Investment Analysis and Management

at
Categories
Tags

 

 

Create a portfolio comprising a collection of three asset classes (two traditional assets, namely stocks and bonds) and one alternative asset class (any one of your choice) taking into consideration risk-return and modern portfolio theory.

You are expected to explain the rationale behind your portfolio selections, and more importantly explain why the portfolio you have constructed using these assets is a robust, well constructed, efficient portfolio in line with the discussion on the subject in class and material covered

Sample Solution

 

 

 

This sample portfolio incorporates two traditional asset classes (stocks and bonds) and one alternative asset class (real estate investment trust – REIT) following principles of Modern Portfolio Theory (MPT). MPT emphasizes diversification to reduce risk without sacrificing returns.

Asset Allocation:

  • 50% – US Large-Cap Stocks (Index Fund): Offers broad market exposure, potential for high growth, and aligns with a long-term investment horizon. Low-cost index funds minimize fees and exploit market efficiency.
  • 30% – Investment Grade Corporate Bonds (ETF): Provides income, stability, and a negative correlation to stocks, potentially mitigating downside risk during market downturns.
  • 20% – Real Estate Investment Trust (REIT): Offers exposure to the real estate market with potentially lower volatility than directly owning properties. It also generates income through rental payments.

Rationale:

  • Diversification: This portfolio allocates across asset classes with varying risk-return profiles. Stocks offer high growth potential but with higher risk, while bonds provide stability and income with lower risk. REITs offer a middle ground with potential for appreciation and income generation, while also exhibiting some decorrelation from stocks. This diversification helps mitigate overall portfolio risk.
  • Modern Portfolio Theory: The portfolio aims to achieve an efficient frontier by maximizing expected return for a given level of risk. By combining assets with low correlation, the portfolio seeks to reduce overall volatility without sacrificing returns significantly.
  • Risk Tolerance: This allocation assumes a moderate risk tolerance. Individuals with higher risk tolerance could increase the stock allocation, while those with lower risk tolerance could increase the bond allocation.

Robustness and Efficiency:

  • Long-Term Focus: This portfolio is designed for a long-term investment horizon (e.g., 10+ years). Long-term investing allows stocks to weather market fluctuations and potentially achieve higher returns.
  • Low-Cost Funds: Utilizing low-cost index funds and ETFs minimizes fees, allowing for better returns.
  • Rebalancing: Periodic rebalancing ensures the target asset allocation remains constant. This helps maintain the desired risk profile and captures market opportunities.

Disclaimer: This is a sample portfolio and does not constitute financial advice. Individual circumstances and risk tolerance should be considered before making any investment decisions.

Additional Considerations:

  • International Diversification: Expanding the portfolio to include international stocks and bonds can further enhance diversification benefits.
  • Alternative Investments: For a more sophisticated portfolio, consider including a small allocation to alternative assets like commodities or private equity (for accredited investors only) to potentially improve diversification and hedge against inflation.

Remember, consulting a financial advisor is crucial for creating a personalized investment plan that aligns with your specific goals and risk tolerance.

 

This question has been answered.

Get Answer