INVESTMENT MANAGEMENT 5th Sem B.
Com
MODULE-5
PORTFOLIO MANAGEMENT
INTRODUCTION
A portfolio Investment can be understood as a bunch of different financial
securities (including assets, stocks, government bonds, corporate bonds, mutual
funds, other money market instruments, cash and cash equivalents, cryptocurrencies,
commodities, and bank certificates of deposit.), bought with an expectation to gain
either in the form of return or increased value, or both. So, the art of constructing
and managing these portfolio investments is known as Portfolio Management.
Portfolio Management aims to meet the long-term financial objectives of the
investors within the given timeline while minimizing the degree of market risk. Such
management services are provided by professionals, known as Portfolio Managers,
who have knowledge of building portfolios, prevailing market situations and future
expectations, understanding of risk appetite, and diversified investment. However,
individuals with such knowledge can manage and oversee the portfolio on their own.
Portfolio Management is not a one-time activity but a continuous process of
building and maintaining the portfolio investment with the intention to earn
maximum gain within the given time frame. It can be understood as a continuous
cycle of security allocation, diversification, supervision, and reconstruction of the
appropriate portfolio. It is based on SWOT Analysis as the Portfolio Managers
identify and analyze strengths and weaknesses of various investment plans and
examines the market opportunities and threats associated with such investment plans
to achieve the investor’s financial objectives.
PORTFOLIO: A portfolio refers to a collection of investment tools such as stocks,
shares, mutual funds, bonds, cash and so on depending on the investor’s income,
budget and convenient time frame.
PORTFOLIO MANAGEMENT: The art of selecting the right investment policy for
the individuals in terms of minimum risk and maximum return is called as portfolio
management.
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Portfolio management refers to managing an individual’s investments in the form of
bonds, shares, cash, mutual funds etc so that he earns the maximum profits within the
stipulated time frame.
Portfolio management refers to managing money of an individual under the expert
guidance of portfolio managers.
In a layman’s language, the art of managing an individual’s investment is called as
portfolio management.
PORTFOLIO MANAGER
A portfolio manager is a professional responsible for making investment
decisions and carrying out investment activities on behalf of vested individuals or
institutions. Clients invest their money into the PM's investment policy for future
growth, such as a retirement fund, endowment fund, or education fund..
NEED FOR PORTFOLIO MANAGEMENT
Portfolio management presents the best investment plan to the individuals as
per their income, budget, age and ability to undertake risks.
Portfolio management minimizes the risks involved in investing and also
increases the chance of making profits.
Portfolio managers understand the client’s financial needs and suggest the best
and unique investment policy for them with minimum risks involved.
Portfolio management enables the portfolio managers to provide customized
investment solutions to clients as per their needs and requirements.
OBJECTIVES OF PORTFOLIO MANAGEMENT
The basic objective of Portfolio Management is to earn a high return at
minimum risk. However, some of the objectives of Portfolio Management are listed
below:
1. Attaining Long-term Financial Goals: An investor always invests with a
motive to secure the future by earning a high return, keeping this in mind
Portfolio Management works with the objective to fulfil the long-term financial
goals of the investors by recommending the most profitable portfolio, overseeing
and rebalancing it from time to time to ensure high return with minimum risk
appetite.
2. Capital Appreciation: Capital appreciation means an increase in the value of an
asset over a time period. Portfolio Management intends to make the portfolio of
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the investor grow, so the market value of the investment rises within the given
timeline, in comparison to its purchase value. Capital appreciation is the main
source of investors’ earnings.
3. Maximizing Return on Investment: Return on Investment shows the earning
from the investment in relation to the expenditure made in such
investment. Portfolio Management aims to maximize the ROI by analyzing the
market before selecting the right investment mix. Other factors like time period,
inflation, Legal restrictions, and economic conditions are also considered.
4. Achieving Asset Allocation: The primary objective of Portfolio Management is
to allocate assets across different investment classes, such as equities, fixed
income, and alternative investments in such a way that the asset allocation goes
with the investor’s risk profile and investment goals.
5. Risk Management: Investment and risk are something that goes side by side and
hence is a major concern of the investors. Portfolio Management minimizes the
degree of risk associated with the investment by using the concept of diversified
investment. Under this, investment is not made in a single category of an asset or
the same industry, rather the investment is scattered into various investment
classes or different industries, so even if any of the categories or industries so a
downfall the other can overcome it by experiencing the rise.
6. Rebalancing and Monitoring the Portfolio: Portfolio Management aims to
regularly monitor and adjust the portfolio by rebalancing the portfolio, adding or
removing assets, or changing investment strategies so, it remains consistent with
the investor’s risk profile and investment goals.
