CFA三级基础段培训项目-case study-R37-Irene

CaseStudyin

PM:

Institutional

),'Ѕঃ׀੟஍ࣹ

ઔ٤͹/XKTK



1-76

TopicinCFALevelIII

Session

Content

ETHICS&PROFESSIONALSTANDARDS(1)&(2)

BEHAVIORALFINANCE

StudySession1-2

StudySession3

StudySession4

StudySession5

StudySession6

StudySession7-8

CAPITALMARKETEXPECTATIONSǏNEWǐ

ASSETALLOCATIONANDRELATEDDECISIONSINPORTFOLIOMANAGEMENT

DERIVATIVESANDCURRENCYMANAGEMENTǏNEWǐ

FIXED-INCOMEPORTFOLIOMANAGEMENT(1)&(2)

StudySession9-10EQUITYPORTFOLIOMANAGEMENT(1)&(2)

StudySession11

ALTERNATIVEINVESTMENTSFORPORTFOLIOMANAGEMENTǏNEWǐ

StudySession12-13PRIVATEWEALTHMANAGEMENT(1)&(2)ǏNEWǐ

StudySession14

StudySession15

StudySession16

PORTFOLIOMANAGEMENTFORINSTITUTIONALINVESTORSǏNEWǐ

TRADING,PERFORMANCEEVALUATION,ANDMANAGERSELECTIONǏNEWǐ

CASESINPORTFOLIOMANAGEMENTANDRISKMANAGEMENTǏNEWǐ

2-76

Reading

37

CaseStudyinPortfolioManagement:

Institutional

3-76

¾ManagingLiquidityRisk

Framework

•

LiquidityProfilingandTime-to-

CashTables

Institutional

•

•

•

RebalancingandCommitments

StressTesting

Derivatives

¾EarninganIlliquidityPremium

¾QUINCOCase

•

•

•

•

•

•

QUINCOInvestmentStrategy

StrategicAssetAllocation

LiquidityManagement

AssetManagerSelection

TacticalAssetAllocation

AssetAllocationRebalancing

4-76

1.ManagingLiquidityRisk

¾Liquidityriskreferstoaportfoliohavingtodisposeofilliquidsecuritiesata

deepdiscountduringtroubledmarkets.

¾Fourkeymethodstomanageliquidityriskinclude

1.liquidityprofilingandtime-to-cashtables,

2.rebalancingandcommitmentstrategies,

3.stresstestinganalyses,

4.derivatives.

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5-76

1.1LiquidityProfilingandTime-to-CashTables

¾Foranendowment,thepotentialcashinflowsandoutflowsmustbe

determined.

zCashoutflowsincludedistributionstotheuniversityandmeetingcapital

callrequirementsforilliquidinvestments.

9Forexample,realassets,privateequity,hedgefunds,andstructured

products).

zCashinflowswouldtypicallyincludedonationsandinvestmentincome

earnedfromtheportfolio.

¾Thenextstepistoestablishatimelinethatinvolvesconstructingaliquidity

classificationschedule(time-to-cashtable).

¾Thatschedulewouldhavethreedistinctcomponents:

1.amountoftimeneededtoconvertassetstocash(TimetoCash),

2.liquidityclassificationlevel(LiquidityClassification),

3.liquiditybudget.

6-76

1.1LiquidityProfilingandTime-to-CashTables

¾Time-to-CashTableandLiquidityBudget.

LiquidityBudget

(%ofportfolio)

TimetoCash

LiquidityClassification

<1week

<1quarter

<1year

Highlyliquid

Liquid

Atleast10%

Atleast35%

Atleast50%

Upto50%

Semi-liquid

Illiquid

>1year

7-76

1.1LiquidityProfilingandTime-to-CashTables

¾Theliquidityclassificationiscloselylinkedtotheamountoftimeittakes

toliquidateaninvestmentwithouthavingamajorimpactonmarkets.

zThelatterwouldbedemonstratedbyaminimaldifferentialinthe

expectedmarketpriceimmediatelybeforeandafteraselltransaction.

zInaddition,aninvestmentthattakesoveroneyeartoexitwouldlikely

beconsideredilliquid.

¾Thetimetocashmayincludeafullrangeofperiodsbeyondthose

illustratedintheaforementionedTime-to-Cashtable,dependingon

whethertheycorrespondtotheinvestor’scashoutflows.

