Portfolio Management in Practice, Volume 2 E-Book

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: The CFA Institute Series
• Sprache: Englisch

Seitenzahl: 1284

Veröffentlichungsjahr: 2020

Beschreibung

Discover the latest essential resource on asset allocation for students and investment professionals. Part of the CFA Institute's three-volume Portfolio Management in Practice series, Asset Allocation offers a deep, comprehensive -treatment of the asset allocation process and the underlying theories and markets that support it. As the second volume in the series, Asset Allocation meets the needs of both graduate-level students focused on finance and industry professionals looking to become more dynamic investors. Filled with the insights and industry knowledge of the CFA Institute's subject matter experts, Asset Allocation effectively blends theory and practice while helping the reader expand their skillsets in key areas of interest. This volume provides complete coverage on the following topics: * Setting capital market expectations to support the asset allocation process * Principles and processes in the asset allocation process, including handling ESG-integration and client-specific constraints * Allocation beyond the traditional asset classes to include allocation to alternative investments * The role of exchange-traded funds can play in implementing investment strategies * An integrative case study in portfolio management involving a university endowment To further enhance your understanding of tools and techniques explored in Asset Allocation, don't forget to pick up the Portfolio Management in Practice, Volume 2: Asset Allocation Workbook. The workbook is the perfect companion resource containing learning outcomes, summary overview sections, and challenging practice questions that align chapter-by-chapter with the main text.

Leseprobe

CFA Institute is the premier association for investment professionals around the world, with over 170,000 members more than 160 countries. Since 1963 the organization has developed and administered the renowned Chartered Financial Analyst Program. With a rich history of leading the investment profession, CFA Institute has set the highest standards in ethics, education, and professional excellence within the global investment community, and is the foremost authority on investment profession conduct and practice.

Each book in the CFA Institute Investment Series is geared toward industry practitioners along with graduate-level finance students and covers the most important topics in the industry. The authors of these cutting-edge books are themselves industry professionals and academics and bring their wealth of knowledge and expertise to this series.

PORTFOLIO MANAGEMENT IN PRACTICE

Volume 2

Asset Allocation

Cover image: © r.nagy/Shutterstock

Cover design: Wiley

Copyright © 2004, 2007, 2015, 2021 by CFA Institute. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, [phone], fax [phone], or on the Web at www.copyright.com. Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, [phone], fax [phone], or online at http://www.wiley.com/go/permissions.

Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose. No warranty may be created or extended by sales representatives or written sales materials. The advice and strategies contained herein may not be suitable for your situation. You should consult with a professional where appropriate. Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages.

For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at [phone], outside the United States at [phone], or fax [phone].

Wiley publishes in a variety of print and electronic formats and by print-on-demand. Some material included with standard print versions of this book may not be included in e-books or in print-on-demand. If this book refers to media such as a CD or DVD that is not included in the version you purchased, you may download this material at http://booksupport.wiley.com. For more information about Wiley products, visit www.wiley.com.

ISBN 978-1-119-78796-9 (Hardcover)

ISBN 978-1-119-78798-3 (ePDF)

ISBN 978-1-119-78797-6 (ePub)

