Chapter 16: The Portfolio Management Process Flashcards
Many clients want assurance that their initial capital investment will largely remain intact. We must assess risk tolerance, and sometimes choose to have a lower return in exchange for safer assets
Safety of income
Regular series of cash flows received from debt and equity securities, such as through dividends, interest, or other forms. Investors usually give up some safety in order to have a higher income from their portfolio
Income
Also referred to as capital gains, which is the profit generated when securities are sold for more than they originally cost to purchase. When capital gains are the focus, the emphasis is on security selection and market timing
Growth
Best safety, very steady income, very limited growth
Short-term bonds
very good safety, very steady income, variable growth
long-term bonds
good safety, steady income, variable growth
preferred shares
least safety, variable income, often the most growth
common shares
Cash/cash equivalent with lowest risk, highest quality
Government Issues (<1 year)
Cash/cash equivalent with highest risk, lowest quality
Corporate issues (<1 year)
Fixed income security with low risk and low price volatility
short term (1 - 5 years)
fixed income security with medium risk and medium price volatility
medium term (5-10 years)
fixed income security with high risk and max price volatility
long term (>10 years)
Low risk; high capitalization; predictable earnings; high yield; high dividend payouts; lower price-to-earnings ratio; low price volatility
Conservative investments
Medium risk; average capitalization; potential for above average growth in earnings; aggressive management; lower dividend payout; higher price-to-earnings ratio; potentially higher price volatility
Growth investments
High risk; low capitalization; limited earnings record; no dividends; price-to-earnings ratio of little significance; short operating history; highly volatile
Venture investments
Maximum risk; shorter term; maximum price volatility; no earnings; no dividends; price-to-earnings ratio not significant
Speculative investments
The period spanning the present until the next major change in a client’s circumstances
Time horizon
Refers to the amount of cash in the portfolio. The cash component could be higher or lower depending on the market cycle
Liquidity requirements
The client’s marginal tax rate dictates the proportion of income the client should receive as interest income in relation to dividends. High tax rates can significantly erode the final return on the investments, such as GICs
Tax Requirements
Any investment that contravenes an act, law, bylaw, regulation, or rule is considered a constraint and must be dealt with. This includes insiders and staff of certain companies.
legal and regulatory requirements
Preferences for ethical investing could be constraints on the client’s portfolio, and should be considered
Unique Circumstances
Agreement between a portfolio manager and a client that provides investment guidelines for the manager
investment policy statement
Includes currency, money market securities, redeemable GICs, bonds with maturity of one year or less, and all other cash equivalents. Generally, 5% of a diversified portfolio, risk averse investors may hold up to 10%
Cash
Bonds due in more than one year, strip bonds, mortgage-backed securities, fixed-income exchange-traded funds, bond mutual funds, and preferred shares. Primarily used to produce income, but also provide some safety of principal, or used to generate capital gains.
Fixed income securities
Includes common shares, equity exchange-traded funds, equity mutual funds, convertible bonds/preferred shares. Purpose is to generate capital gains, either through trading or long-term growth in value
Equity Securities
Collectibles, such as art or coins, Commodities such as gold, Derivatives, Hedge funds, Precious metals, and real estate
other asset classes
Usually specified in the investment policy statement, Investors may have freedom to recommend an array of individual securities, but sometimes specific allocations are fixed.
Asset allocation
We must determine the appropriate balance among the selected asset classes by investigating the client’s full circumstances to determine an appropriate asset mix.
Strategic Asset Allocation
Asset classes will change in value along with fluctuations in the market, and dividends and interest income will flow into the cash component and the asset mix will change. Therefore we must always rebalance before things get too out of hand
Ongoing asset allocation
Technique that adjusts the asset mix to systematically rebalance the portfolio back into it’s long-term target or strategic asset mix
Dynamic asset allocation
When the investment policy statement indicates a particular long-run balance of equities to fixed income, but is not rigid. Allows to capitalize on investment opportunities in one asset class before reverting to the long-term strategic asset allocation
Tactical asset allocation
Step in which specific securities such as stocks, bonds, and managed products, are chosen for inclusion in the portfolio
Selecting securities
Stay informed about client’s objectives, update the profile regularly. Monitor changes in risk tolerance, need for liquidity, need for savings, and tax brackets
Client monitoring
Be constantly aware of the direction of monetary policy, forecasts for GDP growth and shifts, inflation, shifts in consumer demand and capital spending, and the potential impact of these factors on the individual holdings.
Monitoring the market
Include expected activity in the public and private sectors (nationally and internationally), government policies, corporate earnings, economic analysis, existing market conditions, and forecaster’s interpretations of data
Monitoring the economy
Success of the portfolio is determined by comparing the total rate of return of the portfolio under evaluation with average total return of comparable portfolios, in order for the client to compare against average portfolios.
evaluating portfolio performance
total return formula
Increase in market value / Beginning value * 100
sharpe ratio formula
Return of the portfolio - risk free rate / SD of portfolio
This is the process of reallocation assets back to their originally intended portfolio weights by selling securities that have performed will and buying others that have done poorly.
rebalance portfolio
