CFA Level II ExamPortfolio Management and Wealth PlanningMedium
A financial advisor is preparing an Investment Policy Statement (IPS) for a 40-year-old client who is a successful entrepreneur. The client has significant human capital (expected future earnings) but currently holds a concentrated position in the illiquid stock of her own start-up company. She aims for aggressive growth over the next 15-20 years for retirement and her children's education, but also expresses a desire for some portfolio diversification away from her concentrated position. What is the most significant investment constraint that needs to be explicitly addressed in her IPS?
- ATaxes
- BLegal and Regulatory
- CLiquidity
- DTime Horizon
Show answer & explanationAnswer & explanation
Correct answer: C. Liquidity
The client holds a concentrated position in an illiquid stock. This 'illiquid stock' directly points to liquidity as a major constraint. While other constraints are present, the illiquid nature of her primary asset holding is the most pressing and significant constraint that must be addressed, as it impacts her ability to reallocate or diversify her wealth.
Why the other options are wrong
- A. Taxes are always a consideration for entrepreneurs, but the illiquidity of her current holdings is a more immediate and fundamental constraint on portfolio construction.
- B. Legal and regulatory issues might exist with a start-up, but the illiquidity of the stock is explicitly stated as a characteristic and a more direct constraint on her investment strategy.
- D. The time horizon is long (15-20 years), which is an objective, not a constraint in this specific context of the illiquid stock.
IPS Investment Constraints: Liquidity
The ease and speed with which an asset can be converted into cash at a fair market value. A lack of liquidity can restrict investment choices and rebalancing opportunities.
- High liquidity needs require more cash or easily marketable assets.
- Illiquid assets (e.g., private equity, real estate) reduce portfolio flexibility.
- Must consider both current and future liquidity requirements.
Memory trick: Constraints: TULRS are your IPS limitations.