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Chapter 5

Chapter 5. Investors and the Investment Process. Overview of the Investment Process. Specify objectives Identify constraints Formulate an investment policy Monitor performance Reevaluate and modify portfolio as determined from monitoring. Specifying Objectives: Individual Investors.

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Chapter 5

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  1. Chapter5 Investors and the Investment Process

  2. Overview of the Investment Process • Specify objectives • Identify constraints • Formulate an investment policy • Monitor performance • Reevaluate and modify portfolio as determined from monitoring

  3. Specifying Objectives: Individual Investors Balance risk and return Life Cycle is critical to the process of determining the risk/return trade-off Younger investors - willing to bear more risk for higher returns Older investors - willing to accept lower returns for lower risk

  4. Specifying Objectives: Personal Trusts and Mutual Funds • Personal Trusts • Determined by the individual for whom the funds are being managed • Mutual Funds • Varies with type of fund • Detailed in the prospectus

  5. Specifying Objectives: Pension Funds and Endowments • Pension Funds • Defined contribution - shifted to the individual • Defined benefit - depends on average time to retirement of individuals • Endowment Funds • Gifts to nonprofits are invested • Funds from the endowment used by the nonprofit

  6. Specifying Objectives: Insurance Companies • Life Companies • Investments are hedged against potential claims of policy holders • Non-Life Companies • Invest premiums not paid back to policyholders for loss • Hedge against potential claims

  7. Specify Objectives: Banks • Sources of funds: deposits and borrowed funds • Investment of funds: predominately in loans and fixed income securities • Active in the securitized loan and asset markets • Not active in equity except in the Trust Function

  8. Investor Constraints Liquidity - speed and ease with which as asset can be converted into cash Investment Horizon - the planned liquidation date Regulations - specific regulations that may apply to the investor Prudent Man Rule Mutual Fund Diversification Charitable contribution limits

  9. Investor Constraints Tax Considerations - special considerations related to tax position of the investor Unique Needs- special considerations related to the underlying investors Diversification requirements related to employment

  10. Investment Policy: Asset Allocation Decision Individual - depends on life cycle Younger Higher equity 75% Lower safe assets 25% Older Lower equity 40% Higher safe assets 60% Institutional - depends on objectives Example - an all stock mutual fund would want nearly 100% in stock Sector or Region allocations

  11. Investment Policy: Active or Passive Active Trying to secure better than average performance Must balance returns and costs Passive Trying to get average returns rather than do better than the market Mix of Passive and Active

  12. Taxes and Investment Strategy Shelter Options • Deferral of taxes on capital gains • Tax Deferred Retirement Plan • IRA • 401(k) • Taxes are paid on the income from retirement and not on returns from investment

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