Portfolio construction for the wealthy investor

To build a suitable portfolio for a client, an investment adviser should

first seek to understand the client’s investment goals, resources,
circumstances, and constraints.

When constructing a portfolio for a client, it is important to ensure that

the risk of the portfolio is suitable for the client

Constraints

1. Risk tolerance

a) ability
b) willingness

An individual’s overall risk tolerance is a function of his ability to bear

(accept) risk and his willingness to take risk.

The ability to bear risk is measured mainly in terms of objective

factors, such as time horizon, expected income, and the level of
wealth relative to liabilities.

Risk attitude, or willingness to take risk, is a more subjective factor

based on the individual’s psychology and perhaps his/her current
circumstances. Some psychological factors, such as personality type,
self-esteem, and inclination to independent thinking, are correlated
with risk attitude. A willingness to take risk may be gauged by
discussing risk with the client, or by asking the client to complete a
psychometric questionnaire.
The adviser needs to examine whether a client’s ability to take risk is
consistent with the client’s willingness to take risk.

2. Time horizon
It may be the period over which the portfolio is accumulating
before any assets need to be withdrawn; it could also be the
period until the client’s circumstances are likely to change.

The time horizon of the investor will affect the nature of

investments used in the portfolio:
illiquid or risky investments may be unsuitable for an investor
with a short time horizon, because the investor may not have
enough time to recover from investment losses; such
investments, however, may be suitable for an investor with a
longer horizon.

3. Liquidity needs
The liquidity requirements (withdrawal of funds) need to be
stated.
Examples for an individual investor would be outlays for
covering healthcare payments or tuition fees.
When the client does have such a requirement, the adviser
should allocate part of the portfolio to cover the liability :
This part of the portfolio will be invested in assets that are liquid
(that is, easily converted to cash) and low risk.

4. Tax concerns
Tax status varies among investors.
The portfolio should reflect the tax status of the client :
a taxable investor may wish to hold a portfolio that emphasizes
capital gains and receives little income, if income is taxed more
highly than gains.
 5. Legal and regulatory factors
Some investors are subject to restrictions on the composition of
the portfolio: for example, there may be a limit on the proportion
of equities or other risky assets in the portfolio, or on the
proportion of of the portfolio that may be invested overseas.

6. Unique circumstances
An investor may have personal objections to certain type of
investments.

Return objectives

A client’s return objectives can be stated in a number of ways:

 The client may want to achieve a particular percentage rate of

return, for example, x percent.
 The return objective can be stated on a relative basis, for
example, relative to a benchmark return, such as a desire to
outperform the benchmark index by one percentage point per
year.
 The return objective could be a required return, that is, the
amount the investor needs to earn to meet a particular future
goal, such as a certain level of retirement income.

The adviser must ensure that the return objective is realistic.

When a client has unrealistic return expectations, the adviser will

need to counsel the client about what is achievable in the current
market environment and within the client's tolerance for risk.
Portfolio construction

Once the IPS (investment policy statement) has been compiled,

the investment manager can construct a suitable portfolio.

Strategic asset allocation