6-investment processes and portfolio selection

8/19/2019 6-Investment Processes and Portfolio Selection

1/25

Comm 324 --- W. SuoSlide 1Slide 1

Investment Processes,Asset Allocation

&Portfolio Selection


2/25


Objective

Investment process

Asset allocation

What portfolio will one choose among risky assets? wo assets

!eneral case

"fficient frontier

Spreadsheet e#amples


3/25

Comm 324 --- W. SuoSlide $Slide $

Investment %rocess

Step 1& 'reate a Written %olicy Statement !ain (nderstanding

Investor)s financial sit*ation Investor)s time hori+on Investment goal,s- Investor)s ta# sit*ation .egal constraints .i/*idity %ersonal inventory

"#pectations

he %olicy Statement Objective 0enchmark 'onstraint policies Asset allocation policies


4/25

Comm 324 --- W. SuoSlide Slide

Investment %rocess

Step 2& 3orecasting 3*ndamental analysis echnical analysis

4isk54et*rn analysis Step $& Allocating Assets

If no constraints6 asset allocation is accomplished6 the assetallocator)s responsibility is to align portfolio)s e#pected ret*rn andrisk with the client)s goal

'onstrained asset allocation Asset allocator m*st e#amine the make5*p of the portion of the

portfolio that is s*bject to constraints prior to allocating the non5constrained portion


5/25


Investment %rocess

Investing the Allocated 3*nds

8ay be a simple or more complicated task

9o old assets need to be li/*idated? Are large transactions involved?

Step & %erformance 4eports and 3eedback

8eas*res?

:*arterly reports %otential problems


6/25

Comm 324 --- W. SuoSlide ;Slide ;

Asset allocation

Objective& 9etermining the mi#t*re of sec*rities that is most likely

to provide an optimal combination of e#pected ret*rn and

risk for the investor

St*dies have shown that over of variation from

typical portfolios can be e#plained by asset

allocation Where one invests is very important@


7/25Comm 324 --- W. SuoSlide Slide

"#amples

%ortfolio 1& 7=57= allocation between stocks and bonds

%ortfolio 2& ;=5= allocation between stocks and bonds

%ortfolio $& 2=5;=52= allocation between real estate6 stocks

and bonds

%ortfolio & 1=5=52=5$= allocation between real estate6

domestic stocks6 foreign stocks6 and bonds

"#ample& :*een)s %ension 3*nd

http&BB

www/*eens*caBh*manreso*rcesBtotal5compensationBpensionsB

reports

http://www.queensu.ca/humanresources/total-compensation/pensions/reportshttp://www.queensu.ca/humanresources/total-compensation/pensions/reportshttp://www.queensu.ca/humanresources/total-compensation/pensions/reportshttp://www.queensu.ca/humanresources/total-compensation/pensions/reportshttp://www.queensu.ca/humanresources/total-compensation/pensions/reportshttp://www.queensu.ca/humanresources/total-compensation/pensions/reports


8/25Comm 324 --- W. SuoSlide CSlide C

"#amples

T. Rowe Price Non-Retirement goals Matrix

Cash Bonds Stocks

Strategy 1 30 50 20

Strategy 2 20 40 40

Strategy 3 10 20 60

Strategy 4 0 20 80

Strategy 5 0 0 100

Risk Tolerance Time Horizon

3-5 Years 6-10 Years 11 Years

High !trateg" 2 !trateg" 3 !trateg" 5

Moderate !trateg" 1 !trateg" 2 !trateg" 4

Loer #ll $as% !trateg" 1 !trateg" 3


9/25Comm 324 --- W. SuoSlide


10/25Comm 324 --- W. SuoSlide 1=Slide 1=

%ortfolio 8athematics

wo risky assets case 4isk5free and risky asset

hree assets case Spreadsheet e#ample

!eneral case Spreadsheet e#ample


11/25Comm 324 --- W. SuoSlide 11Slide 11

'ombining risk assets

What happens if we choose a portfolio by combing

risky assets wo asset case

"#ample& 3or 2=> in 1 and C=> in 2

"#pected ret*rn 11;=>

Dariance ==1712

Standard deviation =12$= !eneral case

#ssets

Ret&rn !T' r%o

1 18( 30( -0.2

2 10( 15(



wo5Sec*rity %ortfolios

with 9ifferent 'orrelations


13/25Comm 324 --- W. SuoSlide 1$Slide 1$

4elationship depends on correlation coefficient

51= E E F1=

he smaller the correlation6 the greater the risk

red*ction potential

IfG F1=6 no risk red*ction is possible

%ortfolio of wo Sec*rities&

'orrelation "ffects



Optimal 4isky %ortfolio with

wo 4isky Assets

S*ppose o*r investment *niverse comprises the two

sec*rities

4isk free rate& 7>



he Opport*nity Set of the 9ebt and "/*ity3*nds and wo 3easible 'A.s


16/25Comm 324 --- W. SuoSlide 1;Slide 1;

Optimal 'A. and the Optimal 4isky%ortfolio



9etermination of the Optimal Overall

%ortfolio


18/25Comm 324 --- W. SuoSlide 1CSlide 1C

)inal Port*olio

Spreadsheet

0etween 4isk free

4isk portfolio&

Ass*me an investor)s risk aversion

3inal portfolio& 4isk free& 27;1>

In 9ebt& $H=>G2

In e/*ity& $H;=> G ;$>


19/25Comm 324 --- W. SuoSlide 1


20/25Comm 324 --- W. SuoSlide 2=Slide 2=

he set of opport*nities again described by the 'A.

he choice of the optimal portfolio depends on theclient)s risk aversion

A single combination of risky and riskless assets

will dominate

"#tending to Incl*de A 4iskless Asset



Alternative 'A.s

8

",r-

'A. ,!lobal

minim*m variance-

'A. ,A-'A. ,%-

%

A

3

% 8

A

!

%

8



%ortfolio Selection 4isk Aversion&

witho*t borrowingBlending

",r-

"fficientfrontier of

risky assets

8ore

risk5averse

investor

())) ()) ()

:

%S

s

.ess

risk5averseinvestor


23/25

Comm 324 --- W. SuoSlide 2$Slide 2$

%ortfolio Selection 4isk Aversion&

with borrowingBlending

3

%

",r-

r f

A

:

0'A.

s


24/25


+xam,le #sset #llocation

$o&ntr" n/ex !tatistics

,timal allocation

! )R# +R #&s #P $#'

0.6 0.05 0.00 0.00 0.13 0.13 0.00


25/25

lid

%ortfolio Selection 4isk Aversion&with borrowingBlending

With different borrowingBlending rate?

6-investment processes and portfolio selection

Documents