Portfolio perspective
tells us that our fundamental concern is to understand the risk and return in a portfolio context
Importance of the portfolio perspective
- Investors, analysts, and portfolio managers should analyze the risk-return tradeoff of the portfolio as a whole, not the risk-return tradeoff of the individual investments in the portfolio, because unsystematic risk can be diversified away by combining
Steps of the portfolio management process
(1) Planning
(2) Execution
(3) Feedback
Planning
consists of analyzing objectives and constraints, developing an IPS, determining the appropriate investment strategy, and selecting an appropriate asset allocation
Execution
relates to portfolio construction and revision
Feedback
consists of monitoring, rebalancing, and performance evaluation
Investment policy statement
is a written document providing guidelines for portfolio investment decision making
Investment policy statement [Purpose]
- Provides guidance for current and subsequent investment adviser decisions
- Promotes long-term discipline in investment decision making
- Protects against short-term shifts in strategy when either market conditions or portfolio
performance cause panic o
Investment policy statement [Components]
(1) a description of the client's situation
(2) the purpose, as well as identification, of responsibilities
(3) Formal statements of objectives and constraints
(4) a schedule for portfolio performance and IPS review
(5) Asset allocation ranges
(6) Guidanc
Strategic asset allocation
- The final step in the planning stage of the IPS
- This step combines the IPS and capital market expectations to formulate long-term target weightings for the asset classes to be included in the portfolio
Capital market expectations & the IPS influence on the strategic asset allocation decision
While the investment policy statement will outline the appropriate risk-return characteristics for an investment portfolio, the strategic asset allocation to provide these characteristics will depend on capital markets expectations (risk, returns, and cor
Investment time horizon influence on strategic asset allocation
Typically, a longer investment time horizon will lead investors to tolerate more portfolio risk and employ strategic asset allocations more heavily weighted toward asset classes with greater risk and greater expected returns, such as equities
Strategic asset allocation [Common approaches]
(1) Passive investment strategies
(2) Active investment strategies
(3) Semi-active, risk-controlled active, or enhanced index strategies
Investment objectives
- relate to what the investor wants to accomplish with the portfolio
- Objectives are mainly concerned with risk and return considerations
Return objectives
- can be classified as either a desired or a required return
- A desired return is that level of return stated by the client, indicating how much the investor wishes to receive from the portfolio
- A required return represents some level of return that mu
Risk objectives
- are those factors associated with an investor's willingness and ability to take risk
- Combining willingness and ability to accept risk is termed risk tolerance
- Risk aversion indicates an investor's inability and unwillingness to take risk
Willingness vs Ability to Take Risk
Factors that affect risk objectives
(1) Required spending needs
(2) Long-term wealth target
(3) Financial strength
(4) Liabilities
Required spending needs
How much variation in portfolio value can the investor tolerate before being inconvenienced in the short term
Long-term wealth target
How much variation in portfolio value can the investor tolerate before it jeopardizes meeting long-term wealth goals
Financial strength
Can the investor increase savings (or decrease expenditures) if the portfolio is insufficient to meet spending needs
Liabilities
Is the investor legally obligated to make future payments to beneficiaries, or does the investor have certain set spending requirements in retirement (i.e., pseudo liabilities)
Types of investment constraints
(1) Liquidity constraints
(2) Time horizon constraints
(3) Tax constraints
(4) Legal and regulatory factors
(5) Unique circumstances
Investor time horizons
- Investors may have short or long investment horizons, or some combination of the two when multiple investment goals are identified
- Investors with longer horizons (>10 years) have the ability, but not necessarily the willingness, to employ strategic as
Ethical conduct
- The investment professional who manages client portfolios well meets standards of competence and standards of conduct
- It is important to recognize that the portfolio manager, who is an expert in the field with presumably more knowledge of investment p