20 years: Trading & hedge funds
In this video, Trevor introduces the basics of portfolio construction, outlining how the core portfolio is assembled and then explains how the portfolio can be modified due to changes in the economic environment. He finishes with an example of how a portfolio might look once it has been constructed.
In this video, Trevor introduces the basics of portfolio construction, outlining how the core portfolio is assembled and then explains how the portfolio can be modified due to changes in the economic environment. He finishes with an example of how a portfolio might look once it has been constructed.
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12 mins 46 secs
Investment portfolio construction is the process of selecting securities optimally, by taking minimum risk to achieve maximum returns. However, establishing a portfolio isn’t as simple as just buying securities. Objectives of the fund first need to be defined as well as developing an understanding of how different asset classes, funds and weightings impact each other.
Key learning objectives:
Understand the importance of setting financial objectives
Outline the strategic asset allocation (SAA)
Outline the tactical asset allocation (TAA)
Understand the importance of benchmarks
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What is the objective of a pool of available funds? Who is the Investor or Asset Owner? What is their investment horizon?
Once we have a good and clear understanding of the purpose of the investment as well as some underlying characteristics of the asset owner, then we can start putting together their broad risk/return profile which will help us identify the appropriate asset allocation strategy.
This is the core structure of a portfolio, it is put together based on the objectives of the fund, which should have already been established.
It is a long-term decision, with adjustments made on the asset allocations every 3-5 years as underlying considerations change.
Traditionally, the SSA would follow a format of 40% bonds and 60% equities, the idea being that equities do well when the market rallies and bonds provide protection when the economy weakens.
Due to current economic conditions, this traditional split of 60/40 has changed, with alternatives now typically being included in the SAA.
The SAA establishes the long-term investment plan, however during the more medium term geopolitical, economic and business cycles impact financial markets and therefore the underlying asset classes. The purpose of the TAA is to capture some of those interim market moves and adjust the portfolio to reflect those views.
A benchmark is a standard against which the performance of a security, fund or portfolio manager can be measured. They guide the portfolio manager and allow for sponsors to assess how well the PM has done.
The portfolio is compared against its benchmark to assess the risk/return characteristics and differences between the two.
There is a benchmark available for every type of investment strategy or asset class. For example, the S&P 500, the FTSE 100, or even cash indices such as SONIA.
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