1、Chapter 2The Asset Allocation DecisionQuestions to be answered:What is asset allocation?What are the four steps in the portfolio management process?What is the role of asset allocation in investment planning?Why is a policy statement important to the planning process?Chapter 2The Asset Allocation De
2、cision What objectives and constraints should be detailed in a policy statement?How and why do investment goals change over a persons lifetime and circumstances?Why do asset allocation strategies differ across national boundaries?Financial Plan PreliminariesInsuranceLife insurance Term life insuranc
3、e-Provides death benefit only.Premium could change every renewal period Universal and variable life insurance provide cash value plus death benefit Financial Plan PreliminariesInsuranceHealth insuranceDisability insuranceAutomobile insuranceHome/rental insuranceLiability insuranceFinancial Plan Prel
4、iminariesCash reserveTo meet emergency needsIncludes cash equivalents(liquid investments)Equal to six months living expenses recommended by expertsIndividual Investor Life Cycle Accumulation phase early to middle years of working career Consolidation phase past midpoint of careers.Earnings greater t
5、han expenses Spending/Gifting phase begins after retirementIndividual Investor Life Cycle253545556575Net WorthAgeAccumulation PhaseLong-term:Retirement Childrens college Short-term:House CarConsolidation PhaseLong-term:RetirementShort-term:VacationsChildrens CollegeSpending Phase Gifting PhaseLong-t
6、erm:Estate PlanningShort-term:Lifestyle Needs Gifts Exhibit 2.1Life Cycle Investment Goals Near-term,high-priority goals Long-term,high-priority goals Lower-priority goalsThe Portfolio Management Process1.Policy statement-Focus:Investors short-term and long-term needs,familiarity with capital market
7、 history,and expectations2.Examine current and project financial,economic,political,and social conditions-Focus:Short-term and intermediate-term expected conditions to use in constructing a specific portfolio3.Implement the plan by constructing the portfolio-Focus:Meet the investors needs at the min
8、imum risk levels4.Feedback :Monitor and update investor needs,environmental conditions,portfolio performanceExhibit 2.2The Portfolio Management Process 1.Policy statementspecifies investment goals and acceptable risk levelsshould be reviewed periodicallyguides all investment decisionsThe Portfolio M
9、anagement Process 2.Study current financial and economic conditions and forecast future trendsdetermine strategies to meet goalsrequires monitoring and updatingThe Portfolio Management Process 3.Construct the portfolioallocate available funds to minimize investors risks and meet investment goals The
10、 Portfolio Management Process 4.Monitor and updateevaluate portfolio performanceMonitor investors needs and market conditionsrevise policy statement as neededmodify investment strategy accordinglyThe Need For A Policy Statement Helps investors understand their own needs,objectives,and investment con
11、straints Sets standards for evaluating portfolio performance Reduces the possibility of inappropriate behavior on the part of the portfolio manager Investment Objectives Risk Tolerance Absolute or relative percentage return General goalsInvestment ObjectivesGeneral Goals Capital preservation minimiz
12、e risk of real loss Capital appreciation Growth of the portfolio in real terms to meet future need Current income Focus is in generating income rather than capital gainsInvestment ObjectivesGeneral Goals Total return Increase portfolio value by capital gains and by reinvesting current income Maintai
13、n moderate risk exposureInvestment Constraints Liquidity needs Vary between investors depending upon age,employment,tax status,etc.Time horizon Influences liquidity needs and risk toleranceInvestment Constraints Tax concerns Capital gains or losses taxed differently from income Unrealized capital ga
14、in reflect price appreciation of currently held assets that have not yet been sold Realized capital gain when the asset has been sold at a profit Trade-off between taxes and diversification tax consequences of selling company stock for diversification purposesInvestment Constraints Tax concerns(cont
15、inued)interest on municipal bonds exempt from federal income tax and from state of issue interest on federal securities exempt from state income tax contributions to an IRA may qualify as deductible from taxable income tax deferral considerations-compoundingEquivalent Taxable YieldRateTax Marginal1Y
