AFF5270 ASSIGNMENT MONASH UNIVERSITY.docx
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AFF5270 ASSIGNMENT MONASH UNIVERSITY.docx
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AFF5270ASSIGNMENTMONASHUNIVERSITY
ExecutiveSummary
Thisreportconsistsoftwosections:
strategicassetallocationthataimstoconstructalong-terminvestmentportfolioforthefoundationbasedonthehistoricalreturnofthebenchmarksandtestthefeasibilityofmomentuminvestingstrategybyassessinggoodperformedstocksandpoorperformedstocks.
Inthefirstsection,aproperInvestmentPolicyStatement(IPS)isformulatedforthefoundationinreferencetoitsobjectivesandconstraints.Then,theperformanceandthecorrelationofeachassetclassareassessedwiththegivendataofthebenchmarks’historicalreturn.Furthermore,inordertoconstructlong-terminvestmentportfoliothatmeetstherequirementsspecifiedbythefoundation,Excelsolverfunctionisappliedtodeterminetheweightofeachassetclassinaccordancewiththevolatilityandtheexpectedreturn.
Inthesecondsection,wetestthefeasibilityofmomentuminvestingstrategybyassessingtheperformancesoffiveportfolios(equalweightedandvalueweightedapproach)intermsofcomparinggoodstocksandpoorstocks.Basedonourempiricalanalysis,themomentuminvestingstrategycouldbeappliedinreality,wherethestocksperformedwellinthepastcontinuetoperformwellinthefuture.Butallportfoliosareunderperformedorclosetomarketportfolio,whichraisesthequestionwhetheractiveinvestingstrategyissuperiortopassiveinvestingstrategy.Relativelylowerreturnswithsignificantlyhigherriskandvolatility;additionalexpensesfromtransactioncost,taxesandmanagementfees;irrationalfinancialbehaviourcausedhighernon-systematicriskcomparedwithpassivestrategyarethemainpotentialproblemsformomentuminvestingstrategyappliedinpractice.
TableofContent
1.Introduction1
2.InvestmentPolicyStatement(IPS)1
2.1.Objectives1
2.2.Constraints2
3.AnalysisofAssetClassPerformance2
3.1.CumulativeReturn2
3.2.CorrelationofEachAssetClass3
3.3.EconomicCycleandAssetClassPerformance4
3.4.Determinationofexpectedreturn5
4.StrategicAssetAllocation(SAA)7
4.1.RoleofEachAssetClass7
4.2.AssetAllocationDecision7
4.3.HowtheInvestmentPortfolioMeettheIPSRequirements9
4.4.PerformanceofProposedPortfolio9
4.5.ScenarioTesting10
5.MomentumInvestingStrategy12
5.1.MomentumInvestingStrategyandCoreConcept12
5.2.PoorStocksandGoodStocks13
5.3.PerformancesofEqualweightedPortfolio15
5.4.PerformancesofEqualweightedPortfolio18
5.5.RecommendationonMomentumInvesting22
6.Conclusion23
TableofFigure
Figure1:
Summaryofthefoundation’sobjectives1
Figure2:
Yearlycumulativereturnfrom1999to20112
Figure3:
Correlationofassetclass3
Figure4:
Economiccycle4
Figure5:
Summaryofassetclassperformance5
Figure6:
Expectedreturnofeachassetclassbasedonhistoricalreturn5
Figure7:
ExpectedreturnbasedonMonteCarlosimulationtechnique6
Figure8:
Summaryoftherequirements8
Figure9:
Averagemeanandstandarddeviationofyearlyreturn8
Figure10:
Assetallocation8
Figure11:
Portfolioreturnvs.expectedreturn(Yearly)9
Figure12:
YearlySharperatio10
Figure13:
YearlyVAR10
Figure14:
Goodeconomicconditionassetallocation10
Figure15:
Worseeconomicconditionassetallocation11
Figure16:
YearlySharperatiounderdifferentconditions12
Figure17:
Numberofstocksinfiveportfolios14
Figure18:
Performancesofequalweightedportfolio15
Figure19:
Statisticssummaryofequalweightedportfolio17
Figure20:
Cumulativereturnsofequalweightedportfolio18
Figure21:
Performancesofvalueweightedportfolio18
Figure22:
Statisticssummaryofvalueweightedportfolio20
Figure23:
Cumulativereturnsofvalueweightedportfolio21
1.Introduction
Thisreportismainlydividedintotwosections,thefirstsectionaimstoassessthehistoricalreturnofeachassetclassandconstructaportfolioofstrategicassetallocationtomeetthefoundation’sIPSandrequirements.Thesecondsectionattemptstoassessthepastunderperformedstocksandoutperformedstocksinordertoapprovemomentuminvestingstrategycouldbeemployedinreality.Weemployexcelsolverfunctiontoconstructtheinvestmentportfoliobasedonthehistoricalreturn,scenariotestingandvalueatrisk(VAR)areappliedtoassesstheconstructedportfolio’sperformanceinthefirstsection.Inthesecondsection,ourresearchisbasedonempiricalanalysiswhichcomputesthemonthlyreturnoneachportfolioandotherfinancialfigurestoassesstheperformances.Thelimitationsofthisreportaretheaccuracyofthegivendata’sinterpretationdonebyExcelandthebiasoftheinvestmentstrategies’assumptionsappliedtoforecast.
2.InvestmentPolicyStatement(IPS)
TheInvestmentPolicyStatementprovidestheinvestmentobjectivesandconstraintsfortheABCHealthcareFoundation,andguidesitsinvestment.TheIPSoutlinesreturnobjectives,riskobjectivesandconstraintsofthefoundationisshownbelow.
