Questions 31 through 36 relate to Equity Investments.
Smithson Asset Management (SAM) Case Scenario
Smithson Asset Management (SAM) is an institutional portfolio management firm based
in the U.S. SAM has traditionally been biased towards fixed income securities in its
fund’s holdings. Senior asset manager, Raul Gonzales, is seeking to change this by
revising the allocation to include equity securities. He instructs Charles Solanki, manager
of Angular Fund’s investment portfolio, and Jill Lake, manager of The Health Care
Endowment Fund (THCEF), to follow through with the revised allocation.
Angular Fund (AF)
The AF is a defined benefit pension fund characterized by a below average risk tolerance
due to a funding deficit, a low active to retired employees ratio, and deteriorating
financial circumstances of the plan sponsor, Angular Limited.
Gonzales has instructed Solanki to allocate equities to clients’ portfolios. Based on AF’s
risk tolerance, Solanki adopts a passive management approach and benchmarks the equity
allocation to an equity index comprising small- and large-cap equities. He charges a
management fee of 0.1%. Exhibit 1 displays the projected results of his allocation.
Exhibit 1:
AF’s Equity Allocation Portion
Portfolio Benchmark
Expected return 14.0% 12.0%
Information ratio 3.5 N/A
Small-cap allocation 5% 5%
Large-cap allocation 20% 20%
Solanki arranges a meeting with AF’s chief investment officer (CIO) to present the
results achieved. The CIO asks Solanki how the results would have differed if an active
approach were being followed.
The Health Care Endowment Fund (THCEF)
THCEF’s chief investment officer has expressed the preference for an active return,
which does not involve a high degree of risk taking. Lake designs an enhanced indexed
strategy using the Russell 3000 index as benchmark and will make allocation decisions
based on her views concerning the index’s top constituent industry sectors. She will then
select individual index sector stocks based on their potential for active returns. Exhibit 2
displays Lake’s portfolio allocation to the sectors comprising the equity index.
Exhibit 2: THCEF’s Portfolio Allocation
To Russell 3000 Industry Sectors
Portfolio
Benchmark
Allocation (%)
Financial Services 35 35
Technology 25 27
Health Care 40 24
Consumer Discretionary 0 14
Total 100 100
THCEF’s CIO has decided to allocate a portion of the endowment fund towards a full-
blown active risk strategy by setting aside $25 million. Lake designs a strategy which
involves shorting $12.5 million worth of stock with an average beta of 0.40 and going
long $37.5 million worth of stocks with an average beta of 0.80. The opportunity set
comprises small-cap stocks.
31. Which of the following reasons explain why Gonzales has been motivated to
consider equities in the firm’s asset allocation? For:
A. meeting social responsibility investing (SRI) concerns.
B. reducing the impact of inflation on corporate taxation.
C. preserving the purchasing power of the fund during periods of inflation.
32. Based on the expected portfolio results (Exhibit 1), has Solanki held true to his
investment philosophy?
A. No.
B. Yes, he will minimize tracking error.
C. Yes, he will earn an information ratio which exceeds 1.0.
33. Solanki’s best response to the chief investment officer’s query is that if an active
approach is adopted:
A. tax efficiency will be higher.
B. allocation to small-cap equities would be greater than 8%.
C. long-term net-of-fees returns would be higher than 13.9%.
34. Considering Lake’s investment strategy and using the data in Exhibit 2, she least
likely holds an opinion on the industry sector stocks classified as: A. technology.
B. financial services.
C. consumer discretionary.
35. A limitation of the approach being using by Lake to manage THCEF is that:
A. significant leverage is involved.
B. active returns can be replicated.
C. quantitative and mathematical models derived from the analysis rely
heavily on projections concerning asset returns and prices.
36. A characteristic of the strategy being pursued by Lake includes:
A. portable alphas.
B. average market risk exposure.
C. asymmetrical investment opportunity sets.
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