Module: ACFI7015: Research Project

Dissertation title: The Impact of Gold Allocation on Institutional Portfolio Performance

Dissertation topic: Portfolio theory

I. Introduction.

In these latter days gold is undeniably gaining popularity among institutional portfolio
managers as an asset that in an era of ultra-low interest rates could deliver much higher
yield than bonds while serving as a hedging tool that could be applied to well diversify
institutional portfolio in a turbulent stock market (Sanderson, 2018). Conforming to the
influential research by Jaffe (1989), including a certain amount of gold in portfolios can
increase average return and reduce standard deviation. Nonetheless, Warren Buffett
declares that gold has no place in a modern portfolio. The purpose of the dissertation is to
critically test whether the Jaffe’s (1989) statement holds in recent times with the view to
make contribution in creating a portfolio, which can lead to maximum return with possible
minimum market risk, particularly for the UK based portfolio managers.

II. Aims and Objectives.

Aim: The aim of the dissertation is to answer the question on whether institutional investors
should include gold to enhance the portfolio. In case of positive justification, what specific
amount and investment ways are the most preferable in the recent UK economic condition
that faces exit from the European Union. The paper would deal with portfolios of UK
background as the majority of previous studies are USA based and also due to availability of
data.
Objectives:

1. Critically evaluate and contrast past papers on portfolio diversification with gold to
reveal and trace the pattern;
2. Identify whether gold is a defensive asset through correlational analysis;
3. Reasonably construct and evaluate various risk profile portfolios with specific gold
allocation;
4. Critically examine the performance of the portfolios by analysing performance of LSE
listed stocks, UK gilts over the last 20 years (1987-2017);
5. Formulate recommendations for investors on including gold as a part of portfolio.

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 III. Literature Review.

To date there has been little agreement among investors on whether they should have an
allocation to gold in a portfolio at all, and if they do, what percentage of it should account for.
Traditionally, the gold was an inflation hedge and also believed to be high liquid safe heaven
asset due to it is low correlation to stocks and bonds (Draper et al., 2006; Smirnova, 2016).
During the global financial downturn of 2007, gold has demonstrated intense increase in
value while bonds and stocks exhibited the opposite (Hoang et al., 2015). However,
sometimes gold demonstrates relatively high volatility and behave as a risky asset which
indeed doesn’t pay dividends (Baur and McDermott, 2016). The conventional wisdoms
presented thus far supports the idea that it is not always apparent how best to get exposure
from gold as it displays different outcome characteristics over various timescales

There are many studies conducted to analyse gold performance in portfolios. One of the
most influential research was executed by Jaffe (1989) who analysed the gold allocation for
various types of portfolio. Jaffe (1989) found that including a small amount of gold is always
beneficial for the portfolio at least for the considered time period of 16 years from 1971
(when the USA ended convertibility of dollars in gold) until 1987. The more recent research
was presented by Emmrich and McGroarty (2013) who updated and extended the study of
Jaffe (1989). To compare with Jaffe (1989), Emmrich and McGroarty (2013) study covers
30-year period between 1981 and 2011. They divide data into several periods to explore
how gold affects portfolios under specific economic conditions. Moreover, authors examine
the attractiveness of number of recent developed gold investment instruments as gold
exchange traded funds under these different conditions using a variety of methods. Similarly
to Jaffe (1989) statement, the authors have concluded that international portfolio managers
should include gold in a portfolio, specifically 10% of gold allocation is the best of
alternatives.

IV. Research method.

Data collection method: Secondary data will be obtained from DataStream, report and
publications of institutions (ThomsonOne, Bloomberg, etc.)

Firstly, research philosophy of the dissertation is positivism as it strives to test existing theory
(gold is an applicable defensive asset for portfolio diversification) during the research
process by using quantitative methods. Secondly, the research is deductive/experimental
research as it would start with theory followed by theory appliance to the UK based portfolio

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over the twenty years. The conclusions would be compiled based on the theory. In other
word, existing theory will be analysed, hypotheses will be developed and tested during the
research process. Thirdly, time horizon of the study is longitudinal as research aims to
conduct several observations of gold in portfolios over twenty years. The time horizon of
twenty years was selected due to the reason that in last twenty years financial and economic
conditions were volatile enough to trace dependence between gold performance and
financial conditions.

