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INV4801/101 ASSIGNMENT 01 Due date: 23 JUNE 2017 Unique number: 20170623 Aim: To evaluate your knowledge of some of the fundamental aspects of learning units 1 to 3, which deal with the portfolio management process, the Investment Policy Statement (IPS), capital market expectations and asset allocation. Answer the following questions and submit your assignment at https://my.unisa.ac.za 1. The Goveros Tatenda and Ruvarashe Govero, South African citizens, are reviewing their financial plan. The Goveros, both 53 years old, have one daughter, 18 years old. With their combined after-tax salaries totaling R100,000 a year, they are able to meet their living expenses and save R25,000 after taxes annually. They expect little change in either their incomes or expenses on an inflation-adjusted basis other than the addition of their daughter's college expenses. Their only long-term financial goal is to provide for themselves and for their daughter's education. The Goveros both wish to retire in 10 years. Their daughter, a talented musician, has just entered an exclusive five-year university program. This program requires a R50,000 contribution, payable now, to the university's endowment fund. Thereafter, her tuition and living expenses, to be paid entirely by the Goveros, are estimated at R40,000 annually. The Govero's personal investments total R600,000, and they plan to continue to manage the portfolio themselves. They prefer \"conservative growth investments with minimal volatility.\" Onethird of their portfolio is in the stock of Ruvarashe's employer, a publicly traded technology company with a highly uncertain future. The shares have a very low cost basis for tax purposes. The Goveros, currently taxed at 30 percent on income and 20 percent on net realized capital gains, have accumulated losses from past unsuccessful investments that can be used to fully offset R100,000 of future realized gains. In 10 years, Tatenda will receive a distribution from a family trust. His portion is now R1.2 million and is expected to grow prior to distribution. Tatenda receives no income from the trust and has no influence over, or responsibility for its management. The Goveros know that these funds will change their financial situation materially but have excluded the trust from their current financial planning. a) Formulate an Investment Policy Statement (IPS) for the Goveros. No calculations are required for the risk and return objectives. (15) Use the following information to answer questions b & c Barak Zuma and Jacob Mugabe are portfolio managers for the largest mutual fund of Liberty Financial Advisers. Liberty Financial Advisers provides a variety of mutual funds for both individuals and institutions. Zuma has been a portfolio manager for eight years and has seen both bull and bear markets. Mugabe is his assistant and has been at Liberty Financial Advisers for the two years following his graduation from a prestigious Masters in Finance program. In their discussion over lunch, Zuma and Mugabe discuss the latest quarterly earnings announcements for several firms in their portfolio. Despite their optimistic projections for a few firms, most announcements were quite disappointing. Mugabe though states that he is not convinced that their prospects are as grim as the announcements suggest. The next day, Zuma and Mugabe attend a presentation for Liberty Financial Advisers' clients. Their guest presenter is Naboth Machemedze, an economist at the local university who frequently provides economic commentary for national media outlets. During his presentation, Machemedze states that it is likely that South Africa will enter a recession next year. He recommends that the clients shift their assets into investment grade bonds and non-cyclical stocks. He states that he has been successful in predicting recessions over the past 20 years and is certain of his forecasts. He states further that the only time he has been wrong in predicting the business cycle was when the government increased spending beyond that expected. He states that if that had not happened, his prediction of a mild recession would have been correct, instead of the mild expansion that actually occurred. During the afternoon session, Zuma discusses the various strategies at Liberty Financial Advisers. In the valueeglected firm strategy, Liberty Financial Advisers seeks out firms trading at reasonable valuations with no analyst following. Zuma states that several academic studies have shown these firms to be good investments over a 5-year time horizon for the period from 1st of July 2008 to 30 June 2013. Zuma states that he has adopted this strategy for his portfolio. a) Describe the psychological trap that affects Mugabe (5) b) Discuss two behavioral characteristic that Machemedze exhibit in this case. (5) 2. Gweru Innovations U.S based Gweru international (GI) is a financially healthy, rapidly growing import/ export company with a reasonably young workforce. Information regarding GI's defined benefit pension plan appears in Exhibits 1 & 2 Exhibit 1 Asset class Large Capitalisation U.S Equities Small Capitalisation U.S Equities International Equities U.S treasury bills (1-year maturity) U.S intermediate-term bonds and Mortgage-backed securities U.S long term Bonds (10-year duration) Target allocation (%) 35 10 5 10 10 12 7 4.5 17 23 1 19 Income element 7%; price gain element 12% -2- Prior-Year Total return (%) INV4801/101 Exhibit 2 Present value of plan liabilities Market value of plan assets Duration of liabilities Actuarial return assumption GI board's long term total return objective $298 million $280 million 10 years 8% 10% In accordance with GI policy, the plan discounts its liabilities at the market interest rate for bonds of the same duration. GI's risk objectives include a limitation on volatility of surplus. Giselle Engle, the newly appointed chief financial officer, must explain to the board of directors why the surplus declined in a year when the actual investments return was 100 basis points more than the long-term objective stated by the board. a) Calculate GI's corporate pension plan surplus. (2) b) Explain how the plan surplus could increase in a given year despite an actual return in short of the long-term return objective. (5) c) Explain the importance of an appropriate investment time horizon when setting investment policy for GI's corporate pension plan. (3) d) Discus the risk tolerance of GI's corporate pension plan. (5) Use the following information to answer question e. YAPs Foundation Onious Urayai is a consultant to the board of directors of the RSA-based YAPs Foundation. The board asks Urayai to recommend an asset allocation for YAPs. Urayai reviews key objectives of the YAPs investment policy statement shown in below: Return objective: Real required annual rate of return on investment portfolio is 7%. Maintain the purchasing power of the portfolio. Risk objectives: Diversify the portfolio consistent with prudent investment practices. Minimize portfolio risk while achieving the return objective. Leverage is not allowed. For the strategic asset allocation analysis, Urayai has generated the corner portfolios shown in Exhibit 3. Exhibit 3 Corner Portfolios (Risk-free Rate = 3.0%; Inflation 2%) Corner Portfolio Number Annual Expected Return (%) 1 2 3 4 5 6 10.9 10.2 9.4 8.8 8.2 6.9 Annual Expected Standard Deviation (%) 16.3 13.7 10.1 8.6 7.3 5.3 Sharpe Ratio RSA Equities NonRSA Equities Long-term RSA Bonds 0.48 0.53 0.63 0.67 0.71 0.74 100.0 74.1 33.7 31.4 25.0 0.0 0.0 4.0 12.0 12.0 11.8 13.7 0.0 0.0 36.7 26.7 0.0 0.0 Intermediate term RSA Bonds 0.0 0.0 0.0 13.0 45.3 53.0 NonRSA Bonds Real Estate 0.0 0.0 0.0 0.0 3.4 27.1 0.0 21.9 17.6 16.9 14.5 6.2 e) Calculate the nominal required rate of return and determine the percentage that would be invested in each of the asset class based on the most appropriate strategic asset allocation. (10) UNISA 2017 -4