6.2 Alpha case study
The case study below explores an actual investment management agreement and what constraints were imposed in terms of asset classes on the investment manager.
Activity 11 Investment management case study
This is an extract from the investment management agreement (IMA) for a British charitable foundation (endowment fund), code name Alpha, made in 2008.
The table below gives the benchmark portfolio and the risk constraints on the portfolio, imposed through maximum and minimum percentage values for the asset classes and also for the types of assets to be included in the portfolio. The stated investment objective was to outperform the benchmark portfolio over rolling three year periods.
Table 4: Benchmark asset allocation, benchmark indices and constraints for Alpha portfolio
| Asset class | Allocation (%) | Ranges (%) | Benchmark index | |
|---|---|---|---|---|
| UK Equities | 50.0 | FTSE All Share | ||
| Global Equities | 25.0 | |||
| (33.4) | FTSE AW North America | |||
| (33.3) | FTSE AW Developed Europe (ex UK) | |||
| (33.3) | FTSE AW Developed Asia Pacific (inc. Japan) | |||
| Equities | 75.0 | 60.0-85.0 | ||
| UK Bonds | 25.0 | 15.0-40.0 | FTSE A All Stocks | |
| Total | 100.0 | |||
| Overseas Assets | 15.0-35.0 | |||
| Non-benchmark | 0.0-20.0 | |||
| Higher Risk Non-benchmark | 0.0-7.0 | |||
Additional constraints
Bond investments are to be in investment grade A or higher. Higher risk non-benchmark assets (e.g. emerging market equity or debt, or securities investing in illiquid assets) should be limited to 0.0-7.0% of the portfolio, forming part of the 0.0-20.0% of the non-benchmark assets. Non-benchmark assets are assets which do not form part of the designated benchmark indices. Direct investment in illiquid assets is not allowed, e.g. hedge funds, real estate, private equity but is allowed if investment is made via a fund which provides liquidity.
What are the three main investment characteristics of this investment mandate?
Select the correct answers from the options below.
Answer
The main investment characteristics of the mandate are growth (a high proportion of equities), an emphasis on liquidity, and a considerable amount of discretion given to the fund managers in terms of what they can buy and how much they can deviate from the benchmark portfolio.
List three ways in which risk been constrained in this portfolio.
Select the two correct statements from the options below.
Risk has been constrained by:
Answer
Risk has been constrained by limiting the amounts in a particular asset class and by limiting the amount of higher risk securities in any asset class - through credit rating, through type of market (developed/emerging) and through liquidity. However risk has not been quantified, e.g. in terms of tracking error with respect to the benchmark portfolio.
Which of the following statements is correct about constructing the most risky portfolio within the investment guidelines?
Answer
Assuming that higher risk non-benchmark assets are the riskiest investments, the highest risk portfolio would be, say, 7% higher risk non-benchmark investments and 85% equities, with the remaining 8% in non-benchmark assets. However, given the requirement for a minimum of 15% in bonds, the non-benchmark assets would have to be bonds.
What do you think were the riskiest assets in the Crash of 2008?
Answer
In practice, many so-called structured bonds had credit ratings which underestimated their true risk, so the ‘bond’ and ‘non-benchmark’ categories performed poorly. Also funds investing in illiquid assets themselves proved to be illiquid and many suspended pay-outs and suffered losses, although they had promised investors liquidity.
OpenLearn - Asset allocation in investment
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