CONTENTS

Cover

Title Page

Copyright

PREFACE

ACKNOWLEDGMENTS

ABOUT THE CFA INSTITUTE INVESTMENT SERIES

CHAPTER 1: BASICS OF PORTFOLIO PLANNING AND CONSTRUCTION

LEARNING OUTCOMES

1. INTRODUCTION

2. PORTFOLIO PLANNING

3. PORTFOLIO CONSTRUCTION

4. CONCLUSION AND SUMMARY

REFERENCES

PRACTICE PROBLEMS

CHAPTER 2: SECURITY MARKET INDEXES

LEARNING OUTCOMES

1. INTRODUCTION

2. INDEX DEFINITION AND CALCULATIONS OF VALUE AND RETURNS

3. INDEX CONSTRUCTION AND MANAGEMENT

4. USES OF MARKET INDEXES

5. EQUITY INDEXES

6. FIXED-INCOME INDEXES

7. INDEXES FOR ALTERNATIVE INVESTMENTS

8. SUMMARY

PRACTICE PROBLEMS

CHAPTER 3: CAPITAL MARKET EXPECTATIONS, PART 1: FRAMEWORK AND MACRO CONSIDERATIONS

LEARNING OUTCOMES

1. INTRODUCTION

2. FRAMEWORK AND CHALLENGES

3. ECONOMIC AND MARKET ANALYSIS

4. SUMMARY

REFERENCES

PRACTICE PROBLEMS

CHAPTER 4: CAPITAL MARKET EXPECTATIONS, PART 2: FORECASTING ASSET CLASS RETURNS

LEARNING OUTCOMES

1. INTRODUCTION

2. OVERVIEW OF TOOLS AND APPROACHES

3. FORECASTING FIXED-INCOME RETURNS

4. FORECASTING EQUITY RETURNS

5. FORECASTING REAL ESTATE RETURNS

6. FORECASTING EXCHANGE RATES

7. FORECASTING VOLATILITY

8. ADJUSTING A GLOBAL PORTFOLIO

9. SUMMARY

REFERENCES

PRACTICE PROBLEMS

CHAPTER 5: OVERVIEW OF ASSET ALLOCATION

LEARNING OUTCOMES

1. INTRODUCTION

2. ASSET ALLOCATION: IMPORTANCE IN INVESTMENT MANAGEMENT

3. THE INVESTMENT GOVERNANCE BACKGROUND TO ASSET ALLOCATION

4. THE ECONOMIC BALANCE SHEET AND ASSET ALLOCATION

5. APPROACHES TO ASSET ALLOCATION

6. STRATEGIC ASSET ALLOCATION

7. IMPLEMENTATION CHOICES

8. REBALANCING: STRATEGIC CONSIDERATIONS

9. SUMMARY

REFERENCES

PRACTICE PROBLEMS

CHAPTER 6: PRINCIPLES OF ASSET ALLOCATION

LEARNING OUTCOMES

1. INTRODUCTION

2. DEVELOPING ASSET-ONLY ASSET ALLOCATIONS

3. DEVELOPING LIABILITY-RELATIVE ASSET ALLOCATIONS

4. DEVELOPING GOALS-BASED ASSET ALLOCATIONS

5. HEURISTICS AND OTHER APPROACHES TO ASSET ALLOCATION

6. PORTFOLIO REBALANCING IN PRACTICE

7. CONCLUSIONS

REFERENCES

PRACTICE PROBLEMS

CHAPTER 7: ASSET ALLOCATION WITH REAL-WORLD CONSTRAINTS

LEARNING OUTCOMES

1. INTRODUCTION

2. CONSTRAINTS IN ASSET ALLOCATION

3. ASSET ALLOCATION FOR THE TAXABLE INVESTOR

4. REVISING THE STRATEGIC ASSET ALLOCATION

5. SHORT-TERM SHIFTS IN ASSET ALLOCATION

6. DEALING WITH BEHAVIORAL BIASES IN ASSET ALLOCATION

7. SUMMARY

REFERENCES

PRACTICE PROBLEMS

CHAPTER 8: ASSET ALLOCATION TO ALTERNATIVE INVESTMENTS

LEARNING OUTCOMES

1. INTRODUCTION

2. THE ROLE OF ALTERNATIVE INVESTMENTS IN A MULTI-ASSET PORTFOLIO

3. DIVERSIFYING EQUITY RISK

4. PERSPECTIVES ON THE INVESTMENT OPPORTUNITY SET

5. INVESTMENT CONSIDERATIONS RELEVANT TO THE DECISION TO INVEST IN ALTERNATIVES

6. SUITABILITY CONSIDERATIONS

7. ASSET ALLOCATION APPROACHES

8. LIQUIDITY PLANNING

9. MONITORING THE INVESTMENT PROGRAM

10. SUMMARY

REFERENCES

PRACTICE PROBLEMS

CHAPTER 9: EXCHANGE-TRADED FUNDS: MECHANICS AND APPLICATIONS

LEARNING OUTCOMES

1. INTRODUCTION

2. ETF MECHANICS

3. UNDERSTANDING ETFS

4. ETFS IN PORTFOLIO MANAGEMENT

5. SUMMARY

PRACTICE PROBLEMS

CHAPTER 10: CASE STUDY IN PORTFOLIO MANAGEMENT: INSTITUTIONAL

LEARNING OUTCOMES

1. INTRODUCTION

2. BACKGROUND: LIQUIDITY MANAGEMENT

3. QUINCO CASE

4. SUMMARY

REFERENCES

PRACTICE PROBLEMS

GLOSSARY

ABOUT THE AUTHORS

ABOUT THE CFA PROGRAM

INDEX

END USER LICENSE AGREEMENT

Guide

Cover

Table of Contents

Series Page

Title Page

Copyright

Preface

Acknowledgments

About the CFA Institute Investment Series

Begin Reading

Glossary

About the Authors

About the CFA Program

Index

End User License Agreement

Pages

i

ii

iii

iv

xiii

xiv

xv

xvi

xvii

xviii

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30

31

32

33

34

35

36

37

38

39

40

41

42

43

44

45

46

47

48

49

50

51

52

53

54

55

56

57

58

59

60

61

62

63

64

65

66

67

68

69

70

71

72

73

74

75

76

77

78

79

80

81

82

83

84

85

86

87

88

89

90

91

92

93

94

95

96

97

98

99

100

101

102

103

104

105

106

107

108

109

110

111

112

113

114

115

116

117

118

119

120

121

122

123

124

125

126

127

128

129

130

131

132

133

134

135

136

137

138

139

140

141

142

143

144

145

146

147

148

149

150

151

152

153

154

155

156

157

158

159

160

161

162

163

164

165

166

167

168

169

170

171

172

173

174

175

176

177

178

179

180

181

182

183

184

185

186

187

188

189

190

191

192

193

194

195

196

197

198

199

200

201

202

203

204

205

206

207

208

209

210

211

212

213

214

215

216

217

218

219

220

221

222

223

224

225

226

227

228

229

230

231

232

233

234

235

236

237

238

239

240

241

242

243

244

245

246

247

248

249

250

251

252

253

254

255

256

257

258

259

260

261

262

263

264

265

266

267

268

269

270

271

272

273

274

275

276

277

278

279

280

281

282

283

284

285

286

287

288

289

290

291

292

293

294

295

296

297

298

299

300

301

302

303

304

305

306

307

308

309

310

311

312

313

314

315

316

317

318

319

320

321

322

323

324

325

326

327

328

329

330

331

332

333

334

335

336

337

338

339

340

341

342

343

344

345

346

347

348

349

350

351

352

353

354

355

356

357

358

359

360

361

362

363

364

365

366

367

368

369

370

371

372

373

374

375

376

377

378

379

380

381

382

383

384

385

386

387

388

389

390

391

392

393

394

395

396

397

398

399

400

401

402

403

404

405

406

407

408

409

410

411

412

413

414

415

416

417

418

419

420

421

422

423

424

425

426

427

428

429

430

431

432

433

434

435

436

437

438

439

440

441

442

443

444

445

446

447

448

449

450

451

452

453

454

455

456

457

458

459

460

461

462

463

464

465

466

467

468

469

470

471

472

473

474

475

476

477

478

479

480

481

482

483

484

485

486

487

488

489

490

491

492

493

494

495

496

497

498

499

500

501

502

503

504

505

506

507

508

509

510

511

512

513

514

515

516

517

518

519

520

521

522

523

524

525

526

527

528

529

530

531

532

533

534

535

536

537

538

539

540

541

542

543

544

545

546

547

548

549

550

551

552

553

554

555

556

557

558

559

560

561

562

563

564

565

566

567

568

569

570

571

572

573

574

575

576

577

578

579

580

581

582

583

584

585

586

587

588

589

590

591

592

593

594

595

596

597

598

599

600

601

602

603

604

605

606

607

608

PREFACE

We are pleased to bring you Asset Allocation, Volume 2 of Portfolio Management in Practice. This series of three volumes serves as a particularly important resource for investment professionals who recognize that portfolio management is an integrated set of activities. The topic coverage in the three volumes is organized according to a well-articulated portfolio management decision-making process. This organizing principle— in addition to the breadth of coverage, the currency and quality of content, and its meticulous pedagogy—distinguishes the three volumes in Portfolio Management in Practice from other investment texts that deal with portfolio management.

