o Investments in different asset classes usually have low correlation (help
reduce risk).
4. Diversification
Goal: Reduce portfolio risk by spreading investments across uncorrelated or
negatively correlated assets.
Key Point: Correlation can change over time depending on economic or market
conditions.
o Past correlation does not always predict future correlation.
Analysts and investors should consider current economic conditions, not just
historical data, when allocating assets.
Portfolio Management Process – Explained
Portfolio management is a systematic way to build, monitor, and adjust investments
to meet an investor’s financial goals. It ensures that risk and return are balanced according
to the investor’s needs.
Step 1: Develop a Policy Statement (Investment Policy Statement)
What it is: A roadmap for investment decisions.
Explanation:
Think of it as a blueprint for your portfolio.
Defines risk tolerance, financial goals, and constraints like time horizon or
liquidity needs.
Helps ensure that all investment decisions align with the investor’s objectives.
Step 2: Study Current Financial Conditions & Forecast Future Trends
What it is: Analyze the market environment and predict future trends.
Explanation:
Investors need to know how the economy, interest rates, inflation, and markets are
behaving.
Example: If interest rates are expected to rise, bond prices may fall — portfolio may
need adjustment.
Helps in making informed investment choices instead of relying on guesswork.
Step 3: Portfolio Construction
What it is: Build the actual mix of assets.
Explanation:
Use the policy statement and market forecasts to decide what assets to buy and
in what proportions.
Portfolio is dynamic: it should be monitored and adjusted as conditions change.
Example: If stocks have grown faster than bonds, you might need to rebalance to
maintain your target allocation.
Step 4: Performance Measurement and Evaluation
What it is: Check how the portfolio is doing.
Explanation:
Compare portfolio returns and risk to benchmarks (e.g., S&P 500 for stocks).
Identify if portfolio is meeting the expected goals or needs changes.
Helps investors understand which assets are performing well and which aren’t.
Step 5: Portfolio Rebalancing and Revision
What it is: Adjust the portfolio to maintain the desired balance.
Explanation:
Sell overperforming assets and buy underperforming ones to maintain risk-
return balance.
Example: If stocks rise and bonds lag, your portfolio may become too risky —
rebalance by selling some stocks and buying bonds.
Ensures the portfolio stays aligned with the investor’s goals and risk tolerance.
Key Idea (with Explanation)
The portfolio management process is a continuous cycle:
Plan → Execute → Monitor → Adjust → Repeat
Plan: Policy statement & economic/market analysis
Execute: Build the portfolio based on the plan
Monitor & Adjust: Measure performance and rebalance when necessary
Why it matters: This structured approach reduces risk, maximizes returns, and
ensures the portfolio always aligns with investor objectives.
Roles and Functions of a Portfolio Manager (Simplified)
A portfolio manager is a professional who manages investments on behalf of clients
to help them achieve their financial goals. In India, they are regulated by the Securities
and Exchange Board of India (SEBI).
1. Types of Portfolio Managers
Discretionary Portfolio Manager:
o Makes investment decisions independently for each client based on their
objectives.
o Acts individually and does not operate like a mutual fund.
Non-Discretionary Portfolio Manager:
o Manages funds based on client instructions.
Decisions are guided by client’s directions