CFA 2018 r08 managing individual investor portfolios slides

Level III Managing Individual Investor Portfolios www.ift.world Graphs, charts, tables, examples, and figures are copyright 2014, CFA Institute Reproduced and republished with permission from CFA Institute All rights reserved Contents Introduction Case Study Investor Characteristics Investment Policy Statement An Introduction to Asset Allocation www.ift.world Introduction • • • • • • Portfolio management of individual investors Diversity of investor types Learn how to create IPS of individual investors Basics of asset allocation Case Study Based Almost certain to show up on your exam www.ift.world Case Study Stable developed world country; Tax rate = 25%; currency pegged to euro Wealth transfer tax = 50% Peter 59 Entrepreneur Hans 30 Works for Dad Hilda 57 Housewife Christa 25 Artist Mother www.ift.world Jurgen Family Business IngerMarine – Boat Manufacturing Planning to sell for about Euro 55 million Income and Assets See Table www.ift.world Box 1: Jourdan’s Findings and Personal Observations Goals Maintain standard of living New home that ‘makes a statement’ Euro million in Exteriors (Photography) Ensure family’s financial security No formal estate plan Personality Perfectionist Likes to maintain control Risk averse Personality Intentionally removed from family business Encouraged Peter to retire and get close to Christa Wants to become more active in managing family wealth www.ift.world Goals Strong interest in interior design Runs her design company Interior design of new home Personality Gambler Sees father as too conservative Expensive sports car Personality Estranged from family Career in art Raising son without family support Wants to be self reliant but admits to having limited financial expertise Looking forward to increased contact with parents www.ift.world Goals Does not want to stay in boat business Wants career that allows more free time High risk investments Considering minority interest in night club (500k) Looking for a new home (500k – 700k) Goals Wants to be more proactive in financial affairs Recognizes need for coordinated family financial plan but does not want to rely solely on family wealth Wants to move into larger apartment with space for painting studio (Expensive!) Investor Characteristics Before creating IPS we should consider behavioral biases, preferences and perceptions of risk 3.1 Situational Profiling 3.2 Psychological Profiling www.ift.world 3.1 Situational Profiling Sources of Wealth Self-made investors  familiar with risk taking, higher level of self-confidence  high risk tolerance Strong sense of personal control over risks they are taking Reluctant to cede control Passive investors  less experience with risk  generally have reduced willingness to take risk Less confidence that they can rebuild wealth should it be lost Measures of Wealth Look at wealth in the context of lifestyle Does investor perceive that wealth easily supports lifestyle? www.ift.world Stage of Life: Ability to accept risk begins high and declines with age Foundation Phase: Young, long time horizon  Above average tolerance for risk However, many are unwilling or unable to so (Example: Christa) Accumulation Phase: Earnings accelerate, expenses rise too (family, home) If spending habits don’t change  more savings/investment Some might forego saving and increase expenditure on luxury goods Generally high risk tolerance Maintenance Phase: Focus on preserving wealth  risk tolerance down Distribution Phase: Accumulated wealth transferred to other persons or entities Dealing with tax constraints is important www.ift.world 10 Risk Objective Ability to Take Risk Willingness to Take Risk • Quantitative Measurement • Based on financial goals, resources and time frame • How important are the goals? • How much short-fall can be absorbed without jeopardizing investment goals • Subjective • Psychological profiling Exercise: What are Peter and Hilda’s primary and secondary objectives? What is their ability to take risk? • Peter: “Any loss greater than 5% is unacceptable” • What does this say about his willingness to take risk? www.ift.world 16 Constraints • • • • • Liquidity Legal and Regulatory Environment Time Horizon Taxes Unique Circumstances www.ift.world 17 Liquidity Investment portfolio’s ability to efficiently meet an investor’s anticipated and unanticipated demands for cash distributions A portfolio’s liquidity is impacted by: Transaction Costs Price Volatility Significant liquidity requirements limit ability to take risk Three primary types of liquidity requirements: Ongoing Expenses Emergency Reserves Liquidity Events (mostly negative, but could also be positive) Illiquid Holdings www.ift.world 18 Time Horizon 15 years or longer  Long term years or shorter  Short term Single stage vs Multi stage time horizon www.ift.world 19 Taxes Income Tax Gains Tax Wealth Transfer Tax Property Tax Exhibit 7: Taxes affect portfolio performance in two ways Example A: Periodic 25% tax Example B: 25% tax at end www.ift.world 20 Tax Strategies – Basic Principles Tax Deferral Loss Harvesting Tax Avoidance (different from Tax Evasion) Tax Reduction Wealth Transfer Taxes www.ift.world 21 Legal and Regulatory Environment Generally involve taxation and transfer of personal property ownership Personal trusts are tools for implementing certain investment strategies Discuss how the Ingers can use this tool www.ift.world 22 Unique Circumstances www.ift.world 23 IPS for Peter and Hilda Inger Risk and Return Introduction Return Objectives Risk Objectives Ability Willingness Constraints Liquidity Time Horizon Taxes Legal and Regulatory Environment Unique Circumstances www.ift.world 24 An Introduction to Asset Allocation Return Objective Risk Tolerance After-tax returns Tax consequences of shift Rebalancing Asset “location” Asset Allocation Constraints 5.1 Asset Allocation Concepts 5.2 Monte Carlo Simulation in Personal Retirement Planning www.ift.world 25 5.1 Asset Allocation Concepts Example Asset Allocation Concepts (1) Susan Fairfax Read case study Calculate return requirement Exhibit Exhibit 10 www.ift.world 26 Basic process of selecting appropriate strategic asset allocation: Determine which asset allocations meet return requirement Eliminate asset allocations that fail to meet risk objectives Eliminate asset allocations that fail to meet investor constraints Select allocation that is most rewarding for client www.ift.world 27 Example Return Requirement Consider taxes and inflation Dealing with tax-exempt municipal bonds Risk Tolerance Client has stated that worst case nominal return of -10% in any 12-month period is acceptable Read Example www.ift.world 28 5.2 Monte Carlo Simulation Monte Carlo simulation has some advantages over deterministic approaches: More accurately portrays risk-return tradeoff Illustrates tradeoffs between short-term and long-term goals Provides more realistic modeling of taxes Better suited to assessing multi-period effects www.ift.world 29 Review learning objectives Examples Practice Problems www.ift.world 30 ... Study Investor Characteristics Investment Policy Statement An Introduction to Asset Allocation www.ift.world Introduction • • • • • • Portfolio management of individual investors Diversity of investor. .. management of individual investors Diversity of investor types Learn how to create IPS of individual investors Basics of asset allocation Case Study Based Almost certain to show up on your exam... Self-made investors  familiar with risk taking, higher level of self-confidence  high risk tolerance Strong sense of personal control over risks they are taking Reluctant to cede control Passive investors