Advanced Portfolio Management
ADMS 4501 – Winter 2012 – Lois King
Lecture 2 – Chapter 2 – The Asset Allocation Decision – Jan 12
The Asset Allocation Decision
Individual investor life cycle.
The portfolio management process.
The need for policy statement.
Constructing the policy statement.
The importance of asset allocation.
What is Asset Allocation?
o Process of deciding how to distribute an investor’s wealth among different
countries and asset classes for investment purposes.
o Group of securities that have similar characteristics, attributes, and
o Depending on the type of investors, investment objectives and constraints
Individual Investor Life Cycle: Preliminaries
Life insurance: providing death benefits and, possibly, additional cash values.
o Term life and whole life insurance.
o Universal and variable life insurance.
o Health insurance & disability insurance.
o Automobile insurance & home/rental insurance.
o To meet emergency needs.
o Equal to six months living expenses.
Phases of an Investor’s Life Cycle
o Early to middle years of working career.
o Past midpoint of careers. Earnings greater than expenses.
o Begins after retirement.
Life Cycle Investment Goals Near-term, high-priority goals.
Long-term, high-priority goals.
Portfolio Management Process: Policy Statement
Specifies investment goals and acceptable risk levels.
Should be reviewed periodically.
Guides all investment decisions.
Portfolio Management Process
o Focus: Investor’s short-term and long-term needs, familiarity with capital
market history, and expectations.
Examine current and projected financial, economic, political and social
o Focus: Short-term and intermediate-term expected conditions to use in
constructing a specific portfolio.
Implement the plan by constructing the portfolio.
o Focus: Meet the investor’s needs at minimum risk levels.
Feedback loop: monitor and update investor needs, environmental conditions,
evaluate portfolio performance.
Need for Policy Statement
Understand investor’s needs and articulate realistic investment objectives and
o What are the real risks of an adverse financial outcome, and what
emotional reactions will I have?
o How knowledgeable am I about investments and the financial markets?
o What other capital or income sources do I have? How important is this
particular portfolio to my overall financial position?
o What, if any, legal restrictions affect me?
o How would any unanticipated portfolio value change might affect my
Sets standards for evaluating portfolio performance.
o Provides a comparison standard in judging the performance of the
o Benchmark portfolio or comparison standard is used to reflect the risk and
return objectives specified in the policy statement.
o Should act as a starting point for periodic portfolio review and client
communication with the manager.
o Reduces possibility of inappropriate or unethical behaviour of the portfolio
o Helps create seamless transition from one money manager to another
without costly delays. o Provides the framework to help resolve any potential disagreements
between the client and the manager.
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
o Liquidity, time horizon, tax factors, legal and regulatory constraints, and
unique needs and preferences.
o Should be based on investor’s ability to take ris