I&FM Assessment 1 Part 2 – Portfolio Written Assignment Details in 1500 words

Build your Excel spreadsheet

1. Your starting point must be the portfolio Excel spreadsheet you have used for tracking the performance of your investment choices between 1 and 28 February 2016. Adda new worksheet in your Excel file with your portfolio of 9 assets (ignore the money market fund).

a. Look up and download historical prices for your 9 assets – use Yahoo! Finance to obtain monthly data for the last 5 years. Put these in one single Excel sheet (just like I have done for the seminars)

b. Calculate the expected rate of return for each asset (mean) and its risk (standard deviation)

c. Calculate the correlation matrix for your 9 assets.

d. Based on the correlation coefficients pick your 5 ‘best’ assets (you will need to discuss this later on).

2. For the 5 ‘best’ assets portfolio

a. Redistribute the weights between your 5 assets in a similar way to your initial allocation – i.e. increase the weights of the remaining 5 assets and maintain the proportions between them.

b. Calculate the expected portfolio return and the portfolio risk (Markowitz equations)

c. Calculate the portfolio beta

d. Calculate the Sharpe ratio for the 5-asset portfolio made above by assuming a risk free rate of return equal to 0.5%

e. Recalculate the Sharpe ratio after giving equal weights to all 5 assets (i.e. 20% each).

f. Then, order your 5 assets from the highest rate of return to the lowest. Give the following weights to your assets in descending order 35% (to the asset with highest return), 30%, 20%, 10% and 5% (to the asset with the lowest return). Calculate the Sharpe ratio for the new allocations.

Analyse the portfolio in Word document

3. You must first analyse your portfolio choices from a behavioural perspective. To discuss the biases that (may) have influenced your choice of assets. Typical biases to consider are overconfidence, representativeness, availability, ambiguity aversion, narrow framing, herding etc. You will need to cite literature sources (with references) in the discussion.

4. Next you must evaluate your portfolio asset allocation by applying portfolio theory. You will need to cite theory and literature sources (with references) in the discussion.

5. In the body of the Word document, analyse the diversification of the initial 9-asset portfolio

a. How well diversified was it across asset classes? How could you improve it?

b. How well diversified was it within the asset classes? How could you improve it?

c. How well diversified was it across international and domestic? How could you improve it?

6. How did your portfolio perform over your investment period (the month between 1-Feb and 1-Mar)? Would a 1/N strategy have yielded better a better result? (put in equal weights and the portfolio tracking sheet will automatically calculate the new return)

7. Discuss the correlations between your 9 portfolio assets – refer to the matrix in the appendix (point 1.c.)

8. If you were to reduce your portfolio to your 5 ‘best’ assets – which would these be? – refer to the matrix in the appendix (point 1.c. and 1.d.)

9. Using the reduced 5-asset portfolio, discuss how Markowitz diversification would reduce its risk (refer to the calculations in point 2.b.)

10. Look at the portfolio beta you calculated (point 2.c.) and discuss the risk of your 5-asset portfolio relative to the market risk.

11. Analyse the 3 Sharpe ratios you calculated (points 2d-f.). Which allocation is the best, and why?

12. Would this portfolio be good enough for you to meet your retirement goal? Indicate how you think your portfolio performance should be judged or benchmarked over the long-term.

13. With explicit reference to active and passive management, how would you change it?

Criterion Weight Missing – 0% mark Poor – 25% mark OK – 50% mark Good – 100% mark

You must first analyse your portfolio choices from a behavioural perspective. 20% Missing. Unsatisfactory discussion. Analyse your choices and identify the biases and heuristics that might have influenced you. See Redhead Chapter 2 and Singh (2012). OK discussion but review the literature and references. See Redhead Chapter 2 and Singh (2012). Good discussion of point.

Excel workings in Appendix 2% Missing. N/A N/A Task Done

1b. Expected rate of return (mean) and risk (standard deviation) for each asset. 3% Missing. Incorrect method applied – check formulas in the seminar sheets 5 and 6 Correct method applied but incorrect answer. Check the seminar sheets 5 and 6. Correct method and calculation result

1c. Calculate the correlation matrix for your 9 assets 3% Missing. Incorrect method applied – check formulas in the seminar sheets 5 and 6 Correct method applied but incorrect answer. Check the seminar sheets 5 and 6. Correct method and calculation result

2a. Redistribute the weights between your 5 assets 1% Missing. Incorrect method applied – check formulas in the seminar sheets 5 and 6 Correct method applied but incorrect answer. Check the seminar sheets 5 and 6. Correct method and calculation result

2b. Calculate the expected portfolio return and the portfolio risk 5% Missing. Incorrect method applied – check formulas in the seminar sheets 5 and 6 Correct method applied but incorrect answer. Check the seminar sheets 5 and 6. Correct method and calculation result

2c. Calculate the portfolio beta 3% Missing. Incorrect method applied – check formulas in the seminar sheets 5 and 6 Correct method applied but incorrect answer. Check the seminar sheets 5 and 6. Correct method and calculation result

