Steps To Success: Investment Management Simplified

The investment management process is a systematic approach to handling investments, aiming to meet specific financial goals. It involves making informed decisions about assets, portfolios and strategies to maximise returns while minimising risks. Here are the five steps to the investment management process:

1. Set clear investment goals: This initial step involves identifying what you want to achieve financially, such as saving for retirement, funding education or purchasing a home.

2. Determine your risk tolerance: Understanding your risk tolerance ensures your investment strategy aligns with your ability to withstand potential losses.

3. Create an asset allocation plan: Decide how to distribute your investments across different asset classes, such as stocks, bonds and cash, to balance risk and reward according to your risk tolerance and goals.

4. Build your portfolio: Select specific assets within the chosen categories to match your asset allocation strategy, aiming for a well-diversified portfolio that optimises potential returns while managing risk.

5. Monitor and update your portfolio: Regularly review the performance of your assets and make timely adjustments to keep your investments aligned with your financial goals and risk tolerance.

Understanding the client

• Needs and Objectives: It is important to identify the client's investment goals, whether it is wealth creation, income generation, retirement planning, or capital preservation. Understanding their objectives helps in tailoring the investment strategy to meet their specific needs.
• Risk Tolerance: Assessing the client's risk tolerance is crucial in determining the types of investments that align with their comfort level. This includes evaluating their psychological and financial resilience to market uncertainties and fluctuations. Some clients may be more conservative, while others may have a higher risk appetite.
• Financial Situation: Understanding the client's current financial situation is vital. This includes assessing their income, expenses, assets, liabilities, and savings. By evaluating these factors, investment advisors can determine how much the client can invest and the time horizon for their investment goals.
• Tax Status: Considering the client's tax status is an important aspect of the investment process. It helps in structuring the investment strategy in a tax-efficient manner and ensuring compliance with relevant tax regulations.
• Benchmarking: After gaining an understanding of the client's goals and constraints, it is essential to set a benchmark for their portfolio management process. This benchmark will serve as a reference point to evaluate the performance of the investment strategy and determine whether the client's objectives are being met.

By taking the time to understand the client comprehensively, investment advisors can provide tailored advice and strategies that align with the client's needs, risk tolerance, and financial goals. This step ensures that the investments made are suitable for the client's circumstances and help them achieve their desired outcomes.

Asset allocation

The three main asset classes are equities, fixed income, and cash and cash equivalents, each with different risks and return potential. Investors must decide how to allocate their investments among these classes, and this decision will largely determine their investment results. For example, someone saving for a new car in the next year might opt for a conservative mix of cash, certificates of deposit, and short-term bonds. On the other hand, individuals saving for retirement decades away typically invest most of their retirement accounts in stocks, as they can ride out the market's short-term fluctuations.

There is no one-size-fits-all formula for asset allocation, and it may change over time. Financial advisors often recommend holding stocks for five years or longer, with cash and money market accounts for goals less than a year away, and bonds falling somewhere in between. As investors approach retirement, portfolios should generally move towards a more conservative asset allocation to lower risk.

Several strategies can be employed for asset allocation, including:

• Strategic Asset Allocation: This method establishes a base policy mix of assets based on expected rates of return and the investor's risk tolerance and investment time frame. It may involve a buy-and-hold strategy and diversification to reduce risk and improve returns.
• Constant-Weighting Asset Allocation: This approach involves continually rebalancing the portfolio by buying more of an asset when it declines in value and selling when it increases.
• Tactical Asset Allocation: This strategy involves making short-term deviations from the long-run investment policy to capitalise on unusual or exceptional investment opportunities, adding a market-timing component to the portfolio.
• Dynamic Asset Allocation: This active strategy involves constantly adjusting the mix of assets as markets and the economy rise and fall. It relies on a portfolio manager's judgment instead of a target mix of assets.
• Insured Asset Allocation: This strategy is geared towards risk-averse investors, involving setting a base portfolio value that should not be allowed to drop. If the portfolio drops to the base value, the investor switches to risk-free assets.
• Integrated Asset Allocation: This strategy considers both economic expectations and the investor's risk tolerance to establish an asset mix. It includes aspects of other strategies but does not include both dynamic and constant-weighting allocation.

Portfolio strategy

The third step in the investment process is to select the proper strategy for creating a portfolio. This is important as it forms the basis for selecting the assets that will be added to the portfolio. The strategy chosen should align with the investment policies and objectives.

There are two types of portfolio strategies: active and passive. Active portfolio management involves the fund manager or investor proactively buying undervalued securities or short-selling overvalued ones in an attempt to outperform the market. This strategy requires close attention and carries a higher risk and potential for returns. On the other hand, passive portfolio management aims to generate returns equal to the market. It is a reactive strategy where the fund manager or investor makes moves after observing the market's response. This strategy seeks to generate steady returns with lower risk.

When selecting a portfolio strategy, it is crucial to consider the investor's risk tolerance, investment goals, and time horizon. For example, an aggressive investor with a high-risk tolerance and a long investment horizon may opt for an active strategy to maximise potential returns. In contrast, a conservative investor with a low-risk tolerance and a shorter time horizon may prefer a passive strategy to preserve capital.

