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
More than 50% in bonds in the portfolio
Emphasis on liquidity
A majority in overseas assets
Discretion to fund managers on what they could buy
The correct answers are b, c and e.
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.
Quantifying risk by tracking error in the benchmark portfolio
Limiting the amount of higher risk in any asset class
Limiting the amounts in a particular asset class
The correct answers are b and c.
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.
60% equities and 20% non benchmark
85% equities and 7% higher risk non benchmark
The correct answer is b.
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?
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.