TO 24 RELATE TO EQUITY INVESTMENTS RICARDO TORRES CASE SC...
Questions 19 to 24 relate to Equity Investments
Ricardo Torres Case Scenario
Ricardo Torres is a wealth manager serving a US based broker/dealer firm with an
investment advisory division. Torres is responsible for managing the equity portions of
the firm’s high net worth clients. He is currently seeking to invest the funds provided by
his newest client, Frances Redal, in an investment vehicle benchmarked to the S&P 500
index, which is float-adjusted. Based on a meeting with Redal, Torres determines that the
chosen vehicle must consider that his client:
•
has a long-term investment horizon;
•
is risk-averse due to her financial circumstances;
•
requires a tax-efficient solution;
•
requires a low-cost solution;
•
has no concerns for active returns; and
•
would like to minimize liquidity costs should she elect to dispose her investment.
At the conclusion of their meeting, Torres comes to the decision that a passive investment
vehicle should be favored for Redal over one which is actively managed. He shares his
thoughts with Redal and justifies his choice with the following:
Justification 1: “Representing the large-cap segment of a familiar equity market, indexing
to the S&P 500 is the most logical choice.”
Justification 2: “An indexed portfolio has been found to outperform its actively managed
counterpart before and after the consideration of manager fees.”
A year after investing Redal’s funds in a passive investment vehicle, Torres comes to
know that his client has inherited $5 million from her deceased father’s estate. Believing
that this recent development will increase her risk appetite, he decides to add active
foreign equity exposure to Redal’s portfolio by investing the sum in British equities. He
identifies and allocates the funds to a set of four managers each with their distinct
investment styles (Exhibit). The new investment will be indexed to the FTSE index.
Exhibit:
Redal’s Portfolio’s British Equities Allocation
Tracking Risk
Relative to Asset
Expected Active
Funds Allocated
Class Benchmark
Expected
$ Millions
Return (%)
Manager
(%)
A
0.5
0.0
0.0
0.0
B
1.5
2.0
1.5
2.5
C
2.2
4.0
4.0
5.8
D
0.8
5.7
6.3
7.2
19. In light of Redal’s initial circumstances, which of the following passive
investment vehicles is most suitable for her?
A.
Mutual fund
B.
Exchange traded fund (ETF)
C.
Long cash position combined with a long S&P 500 index futures position
20. Justification 1 is most likely:
A.
correct.
B.
incorrect; active management is the most logical choice for large-cap
equities.
C.
incorrect; active management is more appropriate as equity markets are
unfamiliar.
21. Justification 2 is most likely correct with respect to the relative outperformance of
passive investment vehicles:
A.
net of manager fees only.
B.
gross of manager fees only.
C.
both gross and net of manager fees.
22. A criticism of using the S&P 500 index as a benchmark is that the:
A.
resulting benchmark portfolio will be poorly diversified.
B.
index is highly concentrated in high-risk start-up companies.
C.
index will need to be adjusted to reflect stock splits and dividends.
23. Using the information in the Exhibit, the portfolio’s active return with respect to
the British equities allocation is closest to:
A.
1.8%.
B.
2.1%
C.
3.3%.
24. Based on the information presented in the Exhibit, which manager has the highest
true active risk?
A.
B
B.
C
C.
D