¾Theliquiditybudgetwillthenprovideminimumormaximumpercentage

allocationsforthedifferenttimeperiods.

8-76

1.1LiquidityProfilingandTime-to-CashTables

¾Todeveloptheliquiditybudget,theremustbepreliminaryworkperformed

inobservingtheliquiditytraitsoftheinvestmentsoverareasonabletime

period.

zWithinaspecificassetclass,thevariousinvestmentscouldhavevery

diverseliquiditycharacteristics.

9Forexample,exchange-tradedfunds(ETFs)maybemoreliquidthan

commingledfunds.

9Additionally,thesametypeofinvestment(e.g.,commingledfund)may

offerdifferentlevelsofliquidity;onemayoffersemiannualliquidity

becauseitisfocusedonsmall-capforeignstocks,whiletheothermay

offermonthlyliquiditybecauseitisfocusedonlarge-capforeignstocks.

9Thatiswhyitisimportanttoanalyzetheinvestmentsingreaterdetail.

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1.1LiquidityProfilingandTime-to-CashTables

¾Anexcerptofaliquidityprofilingforaportfolio

AssetClassInvestment

LiquidityClassification

Semi-

Asset

Class

Allocation

(%of

Allocation

(%ofoverall

portfolio)

Investment

Vehicle

Highly

Liquid

Liquid

Illiquid

Liquid

portfolio)

Fixed

income

Separate

account

14%

5%

100%

0%

0%

0%

Commingled

fund

8%

1%

8%

100%

100%

0%

0%

0%

0%

0%

0%

0%

0%

Futures

Domestic

equity

Commingled

fund

17%

50%

50%

Separate

account

8%

1%

0%

100%

0%

0%

0%

0%

0%

Futures

100%

10-76

1.2RebalancingandCommitments

¾Inadditiontomanagingliquidity,itisnecessarytomaintaintheoverallrisk

profilewithinadesired(quantitative)rangebecauseovertimeandduring

timesofmarketstress,assetvalueswillchange—sometimesvery

dramatically—thusgreatlyalteringthedesiredbalancesineachassetclass.

¾Itisimportanttohavesufficientliquidassetsandrebalancingmechanisms

inplace.Rebalancingmechanismsincludethefollowing.

zSystematicrebalancingpolicies.Rebalancingdisciplines,suchas

calendarrebalancingandpercent-rangerebalancing,areintendedto

controlriskrelativetothestrategicassetallocation.

zAutomaticadjustmentmechanisms.Thesearemechanismsdesigned

tomaintainastableriskprofilewhenexposuredriftsfromtargeted

exposure.

11-76

1.2RebalancingandCommitments

¾Multi-yearfundingstrategiesforprivatemarketsthatincorporatea

steadypaceofcommitmentstoreachatargetallocationand/ortokeepthe

allocationclosetotargetovertimeareothermeanstoensuretheportfolio

remainsconsistentwithdesiredriskobjectives.

zInvestinginprivatemarketfundsmakesitmoredifficultfortheportfolio

tokeepastableorspecificallocationlevelinthelongtermbecause

withinagivenfund,thetimingandfrequencyofwhenthecommitted

capitalisdrawnandthereturnofcapitaldistributionsarebeyondthe

controloftheinvestor.

zByinvestinginmultiplefunds,however,thetimingandfrequency

becomesmorestable.

¾Theobjectiveofamulti-yearfundingstrategyistodesigna

commitment-pacingstrategythatwillresultinthedesiredportfolio

exposuretotheassetclassovertime.

¾Additionally,theuseofscenarioanalysiscantaketheanalysisfurtherto

accountforvariousmarketconditions.Overtime,thelevelofannual

commitmentswillneedtobeadjustedasneeded.

12-76

1.3StressTesting

¾Stresstestingexplicitlyconsidershowtheliquidityneedsofaportfoliowill

changeduringaperiodofmarketstress.Theideaistoconductanalysisto

assume“worstcase”orveryextrememarketconditionsandtheimpacton

bothassetsandliabilitiesatthesametime.

¾Thestresstestscanbebasedonanycombinationofthefollowing:history,

statisticalmodels,andscenarioanalysis.

13-76

1.4Derivatives

¾Derivativesrequirefarlesscashthaninvestinginunderlyingassets,which

makesderivativesanidealmethodforrebalancing.

