PORTFOLIO MANAGEMENT: CHEAT SHEET

IPS & PORTFOLIO MANAGEMENT PROCESS

IPS = Foundational contract between manager & client

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Mnemonic: RRTTLLU

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THREE-STAGE PORTFOLIO MANAGEMENT PROCESS

PLANNING → Client needs → IPS → Strategic Asset Allocation (SAA)

EXECUTION → Security selection & portfolio construction

FEEDBACK → Monitor, rebalance, update IPS as circumstances change

Key: Rebalance when portfolio DRIFTS beyond IPS band (e.g., ±5%), NOT by calendar.

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SAA vs. TAA

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CAPM: Core Formula & Interpretation

E(Ri) = Rf + βi × [E(Rm) – Rf]

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Beta Interpretation:

• β = 1.0 → moves with market

• β > 1.0 → aggressive (amplifies market moves)

• β < 1.0 → defensive (dampens market moves)

• β = 0 → uncorrelated with market (not possible for equities; zero-beta portfolio is risk-free)

Beta Formula: β = Cov(Ri, Rm) / Var(Rm) = ρ(Ri,Rm) × σi / σm

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CAPM STRENGTHS & LIMITATIONS

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SECURITY SELECTION DECISION RULE

Required Return vs. Expected Return:

• If E(Ri) > Required Return → BUY (underpriced)

• If E(Ri) < Required Return → SELL/AVOID (overpriced)

Required Return = Rf + βi × ERP (from CAPM)

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COMMONLY CONFUSED PAIRS

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QUICK DECISION CHECKLIST

✓ IPS Update Trigger: Change in financial situation, objectives, or constraints (NOT on rigid schedule) ✓ Risk Tolerance Change: Major wealth event, life stage change, liability change ✓ Rebalance Trigger: Portfolio drifts beyond IPS-specified band ✓ Security Buy/Sell: Compare E(Ri) to CAPM required return ✓ Endowment Return Target: Spending Rate + Inflation + Management Fees

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INSTITUTIONAL CLIENT FOCUS

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Element	Definition	Key Detail
Return Requirement	Minimum/target return needed	Absolute (7%) or relative (CPI + 3%)
Risk Tolerance	Ability + Willingness to bear risk	Ability = time horizon, liquidity, cushion; Willingness = psychology
Time Horizon	Investment period	Longer = can take more risk
Tax Considerations	After-tax return impact	Tax-loss harvesting, tax-exempt securities
Liquidity Requirements	Minimum cash reserves	For predictable + emergency spending
Legal/Regulatory	Constraints (ERISA, prudent investor, etc.)	Institutional-specific mandates
Unique Circumstances	ESG, values, specific goals	Client-specific factors
Aspect	Strategic (SAA)	Tactical (TAA)
Horizon	Long-term target	Short-term deviation
Basis	Capital market assumptions + risk tolerance	Market views, valuation signals
Active Risk	None (baseline)	Yes—deliberate vs. SAA
Rebalancing	Restores to SAA target	Active bet
Component	Meaning	Example
E(Ri)	Expected return on asset i	Solving variable
Rf	Risk-free rate	2% (U.S. Treasury)
βi	Beta = systematic risk	1.2 = 20% more volatile than market
E(Rm) – Rf	Equity Risk Premium (ERP)	~5–6% (historical)
Strength	Limitation
Simple, intuitive relationship	Assumes rational investors, perfect markets
Separates systematic vs. unsystematic risk	Only one risk factor; doesn't explain all returns
Benchmarking framework	Betas change over time
Difficult to estimate ERP, Rf in practice
Pair	Distinction
Systematic vs. Unsystematic Risk	Systematic (β) = non-diversifiable, priced in CAPM; Unsystematic = diversifiable, unpaid
Beta vs. Correlation	Beta scales correlation by σi/σm; ρ = -1 to +1, β = unbounded
Alpha vs. Beta Return	Beta return = reward for systematic risk; Alpha = outperformance vs. CAPM prediction
Rebalancing (Calendar vs. Threshold)	Threshold-based = superior (respond to drift); Calendar = arbitrary
SAA vs. IPS	IPS = written policy document; SAA = the target asset mix within the IPS
Client Type	Key Constraint	SAA Driver
Pension Fund	Liability duration & funded status	LDI (liability-driven investing)
Endowment	Perpetual inflation-adjusted spending	8%+ return (long-duration equities/alternatives)
Insurance Co.	Reserve requirements, regulatory capital	Liability matching, credit quality
Sovereign Wealth Fund	Political/fiscal objectives	Diversification, long horizon