Ch.4 The Portfolio Management Process

Question 1

What is the portfolio management process?

Answer 1

It is an integrated, continuous process designed to meet specific client goals and objectives within a set of constraints. The seven key steps are:

1. Determine investment objectives and constraints.
2. Create an investment policy statement
3. Establish an asset allocation strategy.
4. Select securities
5. Monitor the client and the markets
6. Evaluate the portfolios performance
7. Rebalance.

Question 2

How do you determine a client’s investment objective?

Answer 2

Investment objectives describe what the client is trying to achieve with the portfolio. They are expressed in terms of return and risk.

• The return objective states the annual return needed to meet the client’s goals
• The risk objective defines the amount of risk the client can tolerate to meet the return objective. A clients risk objective is a function of his or her risk tolerance, which in turn depends on their willingness and ability to bear risk in the portfolio.

Question 3

What is an investment constraint?

Answer 3

Time horizon, liquidity requirements, tax situation, legal and regulatory requirements, and any unique circumstances. These constraints help define not only the return and risk objectives, but also the securities in which the client can and cannot invest.

Question 4

What is an IPS?

Answer 4

Lays out several key points in a formalized manner. The first point is a summary of the KYC information gathered during an advisor’s meeting. The summary also highlights any other information about the client that may have an effect of how the portfolio is handled.

The IPS acts as the roadmap for achieving the client’s investment objectives. It includes recommendations for an appropriate asset allocation, a suitable investment strategy (active, passive) and possibly an investment style or philosophy (growth/value, interest rate anticipation). I{S also identifies specific investment restrictions.

Question 5

Asset Allocation

Answer 5

determines what proportion of a portfolio should be invested in each asset class. An asset classs is a group of assets with return and risk characteristics that differ from those of other types of assets, or with a particular structure that distinguishes the class from other groups of assets.

Question 6

What are the three components of an asset allocation strategy?

Answer 6

1. Strategic asset allocation
2. Tactical asset allocation
3. Rebalancing

Question 7

Strategic Asset Allocation

Answer 7

refers to the benchmark asset mix designed to achieve a client’s long term goals and objectives

Question 8

Tactical Asset Allocation

Answer 8

refers to decisions by an advisor and his or her client to alter a portfolios SAA to take advantage of perceived opportunities creates by short-term fluctuations in the relative performance of asset classes.

Question 9

Rebalancing

Answer 9

involves reallocating assets to maintain the SAA.

Question 10

Active vs passive strategies

Answer 10

Active strategies attempt to outperform a benchmark by overweighting or underweighting certain market sectors, while passive strategies attempt to match the performance of a benchmark asset mix.

Question 11

Asset allocation should vary by accumulation stage. There are four accumulation stages:

Answer 11

1. The seed-money formation stage
2. The mid-life growth stage
3. The pre-retirement consolidation stage
4. The retirement stage

Question 12

The seed-money formation stage

Answer 12

Usually occurs between the ages of 20 and 40. The objective is to accumulate sufficed seed money to create a base for future growth. This is the client’s most important, yet most vulnerable, stage.

An advisor should consider the seed-money formation stage complete when the client has saved twice his or her estimated annual post-retirement withdrawals.

A client Savings may be small, but from his or her perspective, these savings represent all of the money they have saved in their lifetime. Clients at this stage tend to perceive any loss of seed money as significant.

Question 13

What is a stepping asset allocation strategy?

Answer 13

It reduces the risk of emotional decision making during the early part of the seed money formation stage.

1. Determine the client’s long term asset allocation (use 70/30 split for example)
2. Open the clients account with a 30/70 split. Keep this asset mix for four years.
3. After four years, increase the equity allocation to 50% (halfway between 30% and 70%). Maintain this 50/50 mix for the next four years
4. After eight years, set the asset allocation to the 70/30 long term mix.

Question 14

The Mid-Life Growth Stage

Answer 14

• generally occurs between the ages of 35 and 60.
• They have a good idea what is going on in life. Once children finish their higher education, there is generally more money available for investments.
• The mid life growth stage is complete when the portfolio value is 20 times the estimated annual post retirement withdrawals from the portfolio. -During the pre-retirement consolidation stage, the primary goal is to preserve funds. Possible growth is secondary. The equity portfolio of the portfolio should be the lower of 50% or the optimum asset mix during the mid-life growth stage.

Question 15

Pre-Retirement Consolidation Stage

Answer 15

-Usually occurs between the ages of 55 and 70. Most of the capital formation, whether it is an investment portfolio, real estate, or a business, is completed during this stage.