There is a generally accepted 5-step
investment process used in professional portfolio management:
1. Investment Policy
Statement (IPS) (click to expand)
The investment policy statement
is both the beginning and the end of the investment process. It documents
the issues to be addressed as well as the conclusions drawn from the
process. It should contain the following elements:
- Purpose of an IPS
- Risk Tolerance Assessment
- Investment Objectives
- Investment Expectations by
Investment, Asset, and Aggregate Portfolio
- Performance Measurement and Control
- Adoption of Plan
2. Capital Markets
Expectations (click to expand)
In order to select and combine the various investments into an effective
portfolio, we must make certain assumptions about the performance
characteristics of each asset class.
- Parameters to Estimate
- Asset Classes on Which to Estimate
Parameters
3. Asset Allocation and
Location (click to expand)
The asset classes appropriate to
the investor's situation are then identified and combined into an
efficient portfolio.
- Asset Selection
- Optimization Process
- Asset Allocation
- Rebalancing Parameters
- Asset Location
- Expected Long-Term Benchmark
Portfolio Results
4. Implementation
While the asset allocation
process determines what asset exposure the investor needs, the
implementation process determines how that asset exposure is
achieved.
Active vs. Passive Management
- Active management: Requires economies
of scale that individual investors may not be able to achieve. Identify
asset classes in which active management has significant chance of
material success and those asset classes that it does not, keeping in
mind the effect of taxes.
- Passive management: Identify those
assets in which the investor would be better served by utilizing passive
(index) management.
- Combination: Identify those asset
classes in which the investor can efficiently utilize both active and
passive management strategies. Traynor-Black methodology can be used to
structure these investments.
Strategies
- Strategy identification, selection,
and diversification: Strategies most effective in capturing the desired
economic elements of the asset class are identified, evaluated, and
selected. Several different strategies may be utilized in each asset
class to obtain the desired performance during different market
conditions.
- Manager identification, evaluation,
and selection within each strategy: The managers identified as most
likely to effectively execute the strategy are evaluated and selected.
They are evaluated based upon both effectiveness (risk-adjusted
after-tax returns) and efficiency (after fees and expenses).
- Return enhancement strategies:
Additional strategies can be developed with the investor to provide an
opportunity for enhanced returns. Some examples are concentrated
long/short strategies, economic sector rotation strategies, covered call
writing strategies, and long call option strategies.
- Risk control/reduction strategies:
Additional strategies can be developed with the investor to provide an
opportunity for controlled or reduced risk. Some examples are long put
option strategies, long call option substitution strategies, put/call
collars, and strategies diversifying concentrated or low-basis
investment holdings.
Action Calendar
A calendar is developed identifying who
is going to perform what actions and on what schedule. The calendar
notes which functions are dependent upon prior functions being
completed.
5. Performance Monitoring
and Control (click to expand)
The final step is establishing
the process by which all previous activities are monitored and controlled.
- Performance Measurement
- Underperformance Defined
- Communications Required
*****
This Web site is not intended for distribution to, or use by, any person
or entity in any country or jurisdiction where such distribution or use
would be contrary to local law or regulation.