Professional Documents
Culture Documents
Graphs, charts, tables, examples, and figures are copyright 2014, CFA Institute. Reproduced
and republished with permission from CFA Institute. All rights reserved.
Contents
1.
2.
3.
4.
5.
Introduction
Case Study
Investor Characteristics
Investment Policy Statement
An Introduction to Asset Allocation
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1. Introduction
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2. Case Study
Stable developed world country; Tax rate = 25%; currency pegged to euro
Wealth transfer tax = 50%
Peter
59
Entrepreneur
Hans
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Works for Dad
Hilda
57
Housewife
Christa
25
Artist
Mother
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Jurgen
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Family Business
IngerMarine Boat Manufacturing
Planning to sell for about Euro 55 million
Income and Assets
See Table 1
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Goals
Maintain standard of living
New home that makes a statement
Euro 5 million in Exteriors (Photography)
Ensure familys financial security
No formal estate plan
Personality
Intentionally removed from family
business
Encouraged Peter to retire and get
close to Christa
Wants to become more active in
managing family wealth
Goals
Strong interest in interior design
Runs her design company
Interior design of new home
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Personality
Gambler
Sees father as too conservative
Expensive sports car
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)
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
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!)
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3. Investor Characteristics
Before creating IPS we should consider behavioral biases, preferences
and perceptions of risk
3.1 Situational Profiling
3.2 Psychological Profiling
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Measures of Wealth
Look at wealth in the context of lifestyle
Does investor perceive that wealth easily supports lifestyle?
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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 do so (Example: Christa)
Accumulation Phase: Earnings accelerate, expenses rise too (family, home)
If spending habits dont 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
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More
Risk
Averse
Decisions based
on thinking
Decisions based
on feeling
Methodical
Cautious
Confident
Individualist
Adventurer
Careful
Less
Risk
Averse
Individualist
Spontaneous
Impetuous
Guardian
Celebrity
Anxious
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Less
Risk
Averse
Decisions based
on feeling
Methodical
Cautious
Individualist
Spontaneous
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Liquidity
Legal and Regulatory Environment
Time Horizon
Taxes
Unique Circumstances
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Return Objective
Return objective must be set in the context of risk constraints
Return requirement
vs.
Return desire
Historically the terms growth requirement and income requirement have been used
However, better to think in terms of total return
Learn how to calculate required return
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Risk Objective
Ability 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
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Constraints
Liquidity
Legal and Regulatory Environment
Time Horizon
Taxes
Unique Circumstances
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Liquidity
Investment portfolios ability to efficiently meet an investors anticipated and
unanticipated demands for cash distributions
A portfolios liquidity is impacted by:
1. Transaction Costs
2. Price Volatility
Significant liquidity requirements limit ability to take risk
Three primary types of liquidity requirements:
1. Ongoing Expenses
2. Emergency Reserves
3. Liquidity Events (mostly negative, but could also be positive)
Illiquid Holdings
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Time Horizon
15 years or longer Long term
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Taxes
1.
Income Tax
2.
Gains Tax
3.
4.
Property Tax
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Unique Circumstances
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Risk and
Return
Introduction
Return Objectives
Risk Objectives
Ability
Willingness
Constraints
Liquidity
Time Horizon
Taxes
Legal and Regulatory Environment
Unique Circumstances
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After-tax returns
Tax consequences of shift
Rebalancing
Asset location
Asset
Allocation
Constraints
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Example 2
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 3
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