The portfolio management process Set objective and policy goals Examine and understand the...

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The portfolio management process The portfolio management process

Transcript of The portfolio management process Set objective and policy goals Examine and understand the...

The portfolio management processThe portfolio management process

The portfolio management processThe portfolio management process

• Set objective and policy goals

• Examine and understand the environment

• Construct the portfolio: asset allocation & security selectionasset allocation & security selection

• Monitor and update

Individual investment objectives? Individual investment objectives?

Popular belief:

Investments are aimed at “making money”

Suggested strategies for “making money”Suggested strategies for “making money”

Put $1 in the bank at 3%.

Eventually you will become a billionaire

Put all of your earnings in the lottery.

Eventually you’ll hit the jackpot

Goals vs. objectivesGoals vs. objectives

Financial Goals

Broad financial ends, such as, buying a home, paying for children’s education, etc.

Investment objectives

Stated in terms of risk and return - a function of goals, investment horizon etc.

Investment objectivesInvestment objectives

Are dictated by risk tolerance and time horizon

• Capital preservation• Income • Growth

Individual investment objectivesIndividual investment objectives

Age considerations

Risk consideration

Individual investor life cycleIndividual investor life cycle

• Accumulation phase

• Consolidation phase

• Spending phase

• Gifting phase

Accumulation phaseAccumulation phase

Long-term goals• Retirement• Children’s education• Etc

Short-term goals• Car• House

Consolidation phaseConsolidation phase

Long-term goals• Retirement

Short-term goals• Children’s education• Vacation • Etc.

Spending phaseSpending phase

Long-term goals• Estate planning

Short-term• Life style• Gifts

Gifting phaseGifting phase

Long-term goals• Estate planning

Short-term• Life style• Gifts

Risk considerationsRisk considerations

Factors:

• Psychological makeup

• Family situation

• Income

• Age

Investment constraintsInvestment constraints

• Liquidity needs

• Tax concerns

• Regulations

• Unique needs

Liquidity needsLiquidity needs

Related to investment horizon & age

Longer horizons = accept less liquidity & more risk

Tax concernsTax concerns

Investors think in terms of after-tax return

RegulationsRegulations

Impose restrictions and constraints

Ex:

RRSP: Foreign content rule

Unique needsUnique needs

A function of each individual

Asset classesAsset classes

Classification according to risk and expected return characteristics

• Stocks• Bonds• Risk-free investments

Asset classesAsset classes

Each class can be further divided into subclasses

Bonds:• Long-term corporate bonds• Long-term government bonds• Medium-term corporate bonds• Medium -term government bonds

Etc.

Historical record: 1926-1998 (US)Historical record: 1926-1998 (US)

Geometricmean

Arithmeticmean

Standarddeviation

Large stocks 11.2% 13.2% 20.3%

Small stocks 12.4% 17.4% 33.8%

Long-term corporate bonds 5.8% 6.1% 8.6%

Long-term government bonds 5.3% 5.7% 9.25

US T-bills 3.8% 3.8% 3.25

Inflation 3.1% 3.2 4.5%

Inflation

Historical record: 1948 -1998 (Canada)Historical record: 1948 -1998 (Canada)

Arithmeticmean

Risk premium Standarddeviation

Large stocks 13.2% 7.16% 16.6%

Small stocks 14.8% 8.75% 23.68%

Long-term bonds 7.6% 1.6% 10.6%

T-bills 6% 0 4%

Inflation 4.25% -1.8% 3.5%Inflation

Returns from investing $1: 1948-1999Returns from investing $1: 1948-1999

1945 1975 2000

TSE300

$ 357.3

$ 36.4Bonds

$ 20.4T-bills

Inflation$ 8.4

Asset allocation: Various countriesAsset allocation: Various countries

US & Canada UK Germany Japan

Equity (domestic) 41% 54% 9% 22%

Equity (foreign) 4% 18% 2% 2%

Bonds 29% 12% 45% 22%

Real Estate 8% 9% 5% 6%

Cash 10% 5% 4% 6%

Other 8% 2% 35% 42%

27%

22%

17%

12%

7%

Return

Standard deviation20% 30%

World stock markets annual rates of return and risk in local currency 1986-1997World stock markets annual rates of return and risk in local currency 1986-1997