9Inaddition,afuturesoverlayallowsforrebalancingofmany(butnotall)

assetclasseswithoutalteringanyoftheassetallocationsdeterminedby

theexternalactivemanagers.

¾Withleverage,takingalongfuturespositionrequiresonlyminimalcash

requirementsformargin.

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2.EarninganIlliquidityPremium

¾Itisoftenthecasethatrelativelyilliquidinvestmentssuchasprivateequity

andrealestatewillearnanadditionalreturn(overthemarketreturn)for

takingontheriskofholdingupcapitalforanunknownamountoftime.This

isknownastheilliquidity(orliquidity)premiumearned.

9Studieshaveshownthattheilliquiditypremiumincreaseswiththe

amountoftime(thinkofanupward—slopingyieldcurve,forexample).

¾Adifferentwaytomodeltheilliquiditypremiumistothinkofitasthevalue

ofaputoptionwherethestrikepriceisthemarketableprice(a

theoreticallyestimatedprice,asifitwerefreelytraded)oftheilliquidasset

whenitwaspurchased.

9Thatleadstothecomputationofthepriceoftheilliquidassetasfollows:

illiquidassetprice=marketableassetprice-putprice

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2.EarninganIlliquidityPremium

¾Usingthemarketableandtheilliquidprices,wecanderivetheexpected

returnsforboth,andthedifferenceinexpectedreturnswouldbethe

illiquiditypremiuminpercentagetermsasfollows:

illiquiditypremium(%)=expectedreturnonilliquidasset(%)-expectedreturn

onmarketableasset(%)

¾Thereareasubstantialnumberofstudiestosupportthepositive

correlationbetweenilliquidityandexpectedreturnsforpubliclytraded

stocks.

16-76

Example

¾Aportfolioanalystmakesthefollowingtwostatements:

Statement1:Theilliquiditypremiumisrelativelyeasytodetermine

accurately.

Statement2:Calendarandpercent-rangerebalancingareexamplesof

automaticadjustmentmechanisms.

Howmanyoftheanalyst'sstatementsarecorrect?

A.Zero.

B.One.

C.Two.

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Example

¾Answer:A

Statement1isincorrect.Inpractice,theilliquiditypremiumis

challengingtoaccuratelydeterminegivenalltheotherfactorsthat

interactindeterminingequityreturns.Inaddition,broadmarket

indexesareusedtoestimateilliquiditypremiums,eventhoughthe

typicalinvestorisnotlikelytohavesuchabreadthofinvestment

exposure.

Statement2isincorrect.Calendarandpercent-rangerebalancingare

examplesofsystematicrebalancingpolicies.

18-76

Example

¾Describehowfuturesandoptionscanbeusedforleverageand

liquiditypurposes.

¾Answer:

Takingalongfuturespositionrequiresonlyminimalcashrequirements

formargin,whichisaformofaleveragedinvestment.Therefore,any

cashnotrequiredformargincanbeusedtoinvestinotherassetswith

differinglevelsofliquidity,ortomeetotherliquidityrequirements.

Optionscanbepurchasedatpremiumsthatareoftenonlyafractionof

thecostoftheunderlyingasset,therebyservingasaformofleverage.

Or,optionscanbesoldtoearnpremiumincomethathelpstogenerate

liquidity.

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3.QUINCOCase

¾TheQuadriviumUniversity(QU)endowmentwassetupmanyyearsago

withthepurposeofofferingfinancialassistancetoundergraduatestudents.

Thecurrentvalueoftheendowmentis$8billion,andabout75%ofthat

amounthasunrestricteduse,withtheother25%beingsubjecttodonor-

specifieduserestrictions.

¾QU’sannualoperatingbudgetis$583million,and70%ofthatamount

coverstheremunerationoffacultyandadministrativestaff.Inaddition,the

budgetistocoverdebtpayments,maintenancecosts,andprovidefunds

relatedtoresearchandfinancialaid.Theendowmentmakesannual

distributionstofundabout60%ofQU’soperatingbudget,andthedollar

amountshavebeenincreasingforeachofthepastfiveyears.Greater

stabilityinthedistributionshasbeenrequestedbytheboardofthe

university,sointhatregard,thespendingrulewaschangedafterthe

financialcrisisover10yearsago.

