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Partner Healthcare Essay

1110 words - 5 pages

How “Real Assets” Play in Portfolio?

Partner Healthcare System had established several centrally managed pools to invest their financial resources. Two main pools are short-term pool with average yield of 3.2% and long-term pool (LTP). The Investment Committee was considering the size and composition of the new “real assets”, which are mainly made up of REITs and commodities, to add to the $2.4 billion long-term pool.

To determine the benefit of adding new assets to the portfolio, we need to analyze if the new portfolio’s expected return will increase for a given amount of risk, or equivalently the overall risk will decrease for a given level of expected return. The Sharpe ...view middle of the document...

3% in US stock, 27.7% in foreign stock, 22.4% in bonds, 13.3% in REITs and 22.3% in commodities, which could deliver the target 10% expected return at 8.47% risk- a lower level of risk than any other possible sets of allocation producing 10% expected returns. If we add the short-term pool, the optimal complete portfolio will produce 10% expected return at 8.33% risk with the allocation as: 11.9% in STP, 21.4% in US stock, 27.2% in foreign stock, 9.5% in bonds, 8.7% in REITs and 21.2% in commodities. Compared to 9.94% risk generated by only three asset portfolio for the same level of expected return, adding “real assets” greatly reduced the overall risk and made the investment portfolio more attractive than others.

However, investors may not have specific required return or risk level set up. In this case, the optimal portfolio that offers the best risk-return trade-off should be the one with the highest Sharpe Ratio, which characterizes how well the return of an asset compensates the investor for the risk taken. For 3-asset combination (US stock, foreign stock and bonds), the optimal portfolio generated 11.77% expected return at 11.98% risk with the Sharpe Ratio of 71.48%; Adding REITs only, the optimal portfolio generated 11.4% expected return at 11.37% risk with the Sharpe Ratio of 72.12%; Adding commodities only, the optimal portfolio generated 11.16% expected return at 9.82% risk with the Sharpe Ratio of 81.04%; Adding both REITs and commodities, the optimal portfolio generated 10.92% expected return at 9.46% risk with the Sharpe Ratio of 81.6%. (See Appendix A for the allocation of assets in these four portfolios). From these numbers, 5-asset portfolio definitely beats others with the highest Sharpe Ratio and provides the best benefits to investors. If we include short-term pool in our analysis, the optimal complete portfolio will be slightly different, but the portfolio with five risky assets still offers the best risk-return combination (See Appendix B for the allocation of assets, including short-term pool).

We also understand that the investors’ needs and preferences were quite varied. Some prefer portfolios with lower risks, while others would probably prefer portfolios with higher returns. In this case, we define a hyperbola named as efficient frontier. A portfolio lying on the efficient frontier represents the combination offering the...

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