4 Asset Allocation - Investor Profiles and Portfolio...

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Investor Profiles and Portfolio Management Strategy If you get the asset allocation right, you are home free
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Asset Allocation Asset allocation is generally considered to account for 90% of the results of a portolio It doesn’t matter so much which shares are purchased It is percentage of capital in equities that drives results since equities most volatile and highest yield asset class: If weighted to equities, a portfolio will do very well in a bull market, but very badly in a bear market and will always have higher volatility If weighted to bonds, a portfolio will outperform in a bearish market but underperform in a bull market In fact, while perhaps it is the most important step, it is only one of several steps in the process The composition of portfolio is driven by goals of investor, his tolerance for risk and his financial circumstances
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Four Step Process in Managing a Portfolio Define the objectives and parametres of the client (whether you are acting as advisor or for yourself) Asset Allocation Implementation of purchases of individual assets Periodic rebalancing to take profits and maintain original profile and associated goals
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Four Step Process: Objectives/Parametres Define the objectives and parametres of the client and of fund What is goal of fund: Retirement Steady income with capital preservation Children’s education Risk tolerance of investor Future contributions to fund Does the investor still have high potential for income growth from work? What are expected annual contributions to fund? Does investor himself expect to inherit significant funds? Horizon at which start to draw down funds Full reinvestment of gains (wealthy investor) Reinvest only to offset inflation with excess taken out (endowment) Liquidation at certain date (children’s college tuition) or unknown date (eg death of investor) If personal retirement fund, does investor wish for a signicant portion of fund to be available to his heirs?
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Four Step Process: Objectives/Parametres These parametres determine the “neutral” weighting for the fund In theory, investors should want 100% equities since this class has highest expected rate of return It also has highest variablity/risk which means that while long term it should outperform other asset classes: needs of the investor may mean he has to draw down funds at a moment when the value of the fund is down Investor may not have the stomach for the roller coaster Weighting of equities in fund is driven by these concerns
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Four Step Process: Asset Allocation Based on needs and limits of previous step Determine what is a “neutral asset allocation” for the portfolio Decide whether forecasting of asset class returns will be used to “massage” the neutral weighting Two basic ways of forecasting future market returns : The past is as good an indication as any about the future
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