Investment Planning and Asset Allocation
This domain tests the construction and defence of a portfolio: the investment policy statement, the strategic allocation, the rebalancing rule, and the evidence that the portfolio matches the client's constraints rather than the adviser's enthusiasm.
The investment policy statement
An IPS records objectives (return target, risk limit), constraints (liquidity, time horizon, tax position, legal and unique circumstances), the permitted asset classes, the rebalancing policy and the review cycle. It is the reference document whenever markets make the client want to change course.
Allocation logic
Modern portfolio theory shows that portfolio risk depends on the correlation between holdings, not only on each holding's volatility; low or negative correlation lowers portfolio volatility for the same expected return. Strategic allocation is set by the IPS; tactical tilts are discretionary, capped, and must be justified in writing.
Worked example: risk-adjusted comparison
Portfolio A: expected return 9%, risk-free rate 3%, standard deviation 12%. Sharpe = (9 − 3) / 12 = 0.50. Portfolio B: return 11%, standard deviation 18%. Sharpe = (11 − 3) / 18 = 0.44. Portfolio B earns more but delivers less return per unit of risk; for a client whose IPS caps volatility, A is the correct recommendation. A 1% annual fee on A reduces the ratio to (8 − 3)/12 = 0.42, which shows how cost drag competes with allocation decisions.
Rebalancing
Use tolerance bands (for example ±5 percentage points on a 60/40 mix) rather than calendar-only rebalancing; bands capture more trading discipline and reduce turnover cost.
Traps
- Using past returns as the expected-return input.
- Confusing a client's desire for high returns with capacity to bear drawdowns.
- Rebalancing into an unchanged IPS after a life event.
- Ignoring tax and transaction costs when comparing strategies.