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  • Subject Name : Accounting and Finance

Investment Portfolio and Its Performance

A) Calculate the real return of your client's investment portfolio and its performance relative to the model portfolio over the past 12 months. (4 marks)

Current Portfolio

Benchmark

Construct

Increase

Construct

Increase

Equity

90%

 

70%

-1%

Corporate Bonds

10%

 

30%

3%

Return

1.00%

Return

0.20%

Inflation

1.80%

Inflation

1.80%

Real Return

-0.80%

Real Return

-1.60%

Real return of client’s portfolio is return – inflation which comes to negative 0.80% vs that of the benchmark model portfolio which comes to negative 1.60%

The client has been able to outperform the model portfolio by .80%.

B) Calculate and explain to the client how the performance of their portfolio was attributable to asset allocation and to investment allocation. (6 marks)

Current Portfolio

Benchmark

Construct

Increase

Construct

Increase

Equity

90%

0.78%

70%

-1.00%

Corporate Bonds

10%

3.00%

30%

3.00%

Return

1.00%

Return

0.20%

Inflation

1.80%

Inflation

1.80%

Real Return

-0.80%

Real Return

-1.60%

The corporate bonds are a debt asset class and would perform the same across the corporates and might not be different. Whereas, equity as an asset class would perform significantly different. Since we have been given that the portfolio made a return of 1%, where corporate bonds contributed (10% of 3%) 0.3%, the balance .7% has to come from the equity holdings. Since equity is held upto 90%, .7%/90% is 0.78% approximately.

Now, what is important is that the asset allocation and the investment allocation were both different. Asset allocation suggested was 70:30 but it was entered as 90:10, and since equity had 20% higher weight and the client was able to generate positive returns – the overall portfolio did better vs benchmark.

Now, the investment allocation. If the equity benchmark fell by 1% and the client’s equity rose by .78% - there is a difference of 1.78% or the alpha which the client was able to generate through his equity pickings. This investment allocation is the driving force behind the difference between client and the model portfolio.

C) Explain the primary differences between the two investment holdings in the portfolio to the client. (15 marks)

Investments can be done across multiple asset classes – largely they can be divided into high risk and low risk assets. Equity is a high risk asset – you never know when the company can go bust + there is high volatility because of continuous trading on the open market. However, debt is a low risk asset – because it has fixed returns for a fixed time and there is almost no volatility. (Which is the assumption we have used to compare the debt allocation’s return of 3% across both portfolios)

However, it is not advised to have a large portion of the portfolio into high risk assets or here, equity. Since you do have 90% holdings in equity and have been able to generate returns of .78% - you have made the right calls (or better calls than the market did), but you are also exposing yourself to higher risk. Incase, the equity performed the same for both portfolios – we would have made a return of negative .20% and real return would have been negative 2.4%

Current Portfolio

Benchmark

Construct

Increase

Construct

Increase

Equity

90%

-1.00%

70%

-1.00%

Corporate Bonds

10%

3.00%

30%

3.00%

Return

-0.60%

Return

0.20%

Inflation

1.80%

Inflation

1.80%

Real Return

-2.40%

Real Return

-1.60%

And that would have been bad.

The benchmark is a less risky portfolio whereas the current portfolio is a risky portfolio. Higher risk can lead to higher volatility – as long as the volatility is on the positive side and makes returns for us, it is great. But higher risk can also lead to higher losses and that must be safeguarded – depending on your risk appetitie.

Remember, at the center of any academic work, lies clarity and evidence. Should you need further assistance, do look up to our Accounting and Finance Assignment Help

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