1. The Portfolio Management Process (From Ch. 2)
Investment Analysis and Portfolio Management Sixth Edition by Frank K. Reilly & Keith C. Brown
The Portfolio Management Process (From Ch. 2)

2. The Portfolio Management Process
Figure 2.2
The Portfolio Management Process
1. Policy statement - Focus: Investor’s short-term and long-term needs, familiarity with capital market history, and expectations
2. Examine current and project financial, economic, political, and social conditions - Focus: Short-term and intermediate-term expected conditions to use in constructing a specific portfolio
3. Implement the plan by constructing the portfolio - Focus: Meet the investor’s needs at the minimum risk levels
4. Feedback loop: Monitor and update investor needs, environmental conditions, portfolio performance
Copyright © 2000 by Harcourt, Inc. All rights reserved.

3. The Portfolio Management Process
1. Policy statement
specifies investment goals and acceptable risk levels
should be reviewed periodically
guides all investment decisions
Copyright © 2000 by Harcourt, Inc. All rights reserved.

4. The Portfolio Management Process
2. Study current financial and economic conditions and forecast future trends
determine strategies to meet goals
requires monitoring and updates
Copyright © 2000 by Harcourt, Inc. All rights reserved.

5. The Portfolio Management Process
3. Construct the portfolio
allocate available funds to meet goals and minimize investor’s risks
Copyright © 2000 by Harcourt, Inc. All rights reserved.

6. The Portfolio Management Process
4. Monitor and update
revise policy statement as needed
modify investment strategy accordingly
evaluate portfolio performance
Copyright © 2000 by Harcourt, Inc. All rights reserved.

7. The Need For A Policy Statement
Understand and articulate realistic investor goals
needs, objectives, and constraints
financial markets and risks of investing
Copyright © 2000 by Harcourt, Inc. All rights reserved.

8. Constructing A Policy Statement
What are the real risks of an adverse financial outcome, especially in the short run?
What probable emotional reactions will I have to an adverse financial outcome?
How knowledgeable am I about investments and markets?
Copyright © 2000 by Harcourt, Inc. All rights reserved.

9. Constructing A Policy Statement
What other capital or income sources do I have? How important is this particular portfolio to my overall financial position?
What, if any, legal restrictions may affect my investment needs?
What, if any, unanticipated consequences of interim fluctuations in portfolio value might affect my investment policy?
Copyright © 2000 by Harcourt, Inc. All rights reserved.

10. Standards For Evaluating Portfolio Performance
Benchmark portfolio
risk and return
Matches risk preferences and investment needs
analysis of risk tolerance
return objective goals
Copyright © 2000 by Harcourt, Inc. All rights reserved.

11. Realistic Investor Goals
Capital preservation
minimize risk of real loss
strongly risk-averse or funds needed soon
Capital appreciation
capital gains to provide real growth over time for future need
aggressive strategy with accepted risk
Current income
generate spendable funds
Copyright © 2000 by Harcourt, Inc. All rights reserved.

12. Realistic Investor Goals
Total return
capital gains and income reinvestment
moderate risk exposure
Copyright © 2000 by Harcourt, Inc. All rights reserved.

13. Investment Constraints
Liquidity needs
near-term goals
Time horizon
longer time horizon favors risk acceptability
short time horizon favors less risky investments because losses are harder to overcome in a short time frame
Copyright © 2000 by Harcourt, Inc. All rights reserved.

14. Investment Constraints
Tax concerns
interest and dividends taxed at investor’s marginal tax rate
capital gains may be unrealized
basis and gain or loss realized
revisions to capital gains tax rates
tradeoff with diversification needs for employer’s stock holdings
Copyright © 2000 by Harcourt, Inc. All rights reserved.

15. Legal and Regulatory Factors
Limitations or penalties on withdrawals
Fiduciary responsibilities - “prudent man” rule
Investment laws prohibit insider trading
Copyright © 2000 by Harcourt, Inc. All rights reserved.

16. Unique Needs and Preferences
Personal preferences - socially conscious investments
Time constraints or expertise for managing the portfolio may require professional management
Large investment in employer may require consideration of diversification needs and realistic liquidity
Institutional investors needs
Copyright © 2000 by Harcourt, Inc. All rights reserved.

17. Constructing the Policy Statement
Objectives - risk and return
Constraints - liquidity, time horizon, tax factors, legal and regulatory constraints, and unique needs and preferences
Developing a plan depends on understanding the relationship between risk and return and the importance of diversification
Copyright © 2000 by Harcourt, Inc. All rights reserved.