Harvard Case - Leland O'Brien Rubinstein Associates, Inc.: Portfolio Insurance
"Leland O'Brien Rubinstein Associates, Inc.: Portfolio Insurance" Harvard business case study is written by er Tufano, Barbara B. Kyrillos. It deals with the challenges in the field of Finance. The case study is 23 page(s) long and it was first published on : Feb 9, 1994
At Fern Fort University, we recommend that Leland O'Brien Rubinstein Associates, Inc. (LOR) adopt a strategy of portfolio insurance to manage the risk of their clients' portfolios. This strategy involves using financial derivatives, specifically options, to create a hedge against potential market downturns. By implementing this strategy, LOR can provide their clients with a more stable and predictable return on their investments, ultimately enhancing their financial well-being and risk management capabilities.
2. Background
Leland O'Brien Rubinstein Associates, Inc. (LOR) is an investment management firm specializing in providing investment advice and managing portfolios for high-net-worth individuals and institutions. In 1987, LOR faced a significant challenge as the stock market experienced a sharp decline, leading to substantial losses for their clients. This event prompted LOR to explore new strategies to protect their clients' investments from similar market volatility in the future.
The main protagonists of the case are:
- Leland O'Brien: Founder and CEO of LOR, who is responsible for the firm's overall strategy and direction.
- Rubinstein: A partner at LOR who is responsible for developing and implementing investment strategies.
- The clients: High-net-worth individuals and institutions who rely on LOR for investment advice and portfolio management.
3. Analysis of the Case Study
The case study highlights the increasing need for risk management in the investment industry. The 1987 market crash demonstrated the vulnerability of traditional investment strategies to sudden market downturns. To address this challenge, LOR explored the concept of portfolio insurance.
Portfolio insurance utilizes financial derivatives, specifically options, to create a hedge against market losses. By selling call options and buying put options, investors can create a strategy that limits potential losses while preserving potential upside gains. This approach allows investors to maintain exposure to the market while mitigating the risk of significant losses during market downturns.
Financial analysis of the case reveals that LOR's clients were primarily concerned with preserving capital and achieving consistent returns. Portfolio insurance offered a potential solution by providing a defined downside risk while still allowing for potential upside gains.
Key considerations for LOR in implementing portfolio insurance include:
- Cost of the strategy: Implementing portfolio insurance involves the purchase of options, which can be expensive.
- Complexity of the strategy: Portfolio insurance requires a deep understanding of financial derivatives and their application in portfolio management.
- Potential for losses: While portfolio insurance aims to limit losses, it does not guarantee against them.
4. Recommendations
To effectively implement portfolio insurance, LOR should take the following steps:
- Educate clients: LOR should provide comprehensive education to their clients about portfolio insurance, explaining its benefits, risks, and potential limitations.
- Develop a robust risk management framework: LOR should establish a thorough risk management framework that includes clear guidelines for selecting and managing options strategies.
- Partner with specialists: LOR should consider partnering with specialized financial institutions or consultants with expertise in options trading and portfolio insurance.
- Monitor and adjust: LOR should continuously monitor the performance of portfolio insurance strategies and make adjustments as needed based on market conditions and client objectives.
5. Basis of Recommendations
The recommendations are based on the following considerations:
- Core competencies and consistency with mission: Portfolio insurance aligns with LOR's core competency in investment management and its mission to provide clients with sound financial advice and risk management solutions.
- External customers and internal clients: Portfolio insurance addresses the needs of LOR's clients who seek to protect their investments from market volatility.
- Competitors: Implementing portfolio insurance positions LOR as a leader in the industry, offering a differentiated service to clients compared to competitors.
- Attractiveness ' quantitative measures: The attractiveness of portfolio insurance can be measured through risk-adjusted returns, volatility reduction, and potential for capital preservation.
6. Conclusion
By adopting a portfolio insurance strategy, LOR can enhance its risk management capabilities, provide clients with more stable and predictable returns, and solidify its position as a leading investment management firm. This approach aligns with the evolving needs of high-net-worth individuals and institutions who seek to navigate the complexities of the financial markets while protecting their investments.
7. Discussion
Other alternatives:
- Traditional asset allocation: LOR could continue to rely on traditional asset allocation strategies, but this approach does not provide specific protection against market downturns.
- Passive investing: LOR could recommend passive investing strategies, such as index funds, which offer diversification but may not provide the same level of risk management as portfolio insurance.
Risks and key assumptions:
- Market volatility: The effectiveness of portfolio insurance depends on the level of market volatility. In highly volatile markets, the cost of options may be higher, and the strategy may not be as effective.
- Options pricing: The pricing of options can be complex and subject to fluctuations. LOR must have a deep understanding of options pricing models and the factors that influence them.
- Liquidity: The liquidity of options can vary depending on the underlying asset and market conditions. LOR must ensure that they can readily buy and sell options as needed.
8. Next Steps
To implement the recommended portfolio insurance strategy, LOR should take the following steps:
- Within 3 months: Develop a comprehensive educational program for clients about portfolio insurance.
- Within 6 months: Establish a robust risk management framework for options trading and portfolio insurance.
- Within 9 months: Partner with specialized financial institutions or consultants to provide expertise in options trading and portfolio insurance.
- Ongoing: Continuously monitor the performance of portfolio insurance strategies and make adjustments as needed.
By taking these steps, LOR can effectively implement portfolio insurance and enhance its ability to manage risk and deliver value to its clients.
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Case Description
Leland O'Brien Rubinstein Associates, a small financial advisory firm founded in 1980, has created a successful business by selling a product commonly known as portfolio insurance. Portfolio insurance is a trading strategy that institutional investors use to establish a floor on the value of their equity portfolios, by essentially manufacturing a put option on a broad market index. The crash of 1987 highlights the flaws of this manufacturing process and forces principals of LOR to consider what to do next.
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