Portfolio Construction & Planning

Question 1

What is an IPS

Investment Policy Statement

Answer 1

a document that clearly sets out a client’s return objectives and requirements, risk tolerance over the time horizon, and 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 involves taking a single input (eg, the average growth rate) and assuming this will remain constant over a period – in other words, there is no randomness.
2. Stochastic modelling, in contrast, 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)?

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 Strategic Asset Allocation (TAA)?

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.

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?

Answer 8

Each ESG rating provider uses their own research methodologies to scrutinise businesses this, along with subjective interpretation, can result in ESG ratings varying dramatically for the same product.

Question 9

What does a wrap account include?

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
• They can also be 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.