Additionally, the portfolio strategy should incorporate diversification. By spreading investments across different asset classes, sectors, and geographies, investors can reduce the risk of any one area of the portfolio significantly impacting the overall returns. Diversification also helps capture the long-term returns of all sectors, as it is challenging to predict which sector or asset class will outperform at any given time.

Finally, the portfolio strategy should be regularly monitored and rebalanced to ensure it remains aligned with the investor's goals and risk tolerance. Over time, market movements can cause the portfolio to deviate from its original target allocation, increasing the risk exposure beyond what the investor is comfortable with. Therefore, it is essential to periodically sell investments that have exceeded their target allocations and buy investments that are underrepresented in the portfolio to restore the desired balance.

Asset selection

The investment objectives should align with the investment policies, or the primary purpose of the investment management process becomes meaningless.

Active Asset Selection

Active asset selection is driven by the investor's fervent hope to "beat the market". It involves the investor attempting to buy undervalued assets in each asset class or sell overvalued ones. Active asset selection strategies can be classified into four classes:

• Intrinsic Valuation Models: These models use financial information on an asset to determine whether it is undervalued or overvalued. The value of any asset is viewed as a function of the cash flows generated, the life of the asset, the expected growth in cash flows, and the risk associated with these cash flows.
• Relative Valuation Models: These models attempt to find assets that are undervalued relative to comparable assets.
• Technical Analysis Models: These models use price and volume information on assets to detect trends in prices.
• Private Information Models: These models attempt to obtain more or better information on an asset than is available to other investors.

Passive Asset Selection

Passive asset selection involves investing across assets in an asset class without attempting to make judgments on under or overvaluation.

Considerations for Asset Selection

When selecting assets, investors should consider the following:

• Risk and Return: Investments with higher potential returns typically carry more risk. It is important to determine your risk tolerance and how much uncertainty you are willing to accept.
• Diversification: Diversifying your portfolio by investing across different types of securities, industries, and geographic regions can help manage risk and increase the chances of long-term success.
• Market Forces: Broader market forces, such as economic conditions, political events, investor sentiment, and company-specific factors, can influence the performance of securities.

Analytical Tools for Asset Selection

There are three main market analysis models that can aid in asset selection:

• Fundamental Analysis: This method assesses the intrinsic value of a security by examining critical economic and financial factors. It involves reviewing financial ratios and metrics, such as debt-to-equity ratio, price-to-book ratio, price-to-earnings ratio, and return on equity, to gauge a company's financial health and stability.
• Technical Analysis: This approach focuses on studying historical market data, particularly price and volume, to forecast future price movements and identify trends and patterns. Technical analysts use indicators like moving averages, relative strength index (RSI), and moving average convergence divergence (MACD), as well as chart patterns like "head and shoulders" and "cup and handle".
• Quantitative Analysis: This approach employs mathematical and statistical models to analyze large amounts of data and identify undervalued investments or those with growth potential. Techniques used include time series analysis, regression analysis, and Monte Carlo simulation.

Combining Analytical Methods

Combining fundamental, technical, and quantitative analysis can provide a comprehensive understanding of a security's strengths, weaknesses, and potential. For example, fundamental analysis can be used to identify financially sound companies, technical analysis can determine the optimal time to buy, and quantitative analysis can assess the investment's risk profile and potential returns.

Sustainable and Ethical Considerations

In recent years, sustainable and ethical investing, also known as environmental, social, and governance (ESG) investing, has gained popularity. This approach involves selecting securities based on a company's performance in areas like carbon emissions, labor practices, and boardroom diversity.

Performance evaluation

An annual review is often enough to keep track of the performance of your investments. This can be done by looking at the latest values for your holdings at the same time each year. This can be done by checking your consolidated statements, which contain information about all your accounts. If you have accounts with several firms, you will need to look at different statements to get a complete picture. Many firms also provide online access to account information, so you can look up the latest values for your holdings at any time.

• Yield: This is typically expressed as a percentage and is a measure of the income an investment pays during a specific period, usually a year, divided by the investment's price.
• Rate of Return: Your investment return is all of the money you make or lose on an investment. To find your total return, you add the change in value, up or down, from the time you purchased the investment to all of the income you collected from that investment in interest or dividends.

Other tips to help you evaluate and monitor investment performance include:

• Factoring in transaction fees: Include the transaction fees you pay when buying your investments to ensure an accurate calculation.
• Creating a single spreadsheet for your investments: If your investments are spread out among different financial firms, it is a good idea to create a master spreadsheet that contains each investment and its value at the time of your evaluation.
• Considering the role of taxes on performance: Compute after-tax returns, including capital gains and losses, with the help of a tax professional.
• Factoring in inflation: Inflation means your money loses value over time, so it can play a big role in calculating your return for long-term investments.
• Comparing your returns over several years: This will help you see when different investments performed well or poorly and how your various investments behaved in different market environments.

Frequently asked questions