Portfolio Management — Chapter 1

SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT

Class Notes — Chapter 1
CHAPTER 1
INTRODUCTION TO PORTFOLIO MANAGEMENT

Adapted with Bangladesh Capital Market Context

Based on: S. Kevin, Security Analysis and Portfolio Management, 2nd Edition, PHI Learning

Learning Objectives
After studying this chapter, you should be able to:

• Explain the meaning and importance of investment and portfolio management

• Describe the five phases of the portfolio management process
• Distinguish between security analysis, portfolio analysis, selection, revision and evaluation
• Trace the historical evolution of portfolio management as a discipline
• Explain the role of portfolio management in an emerging market such as Bangladesh
• Identify the key regulatory and market institutions relevant to portfolio management in
Bangladesh
• Appreciate, through a simple illustration, why diversification reduces risk
• Recognise the practical challenges of applying portfolio management in the Bangladesh capital
market

1.1 Introduction

Investing in securities — shares, debentures, bonds and other capital-market instruments — is one of
the most popular ways of building wealth over time. It is rewarding, but it is never free of risk; it
demands scientific knowledge as well as a certain artistic judgement, because both rational calculation
and emotional response influence investment decisions. For an ordinary saver, putting money into
financial securities is often considered among the best available avenues for growing savings, while at
the same time being acknowledged as one of the riskiest.

It is rare for an investor to place his entire savings in a single security. Instead, investors instinctively
spread their money across a group of securities. Such a group, held together as an investment, is called
a portfolio. The construction of a portfolio helps reduce risk without proportionately sacrificing return.
Portfolio management, therefore, is the discipline that deals with the analysis of individual securities as
well as the theory and practice of combining securities optimally into portfolios. An investor who
understands the fundamental principles and analytical tools of portfolio management stands a far better
chance of investment success than one who invests purely on tips, rumours or guesswork.

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Why this matters in Bangladesh

Bangladesh's capital market — comprising the Dhaka Stock Exchange (DSE) and the Chittagong
Stock Exchange (CSE) — has grown rapidly since the 1990s economic liberalisation. A large
number of retail Beneficiary Owner (BO) account holders now participate directly in equity trading,
yet a substantial share of this participation is speculative rather than analysis-driven.
The core message of this chapter — that rational, disciplined portfolio management outperforms
random or tip-based investing — is directly applicable to DSE/CSE investors, mutual fund unit-
holders, and to professionals working with the Investment Corporation of Bangladesh (ICB), asset
management companies, merchant banks and brokerage houses regulated by the Bangladesh
Securities and Exchange Commission (BSEC).

1.1.1 Why a Single Security Is Not Enough — A Simple Illustration

Consider a hypothetical Dhaka-based investor who has Tk 2,00,000 to invest. If he places the entire
amount in the shares of a single RMG (ready-made garment) exporting company, his fortunes become
entirely tied to that one company's performance — a single adverse event (a buyer cancelling orders, a
factory compliance issue, or a rise in cotton import costs) can sharply reduce the value of his entire
investment.

Now suppose instead he divides the same Tk 2,00,000 across four unrelated sectors listed on the DSE
— say, a pharmaceutical company, a bank, a telecommunications operator, and a cement manufacturer.
Because these businesses are driven by different underlying economic factors, it is unlikely that all four
will suffer simultaneously from the same adverse event. A poor quarter for the cement company
(perhaps due to a construction slowdown) may be offset by a strong quarter for the pharmaceutical
company (perhaps due to steady domestic and export demand). The overall variability — or risk — of
his combined holding is therefore lower than the risk of holding any single one of these shares in
isolation, even though his expected return need not fall by much, if at all.

This simple intuition — that combining securities whose returns do not move in perfect lock-step
reduces overall portfolio risk — is the essence of diversification, and it is formalised mathematically in
Chapter 13 (Portfolio Analysis) using the concepts of covariance and correlation. For now, it is enough
to appreciate why professional investors, mutual funds, and portfolio managers virtually never hold just
one security.

1.2 What is Portfolio Management?

An investor considering investment in securities faces the problem of choosing from among a very large
number of available securities. His choice depends on the risk–return characteristics of individual
securities. Having chosen a set of desirable securities, he must further decide how much to invest in
each. Because the risk-return characteristics of a group (portfolio) of securities differ from those of the

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individual securities that make it up, the investor is really searching among an effectively infinite
number of possible portfolios for the one that is 'optimal' for him.

As the economic and financial environment keeps changing, the risk-return characteristics of individual
securities and of portfolios also change continuously. This is what makes periodic review and revision
of an investment portfolio necessary.

