Question

a) Briefly describe the three elements of the portfolio management process. Why is it important that one follow this process? Explain.

b) Compare and contrast Defined Benefit and Defined Contribution Pension plans. Why is there a decline in number of firms offering DB plans as a benefit to their employees? Why is it difficult to have a clear investment policy for a labor union sponsored DB plan? Explain.

c) Briefly describe the three psychological traps when making market forecast as well as one more other challenge that you can face when preparing to make forecast. Be sure to include how you would avoid these issues.

Answer 1

a]

Three elements of the portfolio management process are :

1. Planning - The Investment Policy Statement (IPS) is prepared after discussing with the client their risk/return objectives, liquidity requirements, time horizon, legal/tax issues and other special considerations.
2. Execution - The asset allocation among different asset classes is made according to the client's risk/return objectives and other factors in the IPS. Within each asset class, the security selection is done in which specific securities are identified that are appropriate for the client. Finally, the portfolio is constructed by actually purchasing the securities.
3. Feedback - This is the process of performance measurement and performance reporting. The returns are analyzed to see whether the risk/return objectives were met, and reason for any deviation are identified to take corrective action.

It is important to follow this process so that the client is serviced in a systematic and methodical manner. Following this process ensures that the IPS is adhered to, and any deviations are reported. This also ensures that the reason for each action are recorded for future reference.