BUSA 3700-Investment Analysis
Vanderbilt University
Investment Policy Paper – IPP 1
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Overview
The Investment Policy Paper (IPP), will be an individual project focused on applying a
comprehensive understanding of investment analysis to make practical investment
recommendations. You are responsible for a written pitch explaining your detailed investment
strategy and how it fits the client's goals. You will select a representative investment client from
four profiles provided, interpret the current market environment, and perform research and
analysis to support an investment allocation recommendation for your client appropriate for his
or her risk profile, investment objectives and personal situation. You will determine an
appropriate asset allocation suitable to this client, and then provide a reasonable estimate of
projected annual rates of return to be expected from your recommended allocation. After the
client accepts your proposal, you will then propose financial instruments you will use to execute
on your strategy.
Part A - Select a US-based Client
Choose one US-based client to take on from the four profiles provided below, and answer
the following two questions:
a. Summarize the investor's situation and desired return. Interpret their risk
tolerance, liquidity requirements, investment horizon, and target portfolio value
(real or nominal) 400 words max
b. Calculate the portfolio's target nominal return - including investment returns as
well as withdraws. (i.e. The target return is derived from using the profile
description only - and does take your allocations into account.)
Investor Profiles (choose one from list below)
Investment Profile I - Personal investor middle class
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Investor has received an insurance settlement related to a traffic accident of
$1 million.
She holds a middle management position at a data processing firm with room for
promotions and regular salary increases; she is 35 years old and is able to pay living
expenses for her family, including mortgage payments, from present salary though
she would like to supplement her income with a withdrawal of $10,000 per year from
the fund.
Husband, two children ages three and one. Her husband does not work; they do not
expect to have any more children. BUSA 3700 Investment Analysis
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Vanderbilt University
She does not expect to withdraw any other money from the fund of $1 million until
withdrawing as much as $500k in about 15-18 years for her children's college tuition
and associated expenses in order to spare them student loan debt. The remaining
$500k will continue to be invested for her retirement
• She hopes to retire in about 25 years with enough money to live comfortably on the
aggregate value of her investment.
Investment Profile II - Personal investor High-Net-Worth individual
• Unmarried with no children.
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Stanford programmer that sold the app Chatsnap for $1 million to Google.
Pursues a career as a software developer earning about $180,000 per year but
wishes to open his own software development company within the next 5 years. This
will allow him to work on a contract basis and potentially develop more apps in the
future.
Hopes to use money from the sale of his app to live a comfortable lifestyle
regardless of his employment income. He expects to spend his current salary on
housing and living expenses which will consume all of his salary income.
He is willing to roll the dice and wants an aggressive investment plan that will
maximize his returns over next 5 years. If he wins, it takes pressure off his launch of
his own business; if he loses, he has his salary earnings potential regardless.
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Investment Profile III – Retirement already here
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Charlotte, a 65-year-old widow who has received $1 million from her husband's life
insurance plan.
With her children out of the house and no job to fall back on, it has been estimated
that Charlotte needs around $50,000 to allow her to live without working. This need
is not met by the $14,200 received from Social Security so she needs to withdraw
roughly $36,000 from her savings each year to maintain her lifestyle.
• Though her children are well established financially, she would like to leave the
capital as inheritance for her grandchildren at her death (e.g. $1 million)
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This is her only wealth other than the house she lives in, and with no other
possessions to fall back on Charlotte is totally dependent upon this money to pay off
her expenses.
The AARP recently released data stating that the total medical cost for those over 65
averages $24,000 a year until death. She feels her present medical insurance will
offset at least half of that figure.
Charlotte is risk averse and doesn't want to experience a roller coaster ride with the
money that she depends upon to live out her life comfortably.
Investment Profile IV – Cherry Oaks Endowment fund
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BUSA 3700 Investment Analysis
Vanderbilt University
A new private school named Cherry Oaks Engineering School has recently been
opened in Franklin, Tennessee.
An anonymous donor has given it $1,000,000 for its endowment on the condition
that only the excess returns over 3.5% per annum may be paid out for use by the
school.
The school would like to be able to take out $50,000 each year in order to fund one
teaching post.
After an assessment of the current condition of facilities, the school is looking to use
a cumulative $1.2 million for renovations during years 15-20.
The faculty emphasize the importance of laboratory work and right now the school is
well equipped for the five lab-based courses it provides. As enrollment grows and
technology advances, the school would need $60,000 every 7 years for lab
upgrades.
The school projects to start receiving an estimate of $15,000 as donation after the
first 5 years. As its alumni network grows in the future, the annual donation is
expected to grow by 10%.
To support the school's long-term plans, the endowment has a goal of reaching
$12.5 million in 30 years.
