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Portfolio Diversification: Building A Passive Portfolio With Etfs

The document details a request to simplify a client's portfolio of multiple ETFs into a low-cost portfolio aligned with his goals. The client's financial details and current holdings are provided, consisting of various stock and bond ETFs in an unoptimized allocation. The assistant is asked to propose a new portfolio within the target allocation and risk tolerance using as few ETFs as possible.

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Jeremy Loobs
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28 views

Portfolio Diversification: Building A Passive Portfolio With Etfs

The document details a request to simplify a client's portfolio of multiple ETFs into a low-cost portfolio aligned with his goals. The client's financial details and current holdings are provided, consisting of various stock and bond ETFs in an unoptimized allocation. The assistant is asked to propose a new portfolio within the target allocation and risk tolerance using as few ETFs as possible.

Uploaded by

Jeremy Loobs
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Portfolio Diversification: building a passive

portfolio with ETFs

Case study

This case study was written by Dr. Alexandre Rubesam and Dr. Paolo Mazza (IESEG School of
Management, LEM- CNRS 9221). It is intended to be used as the basis for class discussion
rather than to illustrate either effective or ineffective handling of a management situation. The
case was compiled from published sources.
It has been updated by Dr. Philippe Cogneau in 2024.
We are grateful to the students who were confronted to the case for valuable input for the
content and format of the present case.

© 2022-2024 IESEG School of Management (LEM-CNRS)


No part of this publication may be copied, stored, transmitted, reproduced
or distributed in any form or medium whatsoever without the permission
of the copyright owner.

1
Portfolio Diversification: building a passive
portfolio with ETFs

You have recently been hired as an analyst at Miskatonic Financial Advisors, a firm
that helps retail investors build and manage low-cost portfolios to achieve their
investment goals. The firm has a philosophy of building low-cost, passive portfolios
for long-term growth. Your boss, Ms. H. Carter, has received an email from an old
friend, Mr. E. Prescott, who has come to her recently for financial advice on how to
simplify his portfolio. Ms. Carter has asked you to analyze the situation and propose
a simplified portfolio in line with his requirements and objectives.

Ms. Carter’s email, including details about Mr. Prescott’s financial situation, is shown
in Exhibit 1. Mr. Carter’s current portfolio holdings are shown in Exhibit 2. Information
about the different assets in his portfolio is provided in Exhibit 3.

2
Exhibit 1 – Email from Mr. Carter
From: H. Carter [email protected]
To: You you@ miskatonicfa.com
Date: Wed 16/02/2024 10:00
Subject: Help with a friend’s portfolio

Hi,

Hope everything is going well and that you’re adapting to your new position at our company. I have
an urgent task for you regarding a client’s portfolio. The client, who was just reached out to us, is a
good friend of mine, Mr. E. Prescott. His current portfolio (which is provided in Exhibit 2) is a mess! I
had a conversation with him last week, and he mentioned that, over time, he accumulated positions
in several ETFs, following recommendations from colleagues at work, internet forums and so on.
Basically, he knows very little about investments, and doesn’t even know or remember why he bought
each of the ETFs in his portfolio.

In my discussion with him, we talked about his goals, potential constraints, and his risk preferences.
Based on that, our team put together the summary below. As you can see, despite his lack of care
about his investment portfolio (which is currently valued at $55k), his financial situation is relatively
comfortable. Mr. Prescott has enough cash for emergencies, lives within his means, and saves a decent
percentage of his net income.

Name Mr. Eliott Prescott


Age 35
Employment situation Stable employment
Annual net income $125k/year
Annual expenditures $75k/year
Home ownership Homeowner, fixed-rate mortgage @1.5%/year
with 25 years left. Mortgage payment is
approximately $21k/year.
Assets House (valued at $570k)
Current accounts: $35k
Investment portfolio: $55k, see allocations
below
Liabilities Mortgage: balance left = $375k
Other debt: $12k
Main investment goal Funding retirement
Investment horizon 25-30 years
Liquidity needs None until retirement.
Risk tolerance Medium
Target annual volatility 12.5%
Target asset allocation 70% diversified stocks
45% U.S.
20% other develop. market stocks
5% emerging market stocks
30% diversified U.S. bonds

As you can probably guess from his portfolio holdings (see Exhibit 2), his portfolio is currently above
his identified target volatility and is way off in terms of the proposed target asset allocation. I’d like
you to propose a new portfolio to match his target risk and allocations, keeping as few positions as
possible, and maintaining the lowest cost possible. For the proposed portfolio, please provide an
estimate of the annual return, volatility, Sharpe ratio, and average expense ratio. To help you with
this, please see the stats of the ETFs (using monthly data from last 5 years) in Exhibit 3.

H. Carter
Head of Client Allocations
Miskatonic Financial Advisors

3
Exhibit 2 – Current portfolio holdings
Asset Value as of
16/02/2024
AGG 2,475.00
ARKK 13,750.00
BND 1,375.00
EEM 825.00
EFA 825.00
IEFA 825.00
ITOT 2,750.00
IVV 8,250.00
SPY 16,500.00
TLT 2,475.00
VEU 825.00
VTI 2,750.00
VWO 1,375.00
Total 55,000.00

4
Exhibit 3 (1/2) – Statistics of ETFs (based on 5 years of monthly data)

AGG ARKK BND EEM EFA IEFA ITOT


Annualized 1.25% 10.38% 1.23% 0.35% 2.72% 2.88% 12.06%
return
Annualized 4.24% 38.40% 4.45% 17.04% 15.75% 15.90% 17.79%
Volatility
Sharpe ratio 0.06 0.24 0.05 -0.04 0.11 0.12 0.62
Best monthly 2.78% 25.75% 2.77% 10.34% 14.27% 13.89% 13.20%
return
Worst monthly -3.81% -28.90% -3.97% -15.77% -14.11% -14.63% -13.87%
return
Maximum -11.92% -70.74% -12.23% -29.69% -23.01% -23.53% -21.19%
Drawdown
Expense ratio 0.03% 0.75% 0.03% 0.69% 0.37% 0.08% 0.03%

Exhibit 3 (2/2) – Statistics of ETFs (based on 5 years of monthly data)

IVV SPY TLT VEU VTI VWO


Annualized 12.80% 12.75% 0.96% 2.89% 12.11% 1.92%
return
Annualized 17.29% 17.27% 13.06% 15.50% 17.84% 16.53%
Volatility
Sharpe ratio 0.68 0.68 0 0.12 0.62 0.06
Best monthly 12.68% 12.70% 11.04% 12.60% 13.13% 9.66%
return
Worst monthly -12.14% -12.46% -9.42% -15.13% -13.91% -17.05%
return
Maximum -20.00% -19.98% -30.82% -24.27% -21.32% -28.34%
Drawdown
Expense ratio 0.03% 0.09% 0.15% 0.07% 0.03% 0.08%

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