PROCESS OF PORTFOLIO MANAGEMENT
1. Setting Objectives and Constraints: The first step in portfolio management is
defining investment objectives and constraints. Objectives could include capital
appreciation, income generation, or a combination of both. Constraints may involve
factors such as time horizon, risk tolerance, liquidity needs, and regulatory
considerations. Clear objectives and constraints provide a foundation for constructing
a portfolio tailored to the investor's unique circumstances.
2. Asset Allocation: Asset allocation is a strategic decision that involves determining
the mix of asset classes (e.g., stocks, bonds, cash, real estate) within the portfolio. This
decision is crucial as it significantly influences the portfolio's risk and return profile.
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Modern Portfolio Theory suggests that diversification across different asset classes
can enhance returns for a given level of risk.
3. Security Selection: Once the asset allocation is determined, the next step is
selecting specific securities or investments within each asset class. This involves
analyzing individual stocks, bonds, or other financial instruments to build a well-
diversified portfolio. Fundamental analysis, technical analysis, and other evaluation
methods are employed to identify securities that align with the investor's goals.
4. Risk Management: Managing risk is an integral part of portfolio management.
Techniques such as diversification, hedging, and the use of risk-adjusted metrics help
control and mitigate portfolio risk. Understanding the correlation between different
assets and incorporating risk management strategies are essential for constructing a
resilient portfolio.
5. Portfolio Construction: Portfolio construction involves combining the selected
securities in the desired proportions based on the asset allocation. The goal is to create
a balanced and diversified portfolio that aligns with the investor's risk-return profile.
Attention is given to factors such as sector exposure, geographic considerations, and
market capitalization to ensure a well-rounded investment mix.
6. Monitoring and Rebalancing: Once the portfolio is constructed, continuous
monitoring is essential. Market conditions, economic factors, and changes in the
investor's financial situation may necessitate adjustments. Rebalancing involves
periodically reviewing the portfolio's asset allocation and making adjustments to bring
it back in line with the original strategic plan. This ensures that the portfolio remains
aligned with the investor's goals.
7. Performance Evaluation: Regular performance evaluation helps assess how well
the portfolio is meeting its objectives. Key performance metrics, such as return on
investment, risk-adjusted return, and portfolio volatility, are analyzed. This evaluation
provides insights into the effectiveness of the chosen strategy and helps investors
make informed decisions about the portfolio's future direction.
8. Adaptation to Changing Market Conditions: Portfolio management is not a
static process; it requires adaptability to changing market conditions. Economic shifts,
geopolitical events, and fluctuations in interest rates can impact the performance of
different asset classes. Portfolio managers must stay informed about market trends and
be prepared to adjust the portfolio strategy accordingly.
SELECTION OF SECURITIES AND PORTFOLIO ANALYSIS
Selection of securities and portfolio analysis are critical stages in the
investment management process, encompassing the detailed examination and choice
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of individual investments to include in a portfolio, followed by the ongoing evaluation
of the portfolio's composition and performance. These phases are essential for
constructing a portfolio that aligns with the investor's objectives, risk tolerance, and
investment horizon.
1. Selection of Securities: The selection of securities is a multifaceted process that
involves screening, analysis, and ultimately choosing the stocks, bonds, or other
investment vehicles that will comprise the portfolio. This process is guided by the
investment policy statement (IPS), which outlines the client's goals, risk tolerance,
and other relevant constraints.
2. Screening: Initially, securities are screened based on certain criteria such as asset
class, sector, market capitalization, or geographic location. This step narrows down
the universe of potential investments to those that fit within the strategic asset
allocation framework.
3. Fundamental Analysis: For individual stocks, this involves evaluating a
company's financial health, business model, competitive position in the industry,
growth prospects, and management quality. For bonds, it includes assessing the
issuer's creditworthiness, the bond's maturity, yield, and coupon rate, and any call
or conversion features.
4. Technical Analysis: Some portfolio managers also use technical analysis, which
involves analyzing statistical trends from trading activity and price movements to
predict future price behaviour.
5. Quantitative Analysis: This involves using mathematical models and statistical
techniques to evaluate securities, forecast performance, and assess risk.
Quantitative metrics such as price-to-earnings ratio, debt-to-equity ratio, and return
on equity can be used to compare and select securities.
6. Valuation: The intrinsic value of a security is estimated using various valuation
models and securities are selected based on their comparison to the current market
price. Securities perceived to be undervalued may be considered for purchase,
while those that are overvalued might be avoided or sold.
PORTFOLIO ANALYSIS
Once the portfolio is constructed, ongoing analysis is crucial to ensure that it
continues to meet the investor's objectives and adjust to changing market conditions or
personal circumstances.
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1. Performance Measurement: This involves tracking the return of the portfolio
over time and comparing it against benchmarks and the portfolio's historical
performance. Performance metrics such as the Sharpe ratio, Alpha, and Beta are
used to evaluate the risk-adjusted return of the portfolio.
