Asset Allocation & Portfolio Management Process_lecture 2_2011

8/3/2019 Asset Allocation & Portfolio Management Process_lecture 2_2011

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ASSET

ALLOCATION &PORTFOLIOMANAGEMENTPROCESS

LECTURE 2


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Agendas

PART 1: Investment Policy Statement

- What are the four steps in the portfolio managementprocess?

- Why is a investment policy statement (IPS) importantto the planning process

- What objectives and constraints should beconsidered in a policy statement?

- What is the asset allocation?- How and why investors goal change over a persons

lifetime and circumstance?


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Agendas

PART 2: Market Security Index

- What are some major uses of security marketindicator series (indexes)?

- What are major characteristics of alternativeindexes?


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PART 1

INVESTMENT POLICY STETEMENT


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Portfolio management process

Four steps:

Monitor, evaluate portfolio performance and updateinvetment policy statement

Construct the Portfolio

Investigate current financial and economic conditions,

forecast future trends

Investment Policy Statement (IPS)

http://corporate.morningstar.com/ib/asp/detail.aspx?filter=CIJIndex.xml&xmlfile=1466.xml

https://personal.vanguard.com/us/funds/vanguard/core
http://corporate.morningstar.com/ib/asp/detail.aspx?filter=CIJIndex.xml&xmlfile=1466.xmlhttps://personal.vanguard.com/us/funds/vanguard/corehttps://personal.vanguard.com/us/funds/vanguard/corehttp://corporate.morningstar.com/ib/asp/detail.aspx?filter=CIJIndex.xml&xmlfile=1466.xml


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Investment Policy Statement (IPS)

Constructing a policy statement will:

- Providedisciplinefor the investment process.

- Reduce the possibility of making inappropriate decisions.

- Help investors decide arealistic investment goalsbased

on the understanding their own objectives, constrains andneeds.

- Set a standardfor evaluating portfolio performance:

Benchmark portfolio:

- Risk and return

Match risk preferences and investment needs:

- Analysis of risk tolerance

- Return objective


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Conducting policy statement actually is to determine overallinvestment strategy:

- not indicate which specific securities are sold or bought, but

- provide guidelines on asset classesto invest and the relativeproportionof a investors fund to allocate in each asset class.

Constructing a policy statement(List of questions suggested for investors and advisors (RB,p.55-56)

Investment Policy Statement (Cont.)


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1.Objectives

2.

Constrains

INVESTMENTPOLICY

STATEMENT(IPS)

Investment Policy Statement (Cont.)


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1. Investment Objectives

The investment objectivesof an investment is stated in

terms of both risk and return.

Risk toleranceis affected by many factors such asinvestors family situation, his or her age, cash reserves etc.

rather than just a function of individuals psychology.

returnrisk

investment objectives


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Return objective may be expressed in terms of anabsolute or relative percentage return.

It may also be determined in terms of general goal:capital preservation, capital appreciation, currentincome or total return.

Investment Objectives (Cont.)


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Minimize the risk of loss, usually in real terms Maitain purchasing power of an investment

Strategy for strongly risk averse investors

Capital presevation

Portfolio grow in real terms over time, maily through capital gains Aggressive strategy for investors willing to take a risk

Capital appreciation

Concentrate on generating income rather than capital gains

Current income

Increase portfolio value by both capital gains and reinvestingcurrent income

Maitain moderate risk exposure

Total return

http://www.franklintempleton.co.uk/jsp_cm

/funds/fdata/0643_uk_en.pdf

http://www.franklintempleton.co.uk/jsp_cm/funds/fdata/0643_uk_en.pdfhttp://www.franklintempleton.co.uk/jsp_cm/funds/fdata/0643_uk_en.pdfhttp://www.franklintempleton.co.uk/jsp_cm/funds/fdata/0643_uk_en.pdfhttp://www.franklintempleton.co.uk/jsp_cm/funds/fdata/0643_uk_en.pdf


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Young people with little wealth should not invest money inrisky assets such as stocks because they cannot afford tolose what little money they have do you agree or disagree

with this statement? Why?

