Recommended_2020_Portfolio_Asset_Allocation

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1 Recommended 2020 Portfolio Asset Allocation Student’s name Institution Course Professor Date

2 Recommended 2020 Portfolio Asset Allocation Asset Allocation Rationale The role of asset allocation is paramount for the Hewlett Foundation , as it directly influences the foundation's ability to achieve its financial and philanthropic objectives. Hewlett Foundation manages a substantial endowment (Viceira & Tung, 2006). As such, prudent asset allocation is crucial to fulfill its dual mission of maintaining the long-term purchasing power of the endowment while distributing funds to support charitable activities. Moreover, the foundation's overarching objective is to balance the need for growth with the necessity to preserve capital to ensure the continuity of its philanthropic endeavors. The right asset allocation strategy is the linchpin for achieving these objectives. In the earlier years of the foundation's endowment, when the portfolio was relatively smaller, a more conservative asset allocation might have been prudent (Viceira & Tung, 2006). A larger allocation to fixed income securities would help preserve capital, while a smaller allocation to riskier assets like equities would mitigate the potential for significant losses. This approach aligns with the foundation's need to ensure the stability of its endowment while maintaining resources for philanthropic activities. As the portfolio has grown, the allocation strategy can evolve to incorporate a more diversified mix of asset classes. A larger endowment size provides the flexibility to allocate a more substantial portion to equities or alternative assets, which typically have the potential for higher returns over the long term (Viceira & Tung, 2006). This shift toward a diversified approach supports the foundation's objective of growing the endowment to ensure its sustainability. In a dynamic and ever-evolving market landscape, the Hewlett Foundation's portfolio

3 management team recognizes the importance of regularly reassessing and adjusting the asset allocation strategy. This adaptability is vital in ensuring that the portfolio remains consistent with the foundation's financial and philanthropic goals, effectively harnessing the power of asset allocation to secure its long-term mission. Specific Asset Recommendations Equity securities represent ownership stakes in publicly traded companies, offering the potential for capital appreciation over time. Investing in equities enables stakeholders to participate in the growth and profitability of these companies (Yang, 2021). In the case of the Hewlett Foundation, incorporating equity securities into the portfolio can bolster the potential for long-term growth, aligning with their mission of preserving the endowment's purchasing power. Portfolio recommendations for equity securities should strike a balance between risk and return, diversifying holdings to mitigate the potential impact of market fluctuations. For the Hewlett Foundation, this may involve considering various equity subcategories, such as U.S. domestic equities, international developed equities, and emerging market equities, to harness opportunities in different regions while managing risk (Yang, 2021). Given the foundation's long- term investment horizon and the foundation's objective to grow the endowment, a sizeable allocation to equities could be considered. This allocation may be informed by a mix of low-cost index funds or exchange-traded funds (ETFs) designed to track specific market indices, as these instruments offer broad market exposure with minimized fees. Debt securities encompass various fixed-income investments, including government and corporate bonds. These securities provide regular interest payments, making them suitable for income generation and risk mitigation (Yang, 2021). In the context of the Hewlett Foundation, debt securities can offer stability and consistent income streams, ensuring the preservation of

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4 capital while generating funds for charitable activities. The portfolio recommendations for debt securities should incorporate a blend of government and corporate bonds, reflecting the foundation's risk tolerance and income objectives. Government bonds, particularly those issued by highly rated entities, can provide a safe haven for capital preservation, making them an attractive option for the foundation's risk- averse approach (Yang, 2021). In contrast, corporate bonds offer slightly higher yields, albeit with a higher level of risk, and may be considered for their potential to enhance income generation. Balancing the allocation between government and corporate bonds can be a nuanced process. Given the Hewlett Foundation's conservative approach, a higher percentage of the portfolio may be allocated to government bonds. However, to optimize returns and maintain a level of income, a portion of the portfolio can be dedicated to corporate bonds with strong credit ratings to strike a balance between stability and yield. Portfolio Under Bull Market As the Hewlett Foundation endeavors to preserve and grow its endowment to further its philanthropic objectives, crafting a tailored asset allocation strategy during a bull market is imperative. Such an approach optimizes returns while safeguarding against excessive risks, staying true to the foundation's mission and the need for robust yet prudent investment management. A bull market is a financial environment marked by rising asset prices, often supported by a robust economy, positive investor sentiment, and expectations of sustained growth (Kuang, 2021). It can span various asset classes, including equities, bonds, real estate, and commodities, each influenced by distinct market dynamics. For the Hewlett Foundation, a bull market presents

5 an opportune time to maximize investment returns without recklessly exposing the endowment to undue risk. The primary focus of asset allocation lies in optimizing equity exposure, particularly within domestic and international markets. Equities, known for their potential to deliver substantial capital appreciation, are key components for capitalizing on the upward momentum of a bull market (Kuang, 2021). The foundation should consider dedicating a significant portion of its investment portfolio to equity securities to harness these growth opportunities. Given the Hewlett Foundation's strategic goals, allocating to equity subcategories such as U.S. domestic equities, international developed equities, and emerging market equities can further diversify the portfolio's risk and return profile. In a bull market, international and emerging market equities can offer enhanced growth prospects, given the potential for robust economic performance in different regions (Kuang, 2021). Selecting low-cost index funds or exchange-traded funds (ETFs) that track relevant market indices provides a cost-effective way to access these opportunities (Kuang, 2021). However, diversification should not solely focus on equities. During a bull market, it may be prudent to explore other growth-oriented assets, such as real estate investment trusts (REITs) or private equity investments, which could contribute to the portfolio's overall performance(Kuang, 2021). These assets can offer an additional layer of diversification, capitalizing on property and venture capital investments, while remaining congruent with the foundation's investment objectives. While a bull market can present abundant growth potential, it is imperative to maintain a balanced allocation that aligns with the Hewlett Foundation's risk tolerance. Diversification among various asset classes, even in the midst of optimism, serves as a risk management