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3.QUINCOCase

¾Pre-crisis,asimplespendingruleexistedbasedon5%ofthemarketvalueof

theendowmentatthebeginningoftheyear.

¾Post-crise,thespendingruleincorporatesgeometricsmoothing(theYale

formula)andisexpressedasfollows:

Spendingforcurrentfiscalyear=(66%×spendingforpreviousfiscalyear)+34%

×(5%×endowmentmarketvalueattheendofthepreviousfiscalyear)

¾TocomputetheQUendowment’sspendingforthecurrentyear,the

previousyear’sspendingwas$358.1millionandtheendowment’smarket

valueattheendofthepreviousfiscalyearwas$7,002.3million.

Spendingforcurrentfiscalyear=(66%×$358.1million)+34%×(5%×

$7,002.13million)=$355.4million

21-76

3.QUINCOCase

¾TheQUendowment’sinvestmentobjectiveistoearnasufficientreturnover

thelongtermtocovertheannualspendingandtomaintaintherealvalueof

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¾Atanannual5%spendingrate,2%-3%annualinflationapplicableto

universities,andannualdonationsof1%,theendowmenthasanannual

nominalreturnrequirementof8%-9%.Theriskobjectiveisbetweena12%

and14%annualstandarddeviationofportfolioreturns.

¾Aboardoftrustees(“theTrustees”)overseestheactivitiesofQU.The

QuadriviumUniversityInvestmentCompany(QUINCO)istheuniversity

investmentofficeandisresponsibleformanagingtheQUendowment.

¾AaronWinteristhepresidentofQUINCO,andhereportstotheuniversity

presidentandtotheQUINCOboardofdirectors(“theBoard”).TheBoard

consistsof11membersappointedbytheTrustees,andtheBoarddealswith

approvinginvestmentpolicyandguidelines.QUINCOstaffarechargedwith

implementingtheinvestmentpolicy.

22-76

3.QUINCOCase

¾QUINCO’s13investmentprofessionalsareofficiallyemployedbyQU.

QUINCO’sinvestmentmodelinvolvesimplementationofinvestment

strategybyexternalmanagersinsteadofhavingin-houseinvestment

management.

¾Instead,internalstaffdealwithassetallocation,riskmanagement,manager

selection,andcontinuationdecisionsregardingtheexternalmanagers.

¾Assetsareinvestedin(1)fixedincome,(2)publicequity,(3)privateequity,

(4)realassets(composedofprimarilyprivaterealestateandnatural

resources),and(5)diversifyingstrategies(primarilyhedgefundstrategies

targetinghighabsolutereturnswithlowcorrelationstotraditionalasset

classeslikepublicequityandfixedincome).

¾Thelastthreecategoriescomprisealternativeinvestments.Eachofthefive

categoriesismanagedbyaseniorportfoliomanagerandananalyst.

23-76

3.QUINCOCase

¾Inaddition,theteamincludesaportfoliostrategistinchargeofasset

allocationandriskmanagement,alsosupportedbyananalyst,andthe

presidentoftheofficewhoactsasthechiefinvestmentofficer(CIO).

¾Theportfoliostrategisthasongoingdutiesinvolvingrebalancing,overlays,

andtacticalassetallocation(TAA)tilts.Anydecisionsmadebyexternal

investmentmanagersandTAAdeviationsrequiretheapprovalofthe

internalinvestmentcommittee.Winterleadsthatcommittee,whichincludes

allseniorportfoliomanagersandtheportfoliostrategist.

¾Finally,theBoardmustprovidefinalapprovalforthehiringofanyexternal

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24-76

3.1QUINCOInvestmentStrategy

¾QUINCO’sinvestmentstrategyisconcernedprimarilywiththelongterm.Its

connectionswithQUalumninetworksintheindustryhasallowedthe

endowmenttobenefitfromtheknowledgeofthebest-in-classmanagers.

¾Initially,itsinvestmentuniversewasconfinedtotraditionalpubliclytraded

stocksandbonds.Withgrowthoftheendowment,thelong-termstrategy

begantoincludealternativeinvestments,whichmayallowforgreater

diversificationandhigherrisk-adjustedreturns(inparticular,privateequity

andrealassets).

¾Alternativeinvestmentshavehelpedtoboosttheendowment’sreturnsover

thepast20years,althoughQU’sallocationtoalternativeinvestmentsisstill

belowaveragecomparedtoothercomparableendowments.

