When managing a portfolio for an individual investor, it is important to understand the client's objectives and constraints before investing on their behalf.
The objectives and constraints should be documented within an investment policy statement or IPS.
This protects both the investor and the portfolio manager since it reduces the likelihood of misinterpretation between what the client is hoping to achieve and how the portfolio manager will be investing at the client's money.
The objectives should cover the level of return that the investor requires including whether the return requirement is an absolute or a relative return requirement, which means that the return is considered in a relation to some sort of Benchmark or index.
And whether it is a real return that is after inflation.
Or a nominal return which includes the impact of inflation.
In addition, the client's risk tolerance should be documented.
As to the level of risk they're willing to tolerate.
But also whether they want low volatility of returns or a low risk of making losses meaning they are more focused on Capital preservation.
In terms of constraints these are factors which may inhibit the range of Investments open to the portfolio manager.
These include the time Horizon of the investor the shorter the time Horizon. Typically the lower level of risk. The investor will be willing to take The liquidity of the investor are they likely to need to withdraw money from the portfolio frequently to meet their spending needs.
tax considerations do they pay different rates of tax on income or capital gains? And any legal considerations? Finally any other unique circumstances which are important to the client should also be included within the constraints within the investment policy statement.
Such as a desire not to invest in polluting companies.