The content was developed in partnership by a team of distinguished academics and practitioners, chosen for their acknowledged expertise in the field, and guided by CFA Institute. It is written specifically with the investment practitioner in mind and is replete with examples and practice problems that reinforce the learning outcomes and demonstrate real-world applicability.

The CFA Program curriculum, from which the content of this book was drawn, is subjected to a rigorous review process to assure that it is:

faithful to the findings of our ongoing industry practice analysis

Valuable to members, employers, and investors

Globally relevant

Generalist (as opposed to specialist) in nature

replete with sufficient examples and practice opportunities

Pedagogically sound

The accompanying workbook is a useful reference that provides Learning Outcome Statements, which describe exactly what readers will learn and be able to demonstrate after mastering the accompanying material. additionally, the workbook has summary overviews and practice problems for each chapter.

We hope you will find this and other books in the CFA Institute Investment Series helpful in your efforts to grow your investment knowledge, whether you are a relatively new entrant or an experienced veteran striving to keep up to date in the ever-changing market environment. CFA Institute, as a long-term committed participant in the investment profession and a not- for-profit global membership association, is pleased to provide you with this opportunity.

ACKNOWLEDGMENTS

Special thanks to all the reviewers, advisors, and question writers who helped to ensure high practical relevance, technical correctness, and understandability of the material presented here.

We would like to thank the many others who played a role in the conception and production of this book: the Curriculum and Learning Experience team at CFA Institute with special thanks to the curriculum directors, past and present, who worked with the authors and reviewers to produce the chapters in this book, the Practice Analysis team at CFA Institute, and the Publishing and Technology team for bringing this book to production.

ABOUT THE CFA INSTITUTE INVESTMENT SERIES

CFA Institute is pleased to provide the CFA Institute Investment Series, which covers major areas in the field of investments. We provide this best-in-class series for the same reason we have been chartering investment professionals for more than 45 years: to lead the investment profession globally by setting the highest standards of ethics, education, and professional excellence.

The books in the CFA Institute Investment Series contain practical, globally relevant material. They are intended both for those contemplating entry into the extremely competitive field of investment management as well as for those seeking a means of keeping their knowledge fresh and up to date. This series was designed to be user friendly and highly relevant.

We hope you find this series helpful in your efforts to grow your investment knowledge, whether you are a relatively new entrant or an experienced veteran ethically bound to keep up to date in the ever-changing market environment. As a long-term, committed participant in the investment profession and a not-for-profit global membership association, CFA Institute is pleased to provide you with this opportunity.

THE TEXTS

Corporate Finance: A Practical Approach is a solid foundation for those looking to achieve lasting business growth. In today’s competitive business environment, companies must find innovative ways to enable rapid and sustainable growth. This text equips readers with the foundational knowledge and tools for making smart business decisions and formulating strategies to maximize company value. It covers everything from managing relationships between stakeholders to evaluating merger and acquisition bids, as well as the companies behind them. Through extensive use of real-world examples, readers will gain critical perspective into interpreting corporate financial data, evaluating projects, and allocating funds in ways that increase corporate value. Readers will gain insights into the tools and strategies used in modern corporate financial management.

Equity Asset Valuation is a particularly cogent and important resource for anyone involved in estimating the value of securities and understanding security pricing. A well-informed professional knows that the common forms of equity valuation—dividend discount modeling, free cash flow modeling, price/earnings modeling, and residual income modeling—can all be reconciled with one another under certain assumptions. With a deep understanding of the underlying assumptions, the professional investor can better understand what other investors assume when calculating their valuation estimates. This text has a global orientation, including emerging markets.

Fixed Income Analysis has been at the forefront of new concepts in recent years, and this particular text offers some of the most recent material for the seasoned professional who is not a fixed-income specialist. The application of option and derivative technology to the once staid province of fixed income has helped contribute to an explosion of thought in this area. Professionals have been challenged to stay up to speed with credit derivatives, swaptions, collateralized mortgage securities, mortgage-backed securities, and other vehicles, and this explosion of products has strained the world’s financial markets and tested central banks to provide sufficient oversight. Armed with a thorough grasp of the new exposures, the professional investor is much better able to anticipate and understand the challenges our central bankers and markets face.

International Financial Statement Analysis is designed to address the ever-increasing need for investment professionals and students to think about financial statement analysis from a global perspective. The text is a practically oriented introduction to financial statement analysis that is distinguished by its combination of a true international orientation, a structured presentation style, and abundant illustrations and tools covering concepts as they are introduced in the text. The authors cover this discipline comprehensively and with an eye to ensuring the reader’s success at all levels in the complex world of financial statement analysis.

Investments: Principles of Portfolio and Equity Analysis provides an accessible yet rigorous introduction to portfolio and equity analysis. Portfolio planning and portfolio management are presented within a context of up-to-date, global coverage of security markets, trading, and market-related concepts and products. The essentials of equity analysis and valuation are explained in detail and profusely illustrated. The book includes coverage of practitioner- important but often neglected topics, such as industry analysis. Throughout, the focus is on the practical application of key concepts with examples drawn from both emerging and developed markets. Each chapter affords the reader many opportunities to self-check his or her understanding of topics.

All books in the CFA Institute Investment Series are available through all major booksellers. And, all titles are available on the Wiley Custom Select platform at http://customselect.wiley.com/ where individual chapters for all the books may be mixed and matched to create custom textbooks for the classroom.

CHAPTER 1BASICS OF PORTFOLIO PLANNING AND CONSTRUCTION

Alistair Byrne, PhD, CFA

Frank E. Smudde, MSc, CFA

LEARNING OUTCOMES

The candidate should be able to:

describe the reasons for a written investment policy statement (IPS);

describe the major components of an IPS;

describe risk and return objectives and how they may be developed for a client;

distinguish between the willingness and the ability (capacity) to take risk in analyzing an investor’s financial risk tolerance;

describe the investment constraints of liquidity, time horizon, tax concerns, legal and regulatory factors, and unique circumstances and their implications for the choice of portfolio assets;

explain the specification of asset classes in relation to asset allocation;

describe the principles of portfolio construction and the role of asset allocation in relation to the IPS;

describe how environmental, social, and governance (ESG) considerations may be integrated into portfolio planning and construction.

