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CONTENT
Chapter 1:
2
OVERVIEW OF
THE INVESTMENT PROCESS  1. Introduction
 2. Portfolio Management Process
 3. Individual Investor Life Cycle
Lecturer: Dr. LINH D. NGUYEN
FACULTY OF FINANCE
BANKING UNIVERSITY OF HCMC

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1. INTRODUCTION A. WHAT IS A PORTFOLIO?

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 A. What is a portfolio?
 B. What is portfolio management
 C. What is portfolio’s asset classes
 A portfolio is a basket of assets that can include stocks, bonds,
commodities, currencies, cash equivalents, as well as their fund
counterparts.
 Non-publicly tradable securities like real estate, art, and private
investments can also be included in a portfolio.

 Asset allocation, risk tolerance, and

the individual's time horizon are all
critical factors when assembling and
adjusting an investment portfolio.

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B. WHAT IS PORTFOLIO MANAGEMENT
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 Portfolio management is the act of building and maintaining an
appropriate investment mix for a given risk tolerance.
 The key factors for any portfolio management strategy involve
asset allocation, diversification, and rebalancing rules.
 Active portfolio management seeks to “beat the market”
through identifying undervalued assets, often through short-term
trades and market timing.
 Passive (indexed) portfolio management seeks to replicate the
broader market while keeping costs and fees to a minimum.
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2. THE PORTFOLIO MANAGEMENT PROCESS
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 The unified presentation of portfolio management as a
process represented an important advance in the
investment management literature.
 Portfolio management is a process – an integrated set of
activities that combine in a logical, orderly manner to
produce a desired product.
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C. WHAT IS PORTFOLIO’S ASSET CLASSES
 An asset class is a grouping of investments that exhibit similar
characteristics and are subject to the same laws and regulations.
 Equities (stocks), fixed income (bonds), cash and cash
equivalents, real estate, commodities, futures, and other financial
derivatives are examples of asset classes.
 There is usually very little correlation,
and in some cases a negative
correlation, between different asset
classes.
 Financial advisers focus on asset class
as a way to help investors diversify
their portfolio.
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2. THE PORTFOLIO MANAGEMENT PROCESS
 A. CFA institute investment management process
 B. The need for a policy statement
 C. The importance of asset allocation
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A. CFA INSTITUTE INVESTMENT A. CFA INVESTMENT MANAGEMENT PROCESS

MANAGEMENT PROCESS OVERVIEW
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 Overview  The elements of the investment process

 Investment Objectives  Planning: Establishing all the elements necessary for
decision making (data about clients/capital markets)
 Investment Constraints
 Execution: Details of optimal asset allocation and security
selection
 Feedback: Adapting to changes in expectations and
objectives and changes in portfolio composition

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CFA INVESTMENT MANAGEMENT PROCESS CFA INVESTMENT MANAGEMENT PROCESS

OVERVIEW OVERVIEW
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Planning Feedback Components of the investment management process

I Planning
Specification and quantification of
Investor’s objectives, constraints, Investment A. Identifying and specifying the investor’s objectives and constraints
and preferences Monitoring investor-
Policy Statement related input factors B. Creating the Investment Policy Statement
(IPS)
C. Forming capital market expectations
Execution
D. Creating the strategic asset allocation (target minimum and maximum class weights)
Portfolio construction Attainment of
and revision investor II Execution: Portfolio construction and revision
Determining Strategic asset objectives
Security selection A. Asset allocation (including tactical) and portfolio optimization (combining assets to meet risk
target asset class weights allocation
Port. Implementation Performance and return objectives)
Port. optimization measurement
B. Security selection
C. Implementation
Monitoring economic III Feedback
Relevant economic, Capital market expectations and market input
factors
A. Monitoring (investor, economic, and market input factors)
social, political, and
sector considerations B. Rebalancing
C. Performance evaluation
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CFA INVESTMENT MANAGEMENT PROCESS CFA INVESTMENT MANAGEMENT PROCESS

INVESTMENT OBJECTIVES INVESTMENT OBJECTIVES
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 The investor’s objectives are his investment goals, expressed in
terms of both risk and returns  Investment managers must
assess the level of risk that investors can tolerate in pursuit of
higher returns (risk–return trade-off)
 Risk tolerance:
 A function of an individual’s psychological makeup
 Also affected by other factors, such as a person’s current insurance
coverage, cash reserves, family situation, and age
 Influenced by one’s current net worth and income expectations
 Return objectives
 May be stated in terms of an absolute or a relative percentage return or a
general goal, such as capital preservation, current income, capital
appreciation, or total return
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 Capital preservation
 Means that investors want to minimize their risk of loss,
usually in real terms: They seek to maintain the purchasing
power of their investment
 The return needs to be no less than the rate of inflation
 Capital appreciation
 Is an appropriate objective for investors who want the portfolio
to grow in real terms over time to meet some future need
 Under this strategy, growth mainly occurs through capital gains
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CFA INVESTMENT MANAGEMENT PROCESS CFA INVESTMENT MANAGEMENT PROCESS

