Set out the stages of the process for managing a portfolio
The idea
The process runs in three stages that repeat. Planning establishes the investor's circumstances, writes the investment policy statement and sets the strategic asset allocation against capital market expectations. Execution implements it through asset allocation, security selection and trading. Feedback monitors the portfolio and the investor's circumstances, rebalances toward targets and measures performance against the benchmark the policy specified. The loop closes because circumstances change: the feedback stage feeds the next planning stage rather than ending the process.
A practice question
In which stage of the portfolio management process is the investment policy statement written?
- ExecutionWhy not: Where the policy is implemented through allocation, selection and trading.
- FeedbackWhy not: Where results are measured against the policy and the portfolio is rebalanced.
- Planning - correct
The portfolio management process has three stages: planning, execution and feedback. The investment policy statement is the written plan setting out the client's goals and limits. It is written in the planning stage, before any money is invested, and everything later is measured against it. Execution is the buying and selling that follows the plan. Feedback is measuring results and adjusting.
A harder one
In the three-step portfolio management process, a manager compares the portfolio against its benchmark and trades it back toward target weights. Which step is this?
- Feedback - correct
- PlanningWhy not: Where the targets and the benchmark were set, before there was anything to compare.
- ExecutionWhy not: Trading is involved, but the trigger here is a comparison against the policy, which is what makes it feedback.
Feedback is where the manager monitors the portfolio and the client's situation, measures results against the benchmark and rebalances when weights drift from targets. Trading is involved, but what triggers it is a comparison with the policy, so this is feedback, not execution. For example, if equities have grown from a 60% target to 68% of the portfolio, selling the excess is the response to monitoring. Planning is where the targets and benchmark were set in the first place.
The hardest tier
In the three-step portfolio management process, monitoring shows that a client's circumstances have changed materially. To which step must the manager return to revise the policy statement?
- Execution, because the holdings must now be tradedWhy not: Trading may follow, but only after it has been settled whether the policy itself still fits.
- Feedback, because performance must now be re-measuredWhy not: Feedback is where the change is detected, because it monitors the investor's circumstances, but it does not rewrite the policy. That is done in planning.
- Planning, because the policy statement may no longer fit - correct
If a client's situation changes materially, the objectives and limits in the policy statement may no longer fit. So the manager must go back to planning and revise the statement before changing any holdings. Feedback is where the change is spotted, but the policy is rewritten in planning. For example, if a retirement saver suddenly needs a large sum within two years, the time horizon and liquidity needs change, and the asset allocation must change with them. Rebalancing to a target that is now wrong does harm.
In the app: 9 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
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