Current portfolio analysis and investment solutions for better asset allocation in the family wealth management.

Master in Wealth Management - Personal Portfolio Management Course

Case 2：profiling and portfolio recommendation

Advisors:

Li-Kuan FANG (With other group members)

KINDLISS FAMILY INVESTMENT ESTATE PLANNING

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1. The Problem of Current Portfolio and Our Solution

Current Mr and Ms Kindliss’ portfolio composition reflects a median-defensive appetite to risk. The analysis of the current portfolio includes the Insurance Branch21 (maturity 2 years), 500.000 euro in Saving Account (maturity 2 months) and two investment portfolios of 1.150.000 and 850.000 euro each. We suggest to generate one single investment portfolio in order to maximise the diversification and the asset allocation as well as minimizing transaction costs. Mr and Ms Kindliss benefit for 43% of total patrimony from the aggregate international bond investment, 13% in US large stocks, 5,5% international real estate and 2.75% in gold fund. Although the current allocation reflects almost the family risk appetite, there are still good margin for extra diversification in order to target better expected return with a relative low increase in portfolio volatility.

Indeed, Mr and Ms Kindliss require higher income from their investment for monthly financing without eroding their own capital. Currently the expected return of the portfolio is supposed to be 2,79% with 2.95% of volatility. The suggestion we propose to the family is incrementing diversification within the asset classes just own in the current portfolio and reduce the saving account.

Under diversified and large fixed income position: For making the pattern of Mr. Kindliss’ current portfolio more readable, we treat cash and insurance as parts of fixed income asset, and reasonably set the correlations between them and other assets and their volatilities being zero. Sequentially, a huge part of Kindliss Family current

portfolio is in fixed income asset, nearly 80% as shown by the chart below.

Chart 1：Current Allocation of Current Portfolio

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As Mr. Kindliss mentioned, his risk aversion is rather higher than average and he wants to have a better return than before for sustaining the living standard. But, his current asset allocation is extremely under diversified and conservative, against his current requirements.

2. First Steps of New Allocation:

Keep fixed income asset larger than equity： First, considering Mr. Kindliss profile, we propose to keep fixed income asset still in a larger portion than equities, but with different diversification. We believe this strategic plan can provide more fixed income return without making the portfolio too aggressive. Essentially we would like to combine Kindliss Family expectation with their dream and profile. Lower fixed income asset： Secondly, we will reduce the overall percentage of fixed income asset for a more diversified portfolio and opportunities of extra return from different asset classes, which we believe is helpful to satisfy Mr. Kindliss’ higher than average risk aversion. This includes lowering the cash position appropriately. Lower extreme risk by in-house outlook： Third, considering that the wealth of Mr. and Mrs. Kindliss is derived by their entrepreneurial success, we would like to avoid extreme risk in the portfolio preserving their accumulated wealth. So, we would like to apply some of our in-house outlooks of the financial environment as a protection of his potential loss aversion. A goal of return higher than current historical return and minimise volatility: Fourth, our approach in the client portfolio allocation is setting a goal of return which is higher than the current one minimising the volatility through an optimal diversification, instead of purely maximising the expected Sharpe ratio. The in-house outlook: gold hedging About the in-house outlook, we will suggest Mr. Kindliss to keep holding in gold and treat this fund as a hedge instrument of market crash risk, despite of its negative return in recent years.

Chart 2：First Suggested Allocation

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Table 1：Suggested Portfolio by Details

Categories Individual Securities of New Portfolio % of Individual

Securities % of Categories

% Change from current Ptf

Fixed Income

iShares Barclays TIPS Bond Fund 0.45%

36.52% (6.87%) iShares Barclays Aggregate Bond 29.51%

iSares JPMorgan USD Emerging Markets Bond 6.55%

Equity Vanguard Small Cap ETF 2.00%

22.90% 10.00% Vanguard Large Cap ETF 12.90% Vanguard Mid-Cap ETF 8.00%

Gold SPDR Gold Shares 2.74% 2.74% 0.00%

Real Estate Vanguard REIT Index ETF 5.00%

10.48% 5.00% SPDR Dow Jones Intl Real Estate 5.48%

Cash Saving Account 8.00% 8.00% (8.13%) Insurance Branch21 19.35% 19.35% 0.00%

Sum 100% 100% 30.00%

Referring to the table above, in new portfolio we suggest a decrease of 6.87% in fixed income, no change in gold, 10% higher equity position, 5% increase in real estate and 8.13% decrease in cash savings. Meanwhile, the diversification improved and fixed income family is still larger than equity.

