Investment Strategy Case Problem

Dennis/Peiting Li

2018/12/1

Environment

J.D. Williams is a savings consulting firm that oversees $12 billion in funding for its users. The company uses a number of different financial methods to advise its clients on the best portfolio return, including asset allocation models and percentage limits. In addition, the company is trying to assess the risk tolerance of each customer and adjust the portfolio to meet the needs of individual investors. Williams has just worked with a new client with a $800,000 investment.

Question 1

According to the case, the amount invested in the growth fund must be between 20% and 40% of the total portfolio value, between 20% and 50% of the total portfolio value must be in the income fund and 30% of the total portfolio value must be in the money market fund. The firm’s risk indicators shows the risk of the growth fund at 10%, the money market fund at 1%, and income fund at 7%. Thus all return and risk of all three funds are showing in the table below:

Return Min Max Risk

Growth 0.18 0.2 0.4 0.1

Income 0.125 0.2 0.5 0.07

Money market 0.075 0.3 0.01

Funds available 800000

Max Risk 0.05

By using the problem solver and sumproduct function in xlsx sheet, the recommend on how much of the $800,000 should be invested in each of the three funds are showing in the table below:

Funds

Growth 248888.89

Income 160000

Money market 391111.11

Max Risk 0.05

Return 94133.33

Thus the total return of the investment of 800,000 will be 94133.33 or 94133.33/800000=11.76%

Question 2

Through the re-calculation of the risk index could be increased to 0.055, the recommend on how much of the $800,000 should be invested in each of the three funds are showing in the table below:

Funds

Growth 293333.33

Income 160000

Money market 346666.66

Funds available 800000

Max Risk 0.055

Return 98800

Risk is an important component of the yield paid on an investment. The higher the risk, the higher the associated yield potential. Some investments are less risky than others.(Chris, 2018) The return of the investment of 800,000 will be 98800 or 98800/800000=12.35%, thus if the risk index increases the return of investment will also increase.

Question 3

If the annual yield for the growth fund were revised downward to 16% or even to 14%, the return of investment should also be changed. Here is the return and risk of all three funds after the growth fund return rate change down to 14% showing in the table below:

Return Min Max Risk

Growth 0.14 0.2 0.4 0.1

Income 0.125 0.2 0.5 0.07

Money market 0.075 0.3 0.01

By changing growth fund return rate down to 14%, the amount to be invested in each funds will also be changed. After the re-calculation in xlsx sheet, the new recommend on how much of the $800,000 should be invested in each of the three funds are showing in the table below:

Funds

Growth 160000

Income 293333.33

Money market 346666.67

Funds available 800000

Max Risk 0.05

Return 85066.67

The return of the investment of 800,000 after change will be 85066.67 or 85066.67/800000=10.63%, so if the annual yield for the growth fund lowered the total return of investment will also be lowered, thus if the annual yield for the growth fund were revised downward to 16%, the total return of investment will also be lower than 18%.

Question 4

Assume the amount invested in the growth fund is not allowed to exceed the amount invested in the income fund, the maximum of amount invested in the growth fund will be the same with the amount invested in the income fund. Through the re-calculation of the amount invested in the growth fund is smaller or equal to the amount invested in the income fund, here is the result showing in the table below:

Funds

Growth 213333.33

Income 213333.33

Money market 373333.33

Funds available 800000

Max Risk 0.05

Return 93066.67

If the amount invested in the growth fund is not allowed to exceed the amount invested in the income fund, the total return of investment will be lower than if the amount invested in the growth fund is allowed to exceed the amount invested in the income fund.

Question 5

Asset allocation is the strategy of dividing investment portfolio across various asset classes like stocks, bonds, and money market securities. Essentially, asset allocation is an organized and effective method of diversification. (Shauna, 2018) There are two types of assets, one is physical assets, such as real estate, art, etc.; the other is financial assets, such as stocks, bonds, funds, etc. For different types of investors, the meaning of asset allocation is not the same. For most investors, asset allocation usually means calculating the yield, standard deviation, and correlation of various assets, and using these variables to perform the mean-variance optimization to select portfolios with different risk-return ratios.

Since the company is trying to assess the risk tolerance of each customer and adjust the portfolio to meet the needs of individual investors, using the same asset allocation model for different clients might not be the best idea. The asset allocation model will be helpful in some cases, but using a different asset allocation model for different client will be better than using the same asset allocation model because each clients is looking for different rate of return and different risk that they might take, thus develop a unique asset allocation model for different client will be the best way to advise its clients on the best portfolio return.

Reference

Chris,M. (May 18, 2018) “What is the difference between yield and return?” Retrieved from https://www.investopedia.com/ask/answers/difference-between-yield-and-return/

Shauna, C. (March 8, 2018) “Achieve Optimal Asset Allocation” Retrieved from https://www.investopedia.com/managing-wealth/achieve-optimal-asset-allocation/