James Mason is the Chief Operating Officer of the Homeless Mission Foundation (HMF), a foundation with the purpose of providing food, clothing, and shelter for homeless individuals. Mason is currently in the process of preparing a report to HMF’s board recommending an asset allocation for the foundation. This year, Mason estimates that HMF’s operating budget will be $2.75 million. In order to assist with preparation of his report, Mason has compiled the following data.
- The market value of the foundation is currently $50,000,000.
- The cost for providing services to homeless individuals is expected to rise at a rate of 3.0% per year.
- The board would like to maintain a cash cushion equal to half of the estimated operating budget in order to meet any unexpected expenses.
- Management fees for the foundation are estimated to be 0.40%.
- The board is willing to accept market risk in order to meet its long-term objectives, but the board wants to accept shortfall risk (defined as expected return minus two standard deviations) of no more than 15%.
Mason must recommend one of three different portfolios to the board. Mason’s choice of portfolios is shown below:
| Asset Class |
Portfolio A |
Portfolio B |
Portfolio C |
| Large cap U.S. stocks |
24% |
30% |
20% |
| Small cap U.S. stocks |
10% |
5% |
13% |
| International – Developed market equities |
5% |
13% |
5% |
| International – Emerging market equities |
5% |
5% |
10% |
| U.S. Corporate bonds |
25% |
20% |
17% |
| U.S. Treasury bonds |
20% |
16% |
21% |
| Real estate |
5% |
10% |
10% |
| Cash |
6% |
3% |
4% |
| TOTAL |
100% |
100% |
100% |
| Expected Annual Total Return (%) |
7.85% |
9.20% |
8.80% |
| Expected Standard Deviation (%) |
11.15% |
12.10% |
12.20% |
In his report, Mason is going to recommend a portfolio based on 3 criteria: liquidity needs, return requirements, and shortfall risk. Which of the portfolios should Mason recommend?
A. Portfolio B.
B. Portfolio A.
C. Portfolio C.
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