1. INTRODUCTION

To build a suitable portfolio for a client, investment advisers should first seek to understand the client’s investment goals, resources, circumstances, and constraints. Investors can be categorized into broad groups based on shared characteristics with respect to these factors (e.g., various types of individual investors and institutional investors). Even investors within a given type, however, will invariably have a number of distinctive requirements. In this chapter, we consider in detail the planning for investment success based on an individualized understanding of the client.

This chapter is organized as follows: Section 2 discusses the investment policy statement, a written document that captures the client’s investment objectives and the constraints. Section 3 discusses the portfolio construction process, including the first step of specifying a strategic asset allocation for the client. Section 4 concludes and summarizes the chapter.

2. PORTFOLIO PLANNING

Portfolio planning can be defined as a program developed in advance of constructing a portfolio that is expected to define the client’s investment objectives. The written document governing this process is the investment policy statement (IPS). The IPS is sometimes complemented by a document outlining policy on sustainable investing—distinguishing between companies (or sectors) that either can or cannot efficiently manage their financial, environmental, and human capital resources to generate attractive long-term profitability.1 Policies on sustainable investing may also be integrated within the IPS itself. In the remainder of this chapter, the integration of sustainable investing within the IPS will be our working assumption.

2.1. The Investment Policy Statement

The IPS is the starting point of the portfolio management process. Without a full understanding of the client’s situation and requirements, it is unlikely that successful results will be achieved. “Success” can be defined as a client achieving his or her important investment goals using means that he or she is comfortable with (in terms of risks taken and other concerns). The IPS essentially communicates a plan for achieving investment success.

The IPS is typically developed following a fact-finding discussion with the client. This fact-finding discussion can include the use of a questionnaire designed to articulate the client’s risk tolerance as well as specific circumstances. In the case of institutional clients, the fact finding may involve asset–liability management studies, identification of liquidity needs, and a wide range of tax and legal considerations.

The IPS can take a variety of forms.2 A typical format will include the client’s investment objectives and the constraints that apply to the client’s portfolio.

The client’s objectives are specified in terms of risk tolerance and return requirements. These must be consistent with each other: a client is unlikely to be able to find a portfolio that offers a relatively high expected return without taking on a relatively high level of expected risk. As part of their financial planning, clients may specify specific spending goals, each of which could have different risk tolerance and return objectives.

The constraints section covers factors that need to be taken into account when constructing a portfolio for the client that meets the objectives. The typical categories are liquidity requirements, time horizon, regulatory requirements, tax status, and unique needs. The constraints may be internal (i.e., set by the client), or external (i.e., set by law or regulation). These are discussed in detail below.

Having a well-constructed IPS for all clients should be standard procedure for an investment manager. The investment manager should build the portfolio with reference to the IPS and be able to refer to it to assess the suitability of a particular investment for the client. In some cases, the need for the IPS goes beyond simply being a matter of standard procedure. In some countries, the IPS (or an equivalent document) is a legal or regulatory requirement. For example, UK pension schemes must have a statement of investment principles under the Pensions Act 1995 (Section 35), and this statement is in essence an IPS. The UK Financial Services Authority also has requirements for investment firms to “know their customers.” The European Union’s Markets in Financial Instruments Directive (“MiFID”) requires firms to assign clients to categories, such as eligible counterparties, institutional clients, and retail clients.

In the case of an institution, such as a pension plan or university endowment, the IPS may set out the governance arrangements that apply to the investment funds. For example, this information could cover the investment committee’s approach to appointing and reviewing investment managers for the portfolio, and the discretion that those managers have.

The IPS should be reviewed on a regular basis to ensure that it remains consistent with the client’s circumstances and requirements. For example, the UK Pensions Regulator suggests that a pension scheme’s statements of investment principles—a form of IPS—should be reviewed at least every three years. The IPS should also be reviewed if the manager becomes aware of a material change in the client’s circumstances, or on the initiative of the client when his or her objectives, time horizon, or liquidity needs change.

2.2. Major Components of an IPS

There is no single standard format for an IPS. Many IPS and investment governance documents with a similar purpose (as noted previously), however, include the following sections:

Introduction

. This section describes the client.

Statement of Purpose

. This section states the purpose of the IPS.

Statement of Duties and Responsibilities

. This section details the duties and responsibilities of the client, the custodian of the client’s assets, and the investment managers.

Procedures

. This section explains the steps to take to keep the IPS current and the procedures to follow to respond to various contingencies.

Investment Objectives

. This section explains the client’s objectives in investing.

Investment Constraints

. This section presents the factors that constrain the client in seeking to achieve the investment objectives.

Investment Guidelines

. This section provides information about how policy should be executed (e.g., on the permissible use of leverage and derivatives) and on specific types of assets excluded from investment, if any.

Evaluation and Review

. This section provides guidance on obtaining feedback on investment results.

Appendices

: (A) Strategic Asset Allocation (B) Rebalancing Policy. Many investors specify a strategic asset allocation (SAA), also known as the policy portfolio, which is the baseline allocation of portfolio assets to asset classes in view of the investor’s investment objectives and the investor’s policy with respect to rebalancing asset class weights. This SAA may include a statement of policy concerning hedging risks such as currency risk and interest rate risk.

The sections that are most closely linked to the client’s distinctive needs, and probably the most important from a planning perspective, are those dealing with investment objectives and constraints. An IPS focusing on these two elements has been called an IPS in an “objectives and constraints” format.

In the following sections, we discuss the investment objectives and constraints format of an IPS beginning with risk and return objectives. The process of developing the IPS is the basic mechanism for evaluating and trying to improve an investor’s overall expected return–risk stance. In a portfolio context, return objectives and expectations must be tailored to be consistent with risk objectives. The risk and return objectives must also be consistent with the constraints that apply to the portfolio. In recent years, a large proportion of investors explicitly included non-financial considerations when formulating their investment policies. This is often referred to as sustainable investing (which we discussed earlier, as well as related terms) whereby environmental, social, and governance (ESG) considerations are reflected. Sustainable investing both recognizes that ESG considerations may eventually affect the financial risk-return profile of the portfolio and expresses societal convictions of the investor. In a survey by CFA Institute,3 73% of respondents indicated they take ESG factors in consideration in their investment decisions on behalf of their clients. In this chapter, we discuss sustainable investing aspects of investment policy, where relevant.

2.2.1. Risk Objectives

When constructing a portfolio for a client, it is important to ensure that the risk of the portfolio is suitable for the client. The IPS should state clearly the risk tolerance of the client. Risk objectives are specifications for portfolio risk that reflect the risk tolerance of the client. Quantitative risk objectives can be absolute or relative or a combination of the two.

