AGREE WITH THE RECOMMENDATION. IF THE PROCESS CONTINUES SUBSTANTIA...

3. Agree with the recommendation. If the process continues substantially as before, with the

same staff and Delray can document the past results, BJAM's past record must now be part

of Delray's GIPS presentation. Because Jones had not been active in the investment process

for the last five years, his retirement is not material for GIPS.

Candidate discussion:

1 point for each decision and 1 point for each explanation. Concern 1 is a direct test of the

special issues associated with wrap fees. The question specified that Delray had not previously

offered wrap fee accounts leading to a difference in how the two firms have reported. Concern 2

tests the distinction between internal and external dispersion reporting requirements. GIPS

requires an internal dispersion measure but does not specify what to use. It does specify that

standard deviation for three years of monthly returns be used for the external dispersion.

Concern 3 deals with the apparent exception to the normal GIPS prohibition of retroactively

changing the past GIPS record. It is not really an exception because the GIPS principle is that

the record belongs to the firm and not the individuals involved in the management process.

BJAM is now Delray; this was an acquisition of BJAM. If Jones had been material to the

investment process, that would have been a material change that might prohibit reporting the

past record but it is not an issue here.

(Study Session 18, LOS 34.d, h, l, m, p)

QUESTION 3 (A, B, C) HAS THREE PARTS FOR A TOTAL OF 24 MINUTES

Gordon Brown would like to update the return objective of the $500 million Shailor College

perpetual endowment so that the return includes an adjustment for long-term inflation

expectations and for the costs associated with managing the endowment. Brown believes that

inflation will average 4% over the next several years. The endowment's investment management

fees have averaged 0.35% of assets over the past five years. Brown would also like to generate

a revised asset allocation reflecting more diversification across asset classes, while maintaining

the endowment's 4.5% payout.

Brown has also collected the following information:

 Under relevant tax regulations, the endowment must distribute 4% of portfolio value each

year. A smoothing formula can be applied to meet this distribution target. The endowment

board has directed Brown to hold 6 months of the annual minimum payout as an emergency

cash reserve.

 The board has also informed Brown that $2.6 million will be distributed in 6 months as a one-

time capital expenditure. Brown has noted that Treasury bills have an 8% annual return

(pretax).

 The board has also informed Brown that the college has recently adopted a new tuition policy

to stimulate foreign student enrolment. Foreign students (not residing in the United States at

time of application) can pay their tuition in foreign currency. The program has been highly

successful, and the board has asked Brown to consider how this will affect the portfolio asset

allocation.

...

A. Prepare the objectives and constraints for Shailor College's endowment

portfolio. Calculate the compounded desired and minimum return requirements. Show your

calculations.

Grading Guide

Answer for Question 3-A

Objectives Comments

(1.045)(1.04)(1.0035) - 1 = 9.06% desired

(1.04)(1.04)(1.0035) - 1 = 8.54% minimum return

1 point for showing the three components of return.