BFC5935 Portfolio Management and Theory: Assignment on Performance

This assignment solution addresses portfolio construction and performance analysis, focusing on a superannuation portfolio. It begins by analyzing the historical performance of various asset classes, including equities, fixed income, and REITs, from July 2000 to June 2019, calculating and interpreting annualized returns. The solution then evaluates the return performance of an existing superannuation portfolio from January 2005 to June 2019, calculating its Compound Annual Growth Rate (CAGR). Furthermore, it proposes a strategic asset allocation using arithmetic means of annualised returns to meet specific risk/return targets, utilizing Excel Solver to determine optimal weights and constructing an efficient frontier. The solution compares the performance of the existing and proposed portfolios, evaluating average returns, standard deviations, Sharpe ratios, and the probability of negative returns. Finally, it discusses how personal taxes affect overall return targets.

2. Portfolio construction and performance (40 marks)
(a) Generate annualised return for each asset class from July 2000 to June 2019 and using the data
provided, analyse their performance and examine the relationships among them. Discuss the role
that each asset class plays in an investment portfolio. Note: This should be based on annualised
return calculated for each month from July 2000 to June 2019. You need to use the following
formula to annualise the return of a particular month:
It is clearly evident from the above table that only the Australian Equities, Australian Real Estate, &
US Large Equities have given positive returns from July 2000 to June 2019. Fixed income has not
performed well during this period, which is clearly apparent from the above table.
Role of each asset class in the portfolio: -
Equity asset class provides the investors an opportunity to earn dividend income & capital
appreciation. Equities also provide a hedge against inflation. Also, since their correlation with asset
class is very low, they provide diversification benefits when added to the portfolio.
Bond asset class gives investors a prospect to earn a fixed pay-out at regular intervals, which is not
available with equity investments. Hence, it is a viable investment opportunity for retired people.
But, here, investors do not get any capital appreciation on the original amount, since the principal
amount is paid by the borrower of the capital.

REIT: - REIT’s offer an advantage of investing in Real Estate. Investing in Real estate would be very
difficult, since it requires a huge amount of capital. Another advantage of investing in REIT’s is that
its is very liquid compared to investing in investing in private Real Estate property. REITs typically
invest in several properties, which gives the REIT’s investor a diversified portfolio & eventually
reduces risk.
b) Using the annualised return calculated in (a) above, analyse the return performance of
Andrews’ existing superannuation portfolio over the period January 2005 to June 2019.
If we calculate a CAGR over a 15-year period from Jan 2005 to June 2019 using the PV(1+r) n. By
substituting PV = 1, N =15, r = 2.692%, we get a CAGR of 49%. This can be interpreted through a very
simple example like, if 100 Rs was invested in January 2005, it would become 149 by the end of June
2019.
c) Use arithmetic means of annualised returns (calculated on monthly basis) as the expected
returns for the asset classes going forward (and also other relevant historical statistics), and come
up with an appropriate strategic asset allocation that satisfies identified risk/return targets. Note:
You should use annualised returns calculated on monthly basis for different assets classes for a
very long period for this purpose.
Since, all the bond asset class have given negative returns, we have not included those asset classes
in the strategic asset allocation. Excel Solver has been used to calculate the Optimal Weights. Below
given weights have been calculated under the assumption that historical rates will be expected
returns of each asset class. We get the below optimal weights and second table shows the expected
returns, standard deviation and Sharpe ratios of the portfolio.
Op tim
This is Variance, Co-variance Matrix used in the calculation.
This is the Screenshot showing all the parameters used in solver.

(d) Compare the performance of portfolios (b) and (c) (back testing) and discuss how the new
portfolio meets the Andrews’ investment objectives. You must at least provide the following to
accompany your analysis: i. Average portfolio return, standard deviation and Sharpe ratios over
the period January 2005 to June 2019; ii. Graph and compare the performance of the portfolios
(existing and proposed) for the period January 2005 to June 2019; iii. Probability of generating a
negative return in any one year over the sample period.
Optimal Portfolio Andrew's Superannuation
Portfolio expected Return 6.03% Portfolio expected Return 2.69%
Portfolio SD 9.33% Portfolio SD 7.84%

(e) Draw an efficient frontier for the given portfolios (short sales not allowed). Plot the expected
return and risk of the portfolio proposed for Andrews (in (c) above) in the risk-return space. Is it
important that the portfolio you propose be efficient?
(f) Explain how the personal tax of Andrews affects their overall return target.
Taxes reduce the investable income, that is the amount of money you can invest in different assets
classes would be significantly reduced because of taxes. Lesser the amount of money invested, lesser
would be the returns you can earn.
There are primarily two types of taxes applied on your investments i.e Short-term Capital & long-
term Capital Gains. Short-term capital gains are taxed at your marginal tax rate. Long-term capital
gains — which apply to investments held for more than a year — often come at a lower rate.