Question

A study recently published by UBS indicates that for the second half of 2023 the situation remains very uncertain for Europe as a consequence of the Russia-Ukraine war. They project two scenarios: Recovery with 30% probability and Depression with 70% probability of occurrence. They recommend investing in the Technology Economy, always picking the disruptors and avoiding the laggards. They propose two ETFs, one related to Automation and the other to Education and estimate the expected returns for each of the scenarios proposed. -ETF Automation: Expected return of 10.80% in Recovery and 4.22% in Depression. -EFT Education: Expected return of -2.75% in Recovery and 13.98% in Depression. You consider that the study is accurate and decide, at first, to build a portfolio with these two assets by investing 80% in ETF Automation and 20% in ETF Education. Evaluate your initial decision and determine if there is a better alternative.

Answer 1

By investing 80% in ETF Automation and 20% in EFT Education, we calculate the expected returns for each scenario and find that a diversified portfolio might hedge against risks. However, a reevaluation of the portfolio allocation is advised, considering the higher probability of a Depression.

Step-by-step explanation:

A study by UBS indicates that the situation for Europe in the second half of 2023 is uncertain due to the Russia-Ukraine war. They have provided projections under two scenarios: Recovery and Depression, with a higher likelihood estimated for the latter.

If we consider investing 80% in an ETF Automation with expected returns of 10.80% in Recovery and 4.22% in Depression, and 20% in EFT Education with expected returns of -2.75% in Recovery and 13.98% in Depression, we can calculate the expected returns for the portfolio under both scenarios.

Expected Portfolio Return in Recovery Scenario = (0.8 × 10.80%) + (0.2 × -2.75%) = 8.26%

Expected Portfolio Return in Depression Scenario = (0.8 × 4.22%) + (0.2 × 13.98%) = 5.912%

Taking the probability of each scenario into account, we can calculate the weighted expected return of the portfolio: (8.26% × 30%) + (5.912% × 70%) = 6.3972%. Given that the probability of a Depression is higher, this diversified portfolio strategy might be beneficial to hedge against downside risk.

However, it's always recommended to perform due diligence and to evaluate if a more balanced allocation or different assets altogether might be better in your investment strategy, possibly increasing the weight of the ETF with better performance in the depression scenario if it aligns with your risk tolerance and investment goals.