Portfolio management may therefore be defined as the totality of processes involved in the creation
and maintenance of an investment portfolio. It specifically comprises: security analysis, portfolio
analysis, portfolio selection, portfolio revision and portfolio evaluation. It makes use of analytical
techniques and conceptual theories of rational fund allocation, with the twin objectives of

• Maximising the return on investment for a given level of risk, and

• Minimising the risk for a given level of expected return.
Portfolio management is thus a complex, continuous process that attempts to make investment activity
more rewarding and less risky at the same time.

1.2.1 Why Portfolio Management Is Needed

Left entirely to instinct, most investors would either (a) concentrate their money in whatever security
is currently 'hot' in market conversation, exposing themselves to avoidable risk, or (b) diversify
randomly, without regard to how the risk-return characteristics of different securities interact, thereby
failing to achieve the best possible risk-return trade-off available to them. Portfolio management exists
precisely to correct both failures — by using systematic analysis to (i) identify the universe of
worthwhile securities, (ii) understand how combinations of these securities behave as a group, and (iii)
select and continuously maintain the combination that best matches the investor's own return
requirement and risk tolerance.

Three ideas recur throughout this course and are worth fixing firmly in mind at the outset:

• Return and risk are inseparable. No meaningful investment decision can be made by looking
at expected return alone; the risk taken to earn that return must always be considered jointly with
it.
• The relevant risk of a security is its contribution to portfolio risk, not its risk in isolation. A
security that looks risky on its own may actually reduce overall portfolio risk if its returns move
opposite to the rest of the portfolio — this is a central, sometimes counter-intuitive, insight of
modern portfolio theory (Chapter 13).
• Portfolio management is a process, not a one-time decision. Because markets, companies, and
investor circumstances all change continuously, portfolio construction is never really 'finished'
— it must be revised and re-evaluated on an ongoing basis.

1.3 Phases of Portfolio Management

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Portfolio management is not a single act but a process consisting of several inter-related activities. Five
distinct phases can be identified. Each phase is an integral part of the whole, and the ultimate success
of portfolio management depends on the efficiency with which every one of these phases is carried out.

Phase Name Core Task

1 Security Analysis Examining the risk-return characteristics of

individual securities

2 Portfolio Analysis Identifying the range of possible portfolios and

calculating their risk-return

3 Portfolio Selection Choosing the optimal portfolio from the efficient

set

4 Portfolio Revision Adjusting the portfolio periodically to keep it

optimal

5 Portfolio Evaluation Assessing the performance of the portfolio

against a benchmark

It is useful to picture these five phases not as a straight line but as a continuous cycle: Security Analysis
→ Portfolio Analysis → Portfolio Selection → Portfolio Revision → Portfolio Evaluation →
(feedback) → back to Security Analysis. The output of evaluation (Phase 5) becomes an input into the
next round of security analysis (Phase 1), so the process never truly ends as long as the investor
continues to hold and manage the portfolio.

1.3.1 Security Analysis

Security analysis is the initial phase of portfolio management. The securities available to an investor
are numerous and diverse — traditionally classified into ownership securities (equity and preference
shares) and creditorship securities (debentures and bonds), besides newer instruments such as
convertible debentures, zero-coupon bonds, floating-rate bonds and depository receipts. From this vast
universe, the investor must identify those securities worth including in a portfolio. This calls for detailed
analysis.

A basic strategy in securities investment is to buy underpriced securities and sell overpriced ones.
Security analysis is essentially the exercise of identifying such 'mispriced' securities. There are two
broad, competing approaches:

• Fundamental analysis — concentrates on the fundamental factors affecting a company (EPS,

dividend policy, competitive position, quality of management), its industry, and the economy as
a whole, to arrive at the intrinsic or true worth of a security. A share is bought if its market price
is below intrinsic value (undervalued) and sold if above (overvalued).

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• Technical analysis — assumes that share price movements are systematic and exhibit repeating
patterns. The technical analyst studies historical price and volume data to identify trends, and to
predict future price movements.
A third, more recent perspective — the Efficient Market Hypothesis (EMH) — holds that share prices
instantaneously and fully reflect all available information, implying that consistent abnormal profits
cannot be earned through either fundamental or technical analysis. These approaches are studied in
detail in later chapters of this course.

