Claire Pierce, a vice president for Spencer Design, is a 42-year-old widow who is a resident of the U.S. She has two children: a daughter, aged 21, and a son, aged 7. She has a $2,200,000 portfolio; half of the portfolio is invested in Spencer Design, a publicly traded common stock, which has a cost basis of $350,000. Despite a substantial drop in the value of her portfolio over the last two years, her long-term annual total returns have averaged 7 percent before tax. The recent drop in value has caused her great anxiety, and she believes that she could no longer tolerate an annual decline greater than 10 percent.

Pierce intends to retire in 20 years, and her goals, in order of priority, over the next 20 years are: Funding the cost of her daughters upcoming final year of college, which has a present value of $18,000, and her sons future college costs, which have a present value of $91,000 Increasing the portfolio to a level that will fund her retirement living expenses, which she estimates to be $180,000 after tax for the first year of her retirement Building her dream house in five years, the cost of which (including land) has a present value of $375,000 Giving, if possible, each of her children $1,000,000 when they reach age 40 After subtracting the present value (before tax) of her childrens education costs and her homebuilding costs, the present value of her portfolio is $1,509,000. With continued annual growth of 7 percent before tax, the portfolios value will be approximately $3,928,000 at the end of 20 years. Pierces annual salary is $145,000, her annual living expenses are currently $100,000, and both are expected to increase at an inflation rate of 3 percent annually. Taxes on income and shortterm capital gains (holding period one year or less) are substantially higher than taxes on long term capital gains (holding period greater than one year). For planning purposes, Pierce wants to assume that all returns are fully taxable and that her average tax rate on all income and gains is 30 percent. The inflation and tax rates are expected to remain constant. Currently, Pierce rents a townhouse, has no debt, and adamantly intends to remain debt-free. Spencer Design has no pension plan, but provides company-paid medical insurance for executives for life and for their children to age 25. After tax, Pierces salary just covers her living expenses and therefore does not allow her to make further meaningful capital contributions to her portfolio.

Pierce has prepared the following investment policy statement:

Claire Pierce Investment Policy Statement The portfolio should be invested conservatively, as I want to protect its principal value. My salary covers my current living

expenses, but the portfolio will need a moderate level of liquidity to cover the college expenses. My desire to give each of my children one million dollars when they reach age 40 requires the portfolio to have a long-term focus but allows for a low return objective in keeping with my low risk tolerance. Because of my tax circumstances, the portfolio should focus on securities that generate little or no taxable income.

Tasks

A. Prepare the objectives portion of a new investment policy statement for Pierce. Indicate how each of your two objectives addresses a different weakness in Pierces current investment policy statement.

B. Prepare the constraints portion of a new investment policy statement for Pierce. Indicate how each of your four constraints addresses a different weakness in Pierces current investment policy statement. Note: The legal and regulatory constraint is not applicable and should not be included among the constraints addressed in your response.

Pierce indicates that Spencer Design has a leading and growing market share, as the industry is quite fragmented. The company has shown steady fundamental growth trends, and Pierce intends to hold her Spencer Design stock, which is expected to return at least 9 percent annually before tax with a standard deviation of returns of 20 percent. Pierce has decided to invest the balance of her assets in one of the three alternative portfolios described in table 1.

C. Recommend which one of the three alternative portfolios is most appropriate for the balance of Pierces assets. Justify your recommendation with three reasons.

Pierce is considering three alternative portfolio managers for that portion of her equity portfolio that is not in Spencer Design stock. The average market return and standard deviation characteristics and fees for each of the managers are expected to be very similar. The three managers are further described in table 2

D. Recommend which one of the three portfolio managers is most appropriate for Pierces equity portfolio. Justify your recommendation with one reason.

E. Spencer Design is going to give Claire Pierce a cash bonus of $300,000 at the end of the year. Pierce has several options: 1. add this 300,000 into her current investment portfolio, and at the same time, she would like to put real estate related investment into the portfolio. What type of real estate investment can she choose? 2. Start her dream house plan earlier and change her goals correspondingly.

Which option is more suitable? Justify the choice.