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Asset Allocation Report

Autor:   •  April 1, 2018  •  1,407 Words (6 Pages)  •  178 Views

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Part Ⅲ.FIXED INCOME ALLOCATION

Investments within the fixed income category generally have lower volatility than stocks. The Investment Policy Statement requires a minimum percentage invested in US government debt to reduce overall portfolio risks. Investments in corporate bonds are affected by credit risks, interest risks, and market risks. International bonds are also subject to sovereign risks and exchange risks. To determine the allocation within the fixed income sector, the Committee referred to the correlation between investment-grade bond, high-yield bond, Treasury bond, and public equity, as shown in Exhibit 3, which shows that corporate bonds performance is positively correlated with that of public equity. The Committee will allocate 30% of the fixed income sector in Treasury bonds to reduce volatility.

Exhibit 3. Correlations within the Fixed Income Sector

[pic 1]

The CIO and Investment Committee use the information ratio of major bond managers to evaluate their performance. In Exhibit 5, around 30% of the fixed income sector is in actively managed fund. These funds are chosen for their relatively high 10-year average information ratio and their relatively low expense ratios. The weights can be adjusted within +/- absolute 5% range.

Exhibit 4. Fixed Income Weights

Fund Name

Manager

IR

weight

Benchmark

LSBRX

Daniel J. Fuss

22.22%

14%

MSCI EAFE

MSCI

1.76%

3%

MSCI emerging

MSCI

0.92%

5%

CRSPSCT

CRSP

16.63%

8%

T-bond

30%

S&P/BGCantor US Treasury Bond Index

Investment grade bond

25%

S&P Municipal Bond Investment Grade Index

International bond

5%

S&P International Corporate Bond Index

High yield bond

10%

S&P U.S. High Yield Corporate Bond Index

The allocation for fixed income is also presented in the following chart:

[pic 2]

Part IV. PUBLIC EQUITY ALLOCATION

The annualized return and standard deviation for S&P Small Cap 600 are 8.2% and 19% respectively, over the past 10 years. The annualized return and standard deviation for S&P 500 Large Cap are 6.25% and 15.3%. The Plan also invests in both developed market equity outside US and emerging market equity. Their covariance is presented in Exhibit 6.

Exhibit 6. Covariance within Public Equity

Covariance

S&P 500

S&P 600 Small

MSCI Emerging

MSCI EAFE

S&P 500

0.002216421

0.002369722

0.002112753

S&P 600 small

0.002696314

0.002325592

MSCI emerging

0.003210349

Using historical data, the Committee made the following asset allocation decision for the public equity sector:

[pic 3]

The weights can be adjusted within +/- absolute 8% range. The above allocation optimizes the expected return while keeping the annual standard deviation within 7.5%. The above allocation leads to the following weights in different industries, which approximates their relative weights in US economy.

Exhibit 7. Equity Investment Industry Weights

[pic 4]

Part V. ALTERNATIVE INVESTMENTS

Private equity has lower level of public disclosure and liquidity, but a relatively higher expected return. According to the Wall Street Journal, the 10-year median return of private equity is 12% through 2015, while that of US public equity is 7.9%. Since the Plan has a long investment horizon, around 15% allocation in private equity is suitable. Although private real estate has a high correlation with REIT and REOC, a 15% allocation in private real estate can hedge against inflation risks and provide additional diversification benefits.

Commodities generally have lower correlation with the fixed income sector and public equity. About 20% allocation in commodities can lower the idiosyncratic risks for the whole portfolio. The Committee also allocates 40% in hedge fund for risk diversification. Finally, around 10% Plan assets are allocated in derivatives such as foreign exchange forwards and options for hedging purposes.

Exhibit 8. Alternative Investment Allocation

[pic 5]

Reference

- United States | Economic Forecasts | 2016-2020 Outlook, retrieved from http://www.tradingeconomics.com/united-states/forecast

- Global Growth

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