Asset Allocation and Related Decisions in Portfolio Management - . Discuss two reasons why the proposed asset allocation is inappropriate for Fordhart

#### Solution

The proposed asset allocation for Fordhart is inappropriate because:

1. Given the increasing enrollment trends and recent favorable legal settlement, Fordhart will likely require lower liquidity in the future. The proposed allocation shifts Fordhart’s portfolio away from risky assets (decreases the relative equity holdings and increases the relative bond holdings).
2. The proposed 10% allocation to private equity creates an overly concentrated position in the underlying investment. A 10% allocation to the CFQ Private Equity Fund is $200 million (10% of Fordhart’s $2 billion). The CFQ Private Equity Fund has assets under management (AUM) of $500 million. Hence, Fordhart would own 40% of the entire CFQ Private Equity Fund. This position exposes both Fordhart and the CFQ fund to an undesirable level of operational risk.

Hi everyone, I think the answer is wrong. First of all there will be loss of operating revenue for university and less donations which means that there will be more need for liquidity on the contrary. Secondly, how is the PE fund’s total AUM calculated or where is it given in the question?

My answer was like:

In the environment of decreasing donations and increasing need from endowment due to decreasing enrollment signals that there will be more need for liquidity, in this environment increasing alternative investments significantly at the expense of decreasing investment-grade bonds is not appropriate.

Public equity and Private equity drivers are similar (especially in the long-term) despite the fact that differences as illiquidity and market inefficiency make short-term results different, hence increase in private equity should better come at the expense of decreasing the weight of public equity fund.

Yes i agree with you, the answer looks wrong. I do not see any favourable legal settlements but the opposite with lower donations, also less enrolment etc, they will need more liquidity. Is this from a CFA paper?

I think they got it wrong on the AUM of the fund, i think they meant 400 million. I would just say that they would hold a large proportion of the fund and this would give concentration risks and major liquidity risk (if they needed the cash fast, it is difficult to get it out of a PE when you hold so much of it). I do agree with your definition of Public equity and Private but i think they want you to mention the concentration risk and not how similar they can be over the LT or where the assets are coming from, public equity to private equity.

Thanks for your help!

Problem solved, 2 similar questions’ answers are wrongly placed in CFA ecosystem, answer above is for question below:


And answer of the first question is like below:

The proposed asset allocation for Titan is not appropriate because:

  1. Given the shift in enrollment trends and declining donations resulting from the sanctions, Titan will likely need greater liquidity in the future because of the increased probability of higher outflows to support university operations. The proposed asset allocation shifts Titan’s allocation into risky assets (increases the relative equity holdings and decreases the relative bond holdings), which would introduce greater uncertainty as to their future value.
  2. Titan is relatively small for the proposed addition of private equity. Access to such an asset class as private equity may be constrained for smaller asset owners, such as Titan, who may lack the related internal investment expertise. Additionally, the Sun-Fin Private Equity Fund minimum investment level is $1 million. This level of investment in private equity would be 10% of Titan’s total portfolio value. Given Titan’s declining financial position due to declining enrollments and its resulting potential need for liquidity, private equity at this minimum level of investment is not appropriate for Titan.