25-76

3.1QUINCOInvestmentStrategy

¾Spanninganover20-yearperiodfrom1996to2017,theQUendowment

assetallocationhaschangedasfollows:

zCashallocationhasremainedconstantat1%.

zTraditionalstocks(domestic)andbondsinitiallyaccountedforalmost

70%ofassetsbuthavebeenreducedtoabout30%.

zInternationalequity(developedmarkets)initiallyaccountedforalmost

25%ofassetsbuthavebeenreducedto10%.

zEmergingmarketequityinitiallyaccountedfor0%andhasincreasedto

10%-15%.

zPrivateequityinitiallyaccountedforlessthan5%andhasincreasedto

15%-20%.

zRealassetsinitiallyaccountedforlessthan5%andhaveincreasedto

10%-15%.

zDiversifyingstrategiesinitiallyaccountedfor0%andhaveincreasedto

10%-15%.

26-76

3.1QUINCOInvestmentStrategy

¾Duringthemostrecentstrategicassetallocation(SAA)reviewbythe

QUINCOBoardtwoyearsago,theyresolvedtoincreasetheallocationto

alternativeinvestmentsanddecreasetheallocationtodevelopedmarket

equities(domesticandinternational).

¾CurrentStrategicAssetAllocation

27-76

3.1QUINCOInvestmentStrategy

¾WinterhasworkedatQUINCOforfiveyearsandbecamethepresidentand

CIOoneyearago.Hewillbeperforminghisfirstassetallocationreview.

Winterhasaportfoliostrategyteamtoassisthimwiththereview.Theteam

includesJuliaThompson,theteamlead,aswellasherassetallocation

analysisplustheseniorportfoliomanagersforfixedincomeandpublic

equities.AfterconsultingwiththeBoard,Winteradvisestheteamtodeal

withthefollowingmatterspertainingtothereview:

zAnoptimalliquidityprofileandliquiditymanagementplanforthe

endowment.

zTheSAAincontextoftheinvestmentoutlook;thereisanexpectationof

lowerfuturereturnsinmosttraditionalassetclasses.

zTheuseofTAAasacomplementtoSAAtoimproverisk-adjusted

returns.

zTheQUendowment’sunderperformancecomparedtoitspeers.

28-76

3.2StrategicAssetAllocation

¾Thestrategyteamhavefinishedtheworkrequestedandwillbemakinga

presentationtotheBoard.

¾Aspartoftheireconomicanalysis,theyusedunsmoothingmethodsfor

privateequity(arelativelyilliquidassetclass)duetothesmootherreported

returnsresultingfromthelackoffrequencyofpricingdata.

¾Theunsmoothingmethodsresultedinanupwardadjustmenttothe

reportedvolatilityofprivateequity.

29-76

3.2StrategicAssetAllocation

¾Long-TermExpectedReturn(NetofFees)andVolatilityAssumptions

ExpectedReal

Return(annual

geometricmean,

next10years)

ExpectedNominal

Return(annual

geometricmean,

next10years)

Standard

Deviationof

Returns

Sharpe

Ratio

AssetClass

Cash

(annual)

0.9%

1.8%

5.0%

3.4%

4.3%

7.6%

1.7%

6.3%

Fixedincome

Domesticequity

0.14

0.23

18.1%

Internationaldeveloped

equity

4.8%

7.4%

19.7%

0.20

Emergingmarketequity

Privateequity

6.0%

8.5%

4.5%

4.0%

8.7%

11.2%

7.1%

6.6%

26.6%

24.0%

13.3%

10.0%

0.19

0.32

0.27

0.31

Realassets

Diversifyingstrategies

30-76

3.2StrategicAssetAllocation

¾Withsomeresearch,itwasdeterminedthattheprimaryreasonsforthe

QUendowment’sunderperformancerelativetoitspeerswasthelower

amountofrisktakenandthelowerallocationtoilliquidinvestments,

especiallyprivateequity.

¾Therefore,thecurrentandproposedallocationsareasfollows:

Current

1%

Proposed

1%

Cash

Fixedincome

14%

17%

10%

12%

18%

13%

15%

9%

Domesticequity

15%

9%

Internationaldevelopedequity

Emergingmarketequity

Privateequity

12%

23%

16%

15%

Realassets

Diversifyingstrategies

Note:Inflationassumedtobe2.5%p.a.

