Investment Policy Statement Otto Khatamov

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How to manage investments in assets (i.e. stocks, bonds etc.) to meet specified investment goals?

  • How to manage investments in assets (i.e. stocks, bonds etc.) to meet specified investment goals?



Client needs: Investment policy statement

  • Client needs: Investment policy statement

      • Focus: Investor’s short-term and long-term needs, expectations
  • Portfolio manager: Examine current and projected financial, economic, political, and social conditions

      • Focus: Short-term and intermediate-term expected conditions to use in constructing a specific portfolio
  • Portfolio manager: Implement the plan by constructing the portfolio

      • Focus: Meet the investor’s needs at minimum risk levels
  • Client/Portfolio manager: Feedback loop



The preliminaries



The preliminaries

  • The preliminaries

    • Investment funds after the satisfaction of basic needs (i.e. living cost):
      • Insurance: Life insurance, Health insurance, Automobile and home insurance.
      • Cash reserves (i.e. six months’ living expenses): Emergencies, Job layoffs, Investment opportunities.
    • Investment needs and the life cycle net worth:


The preliminaries

  • The preliminaries

      • Rise and fall of personal Net worth over the lifetime


The preliminaries

  • The preliminaries

      • Benefits from investing early


The preliminaries

  • The preliminaries

      • Rise and fall of personal Net worth over the lifetime


Inputs to the investment policy statement

  • Inputs to the investment policy statement

    • Investment objectives
      • Risk return relationship (pyramid game i.e. Ponzi, Afinsa etc.)
      • What is risk? Risk denotes the probability distribution of possible economic outcomes (danger vs opportunity).
        • Absolute vs relative risk
      • Risk tolerance:
        • Investor’s willingness to accept risk
        • Investor’s ability to accept risk


Inputs to the investment policy statement

  • Inputs to the investment policy statement

    • Investment objectives
      • Suggested initial asset allocation by investment banks (i.e. TRowePrice.com)


Inputs to the investment policy statement

  • Inputs to the investment policy statement

    • Investment objectives
      • The historical record: Bills, bonds and stocks
  • Source: BKM Chapter 5 – Sources: Returns on T-bills, large and small stocks – CRSP, T-bonds - RSP for 1926-1995 returns and Lehman Brothers long-term and intermediate indexes for 1996 and later returns.



Inputs to the investment policy statement

  • Inputs to the investment policy statement

    • Investment objectives: Question
      • Based on the historical record over the long-run, stocks outperformed bonds and bills. Why not invest 100% in stocks?
        • C., Asness, 1996, Why not 100% Equities, The Journal of Portfolio Management.


Inputs to the investment policy statement

  • Inputs to the investment policy statement

    • Investment objectives
      • What is an appropriate investment objective for a 25-year old and a 65-year old investor?
        • Basic needs
        • Capital preservation/appreciation
        • Risk tolerance (assume moderate)


Inputs to the investment policy statement

  • Inputs to the investment policy statement

    • Investment objectives
      • 25-year old investor
        • Basic needs: Steady job, insurance coverage, cash reserve
        • Capital preservation/appreciation: Given the age capital appreciation is more appropriate
        • Risk tolerance (moderate): Assuming long horizon she must invest in risky assets (i.e. riskier than NYSE index). Equity exposure should range from 70% to 90% and the remaining funds should be invested in bonds or short-term notes.


Inputs to the investment policy statement

  • Inputs to the investment policy statement

    • Investment objectives
      • 65-year old investor
        • Basic needs: Steady job, insurance coverage, cash reserve
        • Capital preservation/appreciation: Given the age capital preservation is more appropriate
        • Risk tolerance (moderate): Assuming short horizon and capital preservation she must invest around 50% in bonds and 30% in short-term notes. The remaining should be invested in high-quality stocks (i.e. risk similar to S&P 500). This strategy protects from inflation and provides income rather than capital gains.


Inputs to the investment policy statement

  • Inputs to the investment policy statement

    • Investment objectives: Individuals versus institutions


Inputs to the investment policy statement

  • Inputs to the investment policy statement

    • Investment constraints
      • Liquidity needs
      • 25-year old investor
        • Little need for liquidity
          • Possibility for unemployment or honeymoon expense
      • 65-year old investor
        • Greater need for liquidity
          • Lifestyle needs for expenses


Inputs to the investment policy statement

  • Inputs to the investment policy statement

    • Investment constraints
      • Time horizon
        • Long investment horizon generally need less liquidity and can tolerate greater risk
      • 25-year old investor
        • Due to life expectancies has longer investment time horizon
      • 65-year old investor
        • Due to life expectancies has shorter investment time horizon


Inputs to the investment policy statement

  • Inputs to the investment policy statement

    • Investment constraints
      • Tax concerns
        • Taxable income from interest, dividends or rents are taxable at the investor’s marginal rate (i.e. 10%-40%)
        • Capital gains are taxed differently (i.e. 15%).
        • Capital gains are taxed when they are realised (i.e. asset is sold) whereas income is taxed when it is received
        • International investments
      • 25-year old vs 65-year old investor
        • Depending on their tax bracket may have preferences for different assets i.e. tax-exempt income or tax-deferred plans


Inputs to the investment policy statement

  • Inputs to the investment policy statement

    • Investment constraints
      • Legal and regulatory factors
        • Fund withdrawal from a 401(k) plan before the age of 59.5 are taxable to an additional 10% penalty
      • 25-year old vs 65-year old investor
        • Similar concerns for both investors


Inputs to the investment policy statement

  • Inputs to the investment policy statement

    • Investment constraints
      • Unique needs and preferences
        • Refers to idiosyncratic concerns of each investor
          • Avoid investments in tobacco companies or environmentally harmful products
          • Expertise of the portfolio manager
      • 25-year old vs 65-year old investor
        • Depends on each individual


Inputs to the investment policy statement

  • Inputs to the investment policy statement

    • Investment constraints: Individuals versus institutions


c. Investment policy statement: In detail

  • c. Investment policy statement: In detail

    • Components of investment policy statement
      • Brief description of the client
      • The duties and investment responsibilities of parties involved
      • The statement of investment objectives/constraints
      • The schedule for review of both the investment performance and the investment policy statement
      • Performance measures and benchmarks
      • Investment strategies/style
      • Guidelines for rebalancing the portfolio based on feedback


c. Investment policy statement: In detail

  • c. Investment policy statement: In detail

    • Importance of investment policy statement
      • Define realistic investor goals (i.e. objectives, constraints, education purposes)
      • Standards for evaluating portfolio performance (i.e. benchmark portfolio)
        • Performance vs investment policy statement
      • Other benefits
        • Protection against inappropriate behavior from entrenched managers





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