16、ield MunicipalETYExample If an investor is in the 28%marginal tax rate,a taxable investment yield of 8%has an after-tax yield of 8%(1-0.28),or 5.76%;An equivalent-risk municipal security offering a yield greater than 5.76%offers the investor greater after-tax returns.On the other hand,a municipal bo
17、nd yielding 6%has an equivalent taxable yield of 6%/(1-0.28)=8.33%Effect of Tax Deferral on Investor Wealth over Time0102030 years8%TaxDeferred5.76%After TaxReturn$1,000Investment ValueTime$10,062.66$5,365.91Exhibit 2.6Methods of Tax Deferral Regular IRA-tax deductible Tax on returns deferred until
18、withdrawal Roth IRA-not tax deductible tax-free withdrawals possible Cash value life insurance funds accumulate tax-free until they are withdrawn Employers 401(k)and 403(b)plans tax-deferred investmentsLegal and Regulatory Factors Limitations or penalties on withdrawals Fiduciary responsibilities-“p
19、rudent man”rule Investment laws prohibit insider tradingUnique Needs and Preferences Personal preferences such as socially conscious investments could influence investment choice Time constraints or lack of expertise for managing the portfolio may require professional management Large investment in
20、employers stock may require consideration of diversification needs Institutional investors needsConstructing 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 u
21、nderstanding the relationship between risk and return and the importance of diversificationThe Importance of Asset Allocation An investment strategy is based on four decisions What asset classes to consider for investment What normal or policy weights to assign to each eligible class Determining the
22、 allowable allocation ranges based on policy weights What specific securities to purchase for the portfolioThe Importance of Asset Allocation According to research studies,most(85%to 95%)of the overall investment return is due to the first two decisions,not the selection of individual investmentsRet
23、urns and Risk of Different Asset Classes Historically,small company stocks have generated the highest returns.But the volatility of returns have been the highest too（P38）Inflation and taxes have a major impact on returns（P37）Returns on Treasury Bills have barely kept pace with inflationReturns and R
24、isk of Different Asset Classes Measuring risk by probability of not meeting your investment return objective indicates risk of equities is small and that of T-bills is large because of their differences in expected returns Focusing only on return variability as a measure of risk ignores reinvestment
25、 riskAsset Allocation Summary Policy statement determines types of assets to include in portfolio Asset allocation determines portfolio return more than stock selection Over long time periods,sizable allocation to equity will improve results Risk of a strategy depends on the investors goals and time
26、 horizonAsset Allocation and Cultural Differences Social,political,and tax environments influence the asset allocation decision Equity allocations of U.S.pension funds average 58%In the United Kingdom,equities make up 78%of assets In Germany,equity allocation averages 8%In Japan,equities are 37%of a
27、ssetsSummary Identify investment needs,risk tolerance,and familiarity with capital markets Identify objectives and constraints Enhance investment plans by accurate formulation of a policy statement Focus on asset allocation as it determines long-term returns and riskThe InternetInvestments O Objecti
28、ves and Constraints of Institutional Investors Mutual Funds pool investors funds and invests them in financial assets as per its investment objectivePension Funds Receive contributions from the firm,its employees,or both and invests those funds Defined Benefit promise to pay retirees a specific inco
29、me stream after retirement Defined Contribution do not promise a set of benefits.Employees retirement income is not an obligation of the firm Endowment FundsThey represent contributions made to charitable or educational institutions Insurance Companies Life Insurance Companiesearn rate in excess of
30、actuarial rategrowing surplus if the spread is positivefiduciary principles limit the risk toleranceliquidity needs have increased tax rule changesInsurance Companies Nonlife Insurance Companiescash flows less predictablefiduciary responsibility to claimantsRisk exposure low to moderateliquidity con
31、cerns due to uncertain claim patternsregulation more permissiveBanks Must attract funds in a competitive interest rate environment Try to maintain a positive difference between their cost of funds and their return on assets Need substantial liquidity to meet withdrawals and loan demands Face regulatory constraints感谢！
