Question

Ms Hudson is 60 years of age, is in excellent health, pursues a simple but active lifestyle, and has no children. She has interest in a private company for R180 million and has decided that a medical research foundation will receive half the proceeds now and will be the primary beneficiary of her estate upon death.

Currently, the following assets are available for use in building an appropriate portfolio for h:

R90 million cash (from sale of the private company interest, net of a R90 million gift to the foundation)

R20 million stocks and bonds (R10 million each) R18 million warehouse property (now fully leased) R2 million value of his residence

a. Formulate and justify an investment policy statement setting forth the appropriate guidelines within which future investment

actions should take place. Your policy statement should encompass all relevant objective and constraint considerations.

b. Recommend and justify a long-term asset allocation that is consistent with the investment policy statement you created in Part a. Briefly explain the key assumptions you made in generating your allocation.

Answer 1

ABOUT MR HUDSON

At this point we know (or can reasonably infer) that Mr. Hudson is:

unmarried (a recent widower)

childless

70 years of age

in good health

possessed of a large amount of (relatively) liquid wealth intending to leave his estate to a tax-exempt medical research foundation, to whom he is also giving a large current cash gift

free of debt (not explicitly stated, but neither is the opposite)

in the highest tax brackets (not explicitly stated, but apparent)

not skilled in the management of a large investment portfolio, but also not a complete novice since he owned significant assets of his own prior to his wife’s death

not burdened by large or specific needs for current income

not in need of large or specific amounts of current liquidity

Return Requirements of Mr. Hudson:

The incidental throw-off of income from Mr. Hudson’s large asset pool should provide a more than sufficient flow of net spendable income. If not, such a need can easily be met by minor portfolio adjustments.

Thus, an inflation-adjusted enhancement of the capital base for the benefit of the foundation will be the primary return goal (i.e., real growth of capital).

Tax minimization will be a continuing collateral goal.

Time Horizon of Mr.Hudson: Even disregarding Mr. Hudson’s still-long actuarial life expectancy, the horizon is long-term because the remainder of his estate, the foundation, has a virtually perpetual life span.

Liquidity Requirement: Given what we know and the expectation of an ongoing income stream of considerable size, no liquidity needs that would require specific funding appear to exist.

Taxes: Mr. Hudson is no doubt in the highest tax brackets, and investment actions should take that fact into account on a continuing basis. Appropriate tax-sheltered investment (standing on their own merits as investments) should be considered. Tax minimization will be a specific investment goal.

Legal and Regulatory: none.

Unique Circumstances: The large asset total, the foundation as their ultimate recipient, and the great freedom of action enjoyed in this situation (i.e., freedom from confining considerations) are important in this situation, if not necessarily unique.

ASSUMPTIONS BEFORE MAKING IPS

Given that stocks provide higher risk-adjusted returns than either bonds or cash, and considering that the return goal is for long-term, inflation- protected growth of the capital base, stocks will be allotted the majority position in the portfolio.

This is also consistent with Mr. Hudson’s absence of either specific current income needs (the ongoing cash flow should provide an adequate level for current spending) or specific liquidity needs.

Since the inherited warehouse and the personal residence are significant (15%) real estate assets already owned by Mr. Hudson, no further allocation to this asset class is made.

Given the long-term orientation and the above-average risk tolerance in this situation,

about 70% of total assets can be allocated to equities (including real estate) and about 30% to fixed income assets.

International securities will be included in both areas, primarily for their diversification benefits.

Municipal bonds will be included in the fixed income area to minimize income taxes.

IPS FOR MR HUDSON