FBE555_2006Fall_BlueStar

FBE555_2006Fall_BlueStar - Executive Summary Prepared for...

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Executive Summary Prepared for GAITS Foundation Bluestar Investments Matt Carrier Abel Montanez Paul Intrarakha Andrew Cooper Jordan Wiens Erin La November 14, 2006
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Asset Allocation Recommendation Over 90% of a portfolio’s return is attributable to the asset allocation decision. 1 The GAITS Foundation currently has an asset allocation of: Cash 35% Bonds 23% US Stocks 38% European Stocks 4% Total 100% The $36.5 billion dollar portfolio has an expected annual return of 5.59% with expected annual volatility of 8.24%, according to the 2006 Asset Allocation Study 2 . Bluestar Investments conducted an asset allocation analysis to determine whether or not the Foundation’s current allocation was optimal. The asset allocation modeling process consisted of the following steps: 1. Capital Markets Assumption – projection of risk, return and correlation of asset classes. 2. Asset Side Simulations – determine the appropriate asset classes and acceptable ranges of asset classes. 3. Mean Variance Optimization – optimization of objectives and risk return tradeoffs to create efficient portfolios. Bluestar performed mean variance optimizations with different asset class mixes. Based on our analysis we believe that further diversification into the following asset classes should be examined, as opportunities in return enhancement and risk reduction exist: Emerging Markets Equity and Commoditites Bluestar further recommends that the merits of the EAFE stock be evaluated as a substitute for the current Europe asset allocation, in order to gain wider exposure to the international markets. The EAFE asset has country weights in Europe, Asia, and the Far East. The most often used benchmark for international developed markets is the Morgan Stanley Capital International Europe, Asia, and Far East Index (MSCI EAFE). The returns correlation of the EAFE Index with the U.S. Equity market is not perfect, and therefore provides diversification benefit by potentially lowering the volatility of the overall portfolio. 1 According to a study by Brinson, Singer and Beebower, Financial Analysts Journal, 1991: “Determinants of Portfolio Performance II: An Update” 2 Wilshire Associates 2006 Asset Allocation Study
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The efficiency of this market is also lower than that of the U.S. market, due to lack of complete coverage by security analysts as a result of the country and culture barriers. Therefore, the opportunities for managers to add value through active management are much greater. RECOMMENDATIONS Optimization 1 Should Emerging Markets be added to the allocation mix? T-Bill 35% 19% Stocks 38% 25% LT Treas 23% 24% EAFE 4% 20% EMF -- 12% Return 5.61% 6.40% Risk 8.17% 10.24% Sharpe Ratio 0.32 0.33 Current Mix Portfolio A (Emg Mkts) The mean variance optimization shows that Emerging Markets should be added to the GAITS Foundation portfolio. The addition of Emerging Markets increases the portfolio’s return from 5.61% to 6.40%, and volatility from 8.17% to 10.24%. Although the expected risk increase is significantly higher (207 bps) than the
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FBE555_2006Fall_BlueStar - Executive Summary Prepared for...

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