Examples of an absolute risk objective would be a desire not to suffer any loss of capital or not to lose more than a given percent of capital in any 12-month period. Note that these objectives are not related to investment market performance, good or bad, and are absolute in the sense of being self-standing. The fulfillment of such objectives could be achieved by not taking any risk; for example, by investing in an insured bank certificate of deposit at a creditworthy bank. If investments in risky assets are undertaken, however, such statements would need to be restated as a probability statement to be operational (i.e., practically useful). For example, the desire not to lose more than 4 percent of capital in any 12-month period might be restated as an objective that with 95 percent probability the portfolio not lose more than 4 percent in any 12-month period. Measures of absolute risk include the variance or standard deviation of returns and value at risk.4

Some clients may choose to express relative risk objectives, which relate risk relative to one or more benchmarks perceived to represent appropriate risk standards. For example, investments in large-cap UK equities could be benchmarked to an equity market index, such as the FTSE 100 Index. The S&P 500 Index could be used as a benchmark for large-cap US equities, or for investments with cash-like characteristics, the benchmark could be an interest rate such as Libor or a Treasury bill rate. For risk relative to a benchmark, the measure could be tracking risk, or tracking error.5 In practice, such risk objectives are used in situations where the total wealth management activities on behalf of a client are divided into partial mandates.

For institutional clients, the benchmark may be linked to some form of liability the institution has. For example, a pension plan must meet the pension payments as they come due and the risk objective will be to minimize the probability that it will fail to do so. A related return objective might be to outperform the discount rate used in finding the present value of liabilities over a multi-year time horizon.

When a policy portfolio (that is, a specified set of long-term asset class weightings and hedge ratios) is used, the risk objective may be expressed as a desire for the portfolio return to be within a band of plus or minus X percent of the benchmark return calculated by assigning an index or benchmark to represent each asset class present in the policy portfolio. Again, this objective has to be interpreted as a statement of probability; for example, a 95 percent probability that the portfolio return will be within X percent of the benchmark return over a stated time period. Example 1 reviews this material.

EXAMPLE 1

Types of Risk Objectives

A Japanese institutional investor has a portfolio valued at ¥10 billion. The investor expresses his first risk objective as a desire not to lose more than ¥1 billion in the coming 12-month period. The investor specifies a second risk objective of achieving returns within 4 percent of the return to the TOPIX stock market index, which is the investor’s benchmark. Based on this information, address the following:

Characterize the first risk objective as absolute or relative.

Give an example of how the risk objective could be restated in a practical manner.

Characterize the second risk objective as absolute or relative.

Identify a measure for quantifying the risk objective.

Solutions:

This is an absolute risk objective.

This risk objective could be restated in a practical manner by specifying that the 12-month 95 percent value at risk of the portfolio must not be more than ¥1 billion.

This is a relative risk objective.

This risk objective could be quantified using the tracking risk as a measure. For example, assuming returns follow a normal distribution, an expected tracking risk of 2 percent would imply a return within 4 percent of the index return approximately 95 percent of the time. Remember that tracking risk is stated as a one standard deviation measure.

A client’s overall risk tolerance is a function of the client’s ability to bear (accept) risk and his or her “risk attitude,” which might be considered as the client’s willingness to take risk. For ease of expression, from this point on we will refer to ability to bear risk and willingness to take risk as the two components of risk tolerance. Above average ability to bear risk and above average willingness to take risk imply above average risk tolerance. Below average ability to bear risk and below average willingness to take risk imply below average risk tolerance. These interactions are shown in Exhibit 1.

EXHIBIT 1. Risk Tolerance

Ability to Bear Risk

Willingness to Take Risk

Below Average

Above Average

Below Average

Below-average risk tolerance

Resolution needed

Above Average

Resolution needed

Above-average risk tolerance

The ability to bear risk is measured mainly in terms of objective factors, such as time horizon, expected income, and the level of wealth relative to liabilities. For example, an investor with a 20-year time horizon can be considered to have a greater ability to bear risk, other things being equal, than an investor with a 2-year horizon. This difference is because over 20 years there is more scope for losses to be recovered or other adjustments to circumstances to be made than there is over two years.

Similarly, an investor whose assets are comfortably in excess of their liabilities has more ability to bear risk than an investor whose wealth and expected future expenditure are more closely balanced. For example, a wealthy individual who can sustain a comfortable lifestyle after a very substantial investment loss has a relatively high ability to bear risk. A pension plan that has a large surplus of assets over liabilities has a relatively high ability to bear risk.

The willingness to take risk, or risk attitude, is a more subjective factor based on the client’s psychology and perhaps also his or her current circumstances. Although the list of factors that are related to an individual’s risk attitude remains open to debate, it is believed that some psychological factors, such as personality type, self-esteem, and inclination to independent thinking, are correlated with risk attitude. Some individuals are comfortable taking financial and investment risk, whereas others find it distressing. Although there is no single agreed-upon method for measuring risk tolerance, a willingness to take risk may be gauged by discussing risk with the client or by asking the client to complete a psychometric questionnaire. For example, financial planning academic John Grable and collaborators have developed 13-item and 5-item risk attitude questionnaires that have undergone some level of technical validation. The five-item questionnaire is shown in Exhibit 2.

EXHIBIT 2.

A Five-Item Risk Assessment Instrument

Investing is too difficult to understand.

Strongly agree

Tend to agree

Tend to disagree

Strongly disagree

I am more comfortable putting my money in a bank account than in the stock market.

Strongly agree

Tend to agree

Tend to disagree

Strongly disagree

When I think of the word “risk” the term “loss” comes to mind immediately.

Strongly agree

Tend to agree

Tend to disagree

Strongly disagree

Making money in stocks and bonds is based on luck.

Strongly agree

Tend to agree

Tend to disagree

Strongly disagree

In terms of investing, safety is more important than returns.

Strongly agree

Tend to agree

Tend to disagree

Strongly disagree

Source: Grable and Joo (2004).

The responses, a), b), c), and d), are coded 1, 2, 3, and 4, respectively, and summed. The lowest score is 5 and the highest score is 20, with higher scores indicating greater risk tolerance. For two random samples drawn from the faculty and staff of large US universities (n = 406), the mean score was 12.86 with a standard deviation of 3.01 and a median (i.e., most frequently observed) score of 13.

