Statement of Problem
Partners Healthcare had established several financial resources pools, such as the short-term pool (STP) and the LTP, so that they can satisfy different needs of the several hospitals in the network. In more detail, the STP was invested with very high-quality, short-term fixed-income financial instruments. The average maturity of these instruments is about one to two years. STP is always treated as the risk-free part of the hospitals’ holdings. On the other hand, the LTP is thought as the risky part of holdings. It consists of different forms of equity and a smaller fixed-income part.

In order to diversify the risks of the LTP, the Partners Investment Committee introduced a new type of assets, real assets, into …show more content…

It produces the lowest risk of 8.49%, comparing to original portfolio of 9.94%, REITs only portfolio of 9.69% and Commodities only portfolio of 8.49%. This is the basic concept of diversification, which means that the more assets with less correlation are introduced to the portfolio; the less risky the portfolio will be for any achievable rate of return. [1]

For the overall portfolio, each hospital can allocate between the STP and the LTP. In fact, they can always construct the most efficient portfolio for their acceptable risk level with combination of LTP, which holds the risky assets, and STP, which holds the risk-free asset according to The One-Fund Theorem. [2] For example, if the shareholders want a total return of X, with a 3.2% return of STP and a 10% return of LTP, the proportion of STP and LTP can be obtained through
X= w(0.032) + (1-w)(0.10)
And it is guaranteed to be the optimal portfolio.

Even though Mean-Variance theory can allocate the most optimal portfolio, there are several flaws with its assumptions. First of all, it assumes that assets returns are normally distributed. However, often times, it’s observed that asset returns are more like to be fat-tailed distribution, [3] instead of having thin tails like normal distribution. Second of all, it assumes there is a