Investment Management Lvl 2 Flashcards
Types of portfolio management
- Active portfolio management:
Should produce higher returns. Stocks bought when undervalued and sold when overvalued - Passive portfolio management:
Aims to achieve long term growth while minimising risk - Discretionary portfolio management:
Client notes there financial goals and timeline. Leave to professionals to achieve - Non- discretionary portfolio management:
Client does not want to handover full control of portfolio. Professionals act as advisors
5 Basic principles of portfolio management
Align Your Portfolio With Your Strategy:
This means understanding your investment goals and risk tolerance, and then choosing investments that are likely to help you achieve those goals. For example, if you are young and have a long time horizon, you may be able to tolerate more risk in your portfolio than someone who is nearing retirement.
Diversification:
Don’t put all your eggs in one basket. This means investing in a variety of assets, such as stocks, bonds, and cash. Diversification can help to reduce the overall risk of your portfolio.
Avoid Emotional Investing:
Don’t let your emotions dictate your investment decisions. It’s important to stay calm and rational, even when the market is volatile.
Rebalance Regularly:
Your portfolio’s asset allocation will naturally drift over time as different asset classes perform differently. Rebalancing involves selling some of the assets that have outperformed and buying more of the ones that have underperformed, in order to bring your portfolio back into alignment with your target asset allocation.
Review and Update:
The financial world is constantly changing, so it’s important to review your portfolio regularly and make adjustments as needed. This may involve changing your asset allocation, adding or removing investments, or changing your investment strategy altogether.
Functions of Portfolio Management
Asset Allocation:
This is the foundation of portfolio management. It involves determining the mix of different asset classes (stocks, bonds, cash, etc.) to invest in based on your risk tolerance and investment goals. For example, someone with a high risk tolerance might allocate a larger portion of their portfolio to stocks, which have the potential for higher returns but also come with greater risk. Conversely, someone with a low risk tolerance might invest more heavily in bonds, which generally offer lower returns but are considered to be safer.
Security Selection:
Once you’ve determined your asset allocation, the next step is to choose individual investments within each asset class. This involves researching different investment options and selecting those that have the potential to meet your return objectives while aligning with your risk tolerance.
Risk Management:
This is an ongoing process of identifying, evaluating, and controlling the risks associated with your portfolio. There are many different risk management strategies, but some common ones include diversification (mentioned above) and hedging.
Performance Monitoring:
It’s important to track the performance of your portfolio over time and compare it to your investment goals. This will help you identify any areas where you may need to make adjustments.
Rebalancing:
Over time, the market performance of different asset classes will cause your portfolio’s asset allocation to drift away from your target mix. Rebalancing involves periodically buying and selling assets to bring your portfolio back into alignment with your target allocation.
Cost Management:
Investment fees and expenses can eat into your returns over time. Portfolio managers look for ways to minimize these costs by choosing investments with low expense ratios and by being mindful of trading costs.
Tax Optimization:
The tax implications of your investment decisions can have a significant impact on your overall returns. Portfolio managers try to structure your portfolio in a way that minimizes your tax liability.
Phases of Portfolio Management
Security Analysis:
This is the groundwork phase where you delve deep into individual investment options. You’ll be researching stocks, bonds, mutual funds, or any other asset class you’re considering. The goal is to understand the financial health, future prospects, and potential risks of each investment.
- Portfolio Analysis:
Here, you shift your focus from individual investments to how they work together as a whole. You’ll analyze factors like diversification, risk-return profile, and how different asset classes might interact within your portfolio.
- Portfolio Selection:
Based on your security and portfolio analysis, you’ll now choose the specific investments that will make up your portfolio. This involves considering your investment goals, risk tolerance, and time horizon to create a well-balanced portfolio that aligns with your needs.
- Portfolio Revision:
The financial world is constantly changing, so this phase acknowledges the need for adjustments. As market conditions or your personal circumstances evolve, you may need to revise your portfolio by buying or selling assets to keep it on track with your goals.
- Portfolio Evaluation:
Regularly monitoring your portfolio’s performance is crucial. This phase involves tracking how your investments are performing against your expectations and comparing them to relevant benchmarks. Evaluation helps identify if adjustments are needed or if your overall strategy remains effective.
