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The Investment Process: Objectives, Constraints, Policy, and Monitoring

Learn about the four stages of the investment process, including specifying objectives and constraints, formulating policy, and monitoring and updating your portfolio. Understand the importance of asset allocation and managing portfolios for individual investors, pension funds, and long-term investments.

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The Investment Process: Objectives, Constraints, Policy, and Monitoring

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  1. CHAPTER 21 Investors and the Investment Process

  2. The Four Stages of the Investment Process Specifying objectives Specifying constraints Formulating policy Monitoring and updating portfolio

  3. Specifying Objectives Investment managers must assess the level of risk investors can tolerate in pursuit of higher returns. Objectives and risk tolerance differ by type of investor.

  4. Figure 28.1 CFA Institute Investment Management Process

  5. Table 28.1 Components of the Investment Management Process

  6. Table 28.2 Components of the Investment Policy Statement

  7. Table 28.3 Determination of Portfolio Policies

  8. Table 28.4 Matrix of Objectives

  9. Liquidity Ease (speed) with which an asset can be sold and created into cash Investment horizon - planned liquidation date of the investment Regulations Prudent investor rule Tax considerations Unique needs Specifying Constraints on Investment Policies

  10. Table 28.5 Matrix of Constraints

  11. Policy Statements • The Policy Statement (IPS) provides for: • Governance of the investment program, • The appropriate asset allocation, • Roles of internal and/or external managers, • Monitoring the results, • Risk management, • Appropriate reporting, • Accountability • A course of action in case of market turmoil

  12. Asset Allocation By far the most important part of policy determination is asset allocation, that is, deciding how much of the portfolio to invest in each major asset category. Specify asset classes Specify capital market expectation Derive the efficient portfolio frontier. Find the optimal asset mix. Manage taxes.

  13. Managing Portfolios of Individual Investors • Human capital and insurance • Investment in residence • Saving for retirement and the assumption of risk • Retirement planning models • Manage your own portfolio or rely on others?

  14. Tax Sheltering for Individual Investors Tax-deferral option - controlling the timing of gains on investments. Tax-deferred retirement plans IRAs Keogh plans Deferred annuities Fixed Variable Variable and universal life insurance

  15. Pension Funds Defined contribution plans Investment policy is essentially the same as for a tax-qualified individual retirement account Defined benefit plans Contractual arrangement setting out the rights and obligations of all parties

  16. Pension Funds The tax status of pension funds makes them favor assets with the largest spread between pretax and after-tax rates of return. Pension funds make use of immunization. Investing in equities occurs for both correct and wrong reasons.

  17. Investments for the Long Run Advice from the mutual fund industry: Don’t try to outguess the market by moving your money in and out. Buy and hold instead. Diversify to reduce risk. Put money in stocks, bonds, and money market mutual funds. Avoid keeping 401(k) money in a company’s low-risk default investment scheme. Be wary of investing a large percentage of your 401(k) in your company’s stock.

  18. Investments for the Long Run Investment horizon determines which risk-free rate to choose. Make simple investment choices such as TDRFs (target date retirement funds). Inflation risk and long-term investors: TIPS are helpful but not really risk-free. Market value can fluctuate. Reinvestment rate risk

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