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Module-6
Portfolio Management Strategies and Performance Evaluation: Portfolio
Management Strategies:Active and Passive Portfolio Management strategy.
Portfolio Revision: Portfolio Revision Strategies– Objectives, Performance plans.
Mutual Funds: Concept of Mutual Funds, Participants in MutualFunds, Advantages
of Investment in Mutual Fund, Measure of Mutual Fund Performance.
Portfolio performance Evaluation: Measures of portfolio performance (Theory &
Problems).
Subject Faculty Name & Designation :
Mrs. Ashwini A , [Link] M Assistant
Professor
Portfolio Management Strategies
Meaning: It is a process that organization uses for selection, prioritization and control of
resources within its portfolio of projects, programs and initiatives used to meet strategic goals
and objectives.
There are two types of portfolio management strategies namely:-
1. Active Portfolio Management
2. Passive Portfolio Management
Portfolio Management Strategies
Active management: It is a process of holding securities based on future forecast. The
portfolio managers who pursue active management strategy, with respect to market
components are called as market timers.
Passive management: It is a process of holding well diversified portfolio for long term with the
buy and hold approach. It is an investors attempt to construct a portfolio that resembles overall
market return. The simplest form of passive management is holding the index fund that is
designed to replicate good and well defined index of common stock i.e., BSE-sensex and NSE-
nifty.
Portfolio Revision
Formula plans: This provides the basic rules and regulations for purchase and sale of
securities. The amount to be spent on different type of securities is fixed and it is fixed eithter in
constant or variable ratio which depends on investor’s attitude towards risk and return.
commonly used formula plans are rupee cost averaging, constant rupee plan, constant ratio
plan and variable ratio plan. Formula plan helps to dividend investible fund between aggressive
portfolio and conservative portfolio.
Aggressive Portfolio: It consist more of common stock i.e., equity which yield higher return at
high risk. Its return is volatile because share prices generally fluctuate. Capital appreciation is
high in aggressive portfolio.
Conservative Portfolio: It consist of bonds and debentures that have fixed rate of return. In
this portfolio return is certain and risk is minimized. It serves as a safeguard for price volatility in
aggressive portfolio. Capital appreciation is slow in conservative portfolio.
Assumptions of Formula Plan
Basic Assumptions of Formula Plan are:-
Certain percentage of investors fund is allocated for fixed income securities and common
stock.
If, the market moves higher, the proportion of stocks in the portfolio may eighter decline or
remain constant. Portfolio is more aggressive in low market and conservative in high market.
Securities are bought and sold whenever there is significant change in price.
The investor should strictly follow formula plan.
Investor should select good stock that move along the market and should reflect risk and
return features of market.
Type of Formula Plan
Rupee Cost Averaging: Investor buy varying number of shares at various points of stock
market cycle. Thus, it can be called as time diversification. Stocks with good fundamentals and
long term growth prospectus should be selected. Investor should make commitment of buying
the shares at regular interval. And such stocks tend to volatile in market and provide maximum
benefit from rupee cost averaging.
Constant Rupee Plan: It is called as formula timing plan. This plan enables investor to shift
investment from bonds to stock or vice-versa by maintaining constant amount to be invested in
each stock portion of portfolio. Constant rupee plan starts with the fixed amount of money to be
invested in selected stocks or bond. When the price of stock increases, investor sells sufficient
number of stock to return the original amount of investment in stock. By keeping the value of
aggressive portfolio constant, the remainder is invested in conservative portfolio.
Type of Formula Plan
Constant Ratio Plan: It is also called as formula timing plan. This plan attempt to maintain
constant ratio between aggressive and conservative portfolios. The ratio is fixed by investor and
it is based on investor’s attitude towards risk and return. A conservative investor may like to
have more bonds and aggressive investor may like to have more stock. Once the ratio is fixed,
it is maintained as the market moves up or down and action points are also fixed by the investor
which may vary from investor to investor.
