Reading 25: Asset Allocation－LOS n individual, relating, allocation

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CFA Institute Area 3-5, 7, 12, 14-18: Portfolio Management
Session 7: Asset Allocation
Reading 25: Asset Allocation
LOS n: Contrast the characteristic issues relating to asset allocation for individual investors versus institutional investors and critique a proposed asset allocation in light of those issues.

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Reid Williams is responsible for training new analysts and portfolio managers for Grames Investment Advisors. Since Grames specializes in institutional clients, Williams wants to make sure that his new trainees know the needs of various institutional investors. Reid gives an assignment to all of his trainees to identify general differences in asset allocations for different types of institutional investors. One of Williams trainees, Phil Nagy, turns in his assignment with the following statements.

Statement 1:	A bank is likely to hold more bonds than an insurance companys surplus portfolio.
Statement 2:	An endowment is likely to hold more equities than the portfolio that funds an insurance companys fixed annuities.
Statement 3:	An endowment is more likely to hold more emerging market equities than an insurance companys surplus portfolio.
Statement 4:	A private foundation is likely to have higher cash needs than a pension fund with a low ratio of retired to active lives.

When grading the papers, Williams gives his trainees 25 points for each correct statement. Given the grading criteria, Nagys grade on the paper is most likely:

A) 25 percent.

B) 75 percent.

C) 50 percent.

D) 100 percent.

Answer and Explanation

Three of Nagys four statements were correct, for a score of 75 percent. Statement 1 is correct a banks portfolio is concerned with funding liabilities, and therefore requires more fixed income instruments, while an insurance companys surplus portfolio is focused on growth. Statement 2 is also correct the portfolio that funds an insurance companys fixed annuities is likely to rely more on fixed income securities, while the endowment has more of a total return focus. Statement 3 is incorrect an insurance companys surplus portfolio is very aggressive and should therefore have more emerging market equities than an endowment that likely spends a portion of its portfolio each year. Statement 4 is correct the private foundation has an annual spending requirement and therefore is likely to have higher liquidity needs than a pension fund with a small number of retired employees relative to working employees.