Overview
The investment management process is an integrated framework that links investor objectives with portfolio construction, execution, and ongoing monitoring. It can be broken down into five sequential stages, each feeding into the next.
The investor
Determining the risk profile must begin with an understanding of the investor's objectives, age, investment horizon, preferences and constraints when implementing the portfolio.
Age and investment horizon are closely related. In principle, the younger the investor, the longer the investment horizon — which enables greater risk-taking. The optimal short-term portfolio does not necessarily coincide with the optimal long-term one.
A long-term investor would generally be more willing to hold bonds and equities than cash. As the holding period increases, the probability of loss diminishes and may even disappear.
Attitude vs. capacity for risk
- Attitude towards risk — determined by the client's sensitivity to potential losses and minimum acceptable returns.
- Capacity to take risk — influenced not only by the investment horizon but also by Human Capital: the present value of future labour income. Younger investors can take more risk because their Human Capital can compensate for adverse outcomes in riskier assets.
Investment universe
Traditional investments
Traditional investments (equities, fixed income, cash, mutual funds, ETFs) operate under the assumption of market efficiency — prices reflect all available information and no excess return can be earned on a risk-adjusted basis.
Alternative investments
Alternative investments (hedge funds, private equity, venture capital, real estate, commodities, credit derivatives) operate in the realm of market imperfections and arbitrage opportunities. They target positive absolute returns under any market condition and with low correlation to traditional asset classes.
Institutional investors and large family offices have increasingly allocated to alternatives in search of uncorrelated return sources.
Strategic asset allocation
Strategic Asset Allocation (SAA) provides the investor with a long-term strategic reference for distributing investments across asset classes — the benchmark. It is designed to meet investment objectives under normal market conditions over a full economic cycle.
"91.5% of the success or failure of an investment is explained by asset allocation. Only 6.2% by stock selection, and 2.3% by timing." — Brinson, Singer & Beebower (1977–1987, 82 large pension plans)
The primary source of risk exposure in a portfolio comes from its strategic allocation. Active management (tactical asset allocation) then attempts to exploit financial market opportunities to generate added value (alpha).
Security selection
Security selection translates asset class categories into specific investment instruments, aiming to reflect a more personal style within the portfolio — without deviating excessively from the strategic allocation.
Selection can take place either through direct investment in individual securities (bonds, equities) or through indirect vehicles such as mutual funds, ETFs, or hedge funds.
Control and monitoring
In traditional portfolio management, the portfolio is managed relative to a pre-selected benchmark. The benchmark must be appropriate and should reflect the objectives and constraints identified in the initial phase of the process.
The manager's goal is to beat the benchmark through active management — to generate alpha. Two classic performance measures:
Both measures yield similar conclusions when applied to well-diversified fund groups. More advanced downside risk measures (LPM, CVaR) can also be employed.