Fundamental analysis itself proceeds through a three-tier Economy–Industry–Company (EIC)

framework: the analyst first studies the macroeconomic environment (GDP growth, inflation, interest
rates, exchange rates), then the specific industry to which a company belongs (demand-supply
conditions, competitive intensity, regulatory treatment), and finally the company itself (financial
statements, management quality, competitive position). This EIC framework — covered in Chapters 7
to 9 — is the standard approach used by equity research analysts at brokerage houses and asset
management companies, including those operating in Dhaka.

1.3.2 Portfolio Analysis

A portfolio is a group of securities held together as an investment. Investors build portfolios — rather
than holding a single security — because they are risk-averse: diversification spreads risk by 'not putting
all their eggs into one basket'.

Security analysis provides a set of worthwhile individual securities. From this set, an indefinitely large
number of portfolios can be constructed simply by varying which securities are included and in what
proportion. Each individual security has measurable risk-return characteristics, but a portfolio's risk-
return profile is not merely the simple aggregate of its components — it also depends on how the returns
of the constituent securities move together (their covariance/correlation). Portfolio analysis is the phase
that consists of identifying the range of possible portfolios that can be constructed from a given set of
securities, and calculating their expected return and risk.

For example, if a Dhaka-based fund manager has shortlisted twenty securities from her fundamental
research, she does not stop there — she must next examine how those twenty securities can be combined
in different weightings, and what expected return and risk each such combination produces. With even
a modest number of securities, the number of possible portfolios (differing by which securities are
included and in what proportion) is for practical purposes unlimited, which is precisely why a systematic
mathematical approach — rather than guesswork — is required. This mathematical apparatus is
developed fully in Chapter 13.

1.3.3 Portfolio Selection

Portfolio analysis generates the inputs for portfolio selection. The goal of portfolio construction is to
identify the portfolio that provides the highest return for a given level of risk — such a portfolio is
called an efficient portfolio. Portfolio analysis identifies the entire set of efficient portfolios (the
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efficient frontier); portfolio selection is the process of choosing the single optimal portfolio from this
efficient set, based on the investor's own risk tolerance.

Harry Markowitz's portfolio theory, published in 1952, provides both the conceptual framework and
the analytical (quadratic programming) tools for identifying the optimal portfolio in an objective,
disciplined manner. His approach — now called Modern Portfolio Theory (MPT) — is the foundation
on which the rest of this course is built.

Two investors examining the very same efficient frontier of portfolios may still choose different optimal
portfolios, because the choice ultimately depends on each investor's individual attitude toward risk. A
conservative investor — for instance, someone nearing retirement who depends on investment income
— will select a portfolio from the lower-risk, lower-return end of the efficient frontier, perhaps weighted
toward Bangladesh Government Treasury Bonds and blue-chip DS30 shares. A younger investor with
a longer time horizon and higher risk tolerance may instead select a portfolio from the higher-risk,
higher-return end, with a greater weighting toward growth sectors. Portfolio selection, covered fully in
Chapter 14, therefore combines the objective mathematics of the efficient frontier with the subjective
element of investor risk preference.

1.3.4 Portfolio Revision

Having constructed the optimal portfolio, the investor must continuously monitor it, because the
economy and financial markets are dynamic: securities that were once attractive may cease to be so,
and new opportunities constantly emerge. Portfolio revision may also be triggered by investor-specific
changes — availability of additional funds, a shift in risk appetite, or a need for cash for some other
purpose.

Revision leads to purchase of some new securities and sale of some existing ones, altering the mix and
proportions within the portfolio. This must be done scientifically and objectively; portfolio revision is
as important a part of portfolio management as analysis and selection, yet it is often the most neglected
in practice.

Portfolio revision is not without cost or friction, however. Frequent buying and selling incurs brokerage
commission and, where applicable, capital-gains tax; and there is always the practical difficulty of
deciding exactly when and how much to revise. Two broad revision strategies are used in practice —
active revision, which relies on the manager's own fresh research to time purchases and sales, and
passive revision, which follows predetermined mechanical rules known as formula plans (for example,
rebalancing back to a fixed proportion between an 'aggressive' equity portfolio and a 'defensive' bond
portfolio whenever prices move by a set percentage). These strategies, and their associated costs and
constraints, are examined in Chapter 17.

1.3.5 Portfolio Evaluation

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The objective of constructing and revising a portfolio is to earn maximum return with minimum risk.
Portfolio evaluation is the process of assessing how well the portfolio has actually performed over a
chosen period, in terms of realised return and risk actually borne — compared against objective
benchmarks (such as a market index or peer portfolios).

Evaluation is not merely a scorecard: it also provides a feedback mechanism, revealing weaknesses in
the investment process so they can be corrected in the next cycle. Portfolio management is thus an
ongoing, cyclical process — it begins with security analysis, proceeds through construction, and
continues through revision and evaluation, each cycle feeding improvements into the next.

