10. The principles of investment planning

Question 1

What is the theoretical approach (MPT) to asset allocation?

Answer 1

It uses mathematical analysis and techniques with the aim of obtaining the desired risk–return trade-off.

Question 2

Under the theoretical approach the returns and volatility of a portfolio will depend not just on volatility and return rates but on the ___ between assets.

Answer 2

correlation

Question 3

What is the pragmatic approach to asset allocation

Answer 3

Pragmatists use forward-looking judgements of likely returns & volatility to determine portfolio weightings.

Question 4

Criticism of MPT is that probabilistic techniques work well in ___ but not so well in ___.

Answer 4

• normal conditions
• crises.

Question 5

What is stochastic modelling?

Answer 5

It applies a mathematical technique to generate 1,000s of scenarios based on numerous assumptions.

Question 6

What is a risk with using stochastic modelling?

Answer 6

Very sensitive to changes in assumptions. Often a very small change in 1 assumption can result in a large change in the output.

Question 7

Strategic asset allocation is for the ___ and is generally quite ___.

Answer 7

• long term
• static, only being adjusted if significant change to client requirements/circumstances.

Question 8

Tactical asset allocation is for the ___ and is generally quite ___.

Answer 8

• short term
• fluid.

Question 9

To create an appropriate portfolio, the adviser needs to understand what 4 things?

Answer 9

• Client’s risk tolerance.
• Capacity for loss.
• Time horizons.
• Annualised target returns.

Question 10

~ reduces capacity for loss, while a ~ timescale may increase it.

Answer 10

• Vulnerability
• longer

Question 11

What are the 3 stages of top-down portfolio construction?

Answer 11

1. Asset allocation across region.
2. Choose sector weightings.
3. Select stocks.

Question 12

Bottom-up investment management method of portfolio construction select ~ purely on the basis of their own ~ which often reflects the style/approach of the fund manager.

Answer 12

• stocks
• criteria

Question 13

Name 4 fund management styles.

Answer 13

• Value
• GAARP
• Momentum
• Contrarianism

Question 14

Value investing involves identifying ___.

Answer 14

• businesses whose value is greater than the price placed on them by the market.

Question 15

GAARP investing involves ___.

Answer 15

• finding companies with LT sustainable advantage.

Question 16

Contrarian style investing is most commonly found in ___.

Answer 16

• hedge fund managers.

Question 17

Structured products typically limit the ~~of equity investment in return for a lock-in period of up to ~~.

Answer 17

• capital risk
• 6 years.

Question 18

Managers use ~ to secure the returns, so all structured products involve ~ risk.

Answer 18

• derivatives
• counterparty

Question 19

Structured products ‘hard protection’ is where __ .

Answer 19

a given return is guaranteed.

Question 20

Structured products ‘soft protection’ is where ___.

Answer 20

• investors capital is at risk if a threshold is breached.