1.
2.
2.1.Objectives
Figure1:
Summaryofthefoundation’sobjectives
Majorinvestmentobjective
Growthandincome
Timehorizon
13yearslong-terminvestmenthorizon
Targetreturn
4%plusinflationrateoverfive-yeartimehorizon
TheABCHealthcareFoundation'scurrentmarketvalueislargerthanotherfoundationswithsimilarpurposeinthemarket.Itsreturnobjectivesaretoearnatleast4%plusinflationratemeasuredbytheCPIoverafive-yeartimehorizon.Theirmarketvaluenowis$90million,andannualspendingis4%ofitsmarketvalue.Meanwhile,theaverageinflationraterollingfiveyearsis2.79%.Thus,itsexpectedreturnrateis6.79%.
Riskobjectivesindicatethelevelofrisktolerance,whichrestrictrealreturnachievedbythefund.Itshouldbebasedontheinvestor’srisk-bearingabilityandwillingnessoftakingrisk.Ifthefoundationcannotbearthefluctuationsinthelongrun,itscapitalbasewilldecrease.Therefore,thefoundationshouldinvestinastablefinancialconditionintheforeseeablefuturewithrelativelyhighriskandmoreaggressiveinvestmentpolicybecauseithasnodefinedliabilities.
2.2.Constraints
Timehorizonisrelatedtotheinvestor’snear-termandlong-termhighprioritygoals.Thefoundation’sinvestmenttimeperiodis13years,whichisconsideredaslong-termhorizon.Inadditiontoinvestinginequitiesandbonds,thefoundationneedstoinvestinshort-termmoneymarketinstrumentswhichcanprovideliquidityinordertomeetthe4%annualspendingrequirementusedtosupportcharitableprograms.However,itisabletotoleratesomeshort-termfluctuationsinspending,butthechanceofnotmeetingthespendingrequirementshouldbelessthan30%inanyoneyear.Taxableincomeisoftensubjecttoinventors’marginaltaxrate.Thereisnotaxrequirementrelatedtothefoundation'sincome,butitsincomewillbetaxedifitcannotmeetthespendingrequirement.
3.AnalysisofAssetClassPerformance
3.1.CumulativeReturn
Figure2:
Yearlycumulativereturnfrom1999to2011
Figure2listedtheyearlycumulativereturnofassetclassesfrom1999to2011.ItshowedthatAllOrdinaryIndexhadbestperformancefrom1999to2011followedbyAustralianREITs.Australianshort-termmoneymarketinstrumentmaintainedasteadygrowthduringthistime.Furthermore,bondsfluctuateddramatically,especially5yearsAustralianbondsand10yearsAmericanbonds.S&P500hastheworstperformancecomparedwithothers,whichhadnegativereturnoverthe13years.Generally,theequitymarketoutperformedotherswithhigherreturnandhigherrisk,andbondsgeneratedstablereturnwithlowerrisk.
3.2.CorrelationofEachAssetClass
Thecorrelationisarelationshipbetweentwovariablesinwhichbothvariablesmoveintandem.Apositivecorrelationexistsasonevariableincreasesandtheothervariablesalsoincreases.Whileanegativecorrelationindicatesthattwovariablesmoveinthereversedirection.Itisclosetoprefectcorrelationasthefigureisclosetopositive1.AsisshowninFigure4,AllOrdinaryIndexhasclosecorrelationwithS&P/ASX200,S&P/ASXMIDCAP50andREITs,becausethefiguresaremoreclosetopositive1.However,itisnothighlycorrelatedwithS&P500thoughtheyarebothequityindexduetothedifferenteconomicconditionsinAustralianandUS.Inaddition,equityindexeshavenegativecorrelationwithbonds,whichindicatesthatbondshaveworseperformanceasequitieshavegoodperformance.Moreover,bondshavepositivecorrelationwithAustralianshort-termmoneymarketinstrumentbecausetheyareallfixedincomesecurities.
Figure3:
Correlationofassetclass
3.3.EconomicCycleandAssetClassPerformance
Inordertopredicttheexpectreturnofassetclasses,thehistoricalreturnaredividedintofoursub-periodsbasedontheeconomiccycle.
Figure4:
Economiccycle
Recovery
1999-2001(RecoverfromAsianfinancialcrisis)
Peak
2002-2004
Contraction
2005-2007
Recession
2008-2009(Globalfinancialcrisis)
Recovery
2010-2011
•Recovery(1999-2001)
ASXAORD
(RI)
S&PCOMP
(RI)~A$
REITSAU
(RI)
ADBR090
(IR)
AAUGVG2
(RI)
AAUGVG5
(RI)
AUSGVG5
(RI)~A$
Monthly
mean
0.96%
0.51%
1.08%
0.44%
0.44%
0.33%
0.95%
Equitiesoutperformedbondsandcash.
•Peak(2002-2004)
ASXAORD
(RI)
S&PCOMP
(RI)~A$
REITSAU
(RI)
ADBR090
(IR)
AAUGVG2
(RI)
AAUGVG5
(RI)
AUSGVG5
(RI)~A$
Monthly
mean
0.89%
-0.81%
0.95%
0.41%
0.48%
0.68%
-0.40%
Equitiesoutperformedbondsandcash.
•Contraction(2005-2007)
ASXAORD
(RI)
S&PCOMP
(RI)~A$
REITSAU
(RI)
ADBR090
(IR)
AAUGVG2
(RI)
AAUGVG5
(RI)
AUSGVG5
(RI)~A$
Monthly
mean
1.77%
0.43%
1.
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