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
(click to expand)
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
- Strategies
- Action Calendar
5. Performance
Monitoring and Control
The final step is establishing
the process by which all previous activities are monitored and controlled.
Performance Measurement
- Performance presentation standards:
What conventions will be used in presenting periodic performance.
- Benchmark issues: What market
benchmarks will be used in relative comparisons of each asset class and
strategy.
- Performance attribution: What are the
true sources of return achieved in the portfolio.
Underperformance Defined
- Duration: How long in time will
manager underperformance be tolerated.
- Severity: To what degree will manager
underperformance be tolerated.
- Required actions: What combination
of duration and severity of underperformance causes a manager to be
placed on "watch" for critical review and then for termination.
Communications Required
- Performance reporting: When and what
elements are to be provided by whom and to whom on what regular basis.
- Market events: When and what elements
are to be provided by whom and to whom based upon what market or
portfolio events.
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