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AFCP801: Epeus Portfolio Management - Asset Allocation Advice - Portfolio Management & Valuation Assessment Answer
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Subject Code: AFCP801
Internal Code: E_AI_DIGE_BIG
Portfolio Management & Valuation Assessment Answer
TASK Epeus Portfolio Management Epeus Portfolio Management has developed a reputation for successfully managing equity portfolios. They have frequently been declared finalists for the Money Management Australian Equities Fund Manager of the Year awards. As a result their portfolios have become popular with self?managed super funds as well as institutional funds. Epeus attributes their success to thorough fundamental analysis. This analysis drives the security selection in the funds and has delivered substantial returns. However, recently, some clients have expressed concerns that the funds do not always reflect the performance of the wider stock market. This worry has been fuelled by the way these clients model asset allocation. They typically use market indices to represent the various asset classes they are exposed to and then select active managers to do the actual portfolio management for each of these asset classes. Equity Portfolio Construction Sofia Adams has been working at Epeus as a portfolio analyst for the last few years. She has been given the task of designing a way to manage these clients’ concerns while continuing to capitalise on Epeus’ skill in security selection. She plans to use a single index model based on the S&P ASX 200 index and begins her analysis with seven stocks the firm’s security analysts are currently evaluating. From this analysis, she obtains coefficients for each of the stocks which she uses to construct a variety of potential stock portfolios with differing portfolio objectives. As Sofia carries out this analysis she becomes concerned about the overall validity of the single index model and its resulting coefficients. As an example of her concerns, she is worried about whether the beta coefficients actually coincide with the risk premia earned on the stocks. She, therefore, conducts a second pass regression test of the single index model (including relevant data on additional stocks that had been previously collated) to evaluate this model. Sofia is also concerned that perhaps she isn’t modelling the right risk factors. As she thought about how the firm’s fundamental stock analysis drives the stock selection, she realised that a stronger mapping of the relevant risk patterns might be achieved through using a multi-factor model. However, to further investigate potential risk factors she decides to also research the risk factors being implemented by other investment managers. Asset Allocation Advice The growing reputation and popularity of the Epeus equity portfolios has prompted the firm’s management to consider expanding their product range to include asset allocation advice. At the very least the exercise should help them understand how their clients view the role of the Epeus equity portfolios in the context of their broader diversified funds. Sofia has leapt at the opportunity to expand her involvement and has offered to investigate what asset allocation might potentially look like by combining Australian equities with Australian bonds. She will demonstrate a suite of asset allocation choices reflecting a range of risk profiles. The management of Epeus are keen to be cost efficient if they go down the path of providing asset allocation advice. They have been aware of the rising interest in Robo advice (also referred to as Automated or Digital advice) and wonder whether this would be relevant for their plans. Sofia has therefore been requested to identify an example of an investment manager (or advisor) who provides Robo advice and to consider the relevance of their approach to Epeus. Questions Question 1. (a) Calculate average monthly excess returns for the seven shares and the equity index in the spreadsheet. Report each share’s arithmetic average monthly excess return and standard deviation of excess return (using the population version of the standard deviation equation). (b) Regress the monthly excess returns for each share on the monthly excess returns of the equity index and report each share’s: alpha; beta; t?statistics; and R squared. Also, calculate and report each share’s tracking error ? as implied by the betas and standard deviations of excess returns ? ie from part (a). (c) Run a second pass regression by regressing the average excess returns for the shares from part (a) on their betas and tracking errors (in variance form) from part (b) combined with the data for the additional shares provided in the spreadsheet. Report the gamma 0, gamma 1, gamma 2, standard errors, relevant t?statistics and adjusted R squared (refer to BKM section 13.1). (d) Run a multivariable regression for each of the seven shares by regressing the share’s monthly excess returns on the monthly excess returns of the equity index and the additional factor data (ie Fama French HML index and the Consumer Sentiment Index) provided in the spreadsheet ? refer to Section 13.3 of BKM for an example of a multi factor model (NB: we’re only running a first pass regression here) and for an explanation of the Fama?French factors. Report each share’s alpha, betas; t?statistics; and adjusted R squared. Question 2. Two asset pricing models have been tested in Question 1. Use the results from that question to evaluate these asset pricing models in the context of Epeus’ equity portfolio construction. Question 3. Research two investment managers that use multi factor models in their investment processes. Describe the factors employed and explain how they are used in portfolio construction. Question 4. Use the results from Question 1 parts (a) and (b) to construct the following share portfolios. Only include the original seven shares in the portfolio ? ie do not include the equity index or the additional share data used in Question 1 part (c). Assume zero correlation between the shares’ non?systematic returns when calculating portfolio tracking error (ie portfolio non?systematic risk). Calculate total portfolio risk by combining the systematic element and tracking error of the portfolio per equation 8.16 in BKM. (a) Use solver to find the portfolio weights for a long?only share portfolio with the maximum amount of alpha. State the portfolio weights, alpha, beta, tracking error, information ratio and Sharpe ratio. (b) Use solver to find the portfolio weights for a long?only share portfolio with the minimum amount of tracking error. State the portfolio weights, alpha, beta, tracking error, information ratio and Sharpe ratio. (c) Use solver to find the portfolio weights for a long?only share portfolio with the maximum amount of information ratio plus a beta constrained to a value of one. State the portfolio weights, alpha, beta, tracking error, information ratio and Sharpe ratio. (d) Use solver to find the portfolio weights for a long?only share portfolio with the maximum amount of Sharpe ratio. State the portfolio weights, alpha, beta, tracking error, information ratio and Sharpe ratio. Question 5. Comment on which share portfolios, from the portfolios constructed in Question 4, are better suited for Epeus’ purposes. Suggest some further improvements that could be made to Epeus’ share selection process. Question 6. (a) Calculate the average annual returns and standard deviations (using the population version of the standard deviation equation) of annual returns for Australian shares (based on the S&P/ASX 200 Index data in the spreadsheet), Australian bonds (based on the S&P Australian Bond Index data) and Australian cash (based on the Bloomberg Australian Bank Bill Index data) as well as the correlation of returns between these asset classes. Chart the opportunity set comprised of a wide range of possible “risky portfolios”. Your chart should show standard deviations on the horizontal axis, and returns on the vertical axis. (b) Using the return and risk results from part (a) find the asset class weights for the optimal risky portfolio (assuming cash as a proxy for the risk-free asset) and state the portfolio’s weights, return, risk and Sharpe ratio. (c) Based on the optimal risk portfolio from part (b), chart the capital allocation line. (d) Using the capital allocation line from part (c) and potentially the opportunity set from part (a), present asset allocation portfolios for a range of client risk profiles (i.e. three different risk aversion levels). Question 7. Research an investment manager (or advisor) that provides “Robo” advice. Describe the advice process and evaluate whether this process would suit Epeus’ investment activities, clients and future plans.This Portfolio Management Assessment has been solved by our Portfolio Management experts at My Uni Paper. Our Assignment Writing Experts are efficient to provide a fresh solution to this question. We are serving more than 10000+ Students in Australia, UK & US by helping them to score HD in their academics. Our Experts are well trained to follow all marking rubrics & referencing style.