CH 21

The Portfolio Management Process
Chapter 21 Charles P. Jones, Investments: Analysis and Management, Tenth Edition, John Wiley & Sons Prepared by G.D. Koppenhaver, Iowa State University
21-1
Portfolio Management
Involves decisions that must be made by every investor whether an active or passive investment approach is followed Relationships between various investment alternatives must be considered if an investor is to hold an optimal portfolio
21-2
Portfolio Management as a Process
Definite structure everyone can follow Integrates a set of activities in a logical and orderly manner Continuous and systematic Encompasses all portfolio investments With a structured process, anyone can execute decisions for investor
21-3
Portfolio Management as a Process
Objectives, constraints, and preferences are identified
Leads to explicit investment policies
Strategies developed and implemented Market conditions, asset mix, and investor circumstances are monitored Portfolio adjustments are made as necessary
21-4
Individual vs. Institutional Investors
Institutional investors
Individual investors

Maintain relatively constant profile over time Legal and regulatory constraints Well-defined and effective policy is critical
Life stage matters Risk defined as losing money Characterized by personalities Goals important Tax management is important part of decisions
21-5
Institutional Investors
Primary reason for establishing a longterm investment policy for institutional investors:
Prevents arbitrary revisions of a soundly designed investment policy Helps portfolio manager to plan and execute on a long-term basis
Short-term pressures resisted
21-6
Formulate Investment Policy
Investment policy summarizes the objectives, constraints, and preferences for the investor Information needed
Objectives
Return requirements and risk tolerance
Constraints and Preferences
Liquidity, time horizon, laws and regulations, taxes, unique preferences, circumstances
21-7
Life Cycle Approach
Risk/return position at various life cycle stages
Return
B
Risk
A: Accumulation phase - early career B: Consolidation phase - mid-to late career C: Spending phase spending and gifting
21-8
Investment policy should contain a statement about inflation adjusted returns
Clearly a problem for investors Common stocks are not always an inflation hedge
Unique needs and circumstances
May restrict certain asset classes
21-9
Constraints and Preferences
Time horizon
Objectives may require specific planning horizon
Liquidity needs
Investors should know future cash needs

Ordinary income vs. capital gains Retirement programs offer tax sheltering
Tax considerations

21-10
Legal and Regulatory Requirements
Prudent Man Rule
Followed in fiduciary responsibility Interpretation can change with time and circumstances Standard applied to individual investments rather than the portfolio as a whole
ERISA requires diversification and standards applied to entire portfolio
21-11
Capital Market Expectations
Macro factors
Expectations about the capital markets

Estimates that influence the selection of a particular asset for a particular portfolio Make them realistic Study historical returns carefully
Micro factors
Rate of return assumptions
21-12
Rate of Return Assumptions
How much influence should recent stock market returns have?

Mean reversion arguments Stock returns involve considerable risk
Probability of 10% return is 50% regardless of the holding period Probability of >10% return decreases over longer investment horizons
Expected returns are not guaranteed
21-13
Constructing the Portfolio
Use investment policy and capital market expectations to choose portfolio of assets
Define securities eligible for inclusion in a particular portfolio Use an optimization procedure to select securities and determine the proper portfolio weights
Markowitz provides a formal model
21-14
Asset Allocation
Involves deciding on weights for cash, bonds, and stocks
Most important decision
Differences in allocation cause differences in portfolio performance
Factors to consider
Return requirements, risk tolerance, time horizon, age of investor
21-15
Asset Allocation
Strategic asset allocation
Simulation procedures used to determine likely range of outcomes associated with each asset mix
Establishes long-run strategic asset mix
Tactical asset allocation
Changes is asset mix driven by changes in expected returns Market timing approach
21-16
Monitoring Conditions and Circumstances
Investor circumstances can change for several reasons

Wealth changes affect risk tolerance Investment horizon changes Liquidity requirement changes Tax circumstance changes Regulatory considerations Unique needs and circumstances
21-17
Portfolio Adjustments
Portfolio not intended to stay fixed Key is to know when to rebalance Rebalancing cost involves

Brokerage commissions Possible impact of trade on market price Time involved in deciding to trade
Cost of not rebalancing involves holding unfavorable positions

21-18
Performance Measurement
Allows measurement of the success of portfolio management Key part of monitoring strategy and evaluating risks Important for:

Those who employ a manager Those who invest personal funds
Find reasons for success or failure

21-19
Copyright 2006 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United states Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.
21-20

CH 21

Uploaded by

Copyright:

Available Formats

CH 21

Uploaded by

Document Information

Original Description:

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

CH 21

Uploaded by

Copyright:

Available Formats

The Portfolio Management Process

Portfolio Management as a Process

Portfolio Management as a Process

Objectives, constraints, and preferences are identified

Leads to explicit investment policies

Individual vs. Institutional Investors

Short-term pressures resisted

Formulate Investment Policy

Return requirements and risk tolerance

Constraints and Preferences

Life Cycle Approach

Risk/return position at various life cycle stages

Formulate Investment Policy

Investment policy should contain a statement about inflation adjusted returns

Unique needs and circumstances

May restrict certain asset classes

Formulate Investment Policy

Constraints and Preferences

Objectives may require specific planning horizon

Investors should know future cash needs

Legal and Regulatory Requirements

Prudent Man Rule

ERISA requires diversification and standards applied to entire portfolio

Capital Market Expectations

Expectations about the capital markets

Rate of return assumptions

Rate of Return Assumptions

How much influence should recent stock market returns have?

Mean reversion arguments Stock returns involve considerable risk

Expected returns are not guaranteed

Constructing the Portfolio

Markowitz provides a formal model

Involves deciding on weights for cash, bonds, and stocks

Most important decision

Differences in allocation cause differences in portfolio performance

Return requirements, risk tolerance, time horizon, age of investor

Strategic asset allocation

Establishes long-run strategic asset mix

Tactical asset allocation

Monitoring Conditions and Circumstances

Investor circumstances can change for several reasons

Cost of not rebalancing involves holding unfavorable positions

Those who employ a manager Those who invest personal funds

Find reasons for success or failure

You might also like

Pfad - The Proxy pFad of © 2024 Garber Painting. All rights reserved.