Then, looking at the risk and return profile of the new portfolio by the table below, we would like to provide more efficient expected return on the overall volatility improving the Sharpe ratio, following our aim in accomplishing our obligation of taking care client’s best interest.

Table 2：Risk and Expected Return Characteristics of Current Portfolio and Our Suggestion

Portfolios Expected Return Volatility (Std. Dev.) Sharpe Ratio Current 2.79% 2.95% 0.64

Optimised 4.05% 4.50% 0.70

Extra considered concepts for asset allocation:

Human capital It is the concept of present value of future labor income, which must be considered. Although, safer labor income permits a higher equity allocation, and human capital correlations with stock market. In this case, Mr. Kindliss is not actively working anymore, thus, considering Mr. Kindliss’ human capital we prefer a conservative with a dynamic outlook portfolio allocation, which provides periodical income from the bond market and extra return from the stock and real

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estate allocation. As Mr. Kindliss own risk aversion which is higher than average, we still want to satisfy his needs and potentially protect him at the same time by minimising the volatility risk for the same level of expected return when we build up the new portfolio. Loss aversion: Loss aversion means the amount of the loss matters and it could be even significant than risk aversion. On the other hand, we should take care of loss aversion for entrepreneurs higher than their risk aversions.

Considering the context above, we believe we should take care his loss aversion as well. As we don’t consider any hedge derivative instruments in the portfolio, which could be more expensive, we use in-house outlooks to achieve our hedging strategy. We assume that gold is one of the available hedge instrument in the given securities against market crashing risk. Therefore, we suggest Mr. Kindliss to invest still a certain percentage of gold into the new portfolio.

3. Final Optimisation, Enlarging the Investment Universe

In the framework of behavioural finance of Goal based investing that was introduced by Brunel (2003) who proposed several buckets, we believe that our investors are in the income and in the capital preservation buckets. In other words, they care about sustaining their standard of living and with a low acceptance for drawdown. In term of risk orientation, we have to respect the following criteria in our advice allocation: sustainable volatility, low drawdown risk but try to get some extra yield in a cautious way.

Once, we clearly identify the investor’s need and profile we made a second optimization including the three UCITS funds.

We recommend to keep a cushion of cash at 5% yielding at 0.9% yearly. This amount can be used by them in case they need to access cash quickly.

The Insurance remain at the same level until maturity because if they decide to withdraw their money the penalty would be too high before maturity.

For the bond allocation, which is the core part of the portfolio at 47%. We still want to

diversify the allocation of bonds. Therefore, we kept a portion of the iShares Barclays Aggregate bonds at 22,24%, with the Invesco Balanced Risk Allocation - LU0432616737 at 15% of the total portfolio we get some extra diversification of sovereign bonds and we get some corporate bonds (69% in the fund). In order to get extra yield, we keep the IShares JPMorgan USD Emerging markets bonds at 4.11% and add the Pictet Emerging Local Currency Debt - LU0280437673 at 10%. We want to have two separate lines, one in USD to get no FX risk while having the Pictet fund in local currencies to get extra yield.

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Regarding equities, we made the decision to slightly increase, but in a cautious way. In

the previous allocation, the equity portfolio was concentrated in US stocks. Therefore, we add geographical diversification with a portion in the iShares MSCI Emerging Markets Index at 2%. Emerging markets stocks are not as expensive as Western markets and can provide extra yield. The C+F Vega Equity - BE6251880363 will give an European equity touch (3.8%) and the Invesco Balanced Risk Allocation - LU0432616737 will spread over US, Japan, UK and HK. The main block will remain in US equities with a spread over Large cap stocks that can provide a large dividend (good for the income investment goal) at 7%, and 2.5% each for Vanguard Mid-Cap and Vanguard Small-Cap ETF to provide some growth but for a small part of the portfolio.

Real Estate: we made the decision to sell the Vanguard REIT Index ETF due to the high concentration in the previous portfolio but we keep the SPDR Dow Jones Intl Real Estate at 5.48% which is the same level than before. After careful thinking, we believe that the level of real estate valorisation is relatively high therefore, we do not want our client to be fully exposed, even considering their own house, which is a real estate investment that we do not take into account.

Gold exposure would be reduced because it does not provide any income for our clients. However, we decided to keep a small portion of it to act as a potential hedge in case of extreme event.

