9008INMT Investment Management
To achieve a high financial performance, asset allocation is crucial. Indeed, it has been previously emphasized in Financial Management that, to maximize expected returns and minimize risks, the right combination of assets needs to be in place. This assessment provides the opportunity to operationalize and put in practice this idea based on the approach suggested in Bodie, Kane and Marcus (2018, p. 193):
"the investment decision can be viewed as a top-down process: (1) capital allocation between the risky portfolio and risk-free assets, (2) asset allocation within the risky portfolio across broad asset classes (e.g. U.S. stocks, international stocks, and long- term bonds), and (3) security selection of individual assets within each class".
The goal of maximizing returns concomitantly to minimizing risks is encapsulated in the concept of ‘optimal risky portfolio’ which, in turn, is the focus of this assessment.
By working in the construction of the optimal portfolio, you will gain an in-depth and critical understanding of investment management terminology such as diversification, diversifiable risk, minimum-variance portfolio, portfolio opportunity set, efficient frontier, the capital asset allocation (CAL) line, minimum-variance frontier, efficient frontier of risky assets, and the Sharpe ratio, to cite a few.
Using 20-years of annual data across five asset classes provided in Appendix A (Table 1) and in accordance with the requirements below, you are tasked to write a report that addresses the following:
1.Briefly discuss the five asset classes in Table 1 of Appendix 1. Using the data from Table 1, calculate the Arithmetic Mean (AM), Geometric Mean (GM) and Standard Deviation (σ) of returns of each of the five asset classes. Briefly, discuss the risk-return characteristics of each asset class with reference to these measures.
2.Construct an efficient portfolio. Assume the risk-free rate over the period is 1.75%. Calculate the Efficient Frontier and Capital Allocation Line (CAL) for the five asset classes using the Excel Solver Tool (see prescribed textbook Chapter 7, Appendix A for guidance). You will also need to calculate and provide the ‘Bordered Covariance’ and ‘Correlation Matrices’. Discuss the implications of these five assets on efficient frontier and CAL.
3.Synthesise the various Modern Portfolio Theory (MPT) models in the four credible source references listed (i.e. Bodie, Zane & Marcus 2018; McKay, Shaoiro & Thomas 2018; Page & Panariello 2018; and Santacruz 2016) to provide an in-depth and critical discussion of your results from parts a. and b. Why (or why not) is minimum- variance portfolio still liked by academics and practitioners?