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A key area of testing on the FPE1® and FPE2® examinations is “Asset Management”, and a key topic area is asset allocation. In this e-newsletter, I will discuss asset allocation.

Asset allocation represents the percentages of a client’s assets that are invested in different asset classes, including cash investments, fixed income investments and equity investments. While other investment classes could be included, such as real estate, commodities and alternative investments, this e-newsletter will focus on cash, fixed income and equity investments.

Determining Asset Allocation

The key determinants of asset allocation are: the investor’s profile, including personal and financial information, investment objectives, risk tolerance and investment constraints (such as time horizon, taxes and legal issues); and capital market expectations. Capital market expectations include expected returns for the various asset classes (cash, fixed income and equity securities) and corresponding volatility expectations.

In respect to asset allocation, an overall long-term strategy is required to manage a client’s money. Integrated asset allocation is a popular strategy.

Integrated Asset Allocation

This approach to asset allocation includes two mandatory steps and one optional step.

  1. Strategic Asset Allocation (SAA): This represents determining a long-term asset allocation for the client. This is where the asset allocation of the portfolio is relatively fixed as to percentage weightings (e.g., 5% cash; 45% fixed income; 50% equity).

  2. Dynamic Asset Allocation: This represents rebalancing the portfolio on a regular basis (e.g., annually or after major market movements) to get back to the strategic asset allocation (SAA).

  3. Tactical Asset Allocation (TAA): Here the portfolio manager is allowed to tilt the portfolio away from the strategic asset allocation in order to take advantage of short-term opportunities. For example, he or she might overweight the portfolio in equity securities so as to take advantage of an expected short-term movement in stock prices. Tactical asset allocation is an optional step and is dependent on the client.

Types of Investments

Within each asset class (cash, fixed income and equity), the client has a range of investments that are available.

  • Cash investments include cash, Canada Savings Bonds (CSBs) and money market instruments such as treasury bills, bankers’ acceptances and commercial paper. Money market mutual funds and fixed income investments maturing within one year are also considered cash investments.

  • Fixed Income investments include term deposits, GICs, marketable bonds, stripped bonds, stripped coupons, mortgages, mortgage-backed securities and preferred shares. Mutual funds and exchange traded funds (ETFs) that invest in marketable bonds, stripped bonds, stripped coupons, mortgages and preferred shares are also considered fixed income investments.

  • Equity investments include common shares, convertible bonds, convertible preferred shares, income trusts, and derivative securities including warrants, rights, calls and puts. Equity investments also include mutual funds and ETFs that invest in common shares, income trusts and derivative securities.

To challenge your ability to determine an asset allocation, please examine the portfolio below for John Wright, dated May 31st, 2012. Calculate the total market value of the portfolio and the percentages of the portfolio that are invested in cash, fixed income and equity investments.

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Portfolio for John Wright as at May 31st, 2012

 Securities # Shares/ Units Cost Current Price Market Value
Canadian Oil Sands Income Trust 300 $26 $30
BlackRock S&P TSX 60 i shares ETF units 400 42 40
Superior LSVCC Fund (investing in Manitoba companies only) 500 14 12
Royal Bank $25 Par 5% Preferred Shares, Series E 200 24.50 27
AGF Canadian Corporate Bond Fund (Mutual Fund) 200 8 14
    Face Value Cost Current Price Market Value
CSBs, Series 39, R bonds maturing Nov. 1, 2018 (current minimum interest rate, 2%) $14,000 $100 $100
GOC T-bills maturing in 60 days (yield; 2.44%) 10,000 99.60 99.60
 • Province of Manitoba, 4.75% bonds maturing March 1, 2015 15,000 102.50 104
GOC stripped coupons maturing in 10 years 2,500 67.30 67.30

In the next e-newsletter, I will provide the asset allocation for John Wright’s portfolio, and discuss other issues with “Asset Management”.

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Best of luck!

Sincerely,

Ron Foran, CFP, CFA, CLU, FCSI
President, Foran Financial Institute

Ron Foran is the founder of Foran Financial Institute. He has lectured extensively for 25 years on investments and financial planning across Canada and globally. Ron has a passion for teaching, training and assisting students to pass exams and is the primary instructor for Foran securities and investment management seminars. If you want to learn more about Ron or Foran Financial Institute, please go to www.foranfinancial.com.


Note: Advocis does not award the CFP® and Certified Financial Planner® designation. The right to use the marks CFP®, CERTIFIED FINANCIAL PLANNER® and CFP(logo) is granted under licence by FPSC to those persons who have met its educational standards, passed the FPSC's Certified Financial Planner Examination, satisfied a work experience requirement, and agreed to abide by FPSC Code of Ethics.