31-76

3.2StrategicAssetAllocation

¾Proposedvs.CurrentSAA:ExpectedRisk/ReturnProperties

CurrentProposed

PortfolioCharacteristic

SAA

7.5%

5.0%

12.5%

0.33

SAA

7.8%

5.3%

13.2%

0.34

Expectednominalreturn(annualaverage,geometric,next10years)

Expectedrealreturn(annualaverage,geometric,next10years)

Standarddeviationofreturns(annual)

Sharperatio

Probabilityof25%erosioninpurchasingpowerover20yearswith5%

spendingrate

35%

30%

Note:TheprobabilityoferosioninpurchasingpowerwasderivedbasedonaMonte

Carlosimulationwitha20-yearinvestmenthorizon,assumingexpectedreturnand

volatilitycharacteristicswillbethesameasforthenext10years.

¾ThereisalsosomereportingofMonteCarlosimulationresultstobring

attentiontothepotentialerosioninpurchasingpower.TheBoardiswilling

toacceptanannualizedstandarddeviationofreturnsbetween12%and

14%.

32-76

3.2StrategicAssetAllocation

¾Thompsonisawaretheproposedassetallocationimpliesasmallincrease

intheoverallriskprofileoftheendowmentasmeasuredbythevolatilityof

portfolioreturns(13.2%fortheproposedSAAversus12.5%forthecurrent

portfolio).Shebelievesthattheincreaseinriskisjustifiedby:

zLowerfuturereturnsexpectedforallassetclasseswillnecessitatetaking

onmorerisktomaintainthesamelevelofreturns.

zQU’sendowmenttakesonlessriskthanitspeers.

zTheestimatedSharperatioforfixed-incomeinvestments(lessrisky)

meansthatthereshouldnotbeasmuchallocationtolessriskyassets.

zMonteCarlosimulationshaveindicatedthatinthelongterm,the

proposedassetallocationhasabetterchanceofearningthedesired

realreturnandpreservingpurchasingpower.

33-76

3.3LiquidityManagement

¾Giventheincreasingcomplexityintheinvestmentportfolioandthe

university’srelianceonregulardistributionsfromtheendowment,QUINCO

needsarobustframeworkformanagingliquidity.

¾Aspartoftheirmanagementduties,Thompson’steamperformscashflow

modelingoverseveraltimehorizonsandundernormalandstressedmarket

conditions.Thompsonisworriedthatliquiditymaydeterioratesignificantly

duringstressedmarketconditionsforthefollowingreasons.

zCapitalcallsinprivatemarketsexceedingcapitaldistributions.

zActivationofgates.

zThesmoothingeffect.

34-76

3.3LiquidityManagement

¾Accordingly,Thompson’steamhaspreparedasummaryofliquidityprofiles

asfollows:

zExistingportfolioliquidityprofile

9Normalconditions:highlyliquid(19%),liquid(26%),semi-liquid

(22%),illiquid(33%)

9Stressconditions:highlyliquid(15%),liquid(26%),semi-liquid

(20%),illiquid(39%)

zProposedportfolioliquidityprofile:

9Normalconditions:highlyliquid(14%),liquid(24%),semi-liquid

(23%),illiquid(39%)

9Stressconditions:highlyliquid(11%),liquid(25%),semi-liquid

(21%),illiquid(43%)

35-76

Example

¾DiscussthreereasonswhytheQUendowmentshouldincreaseits

allocationtoilliquidinvestments.

¾Answer:

1.TheQUendowmenthasalong-terminvestmentfocus,which

increasesitsabilitytoinvestinilliquidinvestments.Therefore,the

additionofsuchassetstotheQUendowment’sinvestment

opportunitiesmayallowtheefficientfrontiertobeshiftedupward

sothatitachievesahigherreturnforastatedlevelofrisk.

36-76

Example

¾Answer:

2.TheQUendowmenthasconsistentlyearnedpositivereturnswith

itsilliquid(alternative)investmentsoverthepast20years.After

suchalongtimeperiod,theilliquidinvestmentsportionofthe

portfolioisclearlyestablishedanddiversified.Withateamof

industryexpertsattheirdisposal,includingbest-in-classmanagers,

theendowmentshouldexpecttocontinueearningstrongreturnsin

thefuture,whichjustifiesincreasingtheallocationtoilliquid

investments.

