Portfolio Management Process

Upon determining the type of investment client and their financial goals, a portfolio manager takes a series of steps to ensure the client meets their goals and needs.

1. The Planning Step

Once a portfolio manager has established a client’s objectives and constraints, they must develop an investment policy statement (IPS). This written document spells out all the investment objectives and constraints that apply to a client’s portfolio. It may also contain a reference to a benchmark. A benchmark can be used to assess investment performance and evaluate whether the objectives have, indeed, been achieved.

2. The Execution Step

The execution step has three stages – asset allocation, security analysis, and portfolio construction.

Asset Allocation

The analyst or portfolio manager determines the economic and capital market expectations for various available asset classes. This analysis may be top-down. In this instance, it starts with a consideration of the macroeconomics or industry environment and an evaluation of the asset classes expected to perform well given the environment. Alternatively, the analysis may be bottom-up. Instead of looking at macroeconomics or industry data, this analysis focuses on company-specific factors. A decision will then be taken on the allocation of assets to the available asset classes. Asset classes can include equities, bonds, cash, real estate, commodities, hedge funds, and private equity.

Security Analysis

An analyst can combine top-down and bottom-up views in selecting individual securities to assess the level of returns and risk. This informs the assignment of a valuation to securities being considered for portfolio inclusion.

Portfolio Construction

A diversified portfolio can be constructed using the investment policy statement (IPS), the desired asset allocation, and security analysis. Besides achieving investment performance, risk management is critical in the portfolio construction process. The IPS will outline a client’s risk tolerance, and the portfolio manager must ensure the portfolio is aligned with this risk profile. Once the portfolio manager has chosen securities to buy and the quantities in which to buy them, the transactions will be executed. Often, a specialized trade execution team or external stockbroker executes these transactions.

3. The Feedback Step

After a portfolio manager has constructed a portfolio has been constructed, they need to review and monitor it at an appropriate interval.

Portfolio Monitoring and Rebalancing

Portfolio rebalancing occurs when a portfolio has shifted from the targeted asset allocation due to market movements. If the top-down or bottom-up views change, an individual security or asset class may need to be changed. A change in a client’s circumstances may prompt a revision of the IPS and the portfolio.

Portfolio Measurement and Reporting

Portfolio performance must be evaluated to establish whether the client’s objectives have been met. Portfolio performance may be assessed in relation to the benchmark set out in the IPS. Following analysis of the performance, it may be determined that the client’s objectives have changed. This realization will be factored into the planning and execution steps.

Question

Select the correct sequence of portfolio management steps.

A. Equity valuation, portfolio performance assessment, trade execution.

B. IPS creation, portfolio rebalancing, top-down analysis.

C. IPS creation, portfolio construction, monitoring, and rebalancing.

Solution

The correct answer is C.

The portfolio management process must begin with the creation of an investment policy statement in the planning step. This is followed by analysis and portfolio construction in the execution step. Finally, rebalance, performance measurement, and monitoring are carried out in the feedback step.