Lesson 3 of 8 · All lessons in this module
- The investment policy statement: why and what
- Risk objectives and risk tolerance: ability vs willingnessVideo lesson
- Return objectives and the required returnVideo lesson
- Constraints: liquidity, horizon, tax, legal and unique circumstancesVideo lesson
- Asset classes and the strategic asset allocation
- Integrated case: IPS thresholds, client exclusions and the efficient frontier
- From SAA to portfolio: risk budgeting, TAA, selection and rebalancing
- ESG considerations in planning and construction
Lesson 3 of 8 · 12 min
Return objectives and the required return
A return objective can be absolute or relative, nominal or real, before or after fees and taxes; it must be realistic and consistent with the client's risk tolerance and the market environment.
In short
- Absolute return objectives state a percentage return (nominal or real); relative objectives beat a benchmark such as an equity index or a cash rate (e.g. index + 1%).
- Peer-group objectives (e.g. top half of similar endowments) are problematic: peers' methods are opaque, not everyone can be above average, and a peer benchmark is not investable.
- State clearly whether returns are before or after fees and, for taxable clients, pre- or post-tax; the baseline for a taxable investor is after-tax.
- A required return is what the client must earn to reach a goal; compute the nominal target with inflation, then solve .
- Nominal objectives are easier to measure; real objectives relate better to the goal. Objectives must match risk tolerance and the inflation and market environment; counsel clients with unrealistic expectations.
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