LM 4: Basics of Portfolio Planning & Construction

Question 1

What are the 9 major components of an IPS? ISSPIIIEA

Answer 1

-introduction
-statement of purpose
-statement of duties & responsibilities
-procedures
-investment objective
-investment constraints
-investment guidelines
-evaluation & review
-appendices

Question 2

What is the PURPOSE of the introduction, statement of purpose, statement of duties & responsibilities, procedures, and investment objectives in the IPS?

Answer 2

introduction: describes the client

statement of purpose: states purpose of the IPS

statement of duties and responsibilities: details the duties and responsibilities of the client, the custodian of the clients assets, and the investment managers.

procedures: explains steps to take to keep the IPS current and procedures to follow to respond to various contingencies.

investment objectives: clients return objectives and risk tolerance

Question 3

What is the PURPOSE of the investment constraints, investment guidelines, and evaluation & review in the IPS?

Answer 3

investment constraints: factors that limit the client in achieving the investment objectives

investment guidelines: how policy should be executed, eg leverage and derivatives, and on specific assets excluded from investment

evaluation & review: guidance on obtaining feedback on investment results

Question 4

What is the PURPOSE of the appendices in the IPS?

Answer 4

information about strategic asset allocation & rebalancing policy.

Question 5

What is the difference between absolute risk and relative risk in regard to the IPS?

Answer 5

absolute is spot on must earn 8%

relative is some flexibility vs a benchmark

Question 6

What’s the difference between ability to take on risk vs willingness to take on risk?

Answer 6

ability is how much financial cushion or age, knowledge, etc.

willingness is the attitude or preference for taking on risk

Question 7

What is the difference between absolute return and relative return in regards to the IPS?

Answer 7

absolute return is whatever an asset or portfolio returned over a certain period

relative is is the difference between absolute and performance the extra return above a bench mark

Question 8

What are the 5 constraints to portfolio selection (IPS constraints)?

Answer 8

-unique circumstances
-legal and regulatory factors
-tax concerns
-time horizon
-liquidity

Question 9

Describe what the 5 constraints to portfolio selection are. LTTLU

Answer 9

liquidity: ability to turn investment assets into spendable cash

time horizon: longer the time horizon the more risk and less liquidity the investor can accept in portfolio

tax concerns: different tax benefits may appeal to different investors

legal & regulatory factors: constraints may restrict investing in particular securities

unique circumstances: religious preferences, ESG, etc.

Question 10

What are the 6 ESG considerations or ways to decide ESG? NPESTI

Answer 10

-negative (exclusionary) screening
-positive (best in class) screening
-ESG Integration
-shareholder engagement/ active ownership
-thematic investing
-impact investing

Question 11

What is shareholder engagement/active ownership, thematic investing, and impact investing?

Answer 11

shareholder engagement /active ownership: using shareholder power to achieve ESG objectives

thematic investing: emphasizes single factor such as energy efficiency or climate change

impact investing: seeks to achieve target social or environmental objectives along with measurable financial returns through engagement with company or directly investing in companies

Question 12

What is negative screening, positive screening, & ESG integration?

Answer 12

negative screening: excluding certain sectors or companies from consideration due to ESG concerns or business activities

positive screening: selecting investments which have favorable ESG characteristics

ESG integration: consideration of ESG factors in asset allocation & portfolio construction

Question 13

Returns on asset classes are best described as being a function of:

a. the failure to arbitrage

b. exposure to the idiosyncratic risks of those asset classes

c. exposure to sets of systematic factors relevant to those asset classes

Answer 13

c. exposure to sets of systematic factors relevant to those asset classes

Question 14

What is tactical asset allocation?

Answer 14

an active management portfolio in which they decide to deliberately deviate from the policy portfolio to take advantage of market prices and strengths

Question 15

Risk assessment questioners for investment management clients are most useful in measuring:

a. value at risk

b. ability to take risk

c. willingness to take risk

Answer 15

c. willingness to take risk

we don’t want to know exactly how much in dollar value, we want to know how willing to take risk.

Question 16

For an IPS how many years is considered a long term time horizon?

Answer 16

10 or more years.

Question 17

Whats the difference between systematic risk and unsystematic risk?

Answer 17

Unsystematic risk is a risk specific to a company or industry

Systematic risk is the risk tied to the broader market.

Question 18

What is capital market expectations and what does it include?

Answer 18

Capital market expectations are the risk and return prospects of asset classes.

includes expected risk & returns, standard deviations, and correlations.

Question 19

What does homogenous mean?

Answer 19

means the same

Question 20

What 2 things does the strategic asset allocation combine?

Answer 20

combines the constraints and objectives of the IPS with long-term capital market expectations

Question 21

What is utility function formula?

Answer 21

U = E(R) - ((1/2)* A* o^2)

E(R) = portfolio expected return

A = risk aversion coefficient

o^2 = portfolio variance

Question 22

What is risk budgeting?

Answer 22

deciding the amount of risk to take on in a portfolio and subdividing the risk over the return sources

Question 23

What is the difference between strategic asset allocation and tactical asset allocation?

Answer 23

strategic asset allocation: setting target allocations for various asset classes and rebalances the portfolio periodically.

tactical asset allocation: seeks to add return by varying the weights between asset classes based on forecasts; deviating from strategic asset allocation

Question 24

What is rebalancing of a portfolio?

Answer 24

adjusting the weightings of the different asset classes in your investment portfolio to match up with the strategic asset allocation set forth in the IPS

Question 25

What is core-satellite approach?

Answer 25

involves allocating the majority of a portfolio’s assets to passive or low active investments (the “core”) and placing the remaining funds in actively managed “satellite” accounts.

Question 26

What are 2 new developments in portfolio management?

Answer 26

1. Growth in the offering ETF’s with robo-advice
2. Risk-parity investing

Question 27

What is risk parity investing?

Answer 27

creating a portfolio based on certain risk and return levels instead of 60% stocks and 40% bonds. often uses leverage, short selling, etc.

Question 28

What is Fama French 3 factors and the difference between carhart?

Answer 28

FF proposed that three factors seem to explain asset returns better than just systematic risk. Those three factors are relative size, relative book-to-market value, and beta of the asset.

market risk, (2) the outperformance of small-cap companies relative to large-cap companies, and (3) the outperformance of high book-to-market value companies versus low book-to-market value companies.

market risk, (2) the outperformance of small-cap companies relative to large-cap companies, and (3) the outperformance of high book-to-market value companies versus low book-to-market value companies.

carhart: extends FF and uses momentum (defined as relative past stock returns.)

Question 29

Who does ROBO ADVICE cater too?

Answer 29

Cater to investors with lower levels of investable assets (mass affluent’ and younger investors.)