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Transcript of Managing Portfolio for Individual Investors Jakub Karnowski, CFA Portfolio Management for Financial...
Managing Portfolio for Individual Investors
Jakub Karnowski, CFAJakub Karnowski, CFA
Portfolio Management for Financial Advisers
1. Understanding Client Personalities
1) Situational Profiling
2) Psychological Profiling
2. Developing the Investment Policy Statement
(IPS)
3. CASE STUDY
Table of contents
INVESTORS HAVE DIFFERENT PERSONALITIES AND
DIFFERENT LEVELS OF SOPHISTICATION
3Portfolio Management for Financial AdvisersJakub Karnowski, CFA
The level of client sophistication and investment
education
for investors tend to vary more for personal portfolios
than
for institutional portfolios.
Understanding of each client is essential for preparing
a meaningful set of objectives and constrains…
…that’s WHY various types of situational and
psychological profiling MUST be developed as a
starting point.
4Portfolio Management for Financial AdvisersJakub Karnowski, CFA
! NOTE !
Understanding Client Personalities
1. Understanding Client Personalities
1) Situational Profiling
2) Psychological Profiling
2. Developing the Investment Policy Statement
(IPS)
3. CASE STUDY
Table of contents
Situation Profiling
Sources of WealthThe method of wealth accumulation can have a bearing on attiutudes
towards risk
Entrepreneurs Passive Investors• Created wealth by successfully
starting and running a business• Inherited wealth or accumulated it
over a long period of steady employment
• Familiar with risk-taking; presumed to be more comfortable with high level of risk
• Want a great deal of control and may be less willing to cede control
of a portfolio to professional managers
• Less familiar with risk taking behaviour
• Less confident with reaccumulating wealth if it is lost
6Portfolio Management for Financial AdvisersJakub Karnowski, CFA
Understanding Client Personalities
Measures of Wealth
The relative or absolute size of
wealth may bear on risk taking
attitudes
Absolute measures are often not the
most relevant measure…
If wealth is sufficiently large, the
portfolio is perceived as being large
and the ability to bear risk is high
…the perception of wealth relative
to objectives and goals is more
important
7Portfolio Management for Financial AdvisersJakub Karnowski, CFA
Understanding Client Personalities
Situation Profiling
Stage of LifeThe investor’s stage in life cycle is indicative of the ability or willingness to
bear riskAccumulation
Phase
Consolidation
Phase
Retirement/Gifting
Phase
young investors investors in their middle
years
investors in final years of life
cycle
long time horizon over
which to recover from
short-term performance
dissapointments
accumulated wealth
and liabilities tend to
increse
large sums of wealth may
have been accumulated and
liabilities paid off; investor is
looking to live off the portfolio
or consider it for distribution
they can assume higher
level of risk
risk tolerance should
diminish however the time
horizon is still long
risk tolerance typically
declines (but in some cases it
can still be moderate or high)
8Portfolio Management for Financial AdvisersJakub Karnowski, CFA
Understanding Client Personalities
Situation Profiling
1. Understanding Client Personalities
1) Situational Profiling
2) Psychological Profiling
2. Developing the Investment Policy Statement
(IPS)
3. CASE STUDY
Table of contents
ASSUMPTIONS:
1. Investors are risk averse. When two investments have the same expected
outcome,
the investment with greatest certainty will always be selected
2. Investors have rational expectations. Their decisions include all available
relevant information in unbiased decisions
3. Investors practice asset integration - they view each asset in the portfolio
from
a perspective of how it affects aggregate portfolio risk and return rather than on
a stand-alone asset basis
As a result… asset prices reflect real underlying economic factors
portfolios are viewed in their entirety, which properly reflects expected covariances and correlations between assets
10Portfolio Management for Financial AdvisersJakub Karnowski, CFA
Understanding Client Personalities
Psychological Profiling
Psychological studies have shown that human beings (investors)
do not always exhibit the objective and rational behaviors of
traditional theory
Principles in behavioral finance: Risk – seeking behavior
• Investors prefer uncertain, on average larger loss to small but certain loss
• However they choose small, certain gain to an uncertain gain, on average larger one
(A bird in the hand is worth two in the bush)
Biased expectations. Cause cognitive errors in decision-making and overconfidence in
the ability to predict the future.
EXAMPLE: analysts believe in their own earnings estimation even when the evidence
shows past estimates to be wrong
Asset segregation. Investors evaluate investments based on their stand-alone risk and
return rather than in the context of classic portfolio theory. Asset pricing is based not only
on economic factors but also individual and subjective psychological issues.
As a result, actual investment decision-making is more complex than classic portfolio theory
would imply
11Portfolio Management for Financial AdvisersJakub Karnowski, CFA
Understanding Client Personalities
Psychological Profiling
Methodical Investor
• base decisions on objective „facts”
• work hard to seek out new information
• rely on history and databases
• disciplined and conservative in their investments
Cautious Investor
• have a high need for financial security and to avoid losses
• do not like to make own decisions and do not trust others
• tend to select the least volatile assets and have little asset turnover
• frequently miss investment opportunities
Individualist Investor
• self-confident
• gather information from wide variety of sources to make own decisions
• confident to be successful in the long run
Spontaneous Investor
• quick to make decisions in the heat of the moment not to miss the chance
• achieve high portfolio turnover
• focus on return without considering risk
• doesn’t consider themselves experts, but don’t trust professionals
Most Risk Averse
Least Risk Averse
Base Decisions on Thinking Base Decisions on Feeling
12Portfolio Management for Financial AdvisersJakub Karnowski, CFA
Understanding Client PersonalitiesPsychological Profiling – Investment Personality Type Matrix
1. Understanding Client Personalities
1) Situational Profiling
2) Psychological Profiling
2. Developing the Investment Policy Statement
(IPS)
3. CASE STUDY
Table of contents
It documents the client’s specific investment objectives and the acceptable risk to be taken to accomplish them
It lists any constraints to be observed and guidelines to be followed
It forms the basis for future portfolio monitoring and review
Construction of the IPS is a dynamic process between the client and advisor to establish common objectives and constraints for the portfolio in terms that are realistic and understandable to both parties. Its creation gives the client control over the process and for most investors provides an „education” into relevant investment issues. A well-constructed IPS protects both parties and provides that basis for a periodic review of the relevant information contained on the IPS.
14Portfolio Management for Financial AdvisersJakub Karnowski, CFA
Developing the Investment Policy Statement (IPS)
15Portfolio Management for Financial AdvisersJakub Karnowski, CFA
CASE STUDY