INVESTMENT OBJECTIVES INVESTMENT OBJECTIVES
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 Current income  Investment Objective: 25-Year-Old

 Investors want to generate income rather than capital gains
 Retirees may favor this objective for part of their portfolio to
help generate spendable funds
 Total return strategy
 Investors want the portfolio to grow over time to meet a future
need
 Increase portfolio value by both capital gains and reinvesting
current income
 Assume that he holds a steady job, is a valued employee, has
adequate insurance coverage, and has enough money in the
bank to provide a cash reserve.
 Assume that his current long-term, high-priority investment
goal is to build a retirement fund.
 He can select a strategy carrying moderate to high amounts of
risk because the income stream from his job will probably grow
over time.
 Further, given young age and income growth potential, a total
return or capital appreciation objective is appropriate

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CFA INVESTMENT MANAGEMENT PROCESS CFA INVESTMENT MANAGEMENT PROCESS

INVESTMENT OBJECTIVES INVESTMENT OBJECTIVES
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 Investment Objective: 25-Year-Old  Investment Objective: 65-Year-Old

 Here’s a possible objective statement:  Assume that she has adequate insurance coverage and a cash

Invest funds in a variety of moderate- to higher-risk investments.
The average risk of the equity portfolio should exceed that of a
broad stock market index, such as the NYSE stock index. Foreign
and domestic equity exposure should range from 80 percent to 95
percent of the total portfolio. Remaining funds should be invested
in short- and intermediate-term notes and bonds.
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reserve. Let’s also assume she is retiring this year.
 Depending on her income from social security and a pension
plan, she may need some current income from her retirement
portfolio to meet living expenses. She also needs protection
against inflation
 A risk-averse investor will choose a combination of current
income and capital preservation strategies
 A more risk-tolerant investor will choose a combination of
current income and total return in an attempt to have principal
growth outpace inflation
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CFA INVESTMENT MANAGEMENT PROCESS SMART GOALS

INVESTMENT OBJECTIVES HOW TO MAKE YOUR GOALS ACHIEVABLE
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 Investment Objective: 65-Year-Old
 Here’s an example of such an objective statement:
Invest in stock and bond investments to meet income needs (from
bond income and stock dividends) and to provide for real growth
(from equities). Fixed-income securities should comprise 55–65
percent of the total portfolio; of this, 5–15 percent should be
invested in short-term securities for extra liquidity and safety. The
remaining 35–45 percent of the portfolio should be invested in
high-quality stocks whose risk is similar to the S&P 500 index.
 SMART is an acronym that you can use to guide your goal
setting. To make sure your goals are clear and reachable,
each one should be:
 Specific (simple, sensible, significant).
 Measurable (meaningful, motivating).
 Achievable (agreed, attainable).
 Relevant (reasonable, realistic and resourced, results-based).
 Time bound (time-based, time limited, time/cost limited,
timely, time-sensitive).

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CFA INVESTMENT MANAGEMENT PROCESS CFA INVESTMENT MANAGEMENT PROCESS

INVESTMENT CONSTRAINTS INVESTMENT CONSTRAINTS
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 Constraints also affect the investment plan.  Liquidity Needs

 Liquidity needs  An asset is liquid if it can be quickly converted to cash at a
 Time horizon price close to fair market value
 Tax concerns  An investor may have a primary long-term goal, several near-
 Legal and regulatory constraints term goals may require available funds, ex., buy car, house,
 Unique needs and preferences college tuition payments…
 Time Horizon
 Investors with long investment horizons generally require less
liquidity and can tolerate greater portfolio risk
 Investors with shorter time horizons generally favor more
liquid and less risky investments because losses are harder to
overcome in a short time frame
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CFA INVESTMENT MANAGEMENT PROCESS

INVESTMENT CONSTRAINTS
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 Tax Concerns
 Investment planning is complicated by taxes that can seriously
become overwhelming if international investments are part of
the portfolio
 Taxable income from interest, dividends, or rents is taxable at
the investor’s marginal tax rate
 A note regarding taxes:
 The impact of taxes on investment strategy and final results is
clearly very significant
 Consult a tax accountant for advice regarding tax regulations

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CFA INVESTMENT MANAGEMENT PROCESS CFA INVESTMENT MANAGEMENT PROCESS

INVESTMENT CONSTRAINTS INVESTMENT CONSTRAINTS
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 Legal and Regulatory Factors  Unique Needs and Preferences