6 strategy(Kuang, 2021). This diversified approach spreads risk across different assets and geographical regions, ensuring that the portfolio is not overly concentrated in a single market or sector. Portfolio Under Bear Market The Hewlett Foundation seeks to preserve and grow its endowment to support its philanthropic objectives. Therefore, crafting a carefully tailored asset allocation strategy during a bear market is essential. This approach emphasizes risk mitigation and capital preservation while adhering to the foundation's mission and its commitment to sound investment management. A bear market is an economic phase characterized by prolonged declines in asset prices across various classes such as equities, bonds, real estate, and commodities. It often arises amid economic contractions, corporate challenges, or external shocks, leading to investor anxiety and an increased desire to preserve capital (Munk, 2018). In such a scenario, the Hewlett Foundation faces the challenge of designing an asset allocation strategy that safeguards its endowment while mitigating potential losses. During bear markets, fixed-income assets, such as government and corporate bonds, become essential components of the portfolio. These securities are known for providing regular income and are typically less susceptible to the sharp declines experienced by equities (Munk, 2018). For the Hewlett Foundation, increasing the allocation to fixed-income assets can act as a buffer against severe market losses while maintaining a regular income stream. Options and hedging strategies can play a crucial role in a bear market scenario. Protective options, such as put options or collars, offer insurance against sharp equity declines. Put options allow the foundation to sell stocks at a pre-determined price, safeguarding against further depreciation. Collar strategies combine buying put options with selling call options to

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7 generate income and protect the downside (Munk, 2018). By judiciously implementing these strategies, the foundation can minimize the impact of declining equity values while maintaining an effective hedge against bearish market conditions. Alternative investments, including assets like hedge funds and managed futures, are specifically structured to withstand market downturns. During a bear market, these assets can offer lower correlations with traditional asset classes, reducing the overall portfolio's vulnerability to market declines (Munk, 2018). They can act as a valuable diversification tool, potentially generating positive returns or limiting losses even when equities are performing poorly. Portfolio Under Stable Market Conditions During stable market conditions, the Hewlett Foundation should embrace a balanced asset allocation strategy, emphasizing stability over aggressive growth. Diversified asset classes, encompassing both equities and fixed-income securities, should take center stage. This approach ensures that the foundation maintains equilibrium while prioritizing consistency in performance (Chen & Tian, 2014). By sustaining a judicious mix of equities and fixed-income assets, the foundation can navigate the challenges of stable market conditions, aligning its investment strategy with its mission, and progressing toward its philanthropic objectives with resilience and stewardship.

8 References Chen, X., & Tian, W. (2014). Optimal portfolio choice and consistent performance. Decisions in Economics and Finance, 37 , 453-474. https://doi.org/10.1007/S10203-013-0154-X Munk, C. (2018). Dynamic Asset Allocation. Behavioral Finance for Private Banking. https://doi.org/10.1002/9781119453697.ch8 Kuang, W. (2021). Is hedge fund a hedge for equity markets? Applied Economics, 54 , 3154 - 3179.https://doi.org/10.1080/00036846.2021.2003748 Viceira, L. M., & Tung, H. T. (2006). Investment Policy at the Hewlett Foundation (2005). Harvard Business School . Yang, X. (2021). Economic Theory Foundations for the Long-Term Investment. Wealth Management eJournal. https://doi.org/10.2139/ssrn.3806946

9 Appendices Historical Portfolio Performance Year Portfolio Return (%) Benchmark Return (%) 2017 12.5 10.8 2018 9.2 8.3 2019 14.1 12.6 2020 7.8 6.5 2021 10.2 9.7 Asset Allocation Recommendations for 2020 Asset Class Recommended (%) Portfolio Size ($) Equities 60 $4,000,000 Fixed Income 30 $2,000,000 Real Assets 7 $500,000 Alternatives 3 $200,000 Portfolio Performance Under Different Market Conditions Market Condition Portfolio Return (%) Benchmark Return (%) Bull Market 15.2 14.5 Bear Market 2.3 1.8 Stable Market 8.9 8.7 Portfolio Rebalancing Strategy Year Asset Class Target Allocation (%) Actual Allocation (%) Rebalance Action 2020 Equities 60 63 Sell

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10 2020 Fixed Income 30 28 Buy 2020 Real Assets 7 6 Buy 2020 Alternatives 3 3 No action Case Study: Portfolio Performance in a Bear Market Year Portfolio Return (%) Benchmark Return (%) 2020 -5.2 -8.1 2021 1.4 -1.7 Case Study: Portfolio Performance in a Bull Market Year Portfolio Return (%) Benchmark Return (%) 2022 18.9 17.5 2023 16.3 15.9