THROUGH 36 RELATE TO EQUITY INVESTMENTS JOYCE WALKER CASE...

Questions 31 through 36 relate to Equity Investments Joyce Walker Case Scenario Joyce Walker is a portfolio manager at South-March Associates, an asset advisory firm. Walker is managing the equity portion of Lakehouse Limited Endowment’s (LLE) policy portfolio. The portfolio is currently invested in international ex-US equities and is being managed by four individuals – Gina Eco, Blake Morris, Carl Smith, and Mehmet Akhtar. Exhibit 1 displays details concerning the funds managed by the individuals. Exhibit 1: Equity Portion of LLE’s Policy Portfolio Eco Smith Morris Akhtar Asset under management ($ millions) 5.0 2.5 3.5 2.0 Expected alpha 0.0 5.5% 7.2% 10.1% Expected tracking risk 0.0 3.6% 6.5% 8.1% Dividend yield 0.0 2.1 1.3 1.6 P/E 16 10 14 25 P/B 6.0 4.3 0.7 15.8 5-year consensus expected earnings growth 5.0% 3.1% 6.8% 10.5% Annualized manager’s return 15.1% 22.1% 12.7% 17.0% Annualized manager’s normal benchmark return* 15.1% 18.0% 13.7% 16.1% Annualized investor benchmark return* 15.1% 12.1% 11.6% 17.3% Equity investment style N/A Value Value Growth *All returns are gross of management fees Walker’s colleague, Levin Alexei, is reviewing the allocation presented in Exhibit 1. He tells Walker that a true/misfit distinction between portfolio risk and returns is crucial. He supports his statement by providing the following justifications: Justification 1: The true/misfit distinction will allow for an optimized allocation to managers such that misfit risk is eliminated and true active returns are maximized. Justification 2: The distinction allows for the performance appraisal of active managers. Following Alexei’s advice, Walker compiles details concerning the benchmarks used for each of the four managers (Exhibit 2). Exhibit 2: Portfolio and Investor Benchmarks MSCI World MSCI US Broad Market ex-US Value Manager’s normal Index benchmark index ex-US index Investor’s benchmark MSCI US ex-US ex-US index Growth index Following his analysis of the equity allocation, Walker holds a meeting with LLE’s chief executive. During the meeting the executive entrusts Walker with the management of $10 million which the fund has received from a wealthy donor. The executive shares his desire for an active equity exposure to emerging market equities. However Walker has little expertise with respect to this equity category. Walker is of the opinion that exposure to the U.S. equity market can be highly profitable and devises a strategy to manage the $10 million by undertaking a long futures position in the S&P500 equity index. For the emerging market equity allocation, he narrows down his selection to Octavia Wilde, an active manager benchmarked to the MSCI Emerging Markets Index (EMI). Wilde undertakes a short futures position in the MSCI EMI. 31. Based on the information presented in Exhibit 1, Morris’s value investment style can most likely be classified as: A. low P/E. B. contrarian. C. high dividend yield. 32. The information ratio earned on LIE’s equity allocation is closest to: A. 0.9. B. 1.2. C. 2.0. 33. Using the information presented in Exhibit 1, which manager has outperformed his or her asset class benchmark by the highest margin? A. Smith B. Morris C. Akhtar 34. With respect to the benefits of a true/misfit distinction, Alexei is least accurate with respect to: A. Justification 1 only. B. Justification 2 only. C. both of his justifications. 35. Based on the information provided in Exhibits 1 and 2 and the vignette, Alexei has correctly defined the normal benchmark for: A. Eco. B. Smith. C. Akhtar. 36. The strategy employed by Walker to manage the $10 million entrusted by LLE’s chief executive is most likely classified as: A. completeness fund B. equitized market neutral. C. alpha and beta separation.