Question

A) As a portfolio manager, you apply dynamic allocation. Your 62-year old client with the following portfolio information needs your help to split her money into equity and bond positions. How much does she need to invest in each of these asset classes? Please show your work. m = 1.5 Portfolio current value = $1,500,000 Floor: $500,000 B) What are your thoughts on your final answer in part (A)? Do you think this asset allocation is appropriate for your client? C) Because of the pandemic, stock market crashed and your client lost 1/3 of his portfolio value. Assuming that she did not lose value of her bond portfolio, what adjustments do you recommend for her stock and bond allocation

Answer 1

We can follow the CPPI(Constant proportion portfolio insurance) strategy to rebalance the portfolio. Also, we can arrive at a proportion of asset in the portfolio.

given, m =1.5

portfolio current value = $ 1500 000

safety value =$ 500 000

The asset proportion can be calculated as

$ Stock Investments=M×(TA−F)

where:M=Investment multiplier (More Risk = Higher M)

TA=Total portfolio assets

F=Allowable floor (minimum safety reserve)​

-Investopedia

So, dollar stock investments = 1.5*(1500000-500000) = $1500000

There is no remaining investment in fixed income assets

So,the 62 year old client has all her investment in stocks.This asset allocation is grossly inappropriate for my client .The client has the sum to invest in assets but most likely, does not have the time span to be be invested that long in the market. They should identify her risk tolerance and investment horizon thoroughly before giving her such an aggressive allocation, i.e 100% in stocks.

C) Due to pandemic, she loses 1/3 rd of her portfolio value. So, the new portfolio value=

which is above the allowable floor reserve.Note that her bond allocation was 0.So all the portfolio is comprised of stock investments.

The new asset allocation, given she wants to preserve the bond portfolio is

$ Stock Investments=M×(TA−F)

where:M=Investment multiplier (More Risk = Higher M)

TA=Total portfolio assets

F=Allowable floor (minimum safety reserve)​

Stock allocation = 1.5*(1000000-500000)= 750000

Bond allocation = 1000000-750000= 250000 i.e 25%