EQUITYQUESTION IS COMPOSED OF FOUR PARTS (A, B, C, D) FOR A TOTAL OF 13 MINUTES Randy Rhodes is a wealthy, self-employed chiropractor who made his money opening a number of offices in a large Midwestern city His work keeps him very busy with little time to review his investments Rhodes has always enjoyed reading about the markets, but acknowledges that he does not have time to track them as much as he would like He plans to keep working for another 10 years and has approximately $10 million in investable assets Rhodes is unhappy with his current advisor because his portfolio has underperformed its benchmark Rhodes is considering a new financial advisor, Tim Walcker, CFA Previously, the core of the portfolio was equally invested in the components of the S&P 100, a cap weighted index with quarterly rebalancing Despite holding all 100 stocks in the S&P 100, this investment has lagged the benchmark for the last three years See exhibits A and B for the portfolio's and the S&P 100's performances, respectively Exhibit A Rhodes Portfolio Equal-Weighted S&P 100 Fund 2013 2014 2015 8.3% 11.5% –14.2% Exhibit B S&P 100 Value-Weighted Index 2013 2014 2015 12.3% 15.5% 11.2% Rhodes strongly believes in an active approach, but he has a tendency to be influenced by news articles he's recently read He is willing to accept down years in the markets, yet does not want to lag the index by a wide margin On more than one occasion, he’s said that he would prefer a portfolio of municipal bonds because he is attracted to their tax advantages A Given Rhodes' objectives, identify which type of management (active, passive, or semiactive) is the most appropriate, justifying your response using two reasons from the case (3 minutes) B Explain two reasons the previous manager likely underperformed the value-weighted S&P 100 index Do not discuss the investment manager’s fee (4 minutes) Rhodes is interested in adding two other investments to his portfolio The first is a portfolio comprised of 75 publicly traded U.S companies with the highest net sales, which he read about in a financial publication According to the article, these companies are well diversified because they derive profits from around the world and have a low risk of bankruptcy because of their size The second is a value-weighted index, called the Key Three, containing the three stocks as seen in exhibit C The index company has announced that it will be changing the method of calculating the index to be free float adjusted from its current value weighting scheme Exhibit C The Key Three Index Market Capitalization (Billions) Float General Technical $120 90% Western Utility $80 99% Household Finance $100 93% C Regarding the portfolio made up of the top 75 publicly traded companies in the United States ranked by sales, identify the best way to mimic this portfolio by using either optimization, full replication, or stratified sampling and explain why (3 minutes) D When the Key Three index changes to being float-adjusted, which stock in the index will see its weight in the index increase the most? No calculations necessary (3 minutes) QUESTION HAS THREE PARTS (A, B, C) FOR A TOTAL OF 10 MINUTES Jim Harper is on the board of trustees for an endowment of a small liberal arts college Harper and the board have strong convictions that equity markets are generally efficient They want to hire a manager to actively manage a smaller portion of the equities in the endowment with the rest being indexed Harper is responsible for finding and meeting with potential investment managers and reporting his recommendations back to the rest of the board Michael Peters, CFA, has made it into the final group of managers being considered for the job based on his ability to outperform the broader market index Peters’ expertise is in investing in stocks with high projected growth rates in earnings He often utilizes larger cap stocks and off index investing His five year performance results are shown below: Year Avg Return Peters Total Market Index Large Cap Growth Index Short-Term Treasuries Standard Deviation (1995–2015) 17.2% 15.4% 18.3% 4.4% 16.9% 14.6% 17.3% A Calculate Peters’ true active return and interpret based on those results whether or not Peters should be hired Show your calculations (3 minutes) Harper and the board want to spread the rest of the endowment’s equity portfolio across numerous indices, including the S&P 500, the Russell 2000, and an international index They also want to allocate some funds to publicly traded companies that donate to charitable causes They have located a Charitable Index that represents this strategy The index invests in 500 companies based on criteria that are available with various delays It follows quarterly rebalancing rules, but it is not investable In spite of this, Harper and the board feel strongly about adding this index to their portfolio because the charitable focus aligns with the beliefs of the college B Identify the best way the endowment can invest in the Charitable Index by using either futures, a separate account, or an equity return swap Justify your response with one reason for each method that was not chosen (4 minutes) C Determine the best way the Charitable Index return can be replicated by using either full replication, an equal weighting scheme, or stratified sampling Justify your response with two reasons (3 minutes) QUESTION HAS FIVE PARTS (A, B, C, D, E) FOR A TOTAL OF 17 MINUTES Joyce Brown is a performance analyst with West Coast Consultants (WCC) WCC advises institutional portfolios on a range of investment management issues She is preparing for the annual review meeting with Durham Energy (DE) DE has a large pension fund and employs multiple outside managers and strategies Brown is reviewing the returns- and holdings-based analysis reports for the equity manager who manages the largest portion of the pension fund’s equity allocation Both reports are as of the calendar quarter just ended Returns Based Analysis (Trailing 60 Months) Category: Large cap value Large cap growth Mid cap value Mid cap growth Small cap value Small cap growth Cash equivalents Unexplained Total Fund beta (regression coefficient): 0.11 0.55 0.01 0.12 0.01 0.12 0.09 –0.01 1.00 Holdings Based Analysis (Quarter End) Category: Large cap value Large cap growth Mid cap value Mid cap growth Small cap value Small cap growth Cash equivalents Total Weighting: 0.21 0.17 0.00 0.06 0.40 0.11 0.05 1.00 A Determine the fund’s most recent allocation to cash equivalents (3 minutes) B Explain whether the fund has likely experienced style drift, and support your conclusion with two facts based directly on the reports (4 minutes) C Explain two adverse consequences of style drift for DE (4 minutes) Brown is also reviewing the investment strategies used for the total pension fund portfolio DE has historically focused on long-only strategies but is looking for ways to increase return They are considering a $100 million allocation to a short extension strategy (the SE approach) For SE, $100 million would be allocated to a new manager who will utilize a 130/30 strategy One of the DE Investment Committee members asked Brown if they could achieve the same economic results with a “combination approach” by allocating the new funds to one of their existing longonly managers, then retaining a new manager who is a short sale overlay specialist D Quantify how the “combination approach” would be structured (3 minutes) E Explain which approach (SE or combination) Brown will recommend as most likely more efficient (3 minutes) ... why (3 minutes) D When the Key Three index changes to being float-adjusted, which stock in the index will see its weight in the index increase the most? No calculations necessary (3 minutes) QUESTION. .. 17.2% 15.4% 18 .3% 4.4% 16.9% 14.6% 17 .3% A Calculate Peters’ true active return and interpret based on those results whether or not Peters should be hired Show your calculations (3 minutes) Harper... an equal weighting scheme, or stratified sampling Justify your response with two reasons (3 minutes) QUESTION HAS FIVE PARTS (A, B, C, D, E) FOR A TOTAL OF 17 MINUTES Joyce Brown is a performance