Portfolio Management Project

1. Lai Wei
0569972
bruceweilai@gmail.com or 415-603-8157
Initial report
As my policy paper states, to meet the Ms Gandolf’s return expectation and her lifespan situation, we need to construct an portfolio that has average 3% annual real net return, in order to get a 11% total return at the end of 7th year.
According to analysis in policy paper, I think Ms Gandolf’s case should be put into Moderate & 6-10 Years category according to T.Rowe price matrix as followed. That’s 10% cash, 30% bonds, and 60% stocks.

2. For stocks:
I recommend in this section, most money should be invested in stock indexes, since the rate of return
will meet the return expectation at around 3%. For example, according to the statistics from 1986-2010,
after taxes and inflation, the rate of return for common stocks(S&P 500) is 5.50%. If we diversify the
index well, we could reduce the risk. I select U.S. major stock indexes like S&P 500 index, MidCap 400,
Smallcap600, Russell 2000, , Dow Jones industrial average, Nasdaq Composite, MSCI Pacific Basin, as
well as international stock indexes like Euro Stoxx (Europe), Shanghai Composite(Asia).
The effect of taxes and inflation on investment returns:1986-2010
For stock Index:
There is a priority list for the different stock assets.
The priority is sorted by the Coefficient of Variation (CV) from the smallest to largest. (With the
same expected rate of return, large company stock has the least standard deviation of returns.)
After Taxes and inflation
Common stocks (S&P 500) 5.50%
Barclays Captial Government bond index 2.47%
T-bills( 3 month constat maturity) 0.15%
Municipal bonds 4.05%
Geometric mean Standard deviation CV Priority
Large company stock (S&P 500) 9.94% 18.23% 1.83 1
High-yield corporate bonds(Barclays Capital 8.96% 16.87% 1.88 2
Small company stocks(Russell 2000) 10.63% 21.43% 2.02 3

3. For bonds:
In bond section, I recommend most money to invest in municipal bonds, since muni bonds are tax free. I select some bond indexes like Barclays Capital, Global High Yield constrained, Muni Master/Merrill Lynch 7-12 years, J.P. Morgan CMU.
Summary: No matter I choose stock indexes or bond indexes, the most important principle is diversify the securities well, like U.S. & International, Large Cap & Small Cap, and also those securities should have low correlations. For example, when I have selected S&P 500, I will choose another stock index MSCI Pacific Basin, which has low beta （0.63）with S&P 500 while high return at the same time.

4. Final Report
1. Ten week return change over time.
Beta (Base on Benchmark portfolio): 0.11
Benchmark Return (B) My portfolio Return(My)
5/16 1000 1000
5/23 1005.3 0.53% 1000.8 0.08%
5/30 1011.4 0.61% 1006.4 0.56%
6/6 1022.1 1.06% 1008.2 0.18%
6/13 1016.8 -0.52% 1005.3 -0.29%
6/20 1024.8 0.79% 1007.3 0.20%
6/27 1023.4 -0.14% 1007.7 0.04%
7/4 1029 0.55% 1011.2 0.35%
7/11 1021.5 -0.73% 1015.7 0.45%
7/18 1025.6 0.40% 1024.9 0.91%
7/25 1025.5 -0.01% 1030.4 0.54%
COVAR 3.33469E-06 VAR of benchmarch
Beta 0.11
Return of Benchmark 1,000.0 1,005.3 1,011.4 1,022.1 1,016.8 1,024.8 1,023.4 1,029.0 1,021.5 1,025.6 1,025.5
My portfolio 1,000.0 1,000.8 1,006.4 1,008.2 1,005.3 1,007.3 1,007.7 1,011.2 1,015.7 1,024.9 1,030.4

5. The portfolio is less volatile than the Benchmark since its beta is 0.11
2. Sharpe portfolio performance measure.
Benchmark average return=0.25% , Standard deviation =0.55%
My portfolio average return=0.30%, Standard deviation=0.32%
RFR=0.35%
SM=(0.25%-0.035%)/0.55% = 0.39
SP = (0.30%-0.035%)/0.32% = 0.83
From sharpe ratio we can see the Portfolio did better than the Benchmark.
3. Treynor analysis:
From T values we can see the portfolio performed better than the benchmark.
4. Attribution analysis:
a.
Overall My portfolio return: 3.14%
Overall benchmark return: 2.55%
The portfolio return outperformed the Benchmark overall.
b. Allocation effect:
Benchmark My portfolio
Avreage return 0.25% 0.30%
RFR 0.035% 0.035%
Beta 1.00 0.11
T values 0.002 0.024
Asset class Allocation effect
Stock 0.17%
Bonds -0.11%
Cash 0.02%
Real Esate 0.06%
Sum 0.15%

6. Stock (0.17%) should be more weighted with the fund from the Bond asset (-0.11%),
which on contrary has the lowest allocation return.
c. Selection effect:
I have formed superior stock portfolios, while a bad work in bond selection. I think I
should invest more money into EFT, which I didn’t consider. My stock performed not bad, however,
majority of my stock investment are weighted highly on only a few of individual companies’ stock. It
makes my stock portfolio under a higher risk than the benchmark. Over all, the Total Value
Added=0.15%+0%=0.15%
Summary :
For stock, ETF should be invested more than individual stocks and mutual fund, because individual
stocks’ risk and volatility typically are higher than index, while mutual funds are not exact stock
investment since the holdings of mutual funds also include bonds and cash. In addition, mutual funds
usually have a low return, at least it is true according my mutual funds performance. I should have
followed my trading priority list which I set up in my “Initial report” based on Exhibit 2.9 in textbook:
From my previous conclusion in initial report, large company stock has the lowest Coefficient of
Variation (CV), and it means large company stocks has the least risk per unit of return. In addition, as
Exhibit 2.8 in textbook shows, company stocks(S&P) have the highest return after tax and inflation
(1986-2010):
Asset class Selection effect
Stock 1.29%
Bonds -1.18%
Cash -0.12%
Real Esate 0.00%
Sum 0.00%
Geometric mean Standard deviation Coefficient of Variation Priority
Large company stock (S&P 500) 9.94% 18.23% 1.83 1
High-yield corporate bonds(Barclays Capital 8.96% 16.87% 1.88 2
Small company stocks(Russell 2000) 10.63% 21.43% 2.02 3

7. So the large company stocks section should be my first priority investment in stocks class investment. The second weighted stock index should be small company stocks or international stocks index.
For bonds, Muni bonds index should be invested rather than individual corporate bonds. Corporate bonds may have high-yield, as well as high default rate.
Real Estate should be taken into consideration. The reason why I haven’t is because I think 10 weeks period might be a little short for investment in Real Estate to make a change, which deserves long term holding. In the case of Mrs Gandolf that has 7 years’ long investment period, Real Estate is a good choice.
Overall, it is hard to meet the initial objectives of 3% return. In the future of portfolio management, I will do some research on ETF class, as well as diversification (Large companies, Small capital, International equity), muni bond index (Especially for tax advantage), and Real Estate (For long term).
After Taxes and inflationCommon stocks (S&P 500)5.50% Barclays Captial Government bond index2.47% T-bills( 3 month constat maturity)0.15% Municipal bonds4.05%