Part B - Current Market Environment and Asset Allocation
After selecting the investor profile that will be your client for the term, you should conduct
research and analysis to interpret the current market environment and propose your asset
allocation plan by answering these questions below:
1. Inflation
a. Forecast inflation rate over the investment horizon and briefly provide rationale
(140 words max)
2. Determine allocation to each asset type based on investor's profile. Institutional
publications and the market research will be helpful for projections.
a. Utilize at least FIVE distinct asset types similar to those found in the JPMorgan
handout to compose the portfolio. You need at least one equity and one fixed
income asset type. Alternative assets classes should not represent more than
20% of the portfolio in aggregate. Alternative asset classes
include commodities, real estate (incl. REITS), collectibles, foreign currency,
insurance products, derivatives, venture capital, private equity, and distressed
securities.
b. For each asset, present the forecasted nominal return and risk over the
investment horizon, percent allocation, and dollar allocation. (Hint: for this
question, a long-term capital market projection report by JP Morgan is provided
as an outside source. You are expected to find other similar outsides sources to
back up your projection.) (100 words max each asset type) -
BUSA 3700 Investment Analysis
Vanderbilt University
c. Calculate expected return for the portfolio
d. Calculate risk (standard deviation) for the portfolio – accounting for cross-asset
correlations. (Hint: You are expected to calculate the risk using the covariance
matrix method. The TA's can help with this topic.)
3. Explain the investment strategy's suitability for the client's investment goals
a. For each of the three asset types with the highest allocations, identify two
macroeconomic trends or factors driving the asset's risk-return profile going
forward. (75 words per trend max)
b. Compare the projected return to the target return. How much of the target return
is projected to be achieved through asset allocation?
c. Summarize how your strategic asset allocation is optimal for the client's risk
tolerance, liquidity needs, and investment horizon. (250 words max)
Important Notes and Guidance:
Submit your project as a PDF to BrightSpace. Your Excel back must be submitted as
well but the PDF must be readable and understandable as a standalone file.
You should provide historical data such as trend graphs to back up your forecasts. As
quantifying attributes of asset types, financial markets, and the broad economies is a perpetual
and tremendous effort, much of this project will reference outside sources. Please be
comprehensive in citing reference materials.
The return referred to in Part A (b) is the same as the target return in Part B (3b). This is based
on the investor's profile and required returns as provided in the prompt, independent of your
asset choices.
The expected return in part B (2c) is based on the expected performance of your selected
asset types. State any assumptions you're making if something isn't clear.
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The target return from Part A (b) is based on the investor and the prompt. ("b. Calculate the
portfolio's nominal return – including investment returns as well as withdrawals."), means
calculate the target return. An example would be if I wanted to invest $1m today and withdraw
$1.2m next year, my target would be 20%.
Your expected return will be based on the assets you choose and their weighted average. If I
chose 100% of private equity returning 7.25%, then my expected return is 7.25%. To compare
them, I could say my expected return from asset allocation achieves about 1/3 of the target i.e.
(7.25/20).
In IPP 1, it is NOT always the case that THE EXPECTED RETURN CAN MEET THE TARGET
RETURN YOU HAVE SET but you need to support your work as to how close you think you -
BUSA 3700 Investment Analysis
Vanderbilt University
can come. In IPP 2, you will have a better chance of getting to the target through stock
selection.
In terms of calculating variance of a 5 asset portfolio for part 1. Below is what the variance
would look like for 4 assets; - you can extrapolate to 5.
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σ²(portfolio) = w1201² + w2²σ2² + w3²σ3² + w4²σ4² + 2w1w201σ2p(1,2) +
2w1w30103p(1,3) + 2w1w40104p(1,4) + 2w2w3σ2σ3p(2,3) + 2w2w4o2σ4p(2,4) +
2w3w40304p(3,4)
Every Part of this assignment should be written in paragraph form. In Part 1, tables and
figures should be embedded in the PDF - only reference support files for backup, not for
anything you are showing.
You may choose to factor taxes into your calculations or state that you are ignoring them.
The JP Morgan Long Term Capital Markets Assumptions Matrices in the IPP tab are a
useful guideline for asset performance but there exist many other credible sources
(BlackRock, Vanguard, etc.)
Note: Each row in that JP Morgan file is one asset type
You are not trying to calculate the singular correlation between any two assets. That is
already provided in JPMorgan. You should calculate the total portfolio Std Dev. accounting
for all cross-correlations of 5 or more assets. (See above)
As noted, it may be the case that you are unlikely to realize the client's desired return solely
just through asset allocation. Additional returns can be realized in IPP Part II, through
security selection. In IPP 1, it is more important that you have defined the client's investor
profile well and used proper methodology
As always, The TA's will have a good perspective on what needs to be done.