A crucial point, developed fully in Chapter 18, is that return alone is never a sufficient measure of
performance: a portfolio manager who earned 25% by taking on far greater risk than the market has not
necessarily 'beaten' a manager who earned 18% while taking on much less risk. Proper evaluation
therefore uses risk-adjusted performance measures (such as the Sharpe ratio and Treynor ratio) rather
than raw return alone, and compares results against an appropriate benchmark — for a Bangladeshi
equity fund, this would typically be the DSEX or DS30 index rather than, say, a fixed deposit rate or
an unrelated foreign index.

Applying the five phases to Bangladesh

Security analysis in the DSE/CSE context involves studying audited financial statements filed with
BSEC and the Registrar of Joint Stock Companies and Firms (RJSC), DSE-published corporate
disclosures, and sector-specific factors (e.g., RMG export earnings, remittance inflows, gas/power
tariffs).
Portfolio analysis and selection are practised formally by BSEC-licensed Asset Management
Companies (AMCs) running mutual funds (e.g., ICB Unit Fund, various bank/NBFI-sponsored
funds) and by merchant banks managing discretionary portfolios.
Portfolio revision must account for Bangladesh-specific frictions: circuit breakers on daily price
movement, comparatively thin trading in many listed scrips, and settlement/custody through the
Central Depository Bangladesh Limited (CDBL).
Portfolio evaluation for BD mutual funds is commonly benchmarked against the DSEX index (the
broad DSE index) or the DS30 (blue-chip index), much as Indian funds are benchmarked against
the BSE Sensex or NSE Nifty in the original text.

1.4 Securities Market

Investment in securities involves buying and selling — and the construction and periodic revision of a
portfolio requires numerous such transactions. These transactions take place in the securities market,
broadly divided into:

• The primary market (new issues market), where companies raise fresh capital by issuing new
securities directly to investors — for example, through an Initial Public Offering (IPO).
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• The secondary market (stock exchanges), where securities already issued are subsequently
traded between investors, providing liquidity and continuous valuation.
Stock exchanges provide liquidity to investment in the corporate sector and continuously value listed
securities through the price-discovery mechanism. The functioning of exchanges is regulated by statute
to ensure fair, transparent dealing — in India by the Securities and Exchange Board of India (SEBI);
the Bangladesh equivalent is discussed below.

The securities market can also be segmented by the maturity of instruments traded: the money market
handles short-term instruments (maturity of one year or less) such as treasury bills and commercial
paper, while the capital market handles long-term instruments (equity shares, debentures, bonds).
Portfolio management, as studied in this course, is concerned primarily with capital-market instruments,
though money-market instruments (such as Bangladesh Government Treasury Bills) frequently form
the 'defensive' or low-risk component of a well-constructed portfolio.

Bangladesh securities market structure

Stock exchanges: Dhaka Stock Exchange (DSE, established 1954 as the East Pakistan Stock
Exchange Association) and Chittagong Stock Exchange (CSE, established 1995) are the two
exchanges in Bangladesh — broadly analogous to the role BSE and NSE play in India.
Regulator: The Bangladesh Securities and Exchange Commission (BSEC), established in 1993, is
the counterpart of India's SEBI — it regulates both the primary and secondary markets, licenses
merchant banks, issue managers, brokers, and asset management companies.
Depository: The Central Depository Bangladesh Limited (CDBL) provides electronic
dematerialised holding and transfer of securities — performing the role that NSDL and CDSL
perform in India.
Central Bank linkage: Bangladesh Bank regulates banks and NBFIs that sponsor mutual funds and
merchant banking subsidiaries, and its monetary policy (repo rate, treasury bill/bond yields) is a
key macro input into security and portfolio analysis, much as RBI policy is in the Indian text.

1.5 Evolution of Portfolio Management

Portfolio management, as a systematic discipline, has evolved considerably over the past century.
Broadly, the development of investment management can be traced through three chronological phases
(a classification attributed to J.C. Francis):

(a) The Speculative Phase

In the early twentieth century, investing was largely confined to the wealthy and was speculative in
nature. Price manipulation through 'pools' and 'corners' was common, and investment management
during this era relied heavily on skill, intuition and inside information rather than systematic analysis
— practices that eventually contributed to the US stock market crash of 1929 and prompted the
Securities Act of 1934, which made many such speculative practices illegal. This period also saw the
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beginnings of formal financial-statement analysis — for example, Thomas F. Woodlock's The Anatomy
of a Railroad Report (1900) and John Moody's The Art of Wall Street Investing (1906), which
advocated the use of financial ratios to evaluate securities. Separately, Charles H. Dow's editorials in
the Wall Street Journal (1900–1902) argued that stock price movement was orderly and followed
identifiable trends — this became the foundation of what is today called technical analysis (Chapter
11), later extended by Ralph N. Elliott's Wave Principle (1938).