 The investment process and the financial markets are
highly regulated and subject to numerous laws
 Regulations can constrain the investment choices available
to someone in a fiduciary role
 A fiduciary, or trustee, supervises an investment portfolio
of a third party, such as a trust account or discretionary
account
 All investors must respect certain laws, such as insider
trading prohibitions
 Covers the unique concerns of each investor
 Because each investor is unique, the implications of this
final constraint differ for each person
 Each individual must decide on and then communicate
these specific needs and preferences in their policy
statement

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B. THE NEED FOR THE NEED FOR

AN INVESTMENT POLICY STATEMENT AN INVESTMENT POLICY STATEMENT
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Components of an Investment Policy Statement (IPS)
1. Brief client description
2. Purpose of establishing policies and guidelines
3. Duties and investment responsibilities of parties involved
4. Statement of investment goals, objectives, and constraints
5. Schedule for review of investment performance and the investment
policy statement
6. Performance measures and benchmarks
7. Any considerations in developing strategic asset allocation
8. Investment strategies and investment styles
9. Guidelines for rebalancing
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 Important reasons for constructing an IPS:
 It helps the investor decide on realistic investment goals
after learning about the financial markets and the risks of
investing
 It creates a standard by which to judge the performance
of the portfolio manager
 Protects the client against a portfolio manager’s
inappropriate investments or unethical behavior
 The first step before beginning any investment
program is to construct a comprehensive IPS
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C. THE IMPORTANCE OF ASSET ALLOCATION THE IMPORTANCE OF ASSET ALLOCATION

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 Four decisions involved in constructing an investment strategy: The exhibit shows the
 What asset classes should be considered for investment? relationship between
 What policy weights should be assigned to each eligible asset returns on the target or
class? policy portfolio
 What are the allowable allocation ranges based on policy allocation and actual
weights? returns on a sample
 What specific securities or funds should be purchased for the mutual fund.
portfolio?
 About 90 percent of a
 The asset allocation decision involves the first three points.
fund’s returns over
 How important is the asset allocation decision to an time can be explained
by its target asset
investor? In a word, VERY.
allocation policy.
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3. INDIVIDUAL INVESTOR LIFE CYCLE A. OVERVIEW

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 A. Overview
 B. Benefits of investing early
 C. How much risk is right for you?
 D. Initial risk and investment goal categories and
asset allocations

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OVERVIEW OVERVIEW
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 Accumulation phase  Spending phase

 Early to middle years of working career  Begins after retirement
 Long investment time horizon and future earning ability  Living expenses are covered by social security income and income
 Individuals typically willing to make relatively high-risk investments from prior investments, including employer pension plans
in the hopes of making above-average nominal returns over time  The overall portfolio may be less risky than in the consolidation
 Consolidation phase phase, but investors still need some risky growth investments, such as
 Past midpoint of careers common stocks, for inflation protection
 Earnings greater than expenses  Gifting phase
 Typical investment horizon for this phase is still long (20 to 30  May be concurrent with the spending phase
years), so moderately high-risk investments are attractive  Excess assets can be used to provide financial assistance to relatives
 Individuals in this phase are concerned about capital preservation and or to establish charitable trusts as an estate planning tool to minimize
do not want to take abnormally high risks estate taxes
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C. HOW MUCH RISK IS RIGHT FOR YOU, OR

B. BENEFITS OF INVESTING EARLY
WHAT IS YOUR LEVEL OF RISK TOLERANCE ?
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The Future Value of the

The Future Value of an The Future Value of
Initial Investment Plus “no pain, no gain” “no risk, no reward.”
Initial $10,000 Investment Investing $2,000 Annually
the Annual Investment
Interest rate 7%
20 years $38,696.84 $81,990.98 $120,687.83  How you feel about risking your money will drive many of
30 years $76,122.55 $188,921.57 $265,044.12
40 years ? ? ? your investment decisions.
 The risk-comfort scale extends from very conservative (you
8%
20 years $46,609.57 $91,523.93 $138,133.50 don’t want to risk losing a penny regardless of how little your
30 years $100,626.57 $226,566.42 $327,192.99 money earns) to very aggressive (you’re willing to risk much
40 years $217,245.21 $518,113.04 $735,358.25
of your money for the possibility that it will grow
Giá trị tương lai của một số tiền = × 1+ tremendously).
Giá trị tương lai của dòng tiền cuối kỳ = × 1+ −1 /  As you might guess, most investors’ tolerance for risk falls
1 1 somewhere in between.
Giá trị hiện tại của dòng tiền cuối kỳ = × −
1+
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C. HOW MUCH RISK IS RIGHT FOR YOU, OR

HOW MUCH RISK IS RIGHT FOR YOU?
WHAT IS YOUR LEVEL OF RISK TOLERANCE ?
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3. On days when the stock 4. You’re planning a vacation trip and

