PM: Portfolio Planning and Construction

Question 1

A written investment policy statement will…

Answer 1

include

• description of client circumstances and investment objectives
• statement of the purpose of the IPS
• statement of duties and responsibilities or parties involved
• procedures for updating IPS
• Investment objectives derived from client communications
• Investment constraints to be considered
• Investment Guidelines re execution, asset types and leverage
• Evaluation of performance - benchmark and required info
• Appendices - including specifics re strategic asset allocation, deviations and rebalancing

Question 2

Risk Return Objectives =

Peer performance benchmarks

Answer 2

can be RELATIVE (to the benchmark) or ABSOLUTE (target percentage return, dollar value return. real or nominal return)

re relative objectives: a peer performance benchmark, ie another endowment, suffers from not being INVESTABLE.

Question 3

ABILITY vs WILLINGNESS to take risk =

Answer 3

self explanatory.

willingess = attitudes and beliefs about investment types

note, if the client is willing but does not have the ability to take risk (long investment horizon/wealth/loss insurance/secure job) the low ability will prevail in an advisor’s assessment.

in the opposite circumstance, an advisor will educate the client but it is not his role to make the client more willing to take risk

Question 4

Portfolio Construction: KEY POINTS =

R-R-T-T-L-L-U

Answer 4

Risk

Return

Time horizon

Tax situation

Liquidity

Legal restrictions

Unique circumstances

Question 5

Asset classes & asset allocation =

Answer 5

Post IPS construction: A STRATEGIC ASSET ALLOCATION is constructed, with % for each asset class.

assets within an asset class should be CLOSELY CORRELATED

Question 6

IPS, SAA, Efficient Frontier =

Answer 6

once the investable asset classes are established (incl risk, return, correlations) the PM can create AN EFFICIENT FRONTIER OF PORTFOLIOS and can identify the best portfolio based on the risk return objectives of the IPS.

Question 7

Active vs Passive, tactical allocations, security selection =

Answer 7

deviations from the strategic asset allocation will be part of an ACTIVE STRATEGY.

short term deviations from asset allocation weights are TACTICAL

SECURITY SELECTION refers to deviation from index weights on individual securities (over/underweighting a security or asset class vs bm) - for hedge funds and other non benchmarked asset classes SECURITY SELECTION is NECESSARY (there is no passive option)

Question 8

Risk Budgeting =

Answer 8

an overall limit of risk,

budgeting portions to

a) systematic risk of the strategic asset allocation
b) risk from tactical asset allocation
c) risk from security selection

Question 9

Active manager issues x2 =

Answer 9

if there are other managers actively managing for the client, active positions in both accounts may net out (one o/w and the other u/w a sector) and the risk budget will be under utilized

if all managers are actively managing there may be excessive trading overall - leading to potential higher costs/capital gains taxes compared to an overall efficient tax strategy.

Question 10

Core-satellite approach =

Answer 10

majority of a portfolio is passive

smaller portion is active