Investor’s basic philosophy & preferences that facilitate the discussion of investment risk with the investors.. inherited wealth may be associated with reduced willingness to assume r
Trang 1“ MANAGING INDIVIDUAL INVESTOR PORTFOLIOS ”
3 INVESTOR CHARACTERISTICS
Categorizing individual investors based on their situational characteristics
Investor’s basic philosophy & preferences that facilitate the
discussion of investment risk with the investors
CF = Cash Flow
3.1 Situational Profiling
Approaches of Situational Profiling
Manner of acquiring wealth offers insight into an investor’s
risk attitude
Active investors (e.g successful entrepreneurs) exhibit a
higher level of risk tolerance
Reluctant to cede control to a third party
Passive recipients of wealth (e.g inherited wealth) may be
associated with reduced willingness to assume risk
If investor perceives his holdings as small (large), may demonstrate a low (high) tolerance for portfolio volatility
Low return (high return) portfolio as compared to lifestyle is
considered small (large)
3.1.3 Stage of Life
i) Foundation Phase
Individual’s base establishment phase
Long-time horizon & above avg
risk tolerance
Very few investable assets
ii) Accumulation Phase
Income accelerates & gradually reaches its peak
Risk tolerance, wealth &
long-term time horizon
iii) Maintenance Phase
Individual moves into the later
years of life
Risk tolerance & time horizon
Goal ⇒ preserving wealth
iv) Distribution Phase
Accumulated wealth is
transferred to other persons or entities
Tax constraints & transfer
strategies often become important consideration
SAA = Strategic Asset Allocation
MCS = Monte Carlo Simulation
Trang 23.2 Psychological Profiling
Investors are risk averse
Investors hold rational
expectations
Evaluate investments in portfolio context
Economic considerations
Individual investors are:
Loss averse
Hold biased expectation
Portfolio construction through pyramiding
Economic & subjective
considerations
3.2.3 Personality Typing
Risk averse to potential losses
Strong need for financial security
Prefer low turnover & low volatility
Often missed opportunities due to over
analysis
Undertake research on trading strategies
No emotional attachments to investment
positions
Conservative investors
Highest portfolio turnover ratio& below avg
return
Quick to make investment decisions
More concerned with missing an investment
trend
Place a great deal of faith in handwork
Not afraid to exhibit investment independence
in taking a course of action
4 INVESTMENT POLICY STATEMENT
A well constructed IPS:
Presents the investor’s financial objectives & constraints
Sets operational guidelines for constructing a portfolio
Establish basis for portfolio monitoring & review
Is portable & easily understandable
Document that protects both the advisor & the individual
investor
Trang 34.1 Setting Return and Risk Objectives
Return level necessary to achieve the investor’s primary or critical long-term objectives
Total return approach should be followed
Generally driven by annual spending &
long-term saving goals
Required Return
Return level associated with investor’s secondary goals
Desired Return
When an investor’s return objectives are inconsistent with his risk tolerance, a
resolution is required
If portfolio’s expected return> investor’s return objective then:
Assume less risk to protect the surplus
Use the surplus for assuming greater risk
All CFs should be treated the same way (e.g all should be after-tax)
Determine the amount of investable assets:
If any cash outflow in six months ⇒ PV of outflow should be subtracted
from the investable assets
If inflows> expenses, the additional should be added to investable assets
4.1.2 Risk Objective
Subject to quantitative measurement
Determine the investor’s short-term &
long-term financial needs & goals
Determine the importance of these goals
Determine the investment shortfall that
investor’s portfolio can bear
Important considerations are:
Liquidity needs
Time horizon
Portfolio size
Goals
Ability to Take Risk
Subjective assessment
Psychological profiling provides useful
estimates of an individual’s willingness to take risk
Important considerations are:
Personality type
Portfolio holdings
Implicit or explicit statements
Willingness to Take Risk
State whether the client’s ability & willingness is below avg.,
“avg.” or “above avg.”
Overall risk tolerance ⇒ lesser of the two if they are in conflict
4.2 Constraints
4.2.1 Liquidity
Trang 4Reasons for Liquidity Requirements
One of the portfolio’s highest priorities
Should be met with liquid investments due to
short time horizon
Ongoing Expenses
Precaution against unanticipated events
Reserve size ⇒ 3 months to more than 1 year
of the client’s anticipated expenses
Emergency Reserves
For example a significant charitable gift, home repairs etc
As time horizon to such events, liquidity needs
Transaction costs & price volatility are two characteristics that
determine a portfolio’s liquidity
IPS should specifically identify significant illiquid holdings (e.g
home or primary residence)
Sometimes the home is treated as a long term investment
used to meet long-term housing needs or estate planning goals
Negative Liquidity Events
Long-term time horizon if > 15 or 20 years
Short-term time horizon if < 3 years
Intermediate to long term if 3-15 years
Time horizon can be a single stage or multistage
A shift from one stage to another stage occurs when client’s
objectives & constraints change
4.2.2 Time Horizon
Widely recognized categories of taxes are:
Income tax
Gains tax
Wealth transfer tax
Property tax
Different tax strategies to minimize the impact of taxes includes:
Tax deferral
Tax avoidance
Tax reduction
4.2.3 Taxes
Frequently involve taxation & the transfer of personal property ownership
Prudent investor rule may apply if manager is acting in a
fiduciary capacity
4.2.4 Legal and Regulatory Environment
Trang 5Established by the grantor
Funded when grantor transfers legal ownership of designated assets to the trust
Two types
Revocable trust ⇒ grantor retains control over assets & is responsible for any tax liability
Irrevocable trust ⇒ trust is responsible for tax liability &
terms of the trust are fixed
The Personal Trust
Might include guidelines for social or special purpose investing
List of assets held outside the investment portfolio
Some examples are:
Concentrated position in low basis stock
Significant amount of assets for charity purpose
Significant unusual expenditure
4.2.5 Unique Circumstances
Process of elimination is used to arrive at appropriate SAA
Process of selecting most satisfactory allocation consists of the following steps:
Determine the allocations that meet the investor’s return
requirement
Eliminate allocations that fail to meet risk objectives
Eliminate asset allocations that fail to satisfy the investor’s stated
constraints
Evaluate the expected risk adjusted performance & diversification
attributes
5.1 Asset Allocation Concepts
5 AN INTRODUCTION TO ASSET ALLOCATION
MCS is generally superior to deterministic approach because:
It incorporates path dependency effect & assumptions variability
It generates probability distribution of final value rather than a
single point estimate
It allows projections of best & worst case scenarios
It can capture the variety of portfolio changes
MCS users should:
Choose a simulation that simulates the performance of specific investments & takes into account the tax consequences
Be aware that simulation is input dependent
Drawbacks:
Can be biased by the perceptions of the analyst
5.2 Monte Carlo Simulation (MCS) in Personal Retirement Planning