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ASSET
ALLOCATION &PORTFOLIOMANAGEMENTPROCESS
LECTURE 2
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Agendas
PART 1: Investment Policy Statement
- What are the four steps in the portfolio managementprocess?
- Why is a investment policy statement (IPS) importantto the planning process
- What objectives and constraints should beconsidered in a policy statement?
- What is the asset allocation?- How and why investors goal change over a persons
lifetime and circumstance?
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Agendas
PART 2: Market Security Index
- What are some major uses of security marketindicator series (indexes)?
- What are major characteristics of alternativeindexes?
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PART 1
INVESTMENT POLICY STETEMENT
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Portfolio management process
Four steps:
Monitor, evaluate portfolio performance and updateinvetment policy statement
Construct the Portfolio
Investigate current financial and economic conditions,
forecast future trends
Investment Policy Statement (IPS)
http://corporate.morningstar.com/ib/asp/detail.aspx?filter=CIJIndex.xml&xmlfile=1466.xml
https://personal.vanguard.com/us/funds/vanguard/core
http://corporate.morningstar.com/ib/asp/detail.aspx?filter=CIJIndex.xml&xmlfile=1466.xmlhttps://personal.vanguard.com/us/funds/vanguard/corehttps://personal.vanguard.com/us/funds/vanguard/corehttp://corporate.morningstar.com/ib/asp/detail.aspx?filter=CIJIndex.xml&xmlfile=1466.xml8/3/2019 Asset Allocation & Portfolio Management Process_lecture 2_2011
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Investment Policy Statement (IPS)
Constructing a policy statement will:
- Providedisciplinefor the investment process.
- Reduce the possibility of making inappropriate decisions.
- Help investors decide arealistic investment goalsbased
on the understanding their own objectives, constrains andneeds.
- Set a standardfor evaluating portfolio performance:
Benchmark portfolio:
- Risk and return
Match risk preferences and investment needs:
- Analysis of risk tolerance
- Return objective
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Conducting policy statement actually is to determine overallinvestment strategy:
- not indicate which specific securities are sold or bought, but
- provide guidelines on asset classesto invest and the relativeproportionof a investors fund to allocate in each asset class.
Constructing a policy statement(List of questions suggested for investors and advisors (RB,p.55-56)
Investment Policy Statement (Cont.)
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1.Objectives
2.
Constrains
INVESTMENTPOLICY
STATEMENT(IPS)
Investment Policy Statement (Cont.)
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1. Investment Objectives
The investment objectivesof an investment is stated in
terms of both risk and return.
Risk toleranceis affected by many factors such asinvestors family situation, his or her age, cash reserves etc.
rather than just a function of individuals psychology.
returnrisk
investment objectives
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Return objective may be expressed in terms of anabsolute or relative percentage return.
It may also be determined in terms of general goal:capital preservation, capital appreciation, currentincome or total return.
Investment Objectives (Cont.)
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Minimize the risk of loss, usually in real terms Maitain purchasing power of an investment
Strategy for strongly risk averse investors
Capital presevation
Portfolio grow in real terms over time, maily through capital gains Aggressive strategy for investors willing to take a risk
Capital appreciation
Concentrate on generating income rather than capital gains
Current income
Increase portfolio value by both capital gains and reinvestingcurrent income
Maitain moderate risk exposure
Total return
http://www.franklintempleton.co.uk/jsp_cm
/funds/fdata/0643_uk_en.pdf
Investment Objectives (Cont.)
http://www.franklintempleton.co.uk/jsp_cm/funds/fdata/0643_uk_en.pdfhttp://www.franklintempleton.co.uk/jsp_cm/funds/fdata/0643_uk_en.pdfhttp://www.franklintempleton.co.uk/jsp_cm/funds/fdata/0643_uk_en.pdfhttp://www.franklintempleton.co.uk/jsp_cm/funds/fdata/0643_uk_en.pdf8/3/2019 Asset Allocation & Portfolio Management Process_lecture 2_2011
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Young people with little wealth should not invest money inrisky assets such as stocks because they cannot afford tolose what little money they have do you agree or disagree
with this statement? Why?
Source: Brown. K. C. & Reilly F. K., Investment analysis andPortfolio Management
Investment Objectives (Cont.)
