Portfolio Management Processes To Achieve Goals and Manage Risk Highlighted in Comptroller's Handbook

Portfolio Management Processes To Achieve Goals and Manage Risk Highlighted in Comptroller's Handbook

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he Office of the Comptroller of the Currency (OCC) charters, regulates and supervises all national banks. The OCC has issued several publications regarding investment management which should interest those who maintain individual, ERISA or trust accounts at national banks. In particular, the Comptroller's Handbook entitled, Investment Management Services, is noteworthy reading. Let's examine the OCC's guidelines for "Portfolio Management Processes."

According to the OCC, the goal of the portfolio management process is "to achieve the objectives of the account and effectively manage risk." To do so, there are three stages.

The First Stage

The first stage of the portfolio management process is to develop the investment policy. The policy must be "appropriate and realistic." Accordingly, the investment manager must examine the governing instrument (trust or agency agreement) in creating the fiduciary relationship. The manager must understand the characteristics and investment needs of both the principals and the beneficiaries. The OCC recommends that the manager evaluate the portfolio's current investment holdings to determine whether they are appropriate.

Next, the fiduciary must identify and document the investment objectives of the account. In particular, the manager should "articulate the account's risk tolerance; establish investment goals and return requirements; and detail legal, liquidity, time horizon, taxes, and other special circumstances of the account, its principals, and beneficiaries." The OCC recommends that a portfolio's assets be viewed together with the client's other assets.

Thereafter, the fiduciary decides how to allocate the portfolio assets among various investments. The OCC opines that the asset allocation decisions may be the most important decisions made in terms of the portfolio's long term performance. The primary types of assets often are divided among sectors and investment styles. Fiduciaries employ concepts of modern portfolio theory and efficient frontier analysis. One factor is correlation, which is the degree to which the returns of two investments are related. Other factors may include target limits on the concentration that a particular security or particular asset class may have in the account.

Once the investment manager has selected an appropriate asset allocation, he or she then can select an appropriate performance benchmark to make risk and return comparisons. A benchmark can be a publicly available index or a customized product.

The OCC states that the "culmination" of all of the above activities is the creation of an Investment Policy Statement. This document "ensures continuity of the investment program", "limits second-guessing of investment decisions", and also may "limit the temptation to increase portfolio risk to take advantage of perceived short-term market trends."

The Second Stage

The second stage of the portfolio management process is to implement the investment policy. To do so, the fiduciary must select investment managers and advisers (if outsourcing), and must select and acquire investments based upon the asset allocation guidelines.

Moving forward, the manager must monitor the portfolio. The manager also must re-balance the portfolio based upon the asset allocation guidelines. According to the OCC, "portfolio monitoring and revision is a continual and complicated process that requires extensive analysis and sound judgment." Targeted, short-term changes in the asset mix or sectors (such as moving from stocks to money market accounts during volatile times) may have a place in the portfolio management process.

Further, risk managers at the bank must be furnished with investment performance and compliance reports. The OCC recommends that these reports detail such matters as the portfolio's risk-adjusted return, comparisons to benchmarks and compliance with portfolio guidelines and client needs.

The Third Stage

The third stage is monitoring the investment policy. According to the OCC, an effective monitoring program includes such activities as a "formalized and documented account review process", which includes an annual investment policy review. Client information must be current, and there must be appropriate communication with clients.

Furthermore, internally, there must be "comprehensive risk management reports." Likewise, there must be "interim reviews" to establish that the manager has adhered to asset allocation and individual security guidelines, and to review performance relative to benchmarks. Finally, there must be "monitoring of global and domestic economic conditions, capital markets trends, political environments, regulatory climates, and other competitive factors."

Overall, the Comptroller's Handbook is a valuable resource for investors and their fiduciary investment managers.