1. You win $300 in an office
football pool. You:
(a) spend it on groceries,
(b) purchase lottery tickets
(c) put it in a money market
account,
(d) buy some stock.
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2. Two weeks after buying 100
shares of a $20 stock, the price
jumps to over $30. You decide
to:
(a) Buy more stock; it’s
obviously a winner,
(b) Sell it and take your profits
(c) Sell half to recoup some
costs and hold the rest,
(d) Sit tight and wait for it to
advance even more.
market jumps way up, you:
(a) wish you had invested
more
(b) call your financial
advisor and ask for
recommendations
(c) feel glad you’re not in
the market because it
fluctuates too much
(d) pay little attention
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can either lock in a fixed room-and-
meals rate of $150 per day or book
standby and pay anywhere from $100
to $300 per day. You:
(a) take the fixed-rate deal
(b) talk to people who have been
there about the availability of last-
minute accommodations,
(c) book standby and also arrange
vacation insurance because you’re
leery of the tour operator,
(d) take your chances with standby

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HOW MUCH RISK IS RIGHT FOR YOU? HOW MUCH RISK IS RIGHT FOR YOU?
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 5. The owner of your apartment building is converting the
units to condominiums. You can buy your unit for $75,000
or an option on a unit for $15,000. (Units have recently sold
for close to $100,000, and prices seem to be going up.) For
financing, you’ll have to borrow the down payment and pay
mortgage and condo fees higher than your present rent. You:
 (a) buy your unit,
 (b) buy your unit and look for another to buy,
 (c) sell the option and arrange to rent the unit yourself,
 (d) sell the option and move out because you think the
conversion will attract couples with small children.
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 6) You have been working three years for a rapidly growing
company. As an executive, you are offered the option of
buying up to 2% of company stock: 2,000 shares at $10 a
share. Although the company is privately owned (its stock does
not trade on the open market), its majority owner has made
handsome profits selling three other businesses and intends to
sell this one eventually. You:
 (a) purchase all the shares you can and tell the owner you
would invest more if allowed,
 (b) purchase all the shares,
 (c) purchase half the shares,
 (d) purchase a small amount of shares.
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HOW MUCH RISK IS RIGHT FOR YOU?
7. You go to a casino for the
first time. You choose to
play:
(a) quarter slot machines,
(b) $5 minimumbet
roulette,
(c) dollar slot machines,
(d) $25 minimum-bet
blackjack.
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HOW MUCH RISK IS RIGHT FOR YOU?
 SCORING SYSTEM: Score your answers this way:
 (1) a-1, b-4, c-2, d-3
 (2) a-4, b-1, c-3, d-2
 (3) a-3, b-4, c-2, d-1
 (4) a-2, b-3, c-1, d-4
 (5) a-3, b-4, c-2, d-1
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8. You want to take someone out for a
special dinner in a city that’s new to
you. How do you pick a place?
(a) read restaurant reviews in the local
newspaper,
(b) ask coworkers if they know of a
suitable place,
(c) call the only other person you
know in this city, who eats out a
lot but only recently moved there
(d) visit the city sometime before your
dinner to check out the restaurants
yourself.
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 (6) a-4, b-3, c-2, d-1
 (7) a-1, b-3, c-2, d-4
 (8) a-2, b-3, c-4, d-1
 (9) a-4, b-3, c-2, d-1
 (10) a-2, b-3, c-1, d-4.
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HOW MUCH RISK IS RIGHT FOR YOU?
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9. The expression that best 10. Your attitude toward money is
describes your lifestyle is: best described as:
(a) no guts, no glory, (a) A dollar saved is a dollar
(b) just do it! earned,
(c) look before you leap, (b) You’ve got to spend money to
(d) all good things come to make money,
those who wait. (c) Cash and carry only,
(d) Whenever possible, use other
people’s money.
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HOW MUCH RISK IS RIGHT FOR YOU?
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 What your total score indicates:
 10–17: You’re not willing to take chances with your money,
even though it means you can’t make big gains.
 18–25: You’re semi-conservative, willing to take a small
chance with enough information.
 26–32: You’re semi-aggressive, willing to take chances if
you think the odds of earning more are in your favor.
 33–40: You’re aggressive, looking for every opportunity to
make your money grow, even though in some cases the odds
may be quite long. You view money as a tool to make more
money.
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 25 and 28 points: an aggressive investor.

 20 and 24 points: your risk tolerance is above average.
 15 and 19 points: a moderate investor. This means you
are willing to accept some risk in exchange for a
potential higher rate of return.
 < 15 points: a conservative investor.
 < 10 points: a very conservative investor.

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D. INITIAL RISK AND INVESTMENT GOAL CATEGORIES INITIAL RISK AND INVESTMENT GOAL CATEGORIES
AND ASSET ALLOCATIONS AND ASSET ALLOCATIONS
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