Reference no: EM132888180

Question - Mr. Khakhati Masudi is seventy years old, is in excellent health, pursues a simple but active lifestyle and has no children. He has an interest in a private company worth ZAR 9 million and has decided that a medical research foundation will receive half the proceeds now; it will also be the primary beneficiary of his estate upon his death. Mr. Masudi is committed to the foundation's well-being because he believes that through it, a cure could be found for the disease that killed his wife. He now realizes that an appropriate investment policy and asset allocation are required if his goals are to be met through the optimal investment of his considerable assets. Currently, the following assets are available for use in building an appropriate fund: o ZAR 4.5 million cash (from sale of private company interest, net of the ZAR 4.5 million gift to the foundation); o ZAR 10 million stocks and bonds; o ZAR 9 million warehouse property fully leased; o ZAR 3 million Masudi residence.

a. Formulate and justify an investment policy statement, setting forth appropriate guidelines within which future investment actions should take place. Your policy statement must encompass all relevant objectives and constraints.

b. Recommend and justify a long-term asset allocation strategy that is consistent with the investment policy you created in part (i) above. Briefly explain the key assumptions you have made in generating your strategic asset allocation. 

c. Suppose that Mr. Masudi's investment manager has executed the investment strategy outlined in part (a). One year (four quarters of volatility-induced portfolio rebalancing) later, Mr. Masudi is interested to evaluate the manager's performance over the period. Explain why the geometric average approach will be more suitable for computing average period return than the arithmetic average approach.

d. After computing the average period rate of return, Mr. Masudi would like to evaluate the manager on a risk-adjusted performance basis. He would like to choose from two riskadjusted performance metrics: the Jensen index and the Sharpe index.

i) Explain why the two performance measures may not always provide the same performance signals.

ii) Discuss two major problems with the above risk-adjusted performance indices and others commonly used in portfolio performance evaluation.