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PORTFOLIO CONSTRUCTION | MODULE 2

Benchmarking and budgeting

Continue the portfolio construction course with
module 2, which outlines the first two steps of the portfolio construction process: 1) Benchmarking 2) Budgeting
3) Investing and 4) Monitoring.

What is benchmarking?
Benchmarking involves establishing a standard as a point of reference to measure portfolio performance against, which can help to better compare and evaluate asset allocation.
Arrows

Benchmarking should be the first step in creating a stable portfolio

Take the first step in building an investment portfolio by creating a benchmark.

It serves as a tool for financial professionals to monitor the progress of investments, including projecting what returns their clients can expect to receive at the start of any time period and evaluating returns at the end of a set time period.

All investors should use a benchmark to manage portfolios often and
early in the process

However, financial professionals tend to leave out the benchmark when constructing or making changes to a portfolio, and use it only at the end of their asset allocation process to evaluate a portfolio’s performance.* By using the benchmark at the end of the process, opportunities to pivot and optimize the portfolio throughout the process are forfeited.

3 action items to get started

Currency bubble
Start with a broad strategy

Begin by considering investments from the broadest perspective, evaluating stocks vs. bonds.
3D checklist
Then, narrow in on specific products and timeframes
What assets or asset classes should the performance of this portfolio be measured against?
Time hourglass
Lastly, define your timeframe

What timeframe is appropriate — the next five years, the next full market cycle or the entire investment horizon?

Pick a benchmark that is the best fit

There are different types of benchmarks that help measure success and can be selected based on the investment approach.

Different types of benchmarks
What does budgeting entail?
The budget phase requires considering how to efficiently manage two types of budgets – cost and risk. All financial professionals should set a multi-tiered budget before investing.
Calculator

Budget types

Reduce cost tag
Cost budget
Minimize the cost of fees and taxes to maximize the value of the portfolio.
Measuring risk
Risk budget
Set the suitable level of risk based on the objectives discussed during the benchmark phase. Consider how much risk and what types of risk a client is willing to take.

Reduce costs by combining index, factor and alpha-seeking strategies

Blending complementary sources of return and pairing factor strategies alongside index and alpha-seeking (or active) strategies is one way of reducing costs while helping to improve investment outcomes. Explore the differences between the strategies.

Index strategies

Factor strategies

Alpha-seeking strategies

Seek to provide low-cost, diversified market exposure and can serve as the anchor for core portfolio exposures. Seek to provide incremental returns by targeting historically broad and persistent sources of return such as value, momentum and quality. Seek incremental returns by targeting unique and harder to access insights.
No excess returns, unless through successful market timing. Potentially meaningful excess returns. Potentially meaningful excess returns and differentiated from factor returns.
Lowest fees Low to moderate fees Moderate to high fees

Index strategies

Seek to provide low-cost, diversified market exposure and can serve as the anchor for core portfolio exposures.
No excess returns, unless through successful market timing.
Lowest fees

Factor strategies

Seek to provide incremental returns by targeting historically broad and persistent sources of return such as value, momentum and quality.
Potentially meaningful excess returns.
Low to moderate fees

Alpha-seeking strategies

Seek incremental returns by targeting unique and harder to access insights.
Potentially meaningful excess returns and differentiated from factor returns.
Moderate to high fees
Blending index, factor and alpha strategies
Legend

For illustrative purposes only

Index strategies may provide a well-diversified, low-cost anchor for portfolios.

Consider tilting toward more factors for clients seeking to deliver on differentiated returns at a lower cost.

Consider tilting toward more alpha-seeking for clients seeking higher risk-adjusted return or more opportunistic portfolios.

Index strategies may provide a well-diversified, low-cost anchor for portfolios.

Consider tilting toward more factors for clients seeking to deliver on differentiated returns at a lower cost.

Consider tilting toward more alpha-seeking for clients seeking higher risk-adjusted return or more opportunistic portfolios.

Think differently

Financial professionals who establish a benchmark and reference it regularly provide their clients with transparency into how successfully they are meeting objectives or identify where they may need to pivot. Further, creating a budget and exploring how to best combine different investment strategies to minimize cost can optimize the value of the portfolio.

This concludes the second module of the portfolio construction course. Read the next module, which discusses the last two steps of the portfolio construction process, to continue the course.