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

2. 1.Investment Policy Statement – recap 2.Understanding Client Personalities 1)Situational Profiling 2)Psychological Profiling 3.Developing the Investment Policy Statement (IPS) 4.CASE STUDY Table of contents

3. 3Portfolio Management for Financial Advisers Jakub Karnowski, CFA Investment Policy Statement – recap The investment policy statement (IPS) is critical to the investment management process because it governs allocation of funds to various asset classes, the most important global investment decision ! NOTE !

4. 4Portfolio Management for Financial Advisers Jakub Karnowski, CFA Investment Policy Statement – recap COMPONENTS OF AN IPS CLIENT DESCRIPTION AND PURPOSES RISK/RETURN OBJECTIVES CONSTRAINTS (TURTL)  Liquidity  Time Horizon  Taxes  Legal & Regulatory  Unique Circumstances ASSET ALLOCATION CONSIDERATIONS REVIEW AND MONITORING

5. 1.Investment Policy Statement – recap 2.Understanding Client Personalities 1)Situational Profiling 2)Psychological Profiling 3.Developing the Investment Policy Statement (IPS) 4.CASE STUDY Table of contents

6. INVESTORS HAVE DIFFERENT PERSONALITIES AND DIFFERENT LEVELS OF SOPHISTICATION 6Portfolio Management for Financial Advisers Jakub Karnowski, CFA

7. 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. 7Portfolio Management for Financial Advisers Jakub Karnowski, CFA ! NOTE ! Understanding Client Personalities

8. 1.Investment Policy Statement – recap 2.Understanding Client Personalities 1)Situational Profiling 2)Psychological Profiling 3.Developing the Investment Policy Statement (IPS) 4.CASE STUDY Table of contents

9. Situation Profiling Sources of Wealth The method of wealth accumulation can have a bearing on attiutudes towards risk EntrepreneursPassive 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 9Portfolio Management for Financial Advisers Jakub Karnowski, CFA Understanding Client Personalities

10. 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 10Portfolio Management for Financial Advisers Jakub Karnowski, CFA Understanding Client Personalities Situation Profiling

11. Stage of Life The investor’s stage in life cycle is indicative of the ability or willingness to bear risk Accumulation PhaseConsolidation PhaseRetirement/Gifting Phase young investorsinvestors in their middle yearsinvestors 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) 11Portfolio Management for Financial Advisers Jakub Karnowski, CFA Understanding Client Personalities Situation Profiling

12. 1.Investment Policy Statement – recap 2.Understanding Client Personalities 1)Situational Profiling 2)Psychological Profiling 3.Developing the Investment Policy Statement (IPS) 4.CASE STUDY Table of contents

13. 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 13Portfolio Management for Financial Advisers Jakub Karnowski, CFA Understanding Client Personalities Psychological Profiling

14. 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 14Portfolio Management for Financial Advisers Jakub Karnowski, CFA Understanding Client Personalities Psychological Profiling

15. 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 ThinkingBase Decisions on Feeling 15Portfolio Management for Financial Advisers Jakub Karnowski, CFA Understanding Client Personalities Psychological Profiling – Investment Personality Type Matrix

16. 1.Investment Policy Statement – recap 2.Understanding Client Personalities 1)Situational Profiling 2)Psychological Profiling 3.Developing the Investment Policy Statement (IPS) 4.CASE STUDY Table of contents

17.  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. 17Portfolio Management for Financial Advisers Jakub Karnowski, CFA Developing the Investment Policy Statement (IPS)

18. 18Portfolio Management for Financial Advisers Jakub Karnowski, CFA CASE STUDY