What are the key principles to rebalancing a portfolio
Target Asset Allocation:
This is the core principle. It refers to the desired percentage weighting of each asset class (stocks, bonds, cash, etc.) in your portfolio. This allocation is based on your risk tolerance and investment goals. Rebalancing aims to bring your portfolio back to this target mix after market fluctuations cause it to drift.
Rebalancing Schedule:
You can rebalance based on a set schedule (quarterly, annually) or a tolerance threshold. A tolerance threshold triggers rebalancing only when your asset allocation deviates from your target by a certain percentage (e.g., 5%). The benefit of a schedule is consistency, while a tolerance threshold avoids unnecessary transactions. You can also combine these strategies for a more nuanced approach.
Minimizing Costs:
Rebalancing often involves buying and selling assets, which can incur transaction fees. Here are some ways to minimize costs:
Focus on Larger Divergences:
Rebalance only when asset classes are significantly off target, not for minor deviations.
Tax-Aware Rebalancing: In taxable accounts, consider selling assets with higher capital gains to minimize taxes.
Use New Investment Contributions: Allocate new contributions to underweight asset classes to gradually move your portfolio towards your target allocation.
Discipline and Patience: Rebalancing can be counterintuitive, as it involves selling assets that have performed well and buying those that haven’t. Sticking to your plan and avoiding emotional decisions is key.
Review and Update: As your financial situation and risk tolerance evolve, your target asset allocation may need to be adjusted. Regularly review your portfolio and make updates to your rebalancing strategy as needed.
What is the difference between Asset and Investment Management
- Asset is on a broader scale. Looks out how allocate your assets in a way that meets your investing requirements
- Investment is more specific and focuses on investment portfolios. Identifying financial instruments to purchase and sell
What is investment management
Investment management is the process of selecting and managing investments to achieve specific financial goals.
What are investment managers duties
Focus:
Investment managers primarily deal with investment portfolios, which consist of assets like stocks, bonds, and mutual funds.
Activities:
They research different investment options, select ones they believe will perform well, and then buy and sell them on behalf of their clients.
Goal:
Their main objective is to grow the value of the client’s portfolio over time, while also managing the risk involved.
Name some common investment vehicles
stocks (ownership in companies)
bonds (loans to companies or governments)
mutual funds (pools of investor money invested in various assets)
ETFs (exchange-traded funds similar to mutual funds but trade like stocks)
Explain the concept of risk and return in investment management
Risk refers to the uncertainty of an investment’s outcome (potential for loss). Return is the profit or gain generated by an investment.
What is the time value of money and how does it impact investment decisions
The time value of money acknowledges that a dollar today is worth more than a dollar tomorrow due to potential earning power.
It impacts decisions like investing early for long-term growth.
Differentiate between short-term and long-term investment goals
Short-term goals (less than 5 years) may focus on liquidity and capital preservation.
Long-term goals (retirement, education) can tolerate higher risk for potentially higher returns.
Describe the different types of investment risk
Market risk: Overall market fluctuations affecting all investments.
Company risk: Specific company performance impacting a stock’s price.
Liquidity risk: Difficulty selling an investment quickly without losing value.
Interest rate risk: Bond prices decline when interest rates rise.
How can investors diversify their portfolios to manage risk
Diversification is the key to managing risk. Spreading investments across different asset classes reduces the impact of losses in any one area.
Explain the risk-return tradeoff and its implications for investment strategies.
The risk-return tradeoff implies that higher potential returns are usually accompanied by higher risk. Investors aim to find a balance between risk tolerance and desired return.
What is the role of volatility in investment analysis
Volatility measures the degree of price fluctuation in an investment. A highly volatile investment experiences significant price swings.
How do investors calculate potential returns on investments
Investors calculate potential returns using various methods depending on the investment. For stocks, it might involve analyzing historical price movements and company growth prospects.
What are the basic principles behind value investing
Value investing focuses on buying undervalued stocks believed to be worth more than their current market price.
How do growth investors identify promising companies
Growth investors seek companies with high growth potential, even if their stocks are currently expensive.
