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| Copyright: emevil / 123RF Stock Photo |
A model portfolio is a theoretical portfolio that fund managers construct so that all investment accounts invest in the same market will follow the same investment decision in the model portfolio.
Listed below is an example of a small model portfolio:
| Model Portfolio A | ||
Stock
|
Quote
|
%
|
Amazon
|
AMZN
|
20.0%
|
Apple
|
APPL
|
28.5%
|
Facebook
|
FB
|
15.0%
|
Google
|
GOOG
|
15.0%
|
Intel
|
INTC
|
10.0%
|
Microsoft
|
MSTF
|
10.0%
|
Cash
|
1.5%
| |
100.0%
| ||
Please note that cash component is included because you need to maintain some cash level to facilitate trading.
Most institutional investors restrict the upper limit of the cash level so that the investment account can be fully invested. However, most institutional investors do not allow negative cash or overdraft. The fund manager needs to cover any interest charges for any overdraft. It is prudent to maintain some cash level especially if the investment account is actively traded.
Model Portfolio for Multiple Markets
Constructing a model portfolio for multiple markets is quite different from single market. If an investment firm uses both top down and bottom up investment approach, they will construct their model portfolio at the market/country level.
When you construct a model portfolio for multiple markets, you do not add cash component at the country level. Therefore, each country has 100% allocation, as shown:
US
| |||
Stock
|
Quote
|
Price
|
%
|
Amazon
|
AMZN
|
$346.38
|
20.0%
|
Apple
|
APPL
|
$ 98.97
|
30.0%
|
Facebook
|
FB
|
$ 77.60
|
15.0%
|
Google
|
GOOG
|
$586.08
|
15.0%
|
Intel
|
INTC
|
$ 35.00
|
10.0%
|
Microsoft
|
MSTF
|
$ 45.91
|
10.0%
|
100.0%
| |||
UK
| |||
HSBC
|
HSBA.L
|
$760.00
|
30.0%
|
BP
|
BP.L
|
$445.00
|
30.0%
|
Prudential Plc
|
PRU.L
|
$952.00
|
20.0%
|
Lloyds Banking
|
LLOY.L
|
$ 54.63
|
20.0%
|
100.0%
| |||
German XETRA
| |||
Bayer AG
|
BAYN.DE
|
$ 69.29
|
45.0%
|
Deutsche Bank AG
|
DBK.DE
|
$ 36.10
|
45.0%
|
Commerzbank
|
CBK.DE
|
$ 1.53
|
10.0%
|
100.0%
| |||
Portfolio B
If a portfolio has an investment mandate of 50% US and 50% UK stocks with 2% cash holdings, you need to compute the resulting allocation as follows:
Effective Allocation
| |
US
|
49.00%
|
UK
|
49.00%
|
Cash
|
2.00%
|
100.00%
| |
The formula for effective allocation is: US/UK Allocation * (1 – Cash) = 0.5 * 0.98 = 49%
The allocation for each individual country would be:
US
| ||||
Stock
|
Quote
|
Price
|
%
|
New %
|
Amazon
|
AMZN
|
$ 258.70
|
20.0%
|
9.800%
|
Apple
|
APPL
|
$ 467.90
|
30.0%
|
14.700%
|
Facebook
|
FB
|
$ 27.37
|
15.0%
|
7.350%
|
Google
|
GOOG
|
$ 780.70
|
15.0%
|
7.350%
|
Intel
|
INTC
|
$ 21.19
|
10.0%
|
4.900%
|
Microsoft
|
MSTF
|
$ 27.88
|
10.0%
|
4.900%
|
100.0%
|
49.000%
| |||
UK
| ||||
HSBC
|
HSBA.L
|
$ 660.40
|
30.0%
|
14.700%
|
BP
|
BP.L
|
$ 466.80
|
30.0%
|
14.700%
|
Prudential Plc
|
PRU.L
|
$ 1422.00
|
20.0%
|
9.800%
|
Lloyds Banking
|
LLOY.L
|
$ 74.00
|
20.0%
|
9.800%
|
100.0%
|
49.000%
|
The formula for effective allocation of each individual stock is: Amazon Stock Allocation * US/UK Effective Allocation = 20% * 49% = 9.8%
Portfolio C
Let’s consider another portfolio (Portfolio C) which has an investment mandate of 50% US and 50% Europe with cash of 1%. In this case the fund manager has the sole discretion of allocating 60% UK and 40% XETRA (German market).
Effective Allocation
| |
US
|
49.50%
|
UK
|
29.70%
|
XETRA
|
19.80%
|
Cash
|
1.00%
|
100.00%
| |
The formula for US stocks is:
Effective allocation US = US Allocation(%) * (1 – Cash(%)) = 0.5 * 0.99 = 49.5%
The formula for European stocks is:
Effective allocation UK = UK Allocation(%) * [Europe Allocation(%) * (1 – Cash (%))] = 0.6 * (0.5 * 0.99) = 29.70%
Effective allocation XETRA = XETRA Allocation(%) * [Europe Allocation(%) * (1 – Cash (%))] = 0.4 * (0.5 * 0.99) = 19.80%
| US | Quote | Price |
%
|
New %
|
| Amazon | AMZN | $ 346.38 |
20.0%
|
9.900% |
| Apple | APPL | $ 98.97 |
30.0%
|
14.850% |
| FB | $ 77.60 |
15.0%
|
7.425% | |
| GOOG | $ 586.08 |
15.0%
|
7.425% | |
| Intel | INTC | $ 35.00 |
10.0%
|
4.950% |
| Microsoft | MSTF | $ 45.91 |
10.0%
|
4.950% |
100.0%
|
49.500% | |||
| UK | ||||
| HSBC | HSBA.L | $ 660.40 |
30.0%
|
8.910% |
| BP | BP.L | $ 466.80 |
30.0%
|
8.910% |
| Prudential Plc | PRU.L | $1,422.00 |
20.0%
|
5.940% |
| Lloyds Banking | LLOY.L | $ 74.00 |
20.0%
|
5.940% |
100.0%
|
29.700% | |||
| German XETRA | ||||
| Bayer AG | BAYN.DE | $ 105.60 |
45.0%
|
8.910% |
| Deutsche Bank AG | DBK.DE | $ 27.05 |
45.0%
|
8.910% |
| Commerzbank | CBK.DE | $ 12.67 |
10.0%
|
1.980% |
100.0%
|
19.800% |
The formula for effective allocation of each individual stock is: Stock Allocation * Effective Allocation .
For multiple market allocation, fund managers will focus on asset allocation within a country and they will allocation funds between countries if they have the discretion to do so like in Portfolio C. After which the computation of the exact allocation is depend on the system and fund management support staff.
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