Asset Allocation: Riverdale College

Finance 320 Professor Sapp
Fall 2016 Allocation Project

(100 points) Due: Nov. 3, 2016
Asset Allocation: Riverdale College
Objective: To engage you in a "real life" asset allocation exercise. The project will
require you to apply fundamental concepts of modern portfolio theory to come up with
an efficient portfolio allocation to meet certain objectives. In short, the project will
require you to implement what you have learned in this course.
Teri Riley is a consultant to several college investment offices around the country. She is a
specialist in asset allocation studies. She has accumulated performance figures from a number
of different college endowments, as well as information about the typical stocks/bonds/cash
mixtures common in the endowment universe. She practices a broad policy approach, which
means that she makes recommendations about allocations across asset classes, rather than
about which managers to choose, or which stocks to pick.
Riverdale College is a small mid-western, liberal arts college with a $50 million endowment as
of Dec. 31, 2015. It has had a fixed investment policy of 40% domestic stocks (spread equally
between small and large cap portfolios labeled SMLSTK and LRGSTK, respectively), 20%
international stocks (EAFE), 15% investment-grade corporate bonds (CBOND), 15% U.S.
government bonds (GBOND), and 10% T-bills. This portfolio has been held from 1996 through
2015. The monthly returns on these asset classes are contained in the Excel spreadsheet titled
“dataset2.xls” (available on the course web site). The portfolio manager hired by the college to
manage its endowment fund is a successful alumnus. Most of Riverdale's assets are liquid.
Enrollment at Riverdale has decreased steadily since its peak of 2200 students in 1998 to a low
of 1500 in 2015. Thus far, increased spending from endowment has offset the shortfall in
revenue caused by declining tuition revenues. Since 1998, the annual average spending from
endowment has been 4% (of the total value of the endowment fund) annually. In 2014 and 2015,
the college had to spend 6% and 7%, respectively, and anticipates additional spending of $5
million for the year 2016. Contributions to the endowment have continued steadily at 2% per
year. However, the poor record of the college's football team in recent years is a matter of
concern since it directly affects contributions by alumni (in the mid-seventies the college won
three consecutive Division III national championships). Since the role of the endowment in
meeting budget needs has increased dramatically in the past few years, the college has decided
to review its past performance and future contributions to the institution.
Howard Weaver is the chairman of the endowment committee for the board of trustees of
Riverdale. He found out about Ms. Riley from a friend of his who serves on the board of Rotter
Dame University. Rotter Dame employed Riley in 2015 to review its investment policy and to
recommend an optimal portfolio mix. Riley presented an asset mix for the Rotter Dame
endowment that changed their exposure to stocks from 70% to 40% and increased their
exposure to bonds and alternative assets to 50%. Should Riverdale consider a change in its
long-standing investment policy? How has the endowment and its money managers performed
over the period since 1996? Weaver decided to have Teri and her firm look into these issues.
Weaver was also concerned with how risks should be defined in the context of Riverdale's
investments. He anticipated the need to continue relying on the endowment fund in the coming
years. He felt strongly that a return of 0.01 (or 1 %) per month represented a target portfolio
return that the college should seek to achieve. He wanted Riley to suggest an efficient asset
allocation to achieve this goal. Lastly, Weaver wanted to know whether the board should be
concerned about whether the endowment is adequate for the school's future needs. Can any
improvements be suggested that would help the college to meet its needs going forward?
Based upon her consultations with Weaver, Riley has drawn up a list of issues that need to be
addressed. She has decided to hire your group for this task. You are required to prepare a
preliminary report, which will address the following questions/tasks.
1. How did the Riverdale portfolio perform over the 1998-2015 period? Report the portfolio
mean, standard deviation, and Sharpe ratio.
2. Plot the portfolio frontier given the five risky assets the college is investing in (you may use
the Solver module in Excel for this purpose).
3. Find the mean and standard deviation of the portfolio of risky assets (consisting of
investments in three stock portfolios and two bond portfolios) currently chosen by the
college's fund manager. Plot it. Is this an efficient portfolio? If not, calculate the investment
proportions in the five assets required to construct an efficient risky portfolio, which would
deliver the same expected return as the current choice of risky portfolio.
4. Calculate the investment proportions required to achieve the optimal (tangency) risky
portfolio (you may use the Solver module in Excel for this purpose). What is the expected
return and standard deviation of such a portfolio? Also, be sure to report the weights and
the Sharpe ratio of the tangency portfolio. How does the Sharpe ratio compare to that of
Riverdale’s current risky portfolio?
5. Calculate the investment proportions required to construct a complete portfolio (i.e. one
which mixes the optimal risky portfolio with T-bills) that has an expected return equal to
the present (complete) portfolio's expected return. What is the expected standard deviation
of return on such a portfolio? How does this compare with the standard deviation of
Riverdale’s current complete portfolio?
6. Suggest a complete portfolio allocation between the optimal risky portfolio and T-bills to
achieve the college's objective of a rate of return equal to 0.01 (1%) per month. What is the
expected standard deviation of the portfolio?
7. Weaver is also interested in knowing if the college should include some alternative asset
classes — specifically, real estate, commodities, private equity, hedge funds, and high-yield
bonds — in its portfolio. Make a case for or against the inclusion of five alternative assets
(labeled REITs, TIMBER, PE, HFMACRO, and HYBOND) in the college's overall portfolio.
Justify your decision by depicting the portfolio frontier that includes the five alternative
assets. Plot it on the same graph you constructed for number (2).
8a. Find the optimal (tangency) portfolio consisting of all ten asset classes.
8b. Calculate the complete portfolio allocation required to achieve the target rate of return
mandated by the college using this expanded universe of assets. What is the expected
standard deviation of such a portfolio?
9. Find the 5-asset tangency portfolio, assuming no short sales of risky assets are allowed.
Also, find the 10-asset tangency portfolio, assuming no short sales are allowed. Compare
these results to the tangency portfolios when short sales are allowed. What happens to the
Sharpe ratio? Which assets drop out and which assets dominate?
10. Present a forceful argument for using your services, summarizing what you have shown.
Also, make a few succinct points that might help sway a board member skeptical of asset
allocation methods (the member believes that individual stock selection is more important
than asset allocation).

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Finance 320 Professor Sapp

Fall 2016 Allocation Project

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