1. Given the Client Objectives/Constraints below, go through the investment process to build out a
portfolio for this client.
a. Portfolio Size: $1,000,000
b. Risk Tolerance – Moderate
c. Long time horizon
d. Liquidity constraints
i. Before investing, financial planners generally recommend that clients establish a
safe, liquid, emergency fund (usually 3-6 months worth of expenses, although
this can vary depending on the individual).
1. Assume the client has expenses of $10,000 per month.
2. Make sure and add an allocation to a money market fund to account for
this emergency fund. The SHY ETF would also work for this.
2. Define your asset classes (Min 3, max 10)
a. Briefly discuss your choice of asset classes. (E.g. U.S. Equity, Intl Equity, Fixed Income,
Cash).
b. Determine an ETF to represent your asset classes. Some possible choices are below.
i. SPY U.S. Large Cap Equities
ii. MDY U.S. Mid Cap Equities
iii. IJR U.S. Small Cap Equities
iv. IWF Large Cap Growth
v. IWD Large Cap Value
vi. IWO Small/Mid Cap Growth
vii. IWN Small/Mid Cap Value ETF
viii. EFA Developed Market ex. US Equities
ix. EEM Emerging Market Equities
x. AGG Aggregate Bond Market ETF
xi. TIP Inflation Protected Treasuries
xii. SHY Short term T-bill (Money market proxy)
xiii. HYG High Yield Bonds
xiv. GLD Gold ETF
xv. DBC Commodities ETF
3. Capital Market Expectations
a. Use any method you choose to estimate expected return for one of your asset classes
(state the time horizon you are using, e.g. 5-year)
i. Professional Forecasts
ii. Ibbotsen-Chen
iii. Historical Averages
iv. Fixed Income Building Block Model
v. Note: It is often a good idea to combine/average multiple sources to come up
with a forecast. However, for this project, it is not required.
b. In Excel or Python, calculate the historical 5-year annualized standard deviation of each
asset class to use as your projected standard deviation
c. In Excel or Python, calculate the correlation matrix between your asset classes.
4. Using your asset class definitions,
a. Come up with an asset allocation (i.e. asset class weights) for the client.
i. You may use any of the methods presented in lecture, or a different method not
covered.
1. Even if you choose a simple heuristic method, describe the logic behind
the heuristic and why you decided against other more formal
approaches.
b. Justify your asset allocation weights.
c. Using the standard deviation and correlation calculations from step 3, calculate the
expected portfolio standard deviation.
5. Will you use tactical asset allocation?
a. If yes, how will you implement (tilting strategic weights based on market views, adding
trend following strategies, etc.)
b. If not, why not?
6. Active vs. Passive Management
a. Will you use active and passive management?
b. If so, why or why not?
7. Security Selection
a. Choose a security that pays dividends and perform a dividend discount model valuation.
i. Comment on the difference between the market price and your calculated
valuation.
b. For that same security choose at least one valuation multiple, and use that to comment
on the valuation of the security.
8. Portfolio Construction
a. State your portfolio holdings and weights.
9. Monitor and Review
a. State how you will go about rebalancing the portfolio.
Data Sources
Professional Capital Market Expectations
o https://www.aqr.com/Insights/Research/Alternative-Thinking/2022-Capital-Market-
Assumptions-for-Major-Asset-Classes
o https://www.gmo.com/americas/research-library/gmo-7-year-asset-class-forecast-4q-
2021/?selected_tab_css=lrf-register-tab&Success=27
Economic Forecasts (Growth and Inflation)
o https://www.philadelphiafed.org/surveys-and-data/real-time-data-research/survey-of-
professional-forecasters
o https://www.bls.gov/news.release/ecopro.nr0.htm
o Federal Reserve FOMC Projections
You tube link: https://www.youtube.com/watch?v=b4-RnhSICx0
(instructions)
