosofboththeclients,includingtherecommendedweightsbasedontheoutcomeobtainedduringtheoptimizationprocess.Thistablealsoprovidesanimportantinformationrelatedtothechanges(increaseanddecrease)thateachassetclassthatwasexperienced.Forexample,AEweightwasdecreasedandshifttoothersassetclassesforbothinvestors.
2.2.QualitativeAnalysis
2.2.1.FundamentalRiskApproach
Theweightsprescribedduringtheoptimizationprocess(bysolver)forAbigailandRoberts’portfolioareunreliableandunrealistic,asexcelfacestheproblemof‘errormaximization’,whichwillmaximizetheerrorintheportfoliobyoverestimatingreturnofoneassetclass.Therefore,abetterapproachshouldbeundertakentoimprovetheweightsintheportfolios,whichleadstothefundamentalriskapproach(FRA).
2.2.2.RelevantFundamentalRiskFactorstobeconsidered
▪MacroeconomicRisk:
Duetothehighfluctuationsintheeconomy,allinvestmentshaveexposuretothemacroeconomicrisk,astheassetclassesarewidelyaffectedbyit.Macroeconomicriskcannotbereducedbydiversification,asthecaseoftheidiosyncraticrisk,hencenorecommendedadjustmentshavebeenmadeaccordingtoit.
▪InflationRateRisk:
Asclientsareapproachingtheirretirement,theywillbehighlydependentonthesuperannuationfund.ForAbigail,mostofhercurrentinvestmentsareinAEandAC,whereasforRobert,mostoftheinvestmentsareonlyinAE.Inthiscase,DP,COMandAILBcanbeusedtomanagethisrisk.
▪IlliquidityRisk:
Theilliquidityriskisahugeconcernforanykindofinvestor.However,inthecaseofourinvestorsithasalreadybeenreducedastheconstraintsofthemaximumweightsinilliquidassetsare15%and30%forAbigailandRobertrespectively.Basedonthefactthatthereturnsfromhedgefundhaveanupwardbias,plusextrafeewouldariseforinvestinginthehedgefund,theadjustmentofhedgefundreturnshasbeenmade.
▪InterestRateRisk:
ThecurrentinterestrateinAustraliais3%,whichisartificiallylow,therateisexpectedtoriseto5%incomingfuture.ThusthereturnsoftheFIandWE,Uhasbeenadjustedbasedon5%.
▪ForeignExchangeRisk:
Eventhoughassetclasscouldgiveahigherreturn,itcanbediminishedduetocurrencyrisk.AsitisassumedthattheclientsareexpectedtoliveinAustraliaafterretirement,thecurrencyriskshouldbeconsidered.Thus,riskcanbedecreasedbyadjustingthereturnsofWE,U.
▪HomeBias:
Homebiasexistswheninvestorshavelargeproportionofinvestmentsintheirhomecountry.AsclientstendtoprefertheAustralianinvestments,homebiasneedtobeconsideredasanimportantfactor.
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