This result can also be obtained by computing these

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This result can also be obtained by computing these returns for each of the individual holdings, weighting each result by the portfolio percentage and then adding to derive a total portfolio result. From the data available, it is not possible to determine specifically the inherent degree of portfolio volatility. Despite meeting the return criterion, the allocation is neither realistic nor, in its detail, appropriate to Fairfax’s situation in the context of an investment policy usefully applicable to her. The primary weaknesses are the following: Allocation of Equity Assets. Exposure to equity assets will be necessary in order to achieve the return requirements specified by Fairfax; however, greater diversification of these assets among other equity classes is needed to produce a more efficient, potentially less volatile portfolio that would meet both her risk tolerance parameters and her return requirements. An allocation that focuses equity investments in U.S. large-cap and/or small-cap holdings and also includes smaller international and Real Estate Investment Trust exposure is more likely to achieve the return and risk tolerance goals. If more information were available concerning the returns and volatility of the Reston stock, an argument could be made that this holding is the U.S. equity component of her portfolio. But the lack of information on this issue precludes taking it into account for the Savings Portfolio allocation and creates the need for broader equity diversification. Cash allocation. Within the proposed fixed-income component, the 15% allocation to cash is excessive given the limited liquidity requirement and the low return for this asset class. Corporate/Municipal Bond Allocation. The corporate bond allocation (10 percent) is inappropriate given Fairfax’s tax situation and the superior after-tax yield on municipal bonds relative to corporate (5.5% vs. 4.9% after-tax return). Venture Capital Allocation. The allocation to venture capital is questionable given Fairfax’s policy statement indicating that she is quite risk averse. Although venture capital may provide diversification benefits, venture capital returns historically have been more volatile than other risky assets such as U.S. large- and small-cap stocks. Hence, even a small percentage allocation to venture capital may be inappropriate. 28-11
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Chapter 28 - Investment Policy and the Framework of the CFA Institute Lack of Risk/Volatility Information. The proposal concentrates on return expectations and ignores risk/volatility implications. Specifically, the proposal should have addressed the expected volatility of the entire portfolio to determine whether it falls within the risk tolerance parameters specified by Fairfax.
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