An endowment fund (worth $125m) is invested in primarily invested in developed market equities Equities (60%) and Bonds (40%). There is a large cap bias within equities and a high quality and high duration bias within bonds.

The endowment fund has a real required return of 4.5% per annum in real terms, of which 3.5% is annual spend (equal 3.5% of the average fund value over the previous 5 year), 0.5% as real growth in the value of the fund and an additional 0.5% as a buffer. The fund has generated 5% (in real terms) per annum over the last 10 years. The 3.5% of Spend was made each year without erosion of fund in real terms.

The portfolio manager is considering adding only one alternative investment (AI) with an allocation of 10%, so that the new SAA will be 35:55:10 (Bonds:Equities:AI). The portfolio manager is trying to decide between a Venture Capital fund that invests in new ventures, primarily in the technology sector,ora Private Equity fund that invests in existing large capitalized and listed firms (in the S&P 500).

The portfolio manager understands that almost all alternative investments have low or no (buy/sell or distribution) liquidity, and so the primary consideration to be chosen alternative investment must be able to diversify the risk of the SAA.

Required:

(i)Explainwhy Private Equity and Venture Capital funds are considered Alternative Investments since both AIs invest in equities.

(ii) Explainwhich alternative investment (Venture Capital or Private Equity) has a higher correlation with large capitalized equities.

(iii) Explainwhich alternative investment (Venture Capital or Private Equity) is best suited for inclusion in this portfolio.

Answer rating: 100% (QA)

Private Equity and Venture Capital funds are considered alternative investments because they typical... View the full answer