Managing Portfolio for Individual Investors Jakub Karnowski, CFA Portfolio Management for Financial...

Managing Portfolio for Individual Investors

Jakub Karnowski, CFAJakub Karnowski, CFA

Portfolio Management for Financial Advisers

1. Understanding Client Personalities

1) Situational Profiling

2) Psychological Profiling

2. Developing the Investment Policy Statement

(IPS)

3. CASE STUDY

Table of contents

INVESTORS HAVE DIFFERENT PERSONALITIES AND

DIFFERENT LEVELS OF SOPHISTICATION

3Portfolio Management for Financial AdvisersJakub Karnowski, CFA

The level of client sophistication and investment

education

for investors tend to vary more for personal portfolios

than

for institutional portfolios.

Understanding of each client is essential for preparing

a meaningful set of objectives and constrains…

…that’s WHY various types of situational and

psychological profiling MUST be developed as a

starting point.


! NOTE !

Understanding Client Personalities





(IPS)

3. CASE STUDY

Table of contents

Situation Profiling

Sources of WealthThe method of wealth accumulation can have a bearing on attiutudes

towards risk

Entrepreneurs Passive Investors• Created wealth by successfully

starting and running a business• Inherited wealth or accumulated it

over a long period of steady employment

• Familiar with risk-taking; presumed to be more comfortable with high level of risk

• Want a great deal of control and may be less willing to cede control

of a portfolio to professional managers

• Less familiar with risk taking behaviour

• Less confident with reaccumulating wealth if it is lost



Measures of Wealth

The relative or absolute size of

wealth may bear on risk taking

attitudes

Absolute measures are often not the

most relevant measure…

If wealth is sufficiently large, the

portfolio is perceived as being large

and the ability to bear risk is high

…the perception of wealth relative

to objectives and goals is more

important



Situation Profiling

Stage of LifeThe investor’s stage in life cycle is indicative of the ability or willingness to

bear riskAccumulation

Phase

Consolidation

Phase

Retirement/Gifting

Phase

young investors investors in their middle

years

investors in final years of life

cycle

long time horizon over

which to recover from

short-term performance

dissapointments

accumulated wealth

and liabilities tend to

increse

large sums of wealth may

have been accumulated and

liabilities paid off; investor is

looking to live off the portfolio

or consider it for distribution

they can assume higher

level of risk

risk tolerance should

diminish however the time

horizon is still long

risk tolerance typically

declines (but in some cases it

can still be moderate or high)



Situation Profiling





(IPS)

3. CASE STUDY

Table of contents

ASSUMPTIONS:

1. Investors are risk averse. When two investments have the same expected

outcome,

the investment with greatest certainty will always be selected

2. Investors have rational expectations. Their decisions include all available

relevant information in unbiased decisions

3. Investors practice asset integration - they view each asset in the portfolio

from

a perspective of how it affects aggregate portfolio risk and return rather than on

a stand-alone asset basis

As a result… asset prices reflect real underlying economic factors

portfolios are viewed in their entirety, which properly reflects expected covariances and correlations between assets



Psychological Profiling

Psychological studies have shown that human beings (investors)

do not always exhibit the objective and rational behaviors of

traditional theory

Principles in behavioral finance: Risk – seeking behavior

• Investors prefer uncertain, on average larger loss to small but certain loss

• However they choose small, certain gain to an uncertain gain, on average larger one

(A bird in the hand is worth two in the bush)

Biased expectations. Cause cognitive errors in decision-making and overconfidence in

the ability to predict the future.

EXAMPLE: analysts believe in their own earnings estimation even when the evidence

shows past estimates to be wrong

Asset segregation. Investors evaluate investments based on their stand-alone risk and

return rather than in the context of classic portfolio theory. Asset pricing is based not only

on economic factors but also individual and subjective psychological issues.

As a result, actual investment decision-making is more complex than classic portfolio theory

would imply



Psychological Profiling

Methodical Investor

• base decisions on objective „facts”

• work hard to seek out new information

• rely on history and databases

• disciplined and conservative in their investments

Cautious Investor

• have a high need for financial security and to avoid losses

• do not like to make own decisions and do not trust others

• tend to select the least volatile assets and have little asset turnover

• frequently miss investment opportunities

Individualist Investor

• self-confident

• gather information from wide variety of sources to make own decisions

• confident to be successful in the long run

Spontaneous Investor

• quick to make decisions in the heat of the moment not to miss the chance

• achieve high portfolio turnover

• focus on return without considering risk

• doesn’t consider themselves experts, but don’t trust professionals

Most Risk Averse

Least Risk Averse

Base Decisions on Thinking Base Decisions on Feeling


Understanding Client PersonalitiesPsychological Profiling – Investment Personality Type Matrix





(IPS)

3. CASE STUDY

Table of contents

It documents the client’s specific investment objectives and the acceptable risk to be taken to accomplish them

It lists any constraints to be observed and guidelines to be followed

It forms the basis for future portfolio monitoring and review

Construction of the IPS is a dynamic process between the client and advisor to establish common objectives and constraints for the portfolio in terms that are realistic and understandable to both parties. Its creation gives the client control over the process and for most investors provides an „education” into relevant investment issues. A well-constructed IPS protects both parties and provides that basis for a periodic review of the relevant information contained on the IPS.


Developing the Investment Policy Statement (IPS)


CASE STUDY

Managing Portfolio for Individual Investors Jakub Karnowski, CFA Portfolio Management for Financial...

Documents

Transcript of Managing Portfolio for Individual Investors Jakub Karnowski, CFA Portfolio Management for Financial...