Investment Policy Statement (IPS) : Session Plan
Investment Policy Statement (IPS) : Session Plan
Investment Policy Statement (IPS) : Session Plan
Session Plan
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Preparation of IPS
Major Components of IPS
Situational profiling
Psychological profiling
Introduction
Statement of Purpose
Procedures
Investment Objectives
Investment Guidelines
Appendices
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✦ Generally, clients who perceive their wealth as small are less willing ✤ theoretically above average ability to take risk , but other
to take risk, wish to hold only low-volatility investments. considerations may intrude
✤ Few investable assets
✦ Accumulation Phase
✤ Early middle years of working career
✤ income rising and asset growing
✤ Longer time horizon affords individuals in this phase to take more risk
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✤ Still long time horizon but capital preservation becomes more important
✦ Maintenance Phase
✦ Distribution Phase
✤ Focus shifts to wealth transfer
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Risk Aversion versus Loss Aversion Risk Aversion versus Loss Aversion
.
✦ Risk averse investors always minimise the risk for a given level of
✤ example: given a choice between
return or maximise return for a given level of risk and measure risk
(1) a small known loss of Rs. 800 and as volatility.
(2) a 50/50 chance of losing Rs. 1 ,600 or $0 ✦ Loss averse investors are more focused on avoiding losses than on
maximising return. In addition, faced with a loss they will frequently
choose less certain (more risky) alternative, but faced with a gain
they choose the less risky alternative.
✤ Phrased as a gain, they take certainty, which is consistent with
traditional finance.
✤ Phrased as a loss, they take uncertainty, hoping to avoid a loss,
hence the term loss aversion.
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✦ Integration says investors should analyse the effect of any decision on the total ✦ Rational investors make unbiased decisions and learn from their
portfolio (considering diversification) and optimise total portfolio return for mistakes
risk taken.
✦ Biased expectations imply that do not use all relevant information
✤ Investors consider the correlation of a potential investments with their
existing portfolios. They focus on the impact of adding a new asset on the
and learn from their mistakes but instead put too much confidence
return and risk of the total portfolio. on their abilities to forecast economic events related to investments.
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✦ Based on the risk tolerance and decision making style, Clients can be ✦ Higher risk aversion/low risk tolerance
categorized as
✤ Emotionally focused on financial security, low volatility, and
✤ Cautious avoiding losses
✤ Methodical ✤ Reluctant to make decision or to consult others
✤ Individualistic ✤ Out of fear, they tend to overanalyse or do nothing
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✦ Higher risk aversion/low risk tolerance ✦ Lower risk aversion/high risk tolerance
✤ Relies on thinking and hard facts ✤ Independent thinkers who collect facts, work hard, and may do
their own research
✤ undertake research on trading strategies
✤ No afraid to exhibit investment independence in taking a course of
✤ Continually seek new information, databases, and ideas
action.
✤ No emotional attachment to their investments
✤ Have confidence in their ideas
✤ Are confident in their ability to achieve their long-term
investment objective.
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✦ The investment policy statement is a road map that: ✦ The primary objectives that need to be addressed in contracting an
IPS are the client’s risk and return objectives.
✤ specifies investment goals and acceptable risk levels
✦ These objectives can be stated in qualitative and quantitative terms
✤ should be reviewed periodically
✤ For example - a qualitative return objective may be to “provide
✤ guides all investment decisions
adequate retirement income’.
✦ The need for an IPS
✤ A qualitative risk objective or assessment may be to find that the
✤ Helps investors understand their own needs, objectives, and investment client can tolerate a moderate level of risk
contrasts
✦ For asset allocation purposes, a quantitative specification of return
✤ Set standards (bench mark portfolios) for evaluating portfolio and risk objectives are more useful.
performance
✤ Reduces the possibility of inappropriate behaviour on the part of the
portfolio manager
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✦ Capital Preservation ✦ A Complete return objective will list the client’s objectives which
may include required (high priority goals of the client) and desired
✤ maintenance of the purchasing power of their investment
objectives
✦ Capital appreciation
✤ Required expenditures are those that the individual is obligated to
✤ growth of the portfolio in real terms to meet future need make - (living expenses, medical expenses, and educational
expenses)
✦ Current Income
✤ Desired expenditures are those that are voluntary - (vacation
✤ focus is in generating income rather than capital gains homes, expensive vacations, and large charitable contributions)
✦ Total return ✦ Quantify the investable asset base for the start of the return period
✤ focus is on increasing portfolio value through capital gains and ✦ Quantify the needed return (usually based on the required objectives)
reinvestment of current income
✦ Pay close attention to directions regarding pre-or post tax and real or
nominal return.
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✦ Calculating after-tax return objective: ✦ A simple additive formulation of the absolute return objective is a
good starting point
✤ after tax return = Projected Expenditure ÷ Investable assets
✦ However, the effect of compounding and of expenses should be
✤ After-tax Nominal return = (1+After tax Real Required return) +
incorporated in stating a IPS return objective:
(1+ Current inflation rate in %) -1
Return = (1+ Spending Rate) (1+ Exp. inflation rate) (1+ Investment Expenses)
✦ Multiperiod considerations:
✦ If a client’s return objective is stated as an arithmetic mean annual return objective,
but return is based on the compound rate of return on the portfolio, the objective
should be adjusted upward to reflect the fact that arithmetic returns required to
achieve a goal are higher than returns stated as a compound rate. The adjustment
should be based on the following approximation
Compound Growth Rate = E(Arithmetic return) - 0.5* Variance
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1.Personality Type
2.Self Esteem
3.Inclination for independent thinking
Risk
Tolerance
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✤ Maximum acceptable SD
✤ Shortfall risk
✦ If there is a conflict between ability and willingness, state it and the
opportunity for further discussion with the client.
✦ The conclusion is generally the more conservative of the two.
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✦ ongoing expenses
✦ Emergency reserve
High liquidity needs may reduce ability to take risk.
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✦ With taxes exempt, taxes paid at time t= 0 ✦ Low current income (e.g.equities) - Hold in taxable account
✦ With taxes deferred, taxes paid at time t=N ✦ High current income (e.g. Bonds) - Hold in tax protected a/c
✦ Ceteris paribus, difference in final “spendable cash” is due to
differences in the current tax rate and the expected future tax rate:
✦ Tax rate is lower today - use tax-exempt
✦ Tax rate is lower in future - use tax deferred
✦ Not expected to change - use either
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Legal/Regulatory Important for Institutional Investors ✤ determine the allowable allocation ranges based on policy weights
Unique Circumstances e.g. individual investor with special needs ✤ what specific securities to purchase for the portfolio?
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✦ Real Estate
✦ Alternative Investments
✤ Private equity, natural resources, hedge funds.
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Thank you
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