Experimental research strategy:

The secondary data of below indexes will be collected for correlational analysis to reveal
defensive characteristic of gold. Afterwards, four portfolios will be constructed with various
gold allocation in order to compare their performances and to show whether the asset
allocation of gold produces positive or negative effect on the performance of portfolio.
Following Jaffe (1989), an institutional investment portfolio would include different types of
investments including common stocks represented by FTSE 250 and FTSE Small Cap
indexes, UK sovereign bonds will be expressed by 10 years gilts, stocks of developed
countries by MSCI EAFE index. Gold will be represented by gold bullions and mix (gold
bullion, ETF, gold stocks) which will be examined separately.

Table 1. Data to be obtained for correlational analysis and portfolio performance evaluation. All
data would be collected from ThomsonOne or Bloomberg Terminal to which author has access .

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Table 2. Portfolios with various risk appetite to be constructed to evaluate gold allocation effect.

Portfolio Common stocks Small stocks EAFE Gov. bond Gold bullion only Mix (5%, 10%, and 15%)
1 55% x x x 5%, 10%,15%
2 50% x x x 5%, 10%,15%
Gold bullion, ETF, Gold stocks
3 40% x x x 5%, 10%,15%
4 35% x x x 5%, 10%,15%

Note: All tables are in photo format so word count is not used up.

Data analytical techniques for evaluation of impact of gold allocation on portfolio

performance:

 Monthly average arithmetic and  Monthly standard deviation/beta of

geometric mean of assets; chosen assets;
 CAPM and other alternative models will  Correlational analysis of gold with
be used in order to obtain values of different asset classes over the last 20
betas; years;
 Sharpe ratio;  Jensen’s measure in order to assess
 Treynor’s measure; the possible effectiveness and impact of
the portfolios.

Quality and ethical considerations for experimental research strategy:

The high control over the data can lead to manipulation of them to confirm well established
belief by the analyst. Therefore, the author of the dissertation would strive to be maximally
objective to the data analysis. Due to the reason that testing the theory by quantitative
methods can take a long amount of time and might cause emergence of human error which
will destroy the validity of the research, the author will seek to perform dependable
dissertation which would allow other researches to test over again.

Limitation:

Considering time constraints for the research, the main limitation is related to time horizon of
the study as analysis of 20 years data might not determine the full picture of gold impact on

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portfolio. To add, analysis would be more valuable if mixed method research is included as
interview with institutional portfolio managers on impact of gold allocation on portfolio.

V. Timetable.

Introduction of the dissertation would be conducted at the beginning to keep in mind what
are the purpose and aims of the dissertation. The introduction part will be edited in August to
briefly introduce the findings. Literature review will take longer times as papers already
analysed would be critically reviewed. Research methodology is planned to be the most time
consuming due to data collection, portfolio construction and data analysing. Provided more
spare time, data analysing will last 3 months in summer. Discussion part will last 2 months
as an adequate amount of time needed to conclude results from varied point of view. First
draft will be conducted in July for a broad discussion with supervisor. The second draft and
recommendations the will be given in August. The whole September would be allocated for
only editing and proof-read.

Chart 1. Timescale of the dissertation.

Tasks February March April May June July August September

Introduction
Literature review
Research methodology
Data collection
Portfolio construction
Data analysing
Discussion of findings
Draft
Recommendations/conclusion
Further draft
Proof-read

VI. References.

Baur, D. and McDermott, T. (2016) ‘Why is gold a safe haven?’, Journal of Behavioral and
Experimental Finance, 10, pp.63-71.

Draper, P. et al. (2006) ‘Do precious metals shine? An investment perspective’, Financial
Analysts Journal, 62(2), pp.98-106.

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Emmrich, O. and McGroarty, F. (2013) ‘Should gold be included in institutional investment
portfolios?’, Applied Financial Economics, 23(19), p.1553-1565.

Hoang, T. et al. (2015) ‘Is gold good for portfolio diversification? A stochastic dominance
analysis of the Paris stock exchange’, International Review of Financial Analysis, 42, pp.98-
108.

Jaffe, J. (1989) ‘Gold and gold stocks as investments for institutional portfolios’, Financial
Analysts Journal, 45(2), pp.53-59.

Lu, J. and Chan, C. (2014) ‘Optimal portfolio choice of gold assets in

the differential market and differential game structures’, Review of Quantitative Finance and
Accounting, 42(2), pp.309-325.

Sanderson, H. (2018) ‘Gold rallies to highest level in more than 3 months’, Financial Times,
3 January. Available at: https://www.ft.com/content/e4d43b72-f082-11e7-b220-
857e26d1aca4 (Accessed: 14 January 2018).

Smirnova, E. (2016) ‘Use of gold in financial risk hedge’, Quarterly Journal of Finance and
Accounting, 54(1/2), pp.69-100.

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