Functions of a portfolio manager

The planning step: The first thing a portfolio manager does is to discuss with the client in order to understand his investment objective, goal and level of risk the customer is willing to take. Thus, after the agreement with the customer the investment objectives and policies are formulated, constraints are determined, capital market expectations are formed, and strategic asset allocations are established and an investment policy statement is created (cfainstitute,2018). An investment policy statement is a formal document between the portfolio manager and the client which clearly sets the investor’s goals, objectives and constraints. It allows the investor to determine the factors that are personally important and should be reflected in the investment plan and without it the success of a financial plan is at risk (Reilly et al. 2002 :53). The failure to follow an investment policy statement is evidence of a breach of fiduciary responsibility.
The execution step: After the planning step comes the construction and implementation of the portfolio. The manager together with the investor determine how to allocate the available funds across their options (bonds, stocks, securities etc). The portfolio selection/ composition should minimise the investor’s risk as well as meeting the investor’s needs according to the policy statement. The next step in the process is to implement this portfolio. What is important to be noted in this step is that high transaction explicit and implicit costs like taxes, fees, commissions, bid-ask spread, opportunity costs, market price impacts, etc. can reduce the performance of the portfolio. Hence, the execution of the portfolio needs to be appropriately timed and well-managed (efinancemanagement).

The feedback step: after the funds are invested according to the plan, the manager monitors, evaluates and update the portfolio compared with the plan. The managers must continually monitor the investor’s needs and the capital market conditions so that they can evaluate the portfolio’s performance and compare the relative results to the expectations and requirements of the policy statement. Any changes, updating and rebalancing suggested by the feedback must be examined carefully to ensure that they represent long-run considerations.

Interview Questions

1. According to the description of the portfolio manager process, can you define the daily tasks of a portfolio manager? Planning Tasks
   I. Set meeting with the client to discuss his values, beliefs, priorities, objectives (desired investment outcomes) and constraints (client’s specific liquidity needs, time horizon, unique circumstances, any tax issues and legal and regulatory requirements. Understanding how much risk an investor is willing and able to assume, and how much volatility the investor can endure. (skill based)
   II. Formulation of the Investment Policy Statement which includes : brief client description, the duties and investment responsibilities of the parties involved (client, any investment committee, the investment manager, and the bank custodian), the statement of the unique investment goals, objectives and constraints, the schedule for reviewing the investment performance and the IPS , performance measures and benchmarks to be used in performance evaluation, any other considerations to be taken into account in developing the strategic asset allocation, investment strategies and style, guidelines for rebalancing the portfolio based on feedback. (rule based)
   III. Forming of capital market expectations. Forecasting the risk and return of various asset classes over a long term in order to select portfolios that either maximizes the expected return for certain levels of risk or minimize the portfolio risk for certain levels of expected return. (knowledge based)
   IV. Determination of the strategic asset allocation which is achieved by combining the IPS and capital market expectations in order to determine target asset class weights. The portfolio manager selects from various asset classes and investment options and allocates assets in a way that achieves optimum diversification while targeting the expected returns for the client. (knowledge-based)
   V. If there are any changes in the circumstances of the investor or the market expectations then the portfolio manager needs to change the portfolio strategy and to tactical asset allocation. In case changes become permanent, the investment policy statement must be updated to reflect these changes and the temporary tactical allocation may become the new strategic portfolio allocation. (knowledge-based) execution Tasks
   I. Selection of the specific assets for the portfolio composition based on analysts’ inputs (rule-based)
   II. Use of portfolio optimization techniques like portfolio optimization—quantitative tools for combining assets efficiently to achieve a set of return and risk objectives (rule-based)
   III. After the decision about which option will be bought or sell, the portfolio manager transmits the order internally to the trading desk (skill-based)
   IV. The trader arranges for the execution of the order with a broker-dealer (skill-based) feedback Tasks
   I. Monitoring the investments to ensure that they are still appropriate for the client’s needs. (rule-based)
   II. Stay informed of changes in clients’ circumstances (skill-based)
   III. Systematically review the risk attributes of assets as well as economic and capital market factors
   IV. Rebalance the portfolio (considering taxes and transaction costs) (skill-based)
   V. Measuring the portfolio’s performance relative to the benchmarks and rates of return (rule-based)
   VI. Performance attribution to examine those rates of return to determine the factors that explain how the return was achieved and why the portfolio performed as it did
   VII. Performance appraisal evaluation of how well the portfolio manager performed on a risk-adjusted basis relative to a benchmark.
2. Please classify the above-mentioned tasks into:
   a) skilled based (routine behavior based on learning skills for which the cognitive commitment is very low and reasoning is unconscious, automatic)
   b) ruled based (The person recognizes the situation and applies the right procedure to perform the task, and then performs a series of actions by the use of procedures, a person follows remembered or written rules, cognitive engagement) or
   c) knowledge-based (Improvisation in unfamiliar environments, no procedures or rules available for handling situation, react based on the information available and the knowledge gained in a completely conscious manner)?
3. Do you recognize any of these conditions that are applicable in the portfolio management tasks? (Please tick the list of conditions)
4. Can you describe the most common human errors a portfolio manager is exposed to during the process?
5. What are, in your opinion, the solutions to minimize human error in the portfolio management process?

Sample Solution