2d.Calculate the Sharpe ratio for the 5-asset portfolio 1% Missing. Incorrect method applied – check formulas in the seminar sheets 5 and 6 Correct method applied but incorrect answer. Check the seminar sheets 5 and 6. Correct method and calculation result

2e. Recalculate the Sharpe ratio after giving equal weights to all 5 assets 1% Missing. Incorrect method applied – check formulas in the seminar sheets 5 and 6 Correct method applied but incorrect answer. Check the seminar sheets 5 and 6. Correct method and calculation result

2f. Give the following weights to your assets in descending order 35% (to the asset with highest return), 30%, 20%, 10% and 5% (to the asset with the lowest return) 1% Missing. Incorrect method applied – check formulas in the seminar sheets 5 and 6 Correct method applied but incorrect answer. Check the seminar sheets 5 and 6. Correct method and calculation result

4a. Diversification across assets 4% Missing. Unsatisfactory discussion. See Redhead chapter 13, Armstrong (2008), Kiplinger’s (2011) and Kristof (2013). OK discussion but review literature. See Redhead chapter 13, Armstrong (2008) and Kristof (2013). Good discussion of point.

4b. Diversification within asset classes 4% Missing. Unsatisfactory discussion. See Redhead chapter 13, Armstrong (2008), Kiplinger’s (2011) and Kristof (2013). OK discussion but review literature. See Redhead chapter 13, Armstrong (2008) and Kristof (2013). Good discussion of point.

4c. Diversification domestic and international. 4% Missing. Unsatisfactory discussion. See Redhead chapter 13, Armstrong (2008), Kiplinger’s (2011) and Kristof (2013). OK discussion but review literature. See Redhead chapter 13, Armstrong (2008) and Kristof (2013). Good discussion of point.

5. Portfolio 9 asset performance. 4% Missing. Unsatisfactory discussion. Discuss the performance in context – in relation to the past individual asset performance and the current environment. Further, consider the importance you can place on this one month return. OK discussion of performance in context – in relation to the past individual asset performance and the current environment but elements are missing. Good discussion of point.

5. Portfolio 9 asset performance versus naive diversification. 4% Missing. Go back to the initial portfolio allocation tracking sheet and distribute the £1m equally. Discuss how the annualised rate of return compares with the initial one. See Redhead p.262. Unsatisfactory discussion. Discuss how the annualised rate of return compares with the initial one. See Redhead p262. OK discussion but elements missing. See Redhead p262. Good discussion of point.

6. Discuss the correlations between your 9 portfolio assets 5% Missing. Unsatisfactory discussion. See Redhead p266 and Coaker (2007). OK discussion but review theory. See Redhead p266 and Coaker (2007). Good discussion of point.

7. Which are your portfolio’s 5 ‘best’ assets? Why? 5% Missing. Unsatisfactory discussion. See Redhead p.269-275 and Coaker (2007). OK discussion but review theory. See Redhead p269-275 and Coaker (2007). Good discussion of point.

8. Using the reduced 5-asset portfolio, discuss how Markowitz diversification would reduce its risk. 5% Missing. Unsatisfactory discussion. Must define mean-variance portfolio analysis. See Redhead p.266. OK discussion but review theory. Elements missing or needs revision for clarity. See Redhead p266. Good discussion of point.

9. Discuss the risk of your 5-asset portfolio relative to the market risk (Portfolio Beta) 5% Missing. Unsatisfactory discussion. Review the definition of the Beta and interpret the calculation for your portfolio. See Redhead p.301. OK discussion but elements are missing /unclear. Review theory. See Redhead p.301. Good discussion of point.

10. Analyse the 3 Sharpe ratios you calculated (points 2d-f.). Which allocation is the best, and why? 5% Missing. Unsatisfactory discussion. Review Sharpe ratio formula/definition and interpretation. See Thorp (2013) and Hodges et al (1997). OK discussion but elements are missing /unclear. See Thorp (2013) and Hodges et al (1997). Good discussion of point.

11a. Would this portfolio be good enough for you to meet your retirement goal? 5% Missing. Unsatisfactory discussion. Remember that you have to pay back the £1m borrowed which will accrue 2% interest p.a. The pension will be funded from whatever is left after that. Discuss the assumptions you make about the performance of your portfolio over a long investment horizon. See Redhead p8-12. OK discussion but unclear/elements missing. Remember that you have to pay back the £1m borrowed which will accrue 2% interest p.a. The pension will be funded from whatever is left after that. Discuss the assumptions you make about the performance of your portfolio over a long investment horizon. See Redhead p8-12. Good discussion of point.

11b. How you think your portfolio performance should be judged or benchmarked over the long-term? 5% Missing. Unsatisfactory discussion. Discuss your choice of a benchmark for measuring the performance of the portfolio. See Redhead p139-143. OK discussion but review choice of a benchmark for measuring the performance of the portfolio. See Redhead p139-143. Good discussion of point.

12. With explicit reference to active and passive management, how would you change it? 5% Missing. Unsatisfactory discussion. See Redhead p. 331. OK discussion but review theory. See Redhead p. 331. Good discussion of point.

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