Asset Allocation at the Cook County Pension Fund
The case focuses on the challenges of portfolio allocation, particularly in an environment that has several regulatory and funding constraints. The fact that there is a realistic possibility that the pension fund may run out of resources (money) in the near future brings the abstract concept of risk, as measured by standard deviation, to life. Additionally the funding status of the pension fund forces students to confront the difficulty pf finding investments that have low risk and high reward. On the one hand, a high-return investment could help alleviate the pension fund’s shortfall problem, thereby securing retirement benefits for its members. On the other hand, high-return investments typically come with high risk, meaning that these strategies could push the fund closer to insolvency. Students will ultimately come to appreciate the fundamental trade-off between risk and reward that is central to modern portfolio theory.
This is an individual assignment [final case exam] the case is available on the HBSP web site see syllabus for access URL. The case provides background into the history and current situation with the pension fund. For this assignment, you will arrive at an asset allocation decision using the efficient frontier spreadsheet posted on blackboard. For the spreadsheet, apply the data from the JPM 2020 rate of return, standard deviation and correlation posted on blackboard as the source of data for your modeling. Just use the average arithmetic returns, the volatility number as the standard deviation and the correlation between those asset classes. Your selections are then input, or linked, into the return, risk and correlation cells on the spreadsheet.
Recommendations should be within three pages 1.15 spacing, a fourth page would be the asset allocation page from the spreadsheet included in this assignment. Due date on this assignment November 25, 2020.
Question 1: [7 points]
Imagine you are Nicole Hackett and you have just taken over as CIO of the Cook County in early 2008. The pension was already underfunded (27% unfunded liability, with assets only able to pay only 75% of the promised benefit payouts to current employees and retirees) when you joined. The Global Financial Crisis hits just a few months later, leading to a sever worsening of your funding status. A decade later the situation has somewhat stabilized but the plan is still underfunded by over 40%.
What do you do? What should your objective be?
Question 2: [13 points]
Evaluate the asset classes, equities, fixed income, alternatives, REITS from the JPM 2020 database. You will include 10 investments in your recommendation to Nicola. Provide a brief comment on why you would recommend including your investments in your recommendation. Keep in mind this is broad asset class decisions you can select individual elements in the analysis. (for example you could choose bonds but select high yield and 30 year Treasury bonds as part of the bond allocation), same holds true with the other asset classes.
Question 3: [20 points]
What is your final recommendation on how the pension fund should invest assets to meet the return expectation of the plan?
The analysis, Nicola’s goal is to attain a 7.5% return while keeping the standard deviation of risk between 10 and 15. You will recommendation an asset allocation strategy to Nicola that Cook County may consider adopting to meet the 7.5% return requirement. You must use the JPM 2020 data for this analysis, while using the efficient frontier optimization spreadsheet posted on blackboard. Using/applying outside data will result in a reduction in points for this question. Design an asset allocation model to meet the 7.5% return objective while considering the asset class and risk constraints in the assignment. Apply the concepts of modern portfolio theory in arriving at your final recommendation applying the best risk/return Sharpe ratio when making a final recommendation. Include your spreadsheet with the written analysis. The spreadsheet must identify the investment option you are recommending for Nicola.
Investment Constraints, on broad asset classes, (this is a strategic allocation NO leverage type investments)
Developed Markets US and Non-US Equities: minimum 20%, maximum 50%
Emerging Market Equities minimum 5% maximum 10%
Fixed Income (bonds) minimum 10%, maximum 25%
High Yield fixed income minimum 5% maximum 7%
Alternative investments, including private equity, REITs, hedge funds, private equity, commodities, venture capital; minimum 5% maximum 20%.