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Portfolio management process

The portfolio management process has three steps: planning, execution, and feedback.

The Planning Step

The planning step involves obtaining an understanding of the client’s needs and documenting it through a (written) an investment policy statement (IPS), a statement of a client’s objectives and constraints, which may also list some relevant benchmark against which the portfolio performance would most likely be measured.

The Execution Step

The execution step is concerned with determining the target asset allocation, selecting appropriate securities, and constructing the ultimate portfolio.

Asset allocation refers to the relative proportion of different asset classes (equities versus fixed-income vs real estate, etc.) that an investor would hold. This decision is guided by the creation of economic and capital market expectations.

Top-down vs bottom-up

In the top-down approach, economists form a broad economy-wide view which is used to identify asset classes expected to perform well. An alternative or complementary approach, called the bottom-up approach, requires an analyst to look at management quality and a company’s profile to identify good candidates for investment.

Portfolio construction process

Once the asset allocation has been finalized and investment candidates identified, the portfolio construction process is initiated whose core objective to achieve diversification benefits. Portfolio construction must comply with the risk tolerance threshold identified in the IPS. Different investors have different risk tolerance. Portfolio construction also involves trading in securities, hence management of transaction costs is also important.

The Feedback Step

The feedback step involves portfolio monitoring and rebalancing and its measurement and reporting. Once a portfolio has been created, it needs to be monitored periodically to ensure that it continues to stay in compliance with the IPS and investment strategy. The asset weights may drift away from intended asset allocation or the investor’s circumstances may change, necessitating a rebalancing of the portfolio. An important part of the feedback phase is a measurement of return earned by a portfolio to see whether the investor’s objectives have been met. Such measurement and reporting are often carried in comparison to a relevant benchmark.

by Obaidullah Jan, ACA, CFA on Mon Feb 10 2020

This article can help you prepare for Reading 51 LOSb.

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