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Liquidityneeds
Timehorizon
Taxconcern
Legal&Regula-tory
factors
Uniqueneeds &prefe-rence
2. Investment Constraints
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Liquidity needs: investment plan must considerliquidity needs of investors.
An investor even though has a primary long termgoal, several near term goals may require availablefund such as a house/car down payment or collegeintuition.
Investment Constraints (Cont.)
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Time horizon: is an
investment constraintrelated to near termand long term highpriority goals.
There is the closerelationshipbetweeninvestors liquidity need,
time horizon and abilityto hanle risk
Liquidityneeds
Timehori-zon
Abilityto
hanlderisk
Investment Constraints (Cont.)
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Tax concerns: the differing timing of and tax rates oncapital gains and dividends.
- Interest and dividends are taxed at investorsmarginal tax rate when it is received.
- Capital gains or losses are taxed only when an asset
is sold.
Investment Constraints (Cont.)
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Legal and regulatory factors: both investment processand financial markets are highly regulated and subject tonumerous laws.
Example:
- Foreign investors investing in joint stock companies in Vietnamare subject to limitation of ownership (up to 49%) => room forforeign investors.
- Investment funds of life insurance companies are highlyregulated by rules of allocating risky asset classes
Investment Constraints (Cont.)
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Unique needs and preferences:
- Consider on the basis of personal preference or forsocial consciousness reasons.
- Institutional investors needs (mutual funds, lifeinsurance companies etc.)
- Large investment in employers stock needs to beconsidered in terms of diversification.
Investment Constraints (Cont.)
P li St t t (R i )
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Policy Statement (Review)
Investment Objective: risk return
Investment Constraints: liquidity, time horizon, taxconcerns, legal and regulated factors, unique needs
and preference.
Developing the plan based on the understandingthe relationship between risk and return and the
importance of diversification
A t ll ti
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Asset allocation
- Asset allocation decision: is not isolated decision but a
componentof a structured four step procedure of portfoliomanagement.
- Asset allocation: The process of deciding how to distribute
investors wealth among different asset classesandacross countrieswith the purpose of increase theinvestors wealth.
- Asset class: securities have the similar characteristics,attributes, risk/return characteristics. Exp. Corporate bondclass, government bond class or high yield bond class(junk bond)
A t All ti (C t )
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Aninvestment strategycomprises fourdecisions:
Asset Allocation (Cont.)
Which asset classes?
Which policy weight?
What allowable allocation
ranges?
What specific securities?
Asset
allocation:first two steps
A t All ti (C t )
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Asset allocation is a critical component of the
portfolio management process involves in twocontents:
Most (85% to 95%) of the overall investment return isdue to the asset allocation, not the selection ofindividual investment.
Asset Allocation (Cont.)
A t All ti (C t )
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Asset Allocation (Cont.)
https://personal.vanguard.com/us/funds/vanguard/core
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Social, political and tax environments affect asset
allocation decision:
Equity allocation of U.S pension funds average 58%.
In the U.K, equities make up 78% of assets.
In Germany, equity allocation averages 8%
In Australia, allocation to equity accounts for 40% of
assets
Asset allocation and culture differences
R t d i k f diff t t l
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Higher returns for compensation of taking higher risk
Historically, small company stocks have generatedhighest returns but also have been highest volatile.
Inflation and tax have a major impact on returns
Returns on Treasury Bills have barely kept pace with
inflation.
Returns and risks of different asset classes
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Policy statement determines types of assets toinclude in portfolio.
Asset allocation determines portfolio return more thanstock selection.
Risk of strategy depends on investors goals and time
horizon.
Over long time periods sizable allocation to equity willimprove results
Asset Allocation Summary
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Individual Investment life cycle
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Prelimina-
ries
Accumula-
tion Phase
Consolida-
tion Phase
Spending
Phase
Gifting
Phase
Individual Investment life cycle (Cont.)
-Preliminaries: Insurance, cash reserve
-Accumulation Phase: early to middle years of workingcareer. Relatively high - risk investments.
