Investment Planning

Question 1

Main approaches to asset allocation

Answer 1

Theoretical approach - MPT - mathematical analysis to build optimal portfolio to maximise return for given level of risk

Pragmatic approach - uses forward-looking judgements of likely returns and volatility to determine portfolio weightings - subjective

Question 2

What is stochastic modelling?

Answer 2

Used to optimise portfolios. Stochastic modelling presents data and predicts outcomes that account for certain levels of unpredictability or randomness.

Question 3

Portfolio optimisation assumptions

Answer 3

• Risk - assumes risk follows normal distribution and is adequately measured by standard deviation
• Historic data - may be poor guide to future
• Forecasts - may be inaccurate
• Costs - assumes frequent re-balancing which may not be cost effective

Question 4

Factors to consider with fund selection

Answer 4

• Fund objective
• Costs and charges
• Strength and reputation of management group
• Skill and reputation of individual fund manager

Question 5

What must a suitability / recommendation cover?

Answer 5

• Client’s risk profile
• Asset allocation
• Method & selection of funds within each asset class
• Choice of tax wrapper
• Frequency of review
• Costs of service

Question 6

Benefits of platforms

Answer 6

• Single fee across accounts
• Transparent on costs
• Planning tools
• Reduced paperwork
• Wide choice of funds
• Access to tax wrappers
• Auto rebalancing
• Online valuations / statements
• Enables adviser to implement asset allocation across several tax wrappers but present as consolidated portfolio
• Adviser can generate consolidated statement for income and gains at any time

Question 7

Principle factors affecting investment strategy

Answer 7

• Legal constraints - e.g. if portfolio is managed by trustees
• Nature of liabilities e.g. for DB schemes, age of member etc.
• Cash flow - positive cash flow enables manager to take long term view and accept short term uncertainty
• Taxation - consider effect of tax either on investment or income or capital gain

Question 8

Purpose of rebalancing

Answer 8

• Realign portfolio to original weighting
• To match attitude to risk
• and capacity for loss
• Review of individual funds
• Invest cash
• Adjust portfolio to deal with changes to objectives

Question 9

Things to consider when rebalancing

Answer 9

• Trading costs
• Whether to alter benchmark
• Potential tax liability
• Regulatory issues
• Liquidity
• Is rebalance automatic or manual?
• Frequency of rebalance
• Will existing income be affected?
• Timing of rebalance
• Ongoing suitability of existing funds / asset allocation

Question 10

Reasons for switching

Answer 10

• Value of investment returned due to takeover
• Change of client objectives
• Market conditions adversely affecting original investment
• Client gives clear instruction to switch

Question 11

What is churning?

Answer 11

Where switch occurs where the primary aim to generate fees.