Reading 25 Problem 17

Vol3-page 289-290 I don’t understand why the answer is C(with sharpe ratio 0.40). I picked A because it has the highest sharpe ratio. 0.42. standard deviations for portfolio A and C are 26.7% and 19.8% respectively. Ok portfolio C is more diversified, but portfolio A picks up 3.3% more just for assuming 10% more of IPO/Tech portfolio+5% venture cap fund. But still I think higher sharpe ratio+higher yield justifies A.

Looking at it real quick as I’m still on Reading 23 (boring)…SInce the company is in US Tech it would be prudent to reduce their exposure to tech companies as they are already exposed to that industry. Also there is no need for a 7% position in cash equivalents as there is no immediate need for liquidity. Plus if 13.3% meets or exceeds the plan objective then there is no sense in increasing your risk by almost a 33%. I’d go with C. Just my .02. That problem seems like it belongs in SS4 or 5…

A few points: 1) The company running the DB plan is in the technology sector and portfolio A is heavily invested in risky technology (20% of assets). This is likely to high and returns are likely to correlated for a DB plan. If technology goes down the company may have trouble increasing contributions to the plan at the precise time they would need to (company net income would suffer at the same time tech stock returns dwindle). 2) High allocation to small stocks. combine this with the tech stocks just under 1/2 the portfolio is in above average risky equities. But abover average risk isn’t necessary a bad thing for a well diversified portfolio leading me to… 3) a zero allocation in portfolio A for international equities - so portfolio A isn’t as well diversified as it should be. 4) for a DB plan that has a low need for liquidity (due to a young workforce) portfolio A has a 7% allocation to a money market fund. this is likely to high an allocation and woudl be more than necessary to meet current distributions to retirees. 5) The sharp ratio’s are similar (althogh portfolio A’s is slighly better). Given the less volatile nature of poftfolio C (due to a much better diversified DB plan) i would pick C as well. Of note, Portfolio B is too concentrated in Tech and that is why that one isn’t appropriate

i completely agree with both of you, but they reduced the IPO/tech exposure from 50% to 20% which is significant, my point is 3.3% excess return in the long run is very significant that is worth to bear that risk. Maybe portfolio A is very aggressive for a defined benefit plan. But yes income component of the return should be less than growth component for young workforce.+15% Int’l equity also makes C a better and a more diversified choice. Thx for the comments.

Don’t use where they are currently (50% tech allocation) to decdide the appropriateness of choosing portfolio options (in this case where they are now for portfolio A (20%)). The CFA provides the current portfolio to anchor you to those points in order to have you choose the least appropriate answers. Its a CFA trick. for a DB plan, diversification (approrpraite risk levels) are just as important as return. Don’t get fooled by the extra 3.3% return as the sharpe ratio points out the expected risk adjusted return isn’t significant, and that’s why the sharpe ratio matters in this question.

If only i were on reading 25 …

good point! thx for taking your time to write messages