Investment Management: Allocation vs. Stocks

FIN B385F Investment Management 2021 Spring
Individual Assignment
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INVESTMENT MANAGEMENT
PART A: ANSWER
The assets selected for the fund are uncorrelated, namely stocks and bonds. The rationale for the selection of uncorrelated assets is volatility and risk tolerance. The lack of correlation between assets provides diversification which decreases the overall volatility and risk levels. Asset allocation strategy is largely determined by the fund investment goals. The goal of the Stable Fund is to create a stable growth, low risk and volatility retirement fund. The fund can achieve stable capital growth with low volatility and risk through diversification. Diversification will be achieved by spreading the risk through investing in different types of assets across the fund portfolio. The Stable Fund is a diversified portfolio comprising of stocks (domestic stocks and foreign stocks), bonds, REITS and precious metals. The Fund will comprise 65% stocks (35% domestic stocks and 30% foreign stocks), 20% bonds while REITS and precious metals will comprise 8% and 7% of the fund respectively.
Figure 1: Portfolio Diversification strategy
Asset allocation is the ratio of stocks to fixed income. For example, 60/40, which implies 60% stocks and 40% bonds. However, given the low risk level associated with bonds, the fund might choose the asset allocation formula of 10/90 stocks/bonds, whereas the second investor might opt for an aggressive allocation strategy of 90/10 (Maier-Paape & Zhu, 2018). To achieve stable growth, Investors may opt to invest in gold based on the 70/20/10 stocks/bonds/gold. The 70/20/10 investment strategy refers to 70%, 20% and 10% investment in bonds, stocks and gold. The rationale being that bonds are more stable in the long run as compared to stocks. Using the ‘age-in-bonds’ formula or age-based allocation strategy, the stable fund will provide three options. Firstly, a 40 years old investor would invest 40% in bonds, a 60 year old 60% while a 20 year old would invest 20%. The second allocation strategy is to use the ‘age minus 20’ bond allocation strategy. This implies a 40year old would invest (40-20) 20% , 60 year old 40% while a 20 year old investor would not invest in bonds. The third asset allocation formula is the (age-40)*2. The allocation strategy implies that only investors aged 40 and above would invest in bonds. The allocation strategy permits maximum growth of the fund and early accumulation. Thereafter, capital preservation becomes essential towards retirement. The above three asset allocation strategies are ideal for low, moderate to high risk tolerance investments (Akyol & Cicen. 2017).The Stable Fund fund requires high risk tolerance levels to maintain stable growth in the long term. Subsequently, it will be based on the (age-40)*2 allocation formula.
Figure 2: Portfolio Allocation-bonds vs. Stocks
Source:
The stable fund will use the global bond fund. Investment will be made in bonds issued in the international market to achieve diversification of the bond portfolio. Investment will be made in bond funds, ETFs and diversified mutual funds at low cost below ...