Reading 54: Basics of Portfolio Planning and Construction-LO 2011, allocation, principles, relation, together

1215

Session 12: Portfolio Management
Reading 54: Basics of Portfolio Planning and Construction

LOS g: Discuss the principles of portfolio construction and the role of asset allocation in relation to the IPS.

 

 

The manager of the Fullen Balanced Fund is putting together a report that breaks out the percentage of the variation in portfolio return that is explained by the target asset allocation, security selection, and tactical variations from the target, respectively. Which of the following sets of numbers was the most likely conclusion for the report?

A) 50%, 25%, 25%.

B) 33%, 33%, 33%.

C) 90%, 6%, 4%.

---

 

Several studies support the idea that approximately 90% of the variation in a single portfolio’s returns can be explained by its target asset allocations, with security selection and tactical variations from the target (market timing) playing a much less significant role. In fact, for actively managed funds, actual portfolio returns are slightly less than those that would have been achieved if the manager strictly maintained the target allocation, thus illustrating the difficultly of improving returns through security selection or market timing.

1215

An investment manager has constructed an efficient frontier based on a client’s investable asset classes. The manager should choose one of these portfolios for the client based on:

A) relative valuation of the asset classes.

B) a risk budgeting process.

C) the investment policy statement (IPS).

---

After defining the investable asset classes and constructing an efficient frontier of possible portfolios of these asset classes, the manager should choose the efficient portfolio that best suits the investor’s objectives as defined in the IPS. The investor’s strategic asset allocation can then be defined as the asset allocation of the chosen portfolio. Tactical asset allocation based on relative valuation of asset classes would require the manager to deviate from the strategic asset allocation. Risk budgeting refers to the practice of determining an overall risk limit for a portfolio and allocating the risk among strategic asset allocation, tactical asset allocation, and security selection.