Chart 3：Final Optimised Allocation

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4. Our Final Recommended Portfolio Allocation

Table 3：Final Suggested Portfolio for Mr. Kindliss by Details

Categories Individual Securities of New Portfolio % of Individual

Securities % of

Categories % Change from

current Ptf

Fixed Income

iShares Barclays TIPS Bond Fund 0,00%

46,71%

3..32%

iShares Barclays Aggregate Bond 22,24% iShares JPMorgan USD Emerging Markets Bond 4,11%

Invesco Balanced Risk Allocation - LU0432616737 (69% bonds) 10,35%

Pictet Emerging Local Currency Debt - LU0280437673 10,00%

Equity

iShares MSCI Emerging Markets Index 2,00%

22,45% 9.55%

Vanguard Small Cap ETF 2,50%

Vanguard Large Cap ETF 7,00%

Vanguard Mid-Cap ETF 2,50%

Invesco Balanced Risk Allocation - LU0432616737 (31% equity) 4,65%

C+F Vega Equity - BE6251880363 3,80%

Gold SPDR Gold Shares 1,00% 1,00% (1.74%)

Real Estate Vanguard REIT Index ETF 0,00%

5,48% 0.00% SPDR Dow Jones Intl Real Estate 5,48%

Cash Saving Account 5.00% 5,00% (11.13%) Insurance Branch21 19.35% 19.35% 0.00%

Sum 100,00% 100,00% 25.74%

Table 4：Risk and Expected Return characteristics of Current Portfolio and Our Suggestion

Portfolios Expected Return Volatility (Std. Dev.) Sharpe Ratio Current 2.79% 2.95% 0.64

Final Optimised 5.13% 4.50% 0.94

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5. APPENDIX:

1) Table：Risk-Return of Each Security and Asset Allocation by Percentage

2) Table：Asset Allocation by Amount

AssetsReturn (Yearly)

Std (Annual)

Current WeightFirst

OptimisationBest/Final

OptimisationiShares Barclays TIPS Bond Fund TIP 2,00% 89,60% 0,00% 0,45% 0,00%SPDR Gold Shares GLD -5,50% 17,60% 2,74% 2,74% 1,00%iShares Barclays Aggregate Bond AGG 2,10% 3,20% 39,27% 29,51% 22,24%iSares JPMorgan USD Emerging Markets Bond EMB 2,20% 8,00% 4,11% 6,55% 4,11%Vanguard REIT Index ETF VNQ 7,60% 17,60% 0,00% 5,00% 0,00%SPDR Dow Jones Intl Real Estate RWX 3,30% 17,60% 5,48% 5,48% 5,48%

iShares MSCI Emerging Markets Index EEM -6,30% 22,40% 0,00% 0,00% 2,00%iShares MSCI EAFE Index EFA 1,90% 19,20% 0,00% 0,00% 0,00%Vanguard Small Cap ETF VB 10,10% 19,20% 0,00% 2,00% 2,50%Vanguard Large Cap ETF VV 9,80% 16,00% 12,90% 12,90% 7,00%Vanguard Mid-Cap ETF VO 11,20% 19,20% 0,00% 8,00% 2,50%Insurance INS 2,25% 0,00% 19,35% 19,35% 19,35%Cash CASH 0,90% 0,00% 16,13% 8,00% 5,00%LU0432616737 INBAAA 9,44% 7,77% 0,00% 0,00% 15,00%LU0280437673 PFEMLO 9,39% 10,68% 0,00% 0,00% 10,00%BE6251880363 CFVEGC 13,66% 16,12% 0,00% 0,00% 3,80%

Total TOT 100,00% 100,00% 100,00%

Assets Current WeightFirst

OptimisationBest/Final

OptimisationiShares Barclays TIPS Bond Fund TIP - 13.950 - SPDR Gold Shares GLD 85.000 85.000 31.000 iShares Barclays Aggregate Bond AGG 1.217.500 914.853 689.580 iSares JPMorgan USD Emerging Markets Bond EMB 127.500 203.197 127.500 Vanguard REIT Index ETF VNQ - 155.000 - SPDR Dow Jones Intl Real Estate RWX 170.000 170.000 170.000

iShares MSCI Emerging Markets Index EEM - - 62.000 iShares MSCI EAFE Index EFA - - - Vanguard Small Cap ETF VB - 62.000 77.500 Vanguard Large Cap ETF VV 400.000 400.000 217.000 Vanguard Mid-Cap ETF VO - 248.000 77.500 Insurance INS 600.000 600.000 600.000 Cash CASH 500.000 248.000 155.000 LU0432616737 INBAAA - - 465.000 LU0280437673 PFEMLO - - 310.000 BE6251880363 CFVEGC - - 117.920

Total TOT 3.100.000 3.100.000 3.100.000

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3) Chart：Portfolio Market Line (Shows the Risk-Return Relationship)

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4) Table：Correlation and Variance-Covariance Matrices New Correlation was calculated on Bloomberg in order to obtain the correlations with the 3 funds.