Developing an Investment

Philosophy: Key Steps

Lecturer: Gonçalo Faria
School of Economics and Finance
 Developing an Investment Philosophy: Key steps

Critical idea: every investor / asset manager needs an investment philosophy

Question: what is the process to develop such a philosophy?
Answer - four steps:
o Step 1: Understand the needs of your client

o Step 2: Understand the fundamentals of Risk and Valuation

o Step 3: Develop a perspective about how markets work and how they might
breakdown. This leads to different investment strategies
o Step 4: Find the philosophy that best fits your client
 Developing an Investment Philosophy: Key steps

Comments on step 1. Your client's needs depend on:

o Risk Aversion

o Size of Portfolio: Some strategies require larger portfolios whereas others work only
at a smaller scale. For example, activists require larger portfolios

o Time horizon and cash needs. Example: pension funds and sovereign wealth funds,
both long term oriented vs. high frequency trading funds

o Tax status
 Developing an Investment Philosophy: Key steps

This week we will be focused on Step 2: Understand the fundamentals of Risk and
Valuation

o This can be seen by an asset manager as the “financial tool kit”. It should enable to
understand:

what is risk, types of financial risks and how to measure and manage them

how to value an asset, whether it is a bond, stock, real estate, etc...