(b) The Professional Phase

Following the US securities-trading regulations of 1933–34, the investment industry began the
deliberate process of upgrading its ethics, establishing standard practices, and rebuilding public trust in
securities markets. As a direct result, ordinary people — not just the wealthy — began to participate in
investing, and serious, evidence-based analysis of securities before investment became the professional
norm. It was during this period that the research of Benjamin Graham and David L. Dodd was published
as Security Analysis (1934) — widely regarded as the founding text of the security-analysis profession,
and still read by professional investors today. Graham and Dodd are considered the pioneers of security
analysis as a formal discipline.

(c) The Scientific Phase

This phase began with Harry Markowitz's landmark 1952 paper 'Portfolio Selection' in the Journal of
Finance, followed by his fuller 1959 book, Portfolio Selection: Efficient Diversification of Investments.
Markowitz showed, mathematically, exactly how diversification reduces risk, and provided the
analytical (quadratic programming) tools needed to identify the optimal portfolio in an objective,
disciplined manner — this is regarded as the birth of Modern Portfolio Theory, and won him a share of
the 1990 Nobel Prize in Economic Sciences.

Markowitz's work was subsequently extended by William Sharpe, John Lintner and Jan Mossin
(working independently in the mid-1960s) through development of the Capital Asset Pricing Model
(CAPM) — a simplified, single-factor model relating a security's expected return to its systematic risk
(beta). Sharpe shared the 1990 Nobel Prize with Markowitz and Merton Miller for this contribution. A
further refinement — Stephen Ross's Arbitrage Pricing Theory (APT), developed in the mid-1970s —
extended the single-factor CAPM into a more general multi-factor framework. Both CAPM and APT
are studied in detail in Chapters 15 and 16 of this course.

The professional and scientific phases continue to advance side by side even today, as new statistical
tools, greater computing power, and refined multi-factor models continue to sharpen the discipline.
Contemporary portfolio management — whether practised on Wall Street, at NSE/BSE-linked
institutions in India, or by BSEC-licensed asset managers in Dhaka — draws on this entire lineage of
ideas.

1.6 Role of Portfolio Management

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There was a time when portfolio management was an elite, 'exotic' practice, largely out of reach for
ordinary people. In India (and similarly in Bangladesh), this has changed drastically with economic
liberalisation from the early 1990s onward. Key structural drivers of this change include:

1. Economic liberalisation and globalisation, opening capital markets to a much wider base of
investors and to foreign portfolio flows.
2. Rapid computerisation of exchanges, moving from open-outcry floor trading to automated,
screen-based trading, with resulting gains in transparency, speed and lower transaction costs.
3. The rise of institutional investors — mutual funds, insurance companies, pension/provident
funds — bringing professional, research-backed portfolio management practice to a much larger
pool of capital.
4. Growing acceptance of quantitative techniques (mean-variance optimisation, beta estimation,
CAPM-based pricing) among investment professionals, replacing tip-driven investing with
disciplined analysis.
5. The introduction and gradual expansion of financial derivatives (forwards, futures, options),
broadening the toolkit available for hedging and risk management.
6. International diversification, as investors and funds increasingly hold both domestic and foreign
securities.
Investment today is not a simple process; it requires scientific knowledge, a systematic approach, and
professional expertise. Portfolio management — combining all these elements — is what allows an
investor to achieve efficiency in investment.

1.6.1 Illustrative Case: Two Approaches, Dhaka Stock Exchange

Consider two hypothetical investors, both starting with Tk 5,00,000 in early 2020 to invest on the DSE.

