Portfolio Construction & Planning

Question 1

What is an IPS

Investment Policy Statement - 3 points

Answer 1

A document that clearly sets out a client’s:

• return objectives and requirements
• risk tolerance over the time horizon
• constraints such as liquidity requirements, tax position, regulatory requirements, and unique circumstances.

Question 2

What is the difference between ATR & CFL

Attitude to Risk vs Capacity for Loss

Answer 2

• ATR is subjective in nature
• CFL is an objective measure that describes whether the client will have sufficient income and assets to maintain a comfortable standard of living if their investment performs poorly

Question 3

What is the difference between deterministic & stochastic modelling?

Answer 3

1. Deterministic modelling - takes a single input (eg, the average growth rate) and assumes this will remain constant over a period – in other words, there is no randomness.
2. Stochastic modelling - uses many random variables (based on fluctuations observed in historical data) to model thousands of possible investment return outcomes for almost all asset allocation combinations.

Question 4

What is Strategic Asset Allocation (SAA)?

1) Time frame in nature and more exact 2) What portfolio is constructed

Answer 4

• The decisions on the portfolio mix are taken from a long-term perspective.
• Money managers consider long-term client objectives, as well as capital market expectations, to come to this decision. This composition is called a policy portfolio and may be periodically rebalanced to adjust the portfolio to specific weights.
• The interpretation of ‘long-term’ is vague as it varies with each investor; however, five years is a reasonable minimum reference point.

Question 5

What is Tactical Asset Allocation (TAA)?

what type of investment approach?

Answer 5

• TAA can be described as a moderately active strategy
• Adding short-term, tactical deviations to the portfolio to capitise on inveestment opportunities

Question 6

What are EMH, MPT & CAPM?

Answer 6

• Efficient market hypothesis (EMH) – which posts that all publicly available and relevant information about a particular security is reflected in its price.
• Modern portfolio theory (MPT) – the main objective of which is to have an efficient portfolio (ie, one that yields the highest return for a specific level of risk).
• Capital asset pricing model (CAPM) – which is used to calculate a security’s required rate of return given the systematic risk it provides .i.e. beta

Question 7

What is the opposite of leptokurtosis?

Fat Tails

Answer 7

Platykurtosis (ie, narrow tails)

Question 8

What is the problem with ESG ratings/rankings?

Methodology and interpretation

Answer 8

1) No universal methodology - each ESG rating provider uses their own research methodologies to scrutinise businesses

2) Subjective interpretation - can result in ESG ratings varying dramatically for the same product.

Question 9

What does a wrap account include?

4 investment options

Answer 9

• a cash account
• a pension account with the usual tax advantages
• an ISA
• an offshore/onshore investment bond.

Question 10

What are the 2 disadvantages of wrap accounts?

Answer 10

• flexibility: with only a limited range of assets available, this may make platforms suitable for restricted advice only
• Relatively expensive: as platforms usually levy a wrap fee plus the usual costs of the underlying funds held, while others may impose annual fixed charges.

They tend to be more cost-effective for clients with larger portfolios.