Source: Brown. K. C. & Reilly F. K., Investment analysis andPortfolio Management



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Liquidityneeds

Timehorizon

Taxconcern

Legal&Regula-tory

factors

Uniqueneeds &prefe-rence

2. Investment Constraints


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Liquidity needs: investment plan must considerliquidity needs of investors.

An investor even though has a primary long termgoal, several near term goals may require availablefund such as a house/car down payment or collegeintuition.

Investment Constraints (Cont.)


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Time horizon: is an

investment constraintrelated to near termand long term highpriority goals.

There is the closerelationshipbetweeninvestors liquidity need,

time horizon and abilityto hanle risk

Liquidityneeds

Timehori-zon

Abilityto

hanlderisk



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Tax concerns: the differing timing of and tax rates oncapital gains and dividends.

- Interest and dividends are taxed at investorsmarginal tax rate when it is received.

- Capital gains or losses are taxed only when an asset

is sold.



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Legal and regulatory factors: both investment processand financial markets are highly regulated and subject tonumerous laws.

Example:

- Foreign investors investing in joint stock companies in Vietnamare subject to limitation of ownership (up to 49%) => room forforeign investors.

- Investment funds of life insurance companies are highlyregulated by rules of allocating risky asset classes



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Unique needs and preferences:

- Consider on the basis of personal preference or forsocial consciousness reasons.

- Institutional investors needs (mutual funds, lifeinsurance companies etc.)

- Large investment in employers stock needs to beconsidered in terms of diversification.


P li St t t (R i )


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Policy Statement (Review)

Investment Objective: risk return

Investment Constraints: liquidity, time horizon, taxconcerns, legal and regulated factors, unique needs

and preference.

Developing the plan based on the understandingthe relationship between risk and return and the

importance of diversification

A t ll ti


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Asset allocation

- Asset allocation decision: is not isolated decision but a

componentof a structured four step procedure of portfoliomanagement.

- Asset allocation: The process of deciding how to distribute

investors wealth among different asset classesandacross countrieswith the purpose of increase theinvestors wealth.

- Asset class: securities have the similar characteristics,attributes, risk/return characteristics. Exp. Corporate bondclass, government bond class or high yield bond class(junk bond)

A t All ti (C t )


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Aninvestment strategycomprises fourdecisions:

Asset Allocation (Cont.)

Which asset classes?

Which policy weight?

What allowable allocation

ranges?

What specific securities?

Asset

allocation:first two steps

A t All ti (C t )


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Asset allocation is a critical component of the

portfolio management process involves in twocontents:

Most (85% to 95%) of the overall investment return isdue to the asset allocation, not the selection ofindividual investment.


A t All ti (C t )


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https://personal.vanguard.com/us/funds/vanguard/core


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Social, political and tax environments affect asset

allocation decision:

Equity allocation of U.S pension funds average 58%.

In the U.K, equities make up 78% of assets.

In Germany, equity allocation averages 8%

In Australia, allocation to equity accounts for 40% of

assets

Asset allocation and culture differences

R t d i k f diff t t l


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Higher returns for compensation of taking higher risk

Historically, small company stocks have generatedhighest returns but also have been highest volatile.

Inflation and tax have a major impact on returns

Returns on Treasury Bills have barely kept pace with

inflation.

Returns and risks of different asset classes


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Policy statement determines types of assets toinclude in portfolio.

Asset allocation determines portfolio return more thanstock selection.

Risk of strategy depends on investors goals and time

horizon.

Over long time periods sizable allocation to equity willimprove results

Asset Allocation Summary


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Individual Investment life cycle


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Prelimina-

ries

Accumula-

tion Phase

Consolida-

tion Phase

Spending

Phase

Gifting

Phase

Individual Investment life cycle (Cont.)

-Preliminaries: Insurance, cash reserve

-Accumulation Phase: early to middle years of workingcareer. Relatively high - risk investments.