Note that a question, such as the first one in Exhibit 2, indicates that risk attitude may be associated with non-psychological factors (such as level of financial knowledge and understanding and decision-making style) as well as psychological factors.

The adviser needs to examine whether a client’s ability to accept risk is consistent with the client’s willingness to take risk. For example, a wealthy investor with a 20-year time horizon, who is thus able to take risk, may also be comfortable taking risk; in this case the factors are consistent. If the wealthy investor has a low willingness to take risk, there would be a conflict.

In the institutional context, there could also be conflict between ability and willingness to take risk. In addition, different stakeholders within the institution may take different views. For example, the trustees of a well-funded pension plan may desire a low-risk approach to safeguard the funding of the scheme and beneficiaries of the scheme may take a similar view. The sponsor, however, may wish a higher-risk/higher-return approach in an attempt to reduce future funding costs. When a trustee bears a fiduciary responsibility to pension beneficiaries and the interests of the pension sponsor and the pension beneficiaries conflict, the trustee should act in the best interests of the beneficiaries.

When ability to take risk and willingness to take risk are consistent, the investment adviser’s task is the simplest. When ability to take risk is below average and willingness to take risk is above average, the investor’s risk tolerance should be assessed as below average overall. When ability to take risk is above average but willingness is below average, the portfolio manager or adviser may seek to counsel the client and explain the conflict and its implications. For example, the adviser could outline the reasons why the client is considered to have a high ability to take risk and explain the likely consequences, in terms of reduced expected return, of not taking risk. The investment adviser, however, should not aim to change a client’s willingness to take risk that is not a result of a miscalculation or misperception. Modification of elements of personality is not within the purview of the investment adviser’s role. The prudent approach is to reach a conclusion about risk tolerance consistent with the lower of the two factors (ability and willingness) and to document the decisions made.

Example 2 is the first of a set that follows the analysis of an investment client through the preparation of the major elements of an IPS.

EXAMPLE 2

The Case of Henri Gascon: Risk Tolerance

Henri Gascon is an energy trader who works for a major French oil company based in Paris. He is 30 years old and married with one son, aged 5. Gascon has decided that it is time to review his financial situation and consults a financial adviser. The financial adviser notes the following aspects of Gascon’s situation:

Gascon’s annual salary of €250,000 is more than sufficient to cover the family’s outgoings.

Gascon owns his apartment outright and has €1,000,000 of savings.

Gascon perceives that his job is reasonably secure.

Gascon has a good knowledge of financial matters and is confident that equity markets will deliver positive returns over the longer term.

In the risk tolerance questionnaire, Gascon strongly disagrees with the statements that “making money in stocks and bonds is based on luck” and that “in terms of investing, safety is more important than returns.”

Gascon expects that most of his savings will be used to fund his retirement, which he hopes to start at age 50.

Based only on the information given, which of the following statements is most accurate?

Gascon has a low ability to take risk, but a high willingness to take risk.

Gascon has a high ability to take risk, but a low willingness to take risk.

Gascon has a high ability to take risk, and a high willingness to take risk.

Solution: C is correct. Gascon has a high income relative to outgoings, a high level of assets, a secure job, and a time horizon of 20 years. This information suggests a high ability to take risk. At the same time, Gascon is knowledgeable and confident about financial markets and responds to the questionnaire with answers that suggest risk tolerance. This result suggests he also has a high willingness to take risk.

EXAMPLE 3

The Case of Jacques Gascon: Risk Tolerance

Henri Gascon is so pleased with the services provided by the financial adviser, that he suggests to his brother Jacques that he should also consult the adviser. Jacques thinks it is a good idea. Jacques is a self-employed computer consultant also based in Paris. He is 40 years old and divorced with four children, aged between 12 and 16. The financial adviser notes the following aspects of Jacques’ situation:

Jacques’ consultancy earnings average €40,000 per annum, but are quite volatile.

Jacques is required to pay €10,000 per year to his ex-wife and children.

Jacques has a mortgage on his apartment of €100,000 and €10,000 of savings.

Jacques has a good knowledge of financial matters and expects that equity markets will deliver very high returns over the longer term.

In the risk tolerance questionnaire, Jacques strongly disagrees with the statements “I am more comfortable putting my money in a bank account than in the stock market” and “When I think of the word “risk” the term “loss” comes to mind immediately.”

Jacques expects that most of his savings will be required to support his children at university.

Based on the above information, which statement is correct?

Jacques has a low ability to take risk, but a high willingness to take risk.

Jacques has a high ability to take risk, but a low willingness to take risk.

Jacques has a high ability to take risk, and a high willingness to take risk.

Solution: A is correct. Jacques does not have a particularly high income, his income is unstable, and he has reasonably high outgoings for his mortgage and maintenance payments. His investment time horizon is approximately two to six years given the ages of his children and his desire to support them at university. This finely balanced financial situation and short time horizon suggests a low ability to take risk. In contrast, his expectations for financial market returns and risk tolerance questionnaire answers suggest a high willingness to take risk. The financial adviser may wish to explain to Jacques how finely balanced his financial situation is and suggest that, despite his desire to take more risk, a relatively cautious portfolio might be the most appropriate approach to take.

2.2.2. Return Objectives

A client’s return objectives can be stated in a number of ways. Similar to risk objectives, return objectives may be stated on an absolute or a relative basis.

As an example of an absolute objective, the client may want to achieve a particular percentage rate of return, for example, X percent. This could be a nominal rate of return or be expressed in real (inflation-adjusted) terms.

Alternatively, the return objective can be stated on a relative basis, for example, relative to a benchmark return. The benchmark could be an equity market index, such as the S&P 500 or the FTSE 100, or a cash rate of interest such as Libor. A relative return objective might be stated as, for example, a desire to outperform the benchmark index by one percentage point per year.

Some institutions also set their return objective relative to a peer group or universe of managers; for example, an endowment aiming for a return that is in the top 50 percent of returns of similar institutions, or a private equity mandate aiming for returns in the top quartile among the private equity universe. This objective can be problematic when limited information is known about the investment strategies or the returns calculation methodology being used by peers, and we must bear in mind the impossibility of all institutions being “above average.” Furthermore, a good benchmark should be investable—that is, able to be replicated by the investor—and a peer benchmark typically does not meet that criterion.

