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Investment Decision and Portfolio Management (ACFN 632)

This document discusses asset allocation and portfolio management. It defines asset allocation as the process of distributing wealth across different asset classes and countries. The key aspects are: 1) Developing an investment policy statement that specifies goals, risk tolerance, and reviews. 2) Considering objectives like risk, return, and constraints like liquidity and taxes. 3) Understanding the importance of asset allocation in designing an investment strategy through decisions on asset classes, policy weights, ranges, and specific securities. 4) Approaches to asset allocation include fixed or flexible weightings, and tactical adjustments based on markets.

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36 views

Investment Decision and Portfolio Management (ACFN 632)

This document discusses asset allocation and portfolio management. It defines asset allocation as the process of distributing wealth across different asset classes and countries. The key aspects are: 1) Developing an investment policy statement that specifies goals, risk tolerance, and reviews. 2) Considering objectives like risk, return, and constraints like liquidity and taxes. 3) Understanding the importance of asset allocation in designing an investment strategy through decisions on asset classes, policy weights, ranges, and specific securities. 4) Approaches to asset allocation include fixed or flexible weightings, and tactical adjustments based on markets.

Uploaded by

habtamu
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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Investment Decision and

Portfolio
Management
(ACFN 632)
Chapter 2
Asset allocation decision

1
What is Asset Allocation?
• Asset Allocation
– process of deciding how to distribute an investor’s
wealth among different countries and asset classes
for investment purposes

• Asset Class
– group of securities that have similar
characteristics, attributes, and risk/return
relationships
2
Portfolio Management
Process:
Policy Statement
– Specifies investment goals and acceptable
risk
levels
– Should be reviewed periodically

– Guides all investment decisions

3
Portfolio Management
Process

4
Need for Policy Statement
• Understand investor’s needs and articulate realistic
investment objectives and constraints

– What are the real risks of an adverse financial


outcome, and what emotional reactions will I have?

– How knowledgeable am I about investments and


the financial markets?

– What, if any, legal restrictions affect me?

5
Need for Policy Statement

• Understand investor’s needs and articulate


realistic investment objectives and constraints …
– What other capital or income sources do I have?

– How important is this particular portfolio to my


overall financial position?
– How would any unanticipated portfolio value
change
might affect my investment policy?
6
Need for a Policy Statement
• Sets standards for evaluating portfolio performance
– Provides a comparison standard in judging the
performance of the portfolio manager
– Benchmark portfolio or comparison standard is used to
reflect the risk and return objectives specified in the policy
statement
– Should act as a starting point for periodic portfolio review
and client communication with the manager

7
Need for a Policy Statement

• Other Benefits
– Reduces possibility of inappropriate or unethical behavior
of the portfolio manager.
– Helps create faultless transition from one money manager
to another without costly delays.
– Provides the framework to help resolve any potential
disagreements between the client and the manager.

8 10
Input to the Policy Statement

• Constructing the policy statement begins with a


profile analysis of the investor’s current and
future financial situations and a discussion of

investment objectives and constraints.

9
Input to the Policy Statement

• Objectives
– Risk
– Return

• Constraints
– Liquidity, time horizon, tax factors, legal and
regulatory constraints, and unique needs
and preferences
10
Investment Objectives

• Risk Objectives
 Should be based on investor’s ability to take risk
and willingness to take risk.
Risk tolerance depends on an investor’s current
net worth and income expectations and age.
• More net worth allows more risk taking
• Younger people can take more risk
Careful analysis of client’s risk tolerance should
precede any discussion of return objectives.

11
Investment Objectives

• Return Objectives
– May be stated in terms of an absolute or a
relative percentage return
– Capital Preservation:
• Minimize risk of real losses

12
Investment Objectives

– Capital Appreciation: Growth of the portfolio in


• real terms to meet future need

– Current Income: Focus is in generating income


• rather than capital gains
– Total Return: Increase portfolio value by capital gains and by
reinvesting current income with moderate risk exposure

13
Investment Constraints:
Liquidity
– Liquidity

• Vary between investors; depending upon


age,
employment, tax status, etc.
• Planned vacation expenses and house
down payment are some of the liquidity
needs.
14
Investment Constraints: Time

– Time
• Influences liquidity needs and risk tolerance.

• Longer investment horizons generally requires


less
liquidity and more risk tolerance.
• Two general time horizons are pre-retirement
and
post-retirement periods.
15
Investment Constraints: Taxes

– Interest Income: 100% of all interest income is taxed at


an
investor’s marginal tax rate.
– Interest Income: 100% of all interest income is taxed at
an
investor’s marginal tax rate, in Ethiopia flat rate of 5%.
– Capital gains are also taxed

– Investment on government securities are tax exempt

16
Personal Constraints:
Unique Needs &
• Preferences
Personal preferences such as socially conscious could
influence investment choice
• Time constraints or lack of expertise for managing
the
portfolio may require professional management
• Large investment in employer’s stock may require
consideration of diversification needs
• Institutional investor’s needs- may differ from
17 20
personal
Importance of Asset Allocation

• An investment strategy is based on four decisions


– What asset classes to consider for investment
– What policy weights to assign to each eligible class
– What allocation ranges are allowed based on
policy weights
– What specific securities to purchase for the
portfolio

Measuring risk by the probability of not meeting your


investment return objective indicates risk of
equities is small and that of T- bills is large because
of their differences in expected returns
18
Portfolio Objectives and Policies
• Capital Preservation Objective
– Low-risk, conservative investment strategy
– Emphasis on current income and capital preservation

• Capital Growth Objective


– Higher-risk investment strategy
– Emphasis on more speculative investments

• Tax Efficient Objective


– Emphasis on capital gains and longer holding periods to
defer
19

income taxes
Approaches to Asset Allocation
• Fixed-Weightings Approach: asset allocation plan in which
a fixed percentage of the portfolio is allocated to each
asset category

• Flexible-Weightings Approach: asset allocation plan in which


weights for each asset category are adjusted periodically
based on market analysis

• Tactical Approach: asset allocation plan that uses stock-


index futures and bond futures to change asset allocation
based on market behavior 20
Alternative Asset Allocation

21
Applying Asset Allocation

• Consider impact of economic and other factors on


your investment objective.

• Design your asset allocation plan for the long haul

• Stress capital preservation.

• Provide for periodic reviews to maintain


consistency
with changing investments goals.
22
End

23

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