-Consolidation Phase: past midpoint of career. Earnings

greater than expenses. Moderately high risk investments

-Spending/Gifting Phase: begin after retirement. Protectinvestor capital

I di id l I t t lif l (C t )


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Near-term, high-priority goals

Short time horizson

Emotional importance Exp. House downpayment, parentshaving teenagersneed to pay tuitionfees

Long-term, high-priority goals

Long time horizon

Emotional importance Exp. Retirement plan

Lower-prioritygoals

Nice to meet the

objectives Exp. New car every 3years, redecorate thehome, etc.

Individual Investment life cycle (Cont.)


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PART 2: SECURITY MARKET

INDEXES

PART 2 SECURITY MARKET INDEXES


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PART 2: SECURITY MARKET INDEXES

At least 5 uses:

Uses ofsecurity marketindexes

1. Proxy formarket return

2. Create andmonitor Index

funds

3. Benchmarkto judge

performnaceof portfolio

4. Used topredictmarket

movement

5.Measuremarket returnin academicresearches

Different factors in constructing Market Index


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Different factors in constructing Market Index

Size Breadth source

The sample:

price-weighted series Value-weighted series Unweighted series

Weighting sample members

Athrimetic average Geometric average Compute an Index and have all changes (price or value),

reported in terms of basic index

Computational procedure:

Stock market Indexes


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Stock

market Indexes

Price Weighted Series:

- Dow Jone Industrial Average (DJIA)

- Nikkie Dow Jones Industrial Average

Value Weighted Series:

- NYSE Composite

- S&P 500 Index, S&P 200 Index and more . . .

Unweighted Price Indicator Series- Value Line Average

- Financial Time Ordinary Index

P i W i ht d I di t S i


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Price Weighted Indicator Series

Value Weighted Series


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Value Weighted Series

Value Weighted Series (Cont )


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Derive the initial total market value of all stocks used

in the series

Market value = No of Shares Outstanding x Current MarketPrice

Assign an beginning index value (100) and newmarket values are compare to the base index

Automatic adjustment for split.

Weighting depends on market value

Value Weighted Series (Cont.)

Unweighted Price Indicator Series


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All stocks carry equal weight regardless of price ormarket value.

Some use athrimetic average, others use geomatricavarage of the percent price changes for the stocksin the index.

Unweighted Price Indicator Series

Global Equity Indexes


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There are stock market indexes available for mostindividual foreign markets.

These are closely followed within each country.

Exp. USA S&P500, Australia AXS200, Japan Nikkei,UK FTSE Composite Share Index

Global Equity Indexes

VN Index


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Value weighted index

The basic date is 28/07/2000 with the basic

price is 100

Computing market prices of all companies

listed in HOSE (247 are currently traded).

VN - Index

VN Index (Cont )


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VN Index is calculated as followed:

(Q1iP1i) X 100

VN Index =

QoiPoi

P1i: current price of stock i

Q1i: Number of shares outstanding of stock i

Poi: original price of stock i

Qoi: Number of shares i at time to

VN Index (Cont.)


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When there is a new company being listed or listed

company increase its capital, division factor isadjusted as followed:

Do X V1

D1 =

VN Index (Cont.)

V1 - AV

D1: New division

Do: Original division

Do = Poi x Qoi

V1: Current market value of all stockslisted

AV: Adjusted value


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Exp. The result of trading on 28/7/2000

VN Index (Cont.)

Stocks Price Volume Market Capital

REE

SAM

16.000

17.000

15.000.000

12.000.000

240.000.000.000

204.000.000.000

Total 27.000.000 444.000.000.000


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VN Index = X100 = 105,20

Stocks Price Volume Market Capital

(mn VND)REE

SAM

TMS

HAP

16.900

17.800

14.000

16.000

15.000.000

12.000.000

2.200.000

1.008.000

253.500

213.600

30.800

16.128

Sum 30.208.000 514.028

VN Index (Cont.)

467,1

444


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VN Index (Cont.)

Bond market Indicator Series


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Relatively new and not widely used

Four investment firms maintain indexes forTreasury bonds and other investment grade

(rate BBB or higher) bonds.

SSB, Lehmann Borthers, Merrill lynch, UBS

Non investment grade bonds rated BB, B,CCC, CC and C.

Bond market Indicator Series

Asset Allocation & Portfolio Management Process_lecture 2_2011

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