Variable Ratio Plan: It is also called as formula timing plan. According to this plan, at varying
level of market price, proportion of stocks and bonds change. Whenever stock price increase,
stocks are sold and new ratio is adopted by increasing the proportion defensive or conservative
stock portfolio. To adopt this plan, investor is required to estimate long term trend in the price of
stock.
Type of Formula Plan
Revision and the Cost: Based on risk and return and market attractiveness of stock, the
revision of stock becomes necessary by portfolio manager. In revision of traded volume of
securities, portfolio manager has to focus on price impact and bid-ask spread of stock.
i. Price impact: It effects on the price of stock i.e., if the trade size is heavily on the buyers
side, prices of stock increase. As against, if trade size is heavily on sellers side, price of
stock may decrease.
ii. Bid-ask spread: It is the difference between price that the market maker is willing to buy or
sell the stock. These costs may be higher in small size stock and benefit of revision may be
nullified by it.
[Note: Usually, revision is done with a view of either increasing the expected return or reducing
the risk of portfolio. ]
Mutual fund
• A mutual fund is an investment option where money from
many people is pooled together to buy a variety of stocks,
bonds, or other securities.
• A mutual fund is a type of investment vehicle consisting of
a portfolio of stocks, bonds, or other securities.
• Mutual funds give small or individual investors access to
diversified, professionally managed portfolios.
Types of mutual fund
1. Open-ended mutual fund: In this scheme units are bought and sold continuously. Investor
can directly approach fund manager to buy or sell units.
2. Close-ended mutual fund: This scheme is open for specific time period and during that
period only investor can buy it. When the time period is closed, units are listed in the stock
exchange and investor can trade the units just like other securities in stock market. And the
price may be either quoted at premium or discount.
Advantages of Mutual Fund
Association of Mutual Funds in India (AMFI) has listed following advantages of mutual fund:-
[Link]
[Link] management
[Link] administration
[Link] cost
[Link] potential
[Link]
[Link]
[Link]
[Link] of scheme
[Link] regulated.
KEY PLAYERS IN A MUTUAL FUND
• Asset Management Company- It acts as an
intermediary between investors and the financial
instruments.
• Sponsor
• Trustee
• Custodian
• Registrar and Transfer Agent
Measure of Mutual Fund Performance
• Alpha
• Beta
• R-squared
• Standard Deviation
Portfolio Evaluation
Meaning:
It is a continuous process of evaluation of portfolio performance to identify its
strength and weakness and it is also helpful in providing feedback to evolve
better management strategy. It is carried out to assess risk and return of
different portfolios.
Measures of Portfolio Performance Evaluation
Sharpe’s Performance Index: In this index only single value is used for performance ranking
of various funds or portfolios. It measures risk premium of portfolio relative to total amount risk
in portfolio.
Risk premium is the difference portfolio’s average rate of return and riskless rate of return. S.D
is the risk of portfolio. The index assigns highest value to assets that have best risk adjusted
average rate of return.
Formula = St = Rp - Rf
σp
Measures of Portfolio Performance Evaluation
• Treynor’s Performance Index: This index is based on Characteristic Line
which explains relationship between market performance and fund’s
performance in relation to market return and fund’s return.
• In Treynor’s Performance Index, fund’s return raise at a faster rate than
market performance when market is moving upward and fund’s return decline
slowly than market return in case of downward trend. So, the ideal investor
may place his fund in govt. securities, treasury bill or short sale during
decline stage and earn positive return.
Formula = Tn = Rp - Rf
βp
Measures of Portfolio Performance Evaluation
Jensen’s Performance Index: It is also called as Absolute Risk Adjusted Return Measure. It
measures absolute performance because definite standard is set against which actual
performance is measured. The standard is based on manager’s predictability. A successful
prediction of security price would enable manager to earn higher return at a given level of risk.
This model compares actual (realized) return of portfolio with estimated (predicted) return.
Formula = Rp = αp - Rf + β (Rm - Rf)
Thank you...