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Week 9_tutorial question solutions_Chapter 8 (1)

The document provides solutions to tutorial questions from Chapter 8, focusing on asset allocation strategies and investment performance. It highlights the benefits of real assets like commodities for inflation hedging, the importance of private equities for capital growth, and the limitations of traditional portfolio diversification methods. Additionally, it discusses the selection criteria for investment funds, emphasizing both quantitative and qualitative factors.

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Laiba Raza
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4 views

Week 9_tutorial question solutions_Chapter 8 (1)

The document provides solutions to tutorial questions from Chapter 8, focusing on asset allocation strategies and investment performance. It highlights the benefits of real assets like commodities for inflation hedging, the importance of private equities for capital growth, and the limitations of traditional portfolio diversification methods. Additionally, it discusses the selection criteria for investment funds, emphasizing both quantitative and qualitative factors.

Uploaded by

Laiba Raza
Copyright
© © All Rights Reserved
Available Formats
Download as PDF, TXT or read online on Scribd
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Chapter 8 tutorial question solutions

1. C is correct. Real assets (which include energy, infrastructure, timber, commodities, and farmland)
are generally believed to mitigate the risks to the portfolio arising from unexpected inflation.
Commodities act as a hedge against a core constituent of inflation measures. Rather than investing
directly in the actual commodities, commodity futures may be incorporated using a managed futures
strategy. In addition, the committee is looking for an asset class that has a low correlation with public
equities, which will provide diversification benefits. Commodities are regarded as having much lower
correlation coefficients with public equities than with private equities and hedge funds. Therefore,
commodities will provide the greatest potential to fulfill the indicated role and to diversify public
equities.

2. C is correct. When projecting expected returns, the order of returns from highest to lowest is
typically regarded as private equities, hedge funds, bonds. Therefore, the probability of achieving the
highest portfolio return while maintaining the funded status of the plan would require the use of
private equities in conjunction with public equities. In addition, private equities have a high/strong
potential to fulfill the role of capital growth. Fixed-income investments are expected to have a
high/strong potential to fulfill the role of safety.

3. B is correct. A traditional approach has been used to define the opportunity set based on different
macroeconomic conditions. The primary limitations of traditional approaches are that they
overestimate the portfolio diversification and obscure the primary drivers of risk.

6. C is correct. Statement 3 is correct because risk factor-based approaches to asset allocation can be
applied to develop more robust asset allocations. Statement 4 is correct because a mean–variance
optimization typically overallocates to the private alternative asset classes, partly because of
underestimated risk due to stale pricing and the assumption that returns are normally distributed.

7. C is correct. Park notes that the current macroeconomic environment could lead to a bear market
within a few years. Liquidity planning should take into account that under a scenario in which public
equities and fixed-income investments are expected to perform poorly, general partners may exercise
an option to extend the life of the fund.

8. A is correct. Fund A should be selected based on both quantitative and qualitative factors. Fund A
has a five-year IRR (12.9%) that is slightly lower than, but comparable to, both Fund B (13.2%) and
Fund C (13.1%). Given the sensitivity to the timing of cash flows into and out of a fund associated
with the IRR calculation, however, the final decision should not be based merely on quantitative
returns. It is also important to monitor the investment process and the investment management firm
itself, particularly in alternative investment structures. Considering the qualitative factors identified by
Park, Fund A is the only fund with a strong, positive factor. It benefits from service providers
(administrators, custodians, and auditors) with impeccable reputations. Fund B seems to be
experiencing style drift, which suggests that the returns are not consistent with the manager’s
advertised investment edge (hence, a negative factor). Fund C has experienced the departure of key
persons, which puts future fund returns in jeopardy (hence, a negative factor).

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