3.Comparedtoitspeers,theQUendowmentisunderinvestedin

illiquidinvestments.Therefore,anincreasedallocationisjustifiedto

overcomeitspastunderperformancecomparedtoitspeers.

37-76

Example

¾Discussoneconcernwithincreasingtheallocationtoilliquidassets

anddescribehowthatconcerncanbemitigated.

¾Answer:

Theincreasedallocationtoilliquidassets(especiallyprivateequityand

realassets)introducesmoreunsystematicrisk.Therefore,placing

smalleramountsinalargernumberofinvestmentswillreducemuchof

thatunsystematicrisk.

38-76

Example

¾Usingtheinformationintheaforementionedtable,discusstwo

reasonsthatsupportThompson'sproposedassetallocation.

¾Answer:

Theproposedassetallocationhasabetterrisk-returnrelationshipthan

theexistingSAA,asillustratedintheaforementionedtablebythe

increaseinSharperatiofrom0.33to0.34.

Theproposedassetallocationhasahigherchanceofearningthe

targetreturninthelongterm.UsingtheMonteCarlosimulation

results,thereisa70%probabilityofhavingatleast75%ofthe

purchasingpowerforthenext20years;theresultinthe

aforementionedtableexplicitlystates30%probabilityofa25%

erosion.UndertheexistingSAA,thereisonlya65%probabilityof

havingatleast75%ofthepurchasingpower.

39-76

Example

¾Discusstwotradeoffsinvolvedwithimplementingtheproposedasset

allocation.

¾Answer:

Onetradeoffoftheproposedassetallocationistheincreasein

portfoliovolatility—annualstandarddeviationrises0.7%to13.2%.

However,giventheexpectationoflowerreturnsforallassetclasses,

greaterriskmustbetakentoearnthesamelevelofreturns.

Anothertradeoffisthetransactioncosts,sinceprivateequityandreal

assetsaremostlikelytohavehigherinvestmentmanagementand

performancefeesthantraditionalpublicstockandbondinvestments.

However,thereturnamountsintheaforementionedtable,areona

net-of-feesbasis,sotheyaccountfortheincreasedfees.

40-76

Example

¾StatetwoitemsthatThompsonshouldconfirmbeforeimplementing

theproposedassetallocation.

¾Answer:

Sheshouldconfirmthatthemetricsintheaforementionedtablesuch

asthestandarddeviationofreturns(increasedfrom12.5%to13.2%)

andthe30%probabilityofta25%erosioninpurchasingpowerare

acceptablewithintheendowment’sriskappetite.

Sheshouldconfirmthatafterincreasingtheilliquidassetsallocation,

thenewassetallocationcontinuestomeetalltheportfolioliquidity

requirements.

41-76

Example

¾Discusshowacurrentspendingpolicycouldimpactliquidityneeds

whenmarketconditionsdeteriorate.

¾Answer:

Spendingpolicieshaveabuilt-incountercyclicalimpact,sospending

ratesendupbeinglessthan5%duringstrongermarketconditionsand

morethan5%duringweakermarketconditions.Asaresult,the

endowment’sliquidityneedsareamplifiedduringstressedmarket

conditions.

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42-76

Example

¾DiscussthreetoolsforQUlNCOtouseforliquiditymanagement—

specifically,(1)cashflowforecastingandcommitmentpacingmodels,

(2)liquiditybudgets,and(3)stresstests.

¾Answer:

Cashflowforecastingandcommitmentpacing.modelscanbeusedto

estimatetheincreasedallocationtoprivateequityandrealassets.For

example,cashoutflowsneedtobeestimatedforfuturecommitments

inprivateequity;capitalcallsarelegalobligations.Also,duringmarket

downturns,suchcashoutflowsmaybecomemoreonerousasinflows

frompriorinvestmentscouldbecurtailedorcompletelystoppeddue

toalackofcashasinvestmentsmaynotbeliquidatedduetolow

valuations.Liquiditybudgetscanbecreatedafteraccountingforthe

endowment’scashinflowsandoutflows.

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Example

¾Answer:

Stresstestscanbeperformedusingbothhistoricalinformationand

hypotheticalassumptionswithintheframeworkofsensitivityanalysis

todeterminehowmuchvarianceinliquiditymayoccurandstillbe

withinthe