Reading 44: Basics of Portfolio Planning and Construction (Investment'…
Reading 44: Basics of Portfolio Planning and Construction
Investment Policy Statement (IPS)
to ensure that goals are realistic by requiring investors to articulate their circumstances, objectives and constraints
Is a plan for achieving investment success
Describe the client
Statement of Purpose
Statement of Duties and Responsibilities
of the client, the asset custodian and the investment manager
Related to keeping the IPS updated and responding to unforeseen event
Client's investment needs, specified in term of required return and risk tolerance
Factor that may hinder the ability to meet investment objectives, typically categorized as the time horizon, taxes, liquidity, legal and regulatory, and unique needs.
For example, whether leverage, derivatives or specific kinds of assets are allowed.
Evaluation and Review
Related to feedback on investment results.
May specify the portfolio's strategic assets allocation (policy portfolio) or the portfolio's rebalancing policy.
Risk and Return Objectives
are specifications for portfolios risk, that are developed to embody a client's risk tolerance.
Can be either absolute or relative.
are typically based on investor's desire to meet a future financial goal, such as a particular level of income in retirement
Can be absolute or relative
maybe hindered by the risk objectives
Willingness vs. Capacity to take risk
Willingness to take risk
is related to investor's psychological factors, such as personality or financial knowledge level.
Capacity to take risk
depends on financial factors, such as wealth relative to liabilities, income stability, and time horizon.
investor's overall risk tolerance depends on both his ability to take risk and willingness to take risk.
The need to draw cash from the portfolio for anticipated or unexpected future spending needs.
High liquidity needs often means high portfolio allocation to bond and cash.
Often the period over which assets are accumulated and before withdrawals begin.
Risky or illiquid investments may be inappropriate for investor with short time-horizon
Concern the tax treatment of investor's various accounts, the relative tax treatment of capital gains and income and the investor's marginal tax bracket.
Legal and regulatory constraints
such as government's restriction on portfolio contents and law against insider trading.
Restrictions due to investor preferences (religious, ethical, etc.) or other factor not already considered.
is a group of securities with similar risk and performance characteristics
Examples: Equity, fixed income, cash, real estate,etc.
Portfolio Construction Principles
Strategic asset allocation
is a set of % allocation to various asset classes that is designed to meet the investor's objectives.
is developed by combining the objectives and constraints in the IPS with the performance expectation of various asset class
provides the basic structure of portfolios
Tactical asset allocation
refers to an allocation that deviates from the Strategic allocation
in order to profit from a forecast or shorter-term opportunities in specific asset classes.