-Consolidation Phase: past midpoint of career. Earnings
greater than expenses. Moderately high risk investments
-Spending/Gifting Phase: begin after retirement. Protectinvestor capital
I di id l I t t lif l (C t )
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Near-term, high-priority goals
Short time horizson
Emotional importance Exp. House downpayment, parentshaving teenagersneed to pay tuitionfees
Long-term, high-priority goals
Long time horizon
Emotional importance Exp. Retirement plan
Lower-prioritygoals
Nice to meet the
objectives Exp. New car every 3years, redecorate thehome, etc.
Individual Investment life cycle (Cont.)
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PART 2: SECURITY MARKET
INDEXES
PART 2 SECURITY MARKET INDEXES
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PART 2: SECURITY MARKET INDEXES
At least 5 uses:
Uses ofsecurity marketindexes
1. Proxy formarket return
2. Create andmonitor Index
funds
3. Benchmarkto judge
performnaceof portfolio
4. Used topredictmarket
movement
5.Measuremarket returnin academicresearches
Different factors in constructing Market Index
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Different factors in constructing Market Index
Size Breadth source
The sample:
price-weighted series Value-weighted series Unweighted series
Weighting sample members
Athrimetic average Geometric average Compute an Index and have all changes (price or value),
reported in terms of basic index
Computational procedure:
Stock market Indexes
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Stock
market Indexes
Price Weighted Series:
- Dow Jone Industrial Average (DJIA)
- Nikkie Dow Jones Industrial Average
Value Weighted Series:
- NYSE Composite
- S&P 500 Index, S&P 200 Index and more . . .
Unweighted Price Indicator Series- Value Line Average
- Financial Time Ordinary Index
P i W i ht d I di t S i
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Price Weighted Indicator Series
Value Weighted Series
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Value Weighted Series
Value Weighted Series (Cont )
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Derive the initial total market value of all stocks used
in the series
Market value = No of Shares Outstanding x Current MarketPrice
Assign an beginning index value (100) and newmarket values are compare to the base index
Automatic adjustment for split.
Weighting depends on market value
Value Weighted Series (Cont.)
Unweighted Price Indicator Series
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All stocks carry equal weight regardless of price ormarket value.
Some use athrimetic average, others use geomatricavarage of the percent price changes for the stocksin the index.
Unweighted Price Indicator Series
Global Equity Indexes
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There are stock market indexes available for mostindividual foreign markets.
These are closely followed within each country.
Exp. USA S&P500, Australia AXS200, Japan Nikkei,UK FTSE Composite Share Index
Global Equity Indexes
VN Index
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Value weighted index
The basic date is 28/07/2000 with the basic
price is 100
Computing market prices of all companies
listed in HOSE (247 are currently traded).
VN - Index
VN Index (Cont )
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VN Index is calculated as followed:
(Q1iP1i) X 100
VN Index =
QoiPoi
P1i: current price of stock i
Q1i: Number of shares outstanding of stock i
Poi: original price of stock i
Qoi: Number of shares i at time to
VN Index (Cont.)
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When there is a new company being listed or listed
company increase its capital, division factor isadjusted as followed:
Do X V1
D1 =
VN Index (Cont.)
V1 - AV
D1: New division
Do: Original division
Do = Poi x Qoi
V1: Current market value of all stockslisted
AV: Adjusted value
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Exp. The result of trading on 28/7/2000
VN Index (Cont.)
Stocks Price Volume Market Capital
REE
SAM
16.000
17.000
15.000.000
12.000.000
240.000.000.000
204.000.000.000
Total 27.000.000 444.000.000.000
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VN Index = X100 = 105,20
Stocks Price Volume Market Capital
(mn VND)REE
SAM
TMS
HAP
16.900
17.800
14.000
16.000
15.000.000
12.000.000
2.200.000
1.008.000
253.500
213.600
30.800
16.128
Sum 30.208.000 514.028
VN Index (Cont.)
467,1
444
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VN Index (Cont.)
Bond market Indicator Series
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Relatively new and not widely used
Four investment firms maintain indexes forTreasury bonds and other investment grade
(rate BBB or higher) bonds.
SSB, Lehmann Borthers, Merrill lynch, UBS
Non investment grade bonds rated BB, B,CCC, CC and C.
Bond market Indicator Series