Answer Happy

QUESTION You are due to meet with a potential new client, Mrs Yorkie, who will shortly turn 30 years old. She has recently opened a self-invested personal pension (SIPP), is intending to contribute £6,000 per annum to it (in nominal terms and starting on her 30th birthday) and wishes to receive an annual pension of £20,000 (in real terms) from it when she retires. You have ascertained that she pays income tax at the higher rate of 40%, that inflation is expected to be 1.5% per annum and that current annuity rates are: Retirement age Annuity rate 65 4.2% 60 4.0% 55 3.8% You have already decided that you will advise Mrs Yorkie to invest her SIPP portfolio in a FTSE All-Share equity index tracker fund and one of the gilts shown in the table below. Gilt Maturity Date 4% Treasury 2047 14 July 2047 1.6% Treasury 2052 14 April 2052 3% Treasury 2057 14" February 2057 Market price per £100 nominal £144.90 £91.40 £120.70 Each gilt pays interest on a semi-annual basis, is redeemable at its nominal value of £100 and it is your intention to advise Mrs Yorkie to undertake cash matching. The equity index tracker fund has a tracking error of 0.56% and long run historic total nominal return from UK equities is 8.1%. You are also of the opinion that low risk investors should not hold more than 50% of their portfolios in equity but that this can be increased to 75% for medium risk investors. Required: a) Calculate the expected return of the equity index tracker fund and explain what is meant by tracking error to Mrs Yorkie. (8 marks)