• Investor A acts on tips from a WhatsApp investment group and friends at his workplace, buying
whichever shares are 'trending' at the moment, without examining financial statements, industry
conditions, or how his holdings relate to one another. His entire portfolio ends up concentrated
in two or three small-cap shares from the same sector.
• Investor B follows a disciplined process: she studies economy, industry and company
fundamentals (Chapters 7–9) to shortlist twelve candidate securities across six different sectors,
uses portfolio analysis (Chapter 13) to understand how these securities behave together, selects a
portfolio appropriate to her own moderate risk tolerance (Chapter 14), reviews and revises her
holdings quarterly (Chapter 17), and benchmarks her results each year against the DSEX index
(Chapter 18).
Over time, Investor A's results will tend to be far more volatile — subject to sharp gains in a bull run
but equally sharp losses whenever sentiment turns, or whenever one of his concentrated small-cap
holdings runs into company-specific trouble. Investor B's results, while perhaps less dramatic in any
single quarter, are likely to be steadier and more consistent with her actual risk appetite, because her
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approach explicitly manages risk rather than ignoring it. This illustrative contrast is the practical
justification for everything covered in this course, and mirrors a pattern regulators including BSEC have
repeatedly flagged among retail participants on the DSE and CSE.

The role of portfolio management in Bangladesh's development

Mobilising household savings into productive investment: Bangladesh has a high domestic savings
rate but historically low capital-market depth relative to GDP compared to regional peers;
disciplined portfolio management by AMCs and merchant banks helps channel savings (including
inward remittances) into productive corporate investment.
Institutional growth: The number of BSEC-licensed mutual funds, merchant banks and portfolio
managers has grown steadily since the 1990s; the Investment Corporation of Bangladesh (ICB), a
state-owned institution, has historically played a market-stabilising role somewhat akin to that of
India's UTI in its early decades.
Retail participation and financial literacy: A large share of DSE/CSE turnover comes from retail
BO account holders. A recurring theme in BSEC's investor-protection initiatives is encouraging a
shift away from rumour-driven speculation toward the analysis-based approach this chapter
introduces.
Bond market development: Unlike the fairly developed corporate bond markets referenced in the
original (Indian) text, Bangladesh's corporate bond market remains comparatively underdeveloped,
with government treasury bonds/bills (issued via Bangladesh Bank auctions) dominating fixed-
income portfolios — an important structural difference to keep in mind when applying bond-
valuation concepts (Chapter 10) locally.
Derivatives: Formal exchange-traded derivatives (futures, options) are, as of the period covered by
this course, still at a nascent/developing stage in Bangladesh compared with India's NSE/BSE F&O
segments — relevant when studying Chapters 19–22 of this text.

1.6.2 Institutional Comparison: India (Textbook) vs Bangladesh

Because this textbook is written from an Indian institutional perspective, it is useful to map each Indian
institution or instrument mentioned in the text to its closest Bangladesh counterpart. This mapping will
recur throughout the course.

Function India (as in textbook) Bangladesh equivalent

Capital market SEBI (Securities and Exchange BSEC (Bangladesh Securities

regulator Board of India) and Exchange Commission)

Principal stock NSE (National Stock DSE (Dhaka Stock Exchange)

exchange(s) Exchange) and BSE and CSE (Chittagong Stock
(Bombay/Mumbai Stock Exchange)
Exchange)

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Function India (as in textbook) Bangladesh equivalent

Broad market index Nifty 50 (NSE), Sensex (BSE) DSEX (broad index), DS30
(blue-chip index), DSES
(Shariah index)

Depository NSDL and CDSL CDBL (Central Depository

(electronic holding) Bangladesh Limited)

Early state-run UTI (Unit Trust of India) ICB (Investment Corporation of

investment Bangladesh)
institution

Central bank Reserve Bank of India (RBI) Bangladesh Bank

Company registrar Registrar of Companies (RoC) Registrar of Joint Stock

under MCA Companies and Firms (RJSC)

Government debt G-Secs, Treasury Bills via RBI Treasury Bonds/Bills via
issuance Bangladesh Bank auctions;
Sanchayapatra (national savings
certificates) for retail savers

1.6.3 Challenges and Opportunities for Portfolio Management in Bangladesh

Applying the concepts of this course in Bangladesh requires awareness of several market features that
differ from the more developed markets (and from India's larger, more liquid exchanges) that the
original textbook implicitly assumes:

• Liquidity concentration. Trading volume on the DSE is heavily concentrated in a relatively