In each case, the return requirement can be stated before or after fees. Care should be taken that the fee basis used is clear and understood by both the manager and client. The return can also be stated on either a pre- or post-tax basis when the investor is required to pay tax. For a taxable investor, the baseline is to state and analyze returns on an after-tax basis.

The return objective could be a required return—that is, the amount the investor needs to earn to meet a particular future goal—such as a certain level of retirement income.

The manager or adviser must ensure that the return objective is realistic. Care should be taken that client and manager are in agreement on whether the return objective is nominal (which is more convenient for measurement purposes) or real (i.e., inflation-adjusted, which usually relates better to the objective). It must be consistent with the client’s risk objective (high expected returns are unlikely to be possible without high levels of risk) and also with the current economic and market environment. For example, 15 percent nominal returns might be possible when inflation is 10 percent, but will be unlikely when inflation is 3 percent.

When a client has unrealistic return expectations, the manager or adviser will need to counsel them about what is achievable in the current market environment and within the client’s tolerance for risk.

EXAMPLE 4

The Case of Henri Gascon: Return Objectives

Having assessed his risk tolerance, Henri Gascon now begins to discuss his retirement income needs with the financial adviser. He wishes to retire at age 50, which is 20 years from now. His salary meets current and expected future expenditure requirements, but he does not expect to be able to make any additional pension contributions to his fund. Gascon sets aside €100,000 of his savings as an emergency fund to be held in cash. The remaining €900,000 is invested for his retirement.

Gascon estimates that a before-tax amount of €2,000,000 in today’s money will be sufficient to fund his retirement income needs. The financial adviser expects inflation to average 2 percent per year over the next 20 years. Pension fund contributions and pension fund returns in France are exempt from tax, but pension fund distributions are taxable upon retirement.

Which of the following is closest to the amount of money Gascon will have to accumulate in nominal terms by his retirement date to meet his retirement income objective (i.e., expressed in money of the day in 20 years)?

€900,000

€2,000,000

€3,000,000

Which of the following is closest to the annual rate of return that Gascon must earn on his pension portfolio to meet his retirement income objective?

2.0%

6.2%

8.1%

Solution to 1. C is correct. At 2 percent annual inflation, €2,000,000 in today’s money equates to €2,971,895 in 20 years measured in money of the day [2m × (1 + 2%)20].

Solution to 2. B is correct. €900,000 growing at 6.2 percent per year for 20 years will accumulate to €2,997,318, which is just above the required amount. (The solution of 6.2 percent comes from €2,997,318/€900,000 = (1 + X)20, where X is the required rate of return.)

In the following sections, we analyze five major types of constraints on portfolio selection: liquidity, time horizon, tax concerns, legal and regulatory factors, and unique circumstances.

2.2.3. Liquidity Requirements

The IPS should state what the likely requirements are to withdraw funds from the portfolio. Examples for an individual investor would be outlays for covering health care payments or tuition fees. For institutions, it could be spending rules and requirements for endowment funds, the existence of claims coming due in the case of property and casualty insurance, or benefit payments for pension funds and life insurance companies.

When the client does have such a requirement, the manager should allocate part of the portfolio to cover the liability. This part of the portfolio will be invested in assets that are liquid—that is, easily converted to cash—and have low risk when the liquidity need is actually present (e.g., a bond maturing at the time when private education expenses will be incurred), so that their value is known with reasonable certainty. For example, the asset allocation in the insurance portfolios of US insurer Progressive Corporation (see Exhibit 3) shows a large allocation to fixed-income investments (called “Fixed maturities” by the company), some of which are either highly liquid or have a short maturity. These investments enable the company, in the case of automobile insurance, to pay claims for which the timing is unpredictable.

EXHIBIT 3. Asset Allocation of Progressive Corporation

Source: Progressive Corporation, 2018 Second Quarter Report.

2.2.4. Time Horizon

The IPS should state the time horizon over which the investor is investing. It may be the period over which the portfolio is accumulating before any assets need to be withdrawn; it could also be the period until the client’s circumstances are likely to change. For example, a 55-year-old pension plan investor hoping to retire at age 65 has a ten-year horizon. The portfolio may not be liquidated at age 65, but its structure may need to change, for example, as the investor begins to draw an income from the fund.

The time horizon of the investor will affect the nature of investments used in the portfolio. Illiquid or risky investments may be unsuitable for an investor with a short time horizon because the investor may not have enough time to recover from investment losses, for example. Such investments, however, may be suitable for an investor with a longer horizon, especially if the risky investments are expected to have higher returns.

EXAMPLE 5

Investment Time Horizon

Frank Johnson is investing for retirement and has a 20-year horizon. He has an average risk tolerance. Which investment is likely to be the

least

suitable for a major allocation in Johnson’s portfolio?

Listed equities

Private equity

US Treasury bills

Al Smith has to pay a large tax bill in six months and wants to invest the money in the meantime. Which investment is likely to be the

least

suitable for a major allocation in Smith’s portfolio?

Listed equities

Private equity

US Treasury bills

Solution to 1: C is correct. With a 20-year horizon and average risk tolerance, Johnson can accept the additional risk of listed equities and private equity compared with US Treasury bills.

Solution to 2: B is correct. Private equity is risky, has no public market, and is the least liquid among the assets mentioned.

2.2.5. Tax Concerns

Tax status varies among investors. Some investors will be subject to taxation on investment returns and some will not. For example, in many countries returns to pension funds are exempt from tax. Some investors will face a different tax rate on income (dividends and interest payments) than they do on capital gains (associated with increases in asset prices). Typically, when there is a differential, income is taxed more highly than gains. Gains may be subject to a lower rate of tax or part or all of the gain may be exempt from taxation. Furthermore, income may be taxed as it is earned, whereas gains may be taxed when they are realized. Hence, in such cases there is a time value of money benefit in the deferment of taxation of gains relative to income.

In many cases, the portfolio should reflect the tax status of the client. For example, a taxable investor may wish to hold a portfolio that emphasizes capital gains and receives little income. A taxable investor based in the United States is also likely to consider including U.S. municipal bonds (“munis”) in his or her portfolio because interest income from munis, unlike from treasuries and corporate bonds, is exempt from taxes. A tax-exempt investor, such as a pension fund, will be relatively indifferent to the form of returns.