2. Asset Allocation Review: The portfolio's asset allocation is regularly reviewed to
ensure it remains aligned with the client's strategic asset allocation targets. Market
movements can cause the actual allocation to drift from the target allocation,
necessitating rebalancing.
3. Risk Management: Ongoing risk assessment is essential to identify any changes
in the portfolio's risk profile. This includes measuring portfolio volatility,
assessing diversification benefits, and ensuring that the level of risk is consistent
with the investor's risk tolerance.
4. Rebalancing: Portfolio rebalancing involves realigning the weightings of assets
by buying or selling securities to maintain the original or desired asset allocation.
This is necessary to take advantage of market movements and manage risk.
5. Tax Efficiency: The portfolio is analyzed for tax efficiency, implementing
strategies to minimize tax liabilities through tax-loss harvesting, selecting tax-
efficient investment vehicles, and timing the realization of capital gains and losses.
6. Scenario Analysis and Stress Testing: Portfolio managers may conduct scenario
analysis and stress testing to evaluate how the portfolio would perform under
various market conditions or economic events. This helps in understanding
potential vulnerabilities and planning for contingencies.
The selection of securities and portfolio analysis are ongoing and dynamic
components of the portfolio management process. They require a deep understanding
of financial markets, a disciplined approach to research and analysis, and a
commitment to staying informed about economic and market developments. Through
meticulous selection and continuous analysis, portfolio managers aim to construct and
maintain portfolios that achieve the investment objectives and risk-return profile
desired by the investor.
EVALUATION OF PORTFOLIO
Portfolio evaluation refers to the evaluation of the performance of the portfolio.
It is essentially the process of comparing the return earned on a portfolio with the
return earned on one or more other portfolios or on a benchmark portfolio.
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Portfolio evaluation is the last step in the process of portfolio management. It is
the stage when we examine to what extent the objective has been achieved. It is
basically the study of the impact of investment decisions. Without portfolio
evaluation, portfolio management would be incomplete. It has evolved as an important
aspect of portfolio management over the last two decades.
NEED FOR PORTFOLIO EVALUATION
Investment may be carried out by individuals on their own. The funds available
with individual investors may not be large enough to create a well-diversified
portfolio of securities. Moreover, the time, skill and other resources at the disposal of
individual investors may not be sufficient to manage the portfolio professionally.
Institutional investors such as mutual funds and investment companies are better
equipped to create and manage well diversified portfolios in a professional fashion.
Evaluation is an appraisal of performance. Whether the investment activity is carried
out by individual investors themselves or through mutual funds and investment
companies, different situations arise where evaluation of performance becomes
imperative. These situations are discussed below:
1. Self-evaluation: Where individual investors undertake the investment activity on
their own, the investment decisions are taken by them. They construct and manage
their own portfolio of securities. In such a situation, an investor would like to evaluate
the performance of his portfolio in order to identify the mistakes committed by him.
This self-evaluation will enable him to improve his skills and achieve better
performance in future.
2. Evaluation of portfolio managers: A mutual fund or investment company usually
creates different portfolios with different objectives aimed at different sets of
investors. Each such portfolio may be entrusted to different professional portfolio
managers who are responsible for the investment decisions regarding the portfolio
entrusted to each of them. In such a situation, the organization would like to evaluate
the performance of each portfolio so as to compare the performance of different
portfolio managers.
3. Evaluation of mutual funds1: In India, at present, there are many mutual funds as
also investment companies operating both in the public sector as well as in the private
sector. These compete with each other for mobilizing the investment funds with
individual investors and other organizations by offering attractive returns, minimum
risk, high safety and prompt liquidity. Investors and organizations desirous of placing
their funds with these mutual funds would like to know the comparative performance
of each so as to select the best mutual fund or investment company. For this,
evaluation of the performance of mutual funds and their portfolios becomes necessary.
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4. Evaluation perspective: A portfolio comprises several individual securities. In the
building up of the portfolio several transactions of purchase and sale of securities take
place. Thus, several transactions in several securities are needed to create and revise a
portfolio of securities. Hence, the evaluation may be carried out from different
perspectives or viewpoints such a transactions view, security view or portfolio view.
5. Transaction view: An investor may attempt to evaluate every transaction of
purchase and sale of securities. Whenever a security is bought or sold, the transaction
is evaluated as regards its correctness and profitability.
6. Security view: Each security included in the portfolio has been purchased at a
particular price. At the end of the holding period, the market price of the security may
be higher or lower than its cost price or purchase price. Further, during the holding
period, interest or dividend might have been received in respect of the security. Thus,
it may be possible to evaluate the profitability of holding each security separately.
This is evaluation from the security viewpoint.
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