Portfolio management process

Building a portfolio is not one decision. It is a loop, and it keeps running for as long as the client stays invested.

The workbook calls it a set of integrated activities. They are done in a logical, orderly and consistent way. The aim is to create an optimum portfolio and then keep it optimum.

There are three elements to the loop. Planning comes first. Then execution. Then evaluation.

Planning means writing down what the client wants and what the client can bear. Execution means buying the assets. Evaluation means checking whether any of it worked.

The loop exists because nothing stands still. The client gets older, richer, poorer or more cautious. Markets move. So the adviser has to look again, and again.

The road map for the whole loop is the Investment Policy Statement. Every later decision is judged against it.

The 5 steps, in the workbook's own order (section 15.3).

1. Develop the policy statement. This is a road map. It identifies the investor's risk appetite and defines investment objectives, goals and investment constraints.
2. Study current financial conditions and forecast future trends.
3. Construct the portfolio, taking into account the policy statement and the investor's objectives, risk appetite and horizon. Because investor needs and market forecasts are both dynamic, the portfolio then requires continuous monitoring and rebalancing.
4. Measure and evaluate performance.
5. Review periodically — is the portfolio still consistent with the objectives, and has anything significant changed in the investor's conditions or in a particular fund?

The workbook then compresses those 5 steps into 3 elements: the process moves from planning through execution and then to feedback.

Where the IPS sits. Section 15.3.1 calls the IPS the key step. Either the investor or the adviser drafts it, specifying objectives, goals, constraints, preferences and the risks the investor is willing to take. It has to be updated and revised periodically, because the investor's requirements change. It forms the basis for strategic asset allocation, which the workbook describes as the interaction between the investor's risk-return requirements and expected investment return.

The 4 purposes the policy statement serves (section 15.3.2). It lets investors hold realistic return expectations; it lets the portfolio manager make effective decisions in line with the investor's objectives; it provides a framework for evaluating the manager; and it protects the investor against the manager's inappropriate decisions or unethical behaviour.

The workbook attaches no threshold or time limit to the process itself — no mandated review frequency, no permitted drift, no minimum corpus. The only counts it gives are the ones above: 5 steps, 3 elements, 4 purposes.

Mrs Varghese, aged 42, comes to an adviser with Rs 60,00,000 to invest and a goal of Rs 1,50,00,000 in 15 years for retirement. Run the loop once.

Step 1 — policy statement. Objective: long-term capital appreciation with a retirement date of 15 years out. Risk appetite: moderate. Constraints: Rs 6,00,000 must stay liquid for an emergency reserve, and she will not hold tobacco or gambling stocks. All of that is written down and signed.

Step 2 — conditions and forecasts. The adviser records the return assumptions being used. Assume 11% a year for equity and 7% for debt; the workbook gives no forecast figures of its own.

Step 3 — construct. Against a moderate profile the adviser sets 65% equity and 35% debt:

Blended expected return = (0.65 x 11) + (0.35 x 7) = 9.6% a year. Over 15 years that compounds Rs 60,00,000 to about Rs 2,37,00,000, comfortably past the goal.

Step 4 — measure. After year one equity has returned 19% and debt 6%. The portfolio is worth Rs 46,41,000 + Rs 22,26,000 = Rs 68,67,000, a gain of 14.45%.

Step 5 — review. The weights are now 67.6% equity and 32.4% debt. Restoring 65:35 means selling Rs 1,76,450 of equity and buying debt. And a life event lands: her father moves in and needs care, so the liquidity constraint rises from Rs 6,00,000 to Rs 12,00,000.

That second change does not go back to step 5. It goes back to step 1, because the policy statement itself is now wrong. Which is the whole point of calling this a process rather than a plan.

Chapter 15 (Portfolio Construction Process), section 15.3, with the Investment Policy Statement at 15.3.1, the need for an IPS at 15.3.2 and its constituents at 15.3.3. Expect a question asking for the 5 steps in order, one asking which of planning, execution or feedback a named activity belongs to, and one on the 4 purposes the policy statement serves. The commonest wording asks which step comes first — it is the policy statement, not the asset allocation.

• The policy statement comes first, not the asset allocation. Allocation is inside step 3, after the objectives and constraints are written down.
• 5 steps, 3 elements. Planning, execution and feedback are groupings of the same 5 steps, not a rival list. A question that offers both is testing whether you noticed.
• Evaluation and periodic review are separate steps in the workbook's list. Step 4 measures performance; step 5 asks whether the portfolio still fits the investor.
• A change in the investor sends you back to step 1, not to the rebalancing desk. A new constraint changes the IPS, and the IPS changes everything below it.
• The IPS is the investor's document, not the manager's. One of its 4 purposes is to protect the investor from the manager.
• Do not confuse the process with the portfolio. Portfolio Management Services is a regulated product; this is the method any adviser follows, PMS or not.