2.2.6. Legal and Regulatory Factors

The IPS should state any legal and regulatory restrictions that constrain how the portfolio is invested.

In some countries, such institutional investors as pension funds are subject to restrictions on the composition of the portfolio. For example, there may be a limit on the proportion of equities or other risky assets in the portfolio, or on the proportion of the portfolio that may be invested overseas. The United States has no limits on pension fund asset allocation but some countries do, examples of which are shown in Exhibit 4. Pension funds also often face restrictions on the percentage of assets that can be invested in securities issued by the plan sponsor, so-called self-investment limits.

EXHIBIT 4. Examples of Pension Fund Investment Restrictions

Country

Listed Equity

Real Estate

Government Bonds

Corporate Bonds

Foreign Currency Exposure

Switzerland

50%

30%

100%

100%

Unhedged 30%

Japan

100%

Not permitted

100%

100%

No limits

South Africa

75%

25%

100%

75%

25%

Source: OECD Survey of Investment Regulation of Pension Funds, July 2018.

When an individual has access to material nonpublic information about a particular security, this situation may also form a constraint. For example, the directors of a public company may need to refrain from trading the company’s stock at certain points of the year before financial results are published. The IPS should note this constraint so that the portfolio manager does not inadvertently trade the stock on the client’s behalf.

2.2.7. Unique Circumstances

This section of the IPS should cover any other aspect of the client’s circumstances, including beliefs and values, that is likely to have a material impact on the composition of the portfolio. A client may have considerations derived from his or her religion or ethical values that could constrain investment choices. For instance, an investor seeking compliance with Shari’a (the Islamic law) will avoid investing in businesses and financial instruments inconsistent with Shari’a, such as casinos and bonds, because Shari’a prohibits gambling and lending money on interest. Similarly, an investor may wish to avoid investments that he or she believes are inconsistent with their faith. Charitable and pension fund investors may have constituencies that want to express their values in an investment portfolio.

Whether rooted in religious beliefs or not, a client may have personal objections to certain products (e.g., weapons, tobacco, gambling) or practices (e.g., environmental impact of business activities, human impact of government policies, labor standards), which could lead to the exclusion of certain companies, countries, or types of securities (e.g., interest-bearing debt) from the investable universe as well as the client’s benchmark. Such considerations are often referred to as ESG (environmental, social, governance), and investing in accordance with such considerations is referred to as SRI (socially responsible investing).

There are several implementation approaches in which ESG considerations can be expressed in an investment portfolio. The oldest form is negative screening (or exclusionary screening), which refers to the practice of excluding certain sectors or excluding companies that deviate from accepted standards or norms. Exclusion based on values, such as exclusion of gambling, alcohol, and tobacco-related companies, relate to an investor’s moral or ethical beliefs in a company’s or sector’s business. Exclusion based on standards and norms refers to business practices that an investor does not want to be associated with from either a reputational or financial risk point of view. These practices may include harmful production processes, corruption, and land ownership issues.

Another common approach is best-in-class, whereby investors seek to identify companies within an industry that rank (or score) most favorably based on ESG considerations. Under this approach, investor portfolios would include only securities of those companies that exceed a certain threshold when evaluating ESG considerations. Shareholder engagement (sometimes call active ownership) is the practice of entering into a dialogue with companies (including with respect to ESG issues). Note that this is a different approach than best-in-class selection, where securities companies that do not meet investor standards are excluded. Generally speaking, the IPS should contain guidelines on shareholder voting behavior.

While exclusionary screening and best-in-class eliminate investment options, thematic investing and impact investing focus on investment in objectives, themes, and trends that relate positively to ESG issues. An example of a thematic investment (i.e., related to a business theme or societal trend) that considers ESG would be investments in alternative energy providers. In impact investing, an investment is selected primarily on its expected social or environmental benefits with measurable investment returns.

The final ESG implementation approach, ESG integration, refers to the integration of qualitative and quantitative ESG factors into traditional security and industry analysis. The focus of ESG integration is to identify risks and opportunities arising from ESG factors and to determine whether a company is properly managing its ESG resources in accordance with a sustainable business model. Examples of ESG integration may include potential earnings per share dilution due to a company’s overly generous options program for key executives; a company’s poor environmental safety or labor standards potentially resulting in a large future liability that affects the company’s profitability and financial condition; or a company’s technology leadership position in a certain production process technology may give a company a competitive advantage once new regulations come into place.

These ESG implementation approaches may impact a portfolio manager’s investment universe and, in some cases, the manner in which investment management firms operate. The growth of ESG investing has resulted in the development of new investment management services, such as data providers specializing in quantitative and qualitative data on sustainability and governance aspects of businesses. Data quality, however, needs to be judged carefully in each case: disclosure standards differ across jurisdictions; data services companies may have limited coverage of a relevant investment universe; and data item definitions may differ. Nevertheless, the availability of such data makes it possible to estimate certain ESG considerations (e.g., the CO2 footprint of an investment portfolio) and implement these considerations as a constraint in the portfolio construction process.

EXAMPLE 6

Ethical Preferences

The F&C Responsible UK Equity Growth Fund is designed for investors who wish to have ethical and environmental principles applied to the selection of their investments. The fund’s managers apply both positive (characteristics to be emphasized in the portfolio) and negative (characteristics to be avoided in the portfolio) screening criteria:

Positive criteria

Supplies the basic necessities of life (e.g., healthy food, housing, clothing, water, energy, communication, health care, public transport, safety, personal finance, education)

Offers product choices for ethical and sustainable lifestyles (e.g. fair trade, organic)

Improves quality of life through the responsible use of new technologies

Shows good environmental management

Actively addresses climate change (e.g., renewable energy, energy efficiency)

Promotes and protects human rights

Supports good employment practices

Provides a positive impact on local communities

Maintains good relations with customers and suppliers

Applies effective anti-corruption controls

Uses transparent communication

Negative criteria

Tobacco production

Alcohol production

Gambling

Violent material

Manufacture and sale of weapons

Unnecessary exploitation of animals

Nuclear power generation

Poor environmental practices

Human rights abuses

Poor relations with employees, customers or suppliers

[Excerpted from F&C documents; www.fandc.com/new/Advisor/Default.aspx?ID=79620.]