small number of large-cap and mid-cap scrips; many listed companies trade thinly, which
complicates both portfolio construction (Chapter 13–14) and the assumptions behind risk
measures such as beta (Chapter 6).
• Circuit breakers and price limits. Daily price movement on the DSE/CSE is constrained by
circuit-breaker rules set by BSEC, which affects how quickly new information can be reflected
in price — a relevant consideration when studying the Efficient Market Hypothesis (Chapter 12).
• Corporate bond market depth. Unlike more developed debt markets, Bangladesh's corporate
bond and debenture market remains comparatively shallow; fixed-income portfolios in
Bangladesh therefore rely more heavily on government treasury instruments, bank fixed
deposits, and National Savings Certificates than the corporate bond examples used in Chapter
10.
• Derivatives market development. Formal, exchange-traded futures and options — covered in
Chapters 19 to 22 — are, at the time of writing, still developing in Bangladesh relative to India's
NSE/BSE derivatives segments; portfolio hedging in Bangladesh today more commonly relies
on diversification and asset allocation than on derivative instruments.
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• Investor protection and financial literacy. BSEC maintains an Investor Protection Fund and
has introduced various investor-education initiatives; nonetheless, rumour- and tip-driven trading
remains common among retail BO account holders, reinforcing the practical importance of the
systematic approach this course teaches.
• Growth opportunity. Despite these constraints, Bangladesh's capital market offers considerable
long-term opportunity: a large domestic market, a young population, steady GDP growth,
growing remittance inflows, and an expanding base of institutional investors (mutual funds,
insurance companies, pension and provident funds) all point toward increasing scope for
professional portfolio management over time.

1.7 Financial Derivatives A Preview

Investment in securities is inherently risky because of volatility in prices. Financial derivatives have
evolved specifically as a mechanism for reducing or hedging this risk. A derivative instrument's value
is 'derived' from an underlying asset — a security, a currency, or a commodity — whose price
fluctuations can be hedged by trading in the derivative.

• Forwards and Futures — agreements to buy or sell an underlying asset at a predetermined

price on a specified future date, eliminating uncertainty about the future price.
• Options — contracts giving the holder the right, but not the obligation, to buy (call option) or
sell (put option) an underlying asset at a predetermined price within a specified period.
These instruments — covered in depth in Chapters 19 to 22 of this course — allow investors to combine
security investment with derivative trading, so as to pursue maximum return while actively managing
downside risk. Their availability and depth vary considerably between developed markets, India, and
Bangladesh, as noted in the box above.

It is worth noting that derivatives are used by two distinct types of market participants, a distinction that
recurs throughout Chapters 19–22: hedgers, who already hold (or plan to acquire) the underlying asset
and use derivatives purely to protect against adverse price movement; and speculators, who take
positions in derivatives purely to profit from anticipated price movements, without any underlying need
for the asset itself. A well-managed portfolio uses derivatives, where available, primarily in the hedging
role — for instance, an exporter of readymade garments who will receive US dollar payments in three
months might use a currency forward to lock in today's exchange rate and remove uncertainty about the
taka value of that future receipt, a use case directly relevant to Bangladesh's export-oriented economy.

Conceptual Exercise (For Class Discussion)

✓ The following short scenario-based questions are intended for in-class discussion rather than
numerical computation, and are designed to check conceptual understanding of the five phases
introduced in this chapter.

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✓ A friend tells you he has put his entire savings into a single telecom stock listed on the DSE
because 'it always goes up.' Using the concepts from this chapter, explain what risks he is
exposed to that a diversified portfolio would reduce.
✓ A BSEC-licensed asset management company has shortlisted 15 fundamentally sound
companies across banking, pharmaceuticals, textiles, telecommunications and cement sectors.
Explain, referring to the five phases, what work still remains before the company can construct
an actual mutual fund portfolio for investors.
✓ An investor constructed an 'optimal' portfolio two years ago and has not looked at it since.
Explain, with reference to portfolio revision, why this may no longer be the best portfolio for
him today.
✓ Two Bangladeshi mutual funds report annual returns of 22% and 16% respectively for the
same year. Explain why you cannot conclude, from return figures alone, which fund was
'better managed', and what additional information (introduced later in this course) you would
need.

Summary

Investment in securities involves both return and risk. Because holding a single security exposes an
investor to unnecessary risk, investors construct portfolios — diversified groups of securities — to
reduce risk without sacrificing return proportionately. Portfolio management is the comprehensive,
cyclical process of creating and maintaining such an investment portfolio, comprising five phases:
security analysis, portfolio analysis, portfolio selection, portfolio revision and portfolio evaluation.
Security analysis identifies worthwhile individual securities using fundamental analysis, technical
analysis, or an awareness of market efficiency; portfolio analysis calculates the risk and return of all
feasible combinations of these securities; portfolio selection identifies the single optimal combination
given an investor's risk tolerance; portfolio revision keeps the portfolio optimal as circumstances
change; and portfolio evaluation assesses performance against a suitable benchmark and feeds lessons
back into the next cycle.

The discipline evolved historically from a speculative practice in the early twentieth century, through a
professional phase founded on the work of Benjamin Graham and David Dodd (Security Analysis,
1934), into today's scientific phase built on Harry Markowitz's portfolio theory (1952/1959) and its
subsequent extensions — the Capital Asset Pricing Model of Sharpe, Lintner and Mossin, and the
Arbitrage Pricing Theory of Stephen Ross. In both India and Bangladesh, economic liberalisation,
exchange computerisation, and the growth of institutional investors (mutual funds, merchant banks, and
— in Bangladesh's case — ICB) have made professional portfolio management increasingly central to
how national savings are channelled into productive investment.

The Bangladesh capital market is regulated by BSEC (paralleling India's SEBI), trades on the DSE and
CSE (paralleling NSE/BSE), and settles through CDBL (paralleling NSDL/CDSL) — with a

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comparatively less developed corporate bond market and a still-developing derivatives segment relative
to India. These structural differences do not change the underlying principles taught in this course, but
they do affect how those principles must be applied in practice — a theme this course will return to in
every subsequent chapter.

Key Terms

Term Meaning

Portfolio A group of securities held together as an investment.

Diversification Spreading investment across several securities to reduce risk.

Security Analysis Study of the risk-return characteristics of individual securities.

Efficient Portfolio A portfolio offering the highest return for a given level of risk.

Optimal Portfolio The single best portfolio chosen from the efficient set, per
investor risk tolerance.

BSEC Bangladesh Securities and Exchange Commission — capital

market regulator (cf. SEBI in India).

DSE / CSE Dhaka / Chittagong Stock Exchange — the two exchanges of

Bangladesh (cf. NSE/BSE).

CDBL Central Depository Bangladesh Limited — electronic securities

depository (cf. NSDL/CDSL).

ICB Investment Corporation of Bangladesh — state-owned

investment institution (cf. UTI's early role in India).

DSEX / DS30 Broad market index / blue-chip (30-share) index of the Dhaka
Stock Exchange.

Modern Portfolio Markowitz's mathematical framework (1952) for constructing

Theory (MPT) optimal, diversified portfolios.

CAPM Capital Asset Pricing Model — relates a security's expected

return to its systematic risk (beta).

Formula Plans Predetermined mechanical rules for passive portfolio revision

(Chapter 17).

Quick Self-Check (True / False)

Test your understanding before moving to Chapter 2. Mark each statement True or False, and be ready
to justify your answer.

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I. Rational investors should always choose the portfolio with the highest possible expected
return, regardless of risk.
II. A security that is risky when held alone can sometimes reduce the overall risk of a portfolio.
III. Portfolio revision is a one-time activity performed only when the portfolio is first constructed.
IV. The Efficient Market Hypothesis, Fundamental Analysis and Technical Analysis are three
alternative approaches to security analysis.
V. BSEC is the Bangladesh counterpart of India's SEBI.
VI. CDBL performs a role in Bangladesh comparable to that of NSDL and CDSL in India.
VII. Harry Markowitz's 1952 paper is generally regarded as the starting point of the 'scientific
phase' of portfolio management.
VIII. Returns alone, without reference to risk, are sufficient to judge whether a portfolio has been
well managed.
(Answers: 1–False; 2–True; 3–False; 4–True; 5–True; 6–True; 7–True; 8–False.)

Review Questions

o What is a portfolio? Why do investors prefer holding a portfolio rather than a single security?
o Define portfolio management. What are its twin objectives?
o Describe, in sequence, the five phases of the portfolio management process.
o Distinguish between fundamental analysis and technical analysis as approaches to security
analysis.
o "Portfolio revision is as important as portfolio analysis and selection." Discuss.
o What contribution did Harry Markowitz make to portfolio theory? Why is 1952 considered a
landmark year?
o Explain the role of portfolio management in an emerging economy such as Bangladesh.
o Compare the institutional structure of the Bangladesh capital market (BSEC, DSE, CSE, CDBL,
ICB) with the corresponding Indian institutions described in the textbook (SEBI, NSE, BSE,
NSDL/CDSL, UTI).
o Distinguish between a hedger and a speculator in the context of derivatives trading.
o Why is return alone considered an insufficient measure of portfolio performance? What must
always be considered alongside it?

References

Kevin, S. (2015). Security Analysis and Portfolio Management, 2nd Edition. PHI Learning Private
Limited, Delhi. — Chapter 1: Introduction.

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Supplementary Bangladesh-context material drawn from publicly known facts about BSEC, DSE, CSE,
CDBL, ICB and Bangladesh Bank; instructors/students should verify current figures, rules and
thresholds from